Chapter 8, Organizing to Implement Corporate Diversification Monday & Wednesday, November 2 - 7, 2011 Teaching Notes & Outline Point

to Ponder: Dr. Drucker affirmed that Mission (drives) Structure (drives) Strategy. which ultimately (drives/infuses/influences) how the Implementation process flows [impacted]. Hard Question: What Is Organizing And Why Is It So Important? And, What Does Structure Have To Do With It, You Think?! In the previous chapter [we] discussed diversification and how firms expand to own multiple businesses in their portfolio. We discovered that while embarking on diversification moves to maximize economies of scope is vital to having a successful corporate strategy, a large diversified firm has to be managed and governed efficiently. In other words, the businesses must be run on a day-to-day basis by competing in their product markets effectively and creating corporate value by interacting with other businesses that the parent company owns. Employees must be organized into groups, reporting relationships established, resource allocation processes must be developed in short, the company should be organized to function as a diversified organization. Important Point: Its important to note scholars, that some of the issues examined in this discussion have application in vertical integration, strategic alliances and mergers, and acquisitions. Lil Known Fact! Historically, Alfred Sloan, the CEO of General Motors in the early 1900s, is regarded as the father of the M-form (or the multidivisional form) structure. As GM grew exponentially and began diversifying its product line to manufacture cars at different price points and aimed at specific target markets, Sloan realized that the traditional functional or U-form structure was not effective. He came up with the idea of creating independent divisions (Chevrolet, Pontiac, Cadillac, etc.), all of which reported to a corporate office. The divisions had considerable autonomy (within set corporate criteria) in making product-market decisions and were evaluated as independent profit centers. The idea of the M-form structure as the ideal way to manage large diversified firms was supported by the research of Alfred Chandler, who found that companies such as Sears and DuPont used this structure to expand. Key Concepts: M-Form vs. U-Form Structure; Satisficing; Agency Relationships; Profit and Loss Centers; Corporate Diversification Strategy; Board of Directors; Principals & Agents; Institutional Owners; The Senior Executive; Corporate Staff; Division General Manager; Shared Activity Managers; Managerial Control Process; Management Compensation Key Learning Points: To that end, let me introduce the three fundamental issues firms face in implementing corporate strategy. And, these issues become increasingly important as the firm becomes more complex. Lil Known FactThe more complex organization involving more people it becomes more difficult to align the interests of the firm and the people who work in the firm. Major Take-Always: As firms begin the process of implementing strategy, they confront three key issues: How should information flow within the organization Where and by whom are decisions made How to influence the behavior of people Important Note: Now, let me introduce the concept of bounded rationality and Herbert Simons notion of satisficing decisions. Satisficing means that people will make decisions that they think are good enough even though they cannot make absolutely maximizing decisions because they are bounded in their rationality. The important implication here is that as the information processing requirements faced by an individual manager grow beyond bounded rationality, the manager will continue to make decisions, but the quality of those decisions will decrease. Organizational structure helps in this regard to make information processing more manageable. Note: The important implication here scholars, is that as the information processing requirements faced by an individual manager grow beyond bounded rationality, the manager will continue to make decisions, but the quality of those decisions will decrease. Organizational structure helps in this regard to make information processing more manageable. Important Point: Let me emphasize here the fact that information processing requirements grow with a firm. What the authors mean by bounded rationality is that people have a limit on their capacity to handle information. Because people are bounded in their rationality, managers will satisficemake decisions that are good enoughin the face of growing information processing requirements. Organizational structure allows the information processing requirements of a firm to

be divided up so that managers can operate effectively within their bounded rationality. intended to increase the quality of satisficing decisions.

Organizational structure is

Key Learning Points: I want to emphasize the importance of implementation to the success of any strategy effort. I want to point out that information processing requirements become increasingly large and complex as organizations grow. I want to note that strategy implementation is how large firms are able to handle the monumental amount of information processing that is required in a large firm. I want to elaborate on the notions of bounded rationality and satisficing as elements necessitated by the limits on managerial cognitive ability. ORGANIZATIONAL STRUCTURE AND IMPLEMENTING CORPORATE DIVERSIFICATION Learning Objective #1: Lets define the multidivisional, or M-form, structure and how it is used to implement a corporate diversification strategy. In the M-form structure, each business that the firm engages in is managed through a division. For example, under CEO Jack Welch, General Electric was organized into 13 divisions where each business was evaluated separately and yet shared many resources with each other. Divisions in the M-form structure called strategic business units, business groups, or companies are true profit-and-loss centers, in that the corporate office calculates profits and losses at the level of the division in these firms. Information is summarized and passed up through the organization through these replicated functions. Thus, the Senior Executive is able to handle the summarized information flowing from the divisions. This is the hallmark of the M-form firm. The advantage of the M-form structure is that each independent division can carve out its own destiny in its product-market and focus on making decisions that best suit its specific competitive environment. There is a tradeoff when we create a divisional structure between making information processing more manageable and creating a separation of owners and managers. And, with this separation of owners and managers comes the possibility that the interests of the two may diverge. This separation of owners and managers creates what is known as the agency relationship. The key to an effective agency relationship is for the interests of the two parties to be aligned. In other words, this relationship will work as long as agents make decisions that further the interests of the equity holders. Two common agency problems are: investment in managerial perquisites, and managerial risk aversion.

Example: Perhaps the most egregious example of managers lavishing perquisites on themselves is Dennis Kozlowski of Tyco International. For his wifes 40th birthday, Kozlowski rented a Greek island and threw a lavish party that cost the company millions. This was in addition to using company money to furnish his house with a $15,000 umbrella stand, a $6,000 wastebasket, etc. Important Point: The M-form structure is designed to create checks and balances so that the interests of owners and managers are aligned. One of these important checks is the monitoring role of the board of directors. By clearly delineating the roles of each party involved in managing the organization, the M-form structure attempts to promote congruent objectives. Key Learning Point: The M-form structure provides a way for the interests of owners to be monitored. The board of directors plays this monitoring role. Point out that institutional investors also play a monitoring role in many corporations today. Some institutional investors have board seats and are able to monitor through the board. Other institutional investors may still monitor the activities of managers very closely even if they do not hold seats on the board. Hard Question: Who is [should be] this board, and, what is its role?! A companys board is elected by the firms stockholders. The board role is to monitor the decision making of the managers and ensure that managers interests are aligned with those of the owners. In short, the board plays a key role in minimizing agency problems.

A boards composition is a key issue. Why?! Board members can be internal or external. Internal board members are top managers of the firm (typically the firms CEO, its CFO, and its COO) who serve on the board in addition to their regular duties. At board meetings, internal members convey to the board why they made a particular decision. They bring valuable company and industry tenure and experience to these meetings. Outside board members do not work for the company they are either CEOs or senior executives of other companies or are leading citizens in the community. Ideally, of the 10-15 members in a typical board, the majority should be outsiders. Boards have several important subcommittees, the finance committee (maintains the relationship between the firm and external capital markets), the nominating committee (nominates new board members), and the personnel and compensation committee (evaluates and compensates managers). It makes sense for these committees to be staffed entirely by outsiders. Outside board members are compensated for serving on the board. The final key issue in company boards is the role of the chairman of the board. In many companies, the CEO serves as the chairman of the board. This dual responsibility is the subject of much debate. The key is to strike the right balance between the boards objectivity and its effectiveness in aligning the interests of owners and managers. Institutional owners- They are usually pension funds, mutual funds, insurance companies, or others who own large blocks of shares in a company. Research reveals that, there has been a historical trend for a greater percentage of stock to be owned by institutional owners from 32 percent in 1970 to 59 percent in 2005. Institutional investors are not passive investors because of their sizeable investment, they tend monitor the companys actions more closely and are often quite vocal in demanding changes. One fear is that institutional investors may promote short-term performance measures instead of long-term improvements. However, research has not supported this notion. The Senior Executive Important Point: In an M-form structure, the senior executive is the only one likely to have the breadth of perspective to assess the entire portfolio of businesses owned by the company. Divisional managers know their divisions very well, but their focus is too narrow. They may not know much about the other divisions owned by the company. Therefore, that the senior executive MUST consult with the divisional managers to identify economies of scope that can be leveraged across the portfolio. The main functions of the senior executive are to:

formulate strategy, and

implement strategy. In large M-form firms these functions of the senior executive are often handled by dividing these responsibilities among two or more people and referring to them collectively as the office of the president. Usually there are three main roles in the office of the president: 1) the chair of the board of directorsmonitors management decisions 2) the chief executive officerstrategy formulation 3) the chief operating officerstrategy implementation In some firms one person fulfills all these roles.

Important Point: People often move through these offices as a succession to the top or grooming process. Note: As information flows up through the organization from the divisions there is a summarizing and filtering process so the best and most necessary info for decision making goes to the next level. It is the executives who manage the flow of information and decision making in a firm. The important point is that information is filtered as it rises through the organization. The quality of information flow influences the quality of decisions made based on that information. Corporate staff report to the senior executive and provide advice on functional issues. The information provided by the corporate staff helps the senior executive make important strategy formulation and strategy implementation decisions.

Important Point: There is a difference between a direct, solid-line reporting relationship and an indirect, less formal, dotted-line reporting relationship. Very often, this differentiation can cause conflicts in the organization. Divisional staff managers have a direct, solid-line reporting relationship with their respective corporate staff functional managers. They have a less formal, dotted-line relationship with their division general manager. The division general manager and the senior executive fill similar roles in that they both oversee several different functions. The division general manager reports to the senior executive. Key point, the division managers are concerned primarily with business level strategy whereas the senior executive is concerned primarily with corporate level strategy. In addition to the two roles indicated above, division general managers have two specific responsibilities: to compete for corporate capital to cooperate with other divisions to exploit corporate economies of scope. Hard Question: What is the potential for conflict between these two specific responsibilities?! Division general managers compete for resources with other divisions and cooperate with other divisions to exploit economies of scope. This requirement of simultaneously competing and cooperating with other divisions very often puts an undue burden on the division general manager. Shared Activity Managers Some activities (functions) can be shared by two or more divisions in an M-form firm; and, this sharing creates an economy. For example, a sales and marketing function shared by multiple divisions may be able to offer a higher level of service to all three than any one division could afford on its own. Note: shared activities can be treated as cost centers or as profit centers. Sharing activities helps exploit economies of scope. The cost of the activity is now borne by multiple businesses (or divisions). Activities that are typically shared include: sales force research and development manufacturing distribution

MANAGEMENT CONTROLS AND IMPLEMENTING CORPORATE DIVERSIFICATION Learning Objective #3: Lets discuss how the three management control processes measuring divisional performance, allocating corporate capital, and transferring intermediate products are used to help implement a corporate diversification strategy. To this lets move the discussion away from structural issues to issues of management controls. While structure groups people, assigns tasks and establishes reporting relationships, controls are needed to monitor performance. Three important controls in the M-form structure are: o systems for evaluating divisional performance o systems for allocating capital across divisions o systems for transferring intermediate products between divisions COMPENSATION POLICIES AND IMPLEMENTING CORPORATE DIVERSIFICATION Learning Objective #4: Lets describe the role of management compensation in helping to implement a corporate diversification strategy. Example: Forbes.Coms Executive Compensation survey The highest compensated CEO in 2008 was Lawrence J. Ellison of Oracle who made a whopping $556.98 million. The average pay was $11.4 million. Forbes.com calculates an index termed efficiency. This is a ratio of company stock performance to CEO pay. Ellison came in 103. The #1 CEO on the efficiency scale was Michael Bennett of Terra Industries, whose compensation was $10.47 million and #2 was amazon.coms Jeff Bezos who took in a mere $1.28 million in compensation (forbes.com article dated 4/22/2009). SUMMARY OF IMPLEMENTATION ISSUES In closing, it is important for me to stress that implementation is when the rubber hits the road. The opportunity to exploit economies of scope may be the driving force behind a firms diversification strategy. But economies of scope may only be a mirage unless the firm is organized to exploit it. Again, implementation consists of:

organizational structure management control processes compensation policies. Chapter 9, Strategic Alliance Monday & Wednesday, November 9-14, 2011 Teaching Notes & Outline

Lil Known Fact! o Its not about strategy. Its about execution of strategy. o An alliance is an agreement or friendship between two or more parties, made in order to advance common goals and to secure common interests.

o A business alliance is an agreement between businesses, usually motivated by cost reduction and improved
service for the customer. Alliances are often bounded by a single agreement with equitable risk and opportunity share for all parties involved and are typically managed by an integrated project team.

o There are five basic categories or types of alliances:

Sales alliance Solution-specific alliance Geographic-specific alliance Investment alliance Joint venture alliance

Sales alliance occurs when two companies agree to go to market together to sell complementary products and services. Solution-specific alliance occurs when two companies agree to jointly develop and sell a specific marketplace solution. Geographic-specific alliance is developed when two companies agree to jointly market or co-brand their products and services in a specific geographic region. Investment alliance occurs when two companies agree to join their funds for mutual investment. Joint venture is an alliance that occurs when two or more companies agree to undertake economic activity together o The North Atlantic Treaty Organization [NATO] or, also called the (North) Atlantic Alliance, is an intergovernmental military alliance based on the North Atlantic Treaty which was signed on 4 April 1949. The NATO headquarters are in Brussels, Belgium, and the organization constitutes a system of collective defense whereby its member states agree to mutual defense in response to an attack by any external party Setting the Learning Stage: What McDonalds and Disney have is a strategic alliance. A similar tie-in would be an alliance between (DreamWorks and Burger King or Visa and the NFL) to better help you understand what an alliance is (in broad terms) and how commonplace they are, it is important to relate strategic alliances to the rest of Part 3 of the text. Strategic alliances are a means of vertical integration and/or diversification and hence are part of corporate-level strategy. In this sense, they are a mode of entry once a firm has made the decision to enter a new business. What is a Strategic Alliance? The term strategic alliances is a broad one and includes any kind of cooperative effort between two or more independent organizations. The effort may revolve around manufacturing or marketing or both. Why would firms enter into strategic alliances? According to the authors, firms enter into strategic alliances because of two important motivations: to access complementary resources and capabilities (that they do not have) and/or to leverage existing resources and capabilities. Thus, Disney has the capability to produce movies with compelling characters that children can identify with while McDonalds provides grassroots marketing. The notion of comparative advantage from international trade can be used here to explain the motivation for strategic alliances. Different types of Strategic Alliances: When firms agree to work together to develop, manufacture, or sell products or services, they are engaged in a nonequity alliance. The Disney-McDonalds alliance alluded to earlier is an example of a nonequity alliance. Neither McDonalds nor Disney invested in the equity of the other rather the two agreed to work with each other for a certain

period of time. Such agreements could involving licensing (where one firm allows the use of its design or brand name to another), supply agreements (agreeing to supply inputs), or distribution agreements (agreeing to sell another companys goods). When agreements to work with one another are supplemented with equity investments, equity alliances are formed. The Disney-Pixar alliance is an example. Back in 1986, Disney took a small equity position in Pixar as part of the terms of the strategic alliance. The alliance was prior to Disneys acquisition of Pixar in 2006. A special form of equity alliance is a joint venture. Here, the cooperating companies (the parents) create a legally independent firm in which they invest and from which they share any profits created. For example, the two pharmaceutical companies, Johnson and Johnson and Merck created a joint venture (called Johnson and Johnson Merck Consumer Pharmaceuticals) to market over-the-counter pharmaceuticals such as Mylanta. Important point: From the standpoint of the law, although the strategic alliance partners own the joint venture, courts have ruled that the joint venture is a separate legal entity. When lawsuits were filed against Dow Corning in the silicone gel implant controversy, courts held that claimants cannot include the parent companies in the lawsuit. Teaching Points: Lets be mindful of how gains come from trade and comparative advantage ideas to and see how alliances can create value under certain conditions. If a firm cannot identify a gain from trade from an alliance, the firm should not pursue that alliance I encourage you to reconsider the earlier examples of strategic alliances (such as Disney-McDonalds, Disney-Pixar) to better understand the different types of alliances. Lets be mindful that including equity in an alliance arrangement is a way to align the interests of the partners. Alliances are a very popular means to implement a firms strategy, and particularly so, in international markets.

How do Strategic Alliances Create Value? The motivation to enter into a strategic alliance is value creation for the partners. How is value created in an alliance? Value is created in three broad ways: Helping firms improve the performance of their current operations Creating a competitive environment favorable to superior performance Facilitating entry and exit

Lets think of these motivations as value creating opportunities. If sources of value creation and gains from trade cannot be identified in an alliance, then managers should be wary of entering into the alliance. Strategic Alliance Opportunities: Economies of scale (described in chapter 2) exist when per unit cost of production falls as the volume of production increases. A single firm, for various reasons, may not have the scale to benefit from these economies. By combining with another firm, the efficient scale can be reached. Alliances may help improve operations because of learning opportunities. When firms work together, they can observe each other and transfer skills across firms. Such interactions help in learning. General Motors wanted to learn lean production techniques. Toyota, on the other hand, wanted to learn to operate manufacturing plants in the U.S., particularly to adapt their famed production technology to U.S. workers. Alliances are attractive when firms engage in projects that are expensive and where the risks are high. By combining forces, each firm reduces the downside risk if the project fails. Of course, this also means that the firms have to share the profits generated by the project. Alliance Threats: Incentives to Cheat on Strategic Alliances: Given the enormous benefits that firms can get by forming strategic alliances, as discussed in the previous section, why do a large number of alliances fail? Clearly, alliances may fail because the value creating potential may have been overestimated to begin with. However, there is also a second possibility. Alliances may fail because an alliance partner cheats that is, not cooperate in a way that maximizes the value of the alliance. One of the key challenges to a successful strategic alliance strategy is that partners often face strong incentives to misappropriate the value created within an alliance. These challenges arise primarily because of the difficulties of monitoring the actions of other partners. Partners may take advantage of other partners at several points in an alliance

relationship: in contributions to the alliance, in performance within the alliance, and in allocating the value created in the alliance. Adverse Selection: Firms enter into alliances to pool resources and skills. What happens when a firm promises certain resources to the alliance partner but does not deliver? This situation is called adverse selection. In many cases, particularly involving tangible resources, an alliance partner can determine exactly what its partner is bringing to the table. In such observable resource pooling, the possibility of adverse selection is minimized. If the resources that a potential partner has are not attractive, then the firm seeking a partner can look for other partners that have these resources. But the problem becomes much more challenging when the resources are intangible knowledge of markets, human capital, contacts, etc. These are difficult to observe and so firms enter into the alliance hoping that the partner indeed has these resources. When this is not true, the value creation potential of the alliance is constrained. Moral Hazard: In the case of adverse selection, the partner does not have the resources that it promised to contribute to the alliance. Moral hazard is when the partner has these resources but fails to make any or most of these resources available to the alliance partners. A partner may promise to send the best and brightest engineers to work in an alliance and then choose to actually send only mediocre engineers to work in the alliance. In a sense, the difference between adverse selection and moral hazard is this: adverse selection in an alliance is akin to an employee getting a job by falsely stating that he/she has certain skills important to the job. Moral hazard is when the person has these skills but chooses not to use them in the job. Hold Up: Sometimes, the strategic alliance may call for one partner to make a transaction-specific investment. Transaction-specific investments introduce the possibility of holdup. Strategic Alliances and Sustained Competitive Advantage: Strategic alliances can be sources of sustained competitive advantage. The VRIO framework can be used once again to examine this contention. By exploiting one or more of the opportunities and avoiding the threats discussed earlier, alliances create value. How about the other parts of the VRIO framework? The Rarity of Strategic Alliances: Given the vast number of strategic alliances announced on a regular basis in the business press, it is clear that alliances per se are not rare, even within an industry. However, it is not the creation of strategic alliances that should be looked at. Rather, what makes an alliance rare is the motivation to form the alliance and the type of resources that partners pool to form the alliance. Look at this example: Lets say that several firms in an industry enter into independent strategic alliances. Imagine that only one firm enters into an alliance for learning purposes. It cooperates with another firm that has valuable resources to offer in the area of learning. This would make this alliance rare. The Imitability of Strategic Alliances: Strategic alliances can be imitated by direct duplication or by substitution. When these avenues are not possible (in that they dont create the same value), the alliance passes the costly-to-imitate test. Once again, alliances can be imitated by direct duplication. If Firm A in an industry can form a marketing alliance, its competitor, Firm B can form a similar alliance. The test, though, is in combining the partners resources in such a way that value creation is maximized. Successful alliances are typically characterized by complex social relationships between the partners. There is usually a great amount of trust and information exchange among the partners. This may be difficult to imitate by others. Some firms may have tremendous expertise in forming and managing alliances and may benefit from the learning curve. This may be difficult for others to imitate. Organizing to Implement Strategic Alliances: To maximize the value of a strategic alliance, it must be organized in a way that opportunities are exploited and threats are avoided. The O in the VRIO framework, thus, is a very critical component of strategic alliance success. Many alliances fail because of governance problems. It is a good idea for the instructor to first of all list the organizing options by dividing them into formal and informal categories. Formal options are: explicit contracts and legal sanctions; equity investments, and joint ventures. The informal ones are: trust and firm reputation. Explicit Contract and Legal Sanctions: The threats that adversely affect the success of an alliance (adverse selection, moral hazard, and holdup) can be anticipated and the alliance contract can explicitly provide remedies for them. The contract can include legal sanctions for breach of these provisions. Table 9.6 in the text provides a long list of provisions commonly found in strategic alliance

agreements. If time permits, the instructor can go through some of these to illustrate how contract provisions can prevent problems between alliance partners. Equity Investments: Equity investments increase the stake for firms involved in the alliance. Because Firm A has invested in the equity of Firm B as part of the alliance (called equity alliances), Firm A is not likely to cheat Firm B. If it does, then its equity in Firm B loses value. Equity arrangements are particularly common among Japanese companies. These cross holdings (the network is called a keiretsu) reduce the incentives for one firm to cheat the other for short-term gains. Joint Ventures: Just as equity alliances minimize the possibility of cheating because of the financial impact to both firms, joint ventures are a good organizational option for the same reason. Both firms have a financial interest in the joint venture. If one cheats the other, the joint venture suffers. Losses incurred by the joint venture affects the financials of both firms. Joint ventures are the preferred mode of alliances when the possibility of cheating is high. Trust: Lets examine the issue of trust and it importance to alliances. Research has indicated that the one characteristic that is common in most successful alliances appears to be a significant amount of trust placed by the partners in each other. Beyond contractual provisions, trust is what is likely to bind the two firms in a cooperative relationship and take care of everyday problems that may surface. Firms that have a successful track record of alliances seem to excel in this area. Research suggests that trust in an alliance can serve as a substitute for more formal governance mechanisms like contracts. Even though almost every alliance has a contract the role of the contract in the alliance can vary a great deal from being relied upon almost daily to never being referenced once it is signed. In those alliances where the contract is seldom looked to after the creation of the alliance, trusting relationships are relied upon to guide the behavior of partners. Firm Reputation: If a firm seeks to use strategic alliances as a means to compete in its industry, needless to say, it should maintain a reputation as a reliable partner. If it maximizes its value in a specific alliance through cheating, it is unlikely to find companies willing to partner with it in the future. It behooves a firm to maintain its reputation so as to not preclude the possibility of forming alliances in the future. This threat that of a smeared reputation, is likely to have a greater effect, in some cases, that what is contractually written. However, the possibility of a tarnished reputation may not work to prevent opportunistic behavior in some cases. Obviously, subtle cheating is less likely to draw the same attention as overt cheating. Also, the information about a firm cheating must be made public in order for it to be a threat. Some firms may not be well connected in a network to enable this. Finally, tarnished reputation (or the fear of it) may not help the affected partner in the current alliance. In short, this is not a panacea for alliance problems. Teaching Points: Organizational choices for strategic alliances fall into two broad categories: formal and informal. Equity alliances and joint ventures are quite useful ways to ensure that firms do not cheat because there is a financial issue involved. Joint ventures are useful when transaction-specific investment is required by one party. Subjective issues like reputation and trust are critically important in the management of alliances.

Summary: Alliances are becoming increasingly popular as vehicles for a variety of strategic purposes. There are a number of ways by which alliances create value. However, it is important that a firm approach alliances using the VRIO lens. Alliances have to create value, be rare and costly-to-imitate, and be organized in such a way that it achieves its purpose. Understand that alliances are a form of organizing economic exchange. These economic exchanges should produce gains from trade. I encourage you to identify the resource combinations that form the basis for gains from trade in any alliance. Furthermore, I encourage you be aware that simply identifying the gains from trade is not enough to ensure alliance success. The exchange must be managed in an appropriate way if the gains from trade are to be realized. As with other strategy concepts covered in the course, alliances require firm capabilities. Some firm will be better at creating and managing alliances than others. I remind you that you I have shown you a way to analyze alliances that will allow you to draw well-informed conclusions as to whether or not an alliance will result in competitive advantage.

Chapter 10, Mergers and Acquisitions Monday & Wednesday, November 28-30, 2011 Teaching Notes & Outline

Lets Set the Learning Stage Reported n=450 wireless mergers in last 10 years First 11 months in 2008, there were 8, 190 acquisitions/mergers in US In 2007, the total value of announced mergers activities in the US was $1.7 trillion Why Mergers and Acquisitions? Lil Known Fact: Mergers and acquisitions (often referred to as M&A) help a firm implement a strategy of diversification or vertical integration. In other words, while vertical integration and diversifications are corporate-level strategy options, M&A (along with strategic alliances and internal development) is a vehicle or mode of entry. Hard Question: What would the role of the M&A activity look like in the strategic management process?! It is a mode of entry into various businesses that a firm may want to enter as a part of the firms corporate level strategy. M&A activity should satisfy the logic of corporate level strategy. Let me point out that I am not claiming that managers always adhere to this logic, but that as an element of corporate level strategy, M&A activity should satisfy this logic. What are Mergers and Acquisitions? While the words are used interchangeably, they mean something different. Merger sounds less threatening and is often used in press releases in an effort to make a deal more attractive. Acquisition is the purchase of a firm. The purchase does not have to be 100 percent ownership. It could be a majority ownership (greater than 51 percent of the acquired firms stock) or a controlling interest (enough stock ownership to control management and strategic decisions at the acquired firm). According to the authors, acquisitions can be friendly or unfriendly. In a friendly acquisition, the management of the acquired firm wants the firm to be acquired. In an unfriendly acquisition (also called hostile takeovers), the management of the target firm does not want the firm to be acquired. Now, lets look at the mechanics of M&A activity. For starters, we know that this activity is tightly regulated by the SEC. Key Learning Point: While a merger may start out as a transaction between equals, it may happen that in the course of time, one firm dominates the other. The point is that a merger may end up looking like an acquisition in terms of which firm has control. Major Take-Aways: Mergers and acquisitions are extremely popular as evidenced by their coverage in the business press. The M&A activity is a much-used vehicle particularly for a strategy of diversification. Again, while the business press may use the terms mergers and acquisitions interchangeably, the two are different. Note the difference between a friendly acquisition and an unfriendly [give some examples]. The M&A activity should create value for a firm according to the logic of corporate level strategy. Lets recall the gains acquired from the trade concept from strategic alliances and to the notion of economies of scope that reminds us about how this value might be created.

The Value of Mergers and Acquisitions M&A activity presents an interesting question. M&A activity is a common occurrence in the corporate world and the dollar values involved in these transactions amount to trillions. Yet, it is not clear that M&A activity actually generates value for firms implementing these strategies.

Note: An M&A strategy makes sense for a firm if the transaction creates value for the firm, whether it be the acquiring firm or the acquired firm. Not all M&As create value.

Summary of Mergers and Acquisitions It is important that we [you scholars] understand that M&A activity is a commonplace occurrence in the business world. On a regular basis they read about these transactions and some may have worked in an organization that was involved in M&A activity. One of the most important things to take away from this chapter is that M&A activity is part of a firms corporate level strategy. As such, M&A activity should generate value for the firm that stems from economies that shareholders could not get by simply diversifying their individual portfolios. The popularity of M&A activity runs contrary to the research on the value created by these transactions. The essence of the research findings is that stockholders of target firms gain while those of bidding firms do not. However, the popularity of M&A activity is not so perplexing when the long term results of the strategy are considered. Remember, that the outstanding long term results of Wells Fargo were the result of Wells Fargo pursuing an M&A strategy with attention to detail and spreading its core competencies to its targets.

Chapter 11, International Strategies Wednesday, December 8, 2011 Teaching Notes & Outline What are International Strategies? International Strategy Defined. International strategy simply refers to the concept of operating in multiple countries simultaneously. A good example of a company implementing international strategies would be Procter and Gamble. The company operates in over 80 countries (meaning it has either production facilities or sales offices) and sells its products in over 180 countries. This helps us to better understand just how widespread the company is in terms of its global reach. Hard Question: What is the relationship between International Strategy and other Corporate Strategies including [vertical integration and diversification]? According to the authors international strategy is just corporate strategy in a different geographical context. This piece provides the link between this chapter and the topics discussed in part 3 of the book corporate strategies such as vertical integration, diversification, strategic alliances, and mergers and acquisitions. Therefore, why firms might want to pursue corporate strategies in an international context are essentially the same reasons why firms pursue corporate strategies International strategies can be pursued by any kind of firm large, medium, or small. In addition, these strategies can be pursued at any time in a companys life. Key Learning Points:

International strategies are extremely popular as evidenced by their coverage in the business press. And, so we learn that international activity is a much-used vehicle particularly for a strategy of diversification. International strategies are not a recent development. They have been around for a very, very long time.

Most major companies have diversified their revenue base by getting sales from several foreign markets. We can see how some seemingly U.S. companies get a substantial part of their revenues from abroad.

The Value of International Strategies Hard Question: So, what do international strategies have to do with the VRIO framework? Let me reiterate that to be a source of sustained competitive advantages for firms, international strategies must exploit a firms valuable, rare, and costly to imitate resources and capabilities. Not just that, but the firm must be organized in such a way that it can realize the advantages of these resources and capabilities. Key Learning Point: To Gain Access to New Customers for Current Products or Services International strategy creates value if such a foray helps the firm gain access to new customers for its current product or service offerings. If customers in foreign markets are both willing and able to buy the firms products or services, then the firm can increase its revenues in pursuing this option. The key question, then, is will the firms offerings sell in foreign markets? This leads to the issue of convergence vs. divergence of tastes worldwide. Different physical standards internationally (size, for example) Differences in tastes

These differences can be addressed by being sensitive to local market needs. A good example of this is McDonalds sensitivity to Indian belief in the sacredness of the cow by eschewing beef-based burgers in its stores in that country. Once we address the issue of willingness, we can turn to ability to buy or affordability. A firm looking into international markets should realize that are at least three reasons local customers may be willing but unable to buy the firms products: Inadequate distribution channels Trade barriers Insufficient wealth to make purchases

Distribution is not organized in many foreign markets the same way it is in Western Europe or the U.S. Besides, firms already operating in these markets may control the distribution networks effectively locking out potential foreign entrants. In addition, inadequate transportation, warehousing, and retail facilities may hinder entry into some foreign markets. Table 11 presents a daunting list of tariffs, quotas, and nontariff trade barriers. Finally, foreign consumers may not have the financial wherewithal to buy certain goods or services provided by foreign firms. Per capita GDP varies widely among countries. To Gain Access to Low-Cost Factors of Production So far we have looked at the demand side of going international how to sell more of the product or the service. Lets defer our attention to the fact that supply side motivations are also valid reasons for going abroad. The three basic inputs that every firm needs raw materials, labor, and technology all may prompt firms to go international. Accessing low-cost raw materials has historically been the motivation for international operations. Thus, coffee companies set up operations in coffee producing countries. Tropicana has operations in Brazil to access that countrys orange supply. Labor costs vary across the world. The Made in China label has become quite ubiquitous in the American economy because of the low cost of labor in that country. Many companies have moved their call centers to countries such as India to take advantage of the availability of low cost English-speaking people in that country. There is a dark side to this, however, as described in the Race to the Bottom ethics and Strategy box. For many people, low cost labor would conjure up images of sweat shops and inhumane working conditions.

Maquiladoras, or manufacturing plants owned by foreign companies but operated in Mexico close to the U.S. border have become commonplace. Labor costs in Mexico are roughly one-fifths of those in the U.S., making maquiladoras highly attractive. Access to foreign technology may also motivate firms to go abroad. This typically happens in the case of companies from less technologically advanced countries setting up operations in countries with more advanced technologies. To Develop New Core Competencies A company may want to develop new competencies to help it compete in the global marketplace. This motivation may prompt it to go international to either adapt its existing competencies to market conditions or to help develop new ones. For this to happen, though, the organization has to have a learning orientation. Wal-Mart, for example, made a number of mistakes in its international operations (it stocked its Mexican stores with snowmobiles, for example!), but learnt from every one of them to have a sizeable international business. Learning is critical to success in the international setting. On one level, firms have to learn about the new market before entering. For example, as suggested above firms need to learn which resources and capabilities may or may not meet the VRIO criteria. On another level, firms must continue to learn after entering the new market. This is especially true when firms have entered the new market with a partner. If the firm is attempting to acquire new resources and capabilities, learning will obviously be critical to success. Key Learning Point: A learning mentality not only helps the firm absorb knowledge in a new market, it also helps the firm avoid costly overconfidence. Some firms commit costly cultural faux pas simply because they are too arrogant to invest in learning about the local culture. To Leverage Current Core Competencies in New Ways International operations can also help firms use existing competencies in new product/market arenas. Doing this allows the firm to exploit new opportunities that play to their existing strengths. The example given in the book of Hondas entry into the lawn mower business is a good one. Honda has core competencies in developing high performance power trains. They used to create successful businesses in motor cycles and automobiles. The U.S. market, however, gave them a new opportunity in lawn mowers that they did not have in Japan. To Manage Corporate Risk The topic of diversification to manage corporate risk was first visited in Chapter 7. The conclusion in that chapter was that since outside shareholders can diversify their own investment portfolio in a more efficient way, corporate diversification for the sole purpose of risk reduction was a questionable motivation. The same holds true in the case of diversification in an international context, but for two exceptions. Hard Question: If investor A wants to diversify his risks, can he invest in multiple domestic stocks? The answer to this is a yes. Heres Why! It is quite easy for investor A to buy a number of domestic stocks to own a reduced risk diversified portfolio. What if he wants to own stocks of foreign companies to reduce his exposure to one countrys stocks? This is not as easy as diversifying into domestic stocks. In certain cases, there are barriers to international capital flows. In such cases it is more efficient for the firm to diversify internationally to reduce risks. The second exception has to do with privately owned firms. Shareholders in such firms may continue to own the firms stock for a variety of reasons and hence may not have the liquidity to diversify their investment. In such cases, it may be justifiable for the firm to do so. Key Learning Points: Let me underscore the importance of value creation as the key motivation behind international expansion. Emphasize the need to look at motivations both from a revenue viewpoint (demand side) as well as from a cost viewpoint (supply side). In addition, learning and risk reduction are also good motivations.

Financial and Political Risks in Pursuing International Strategies Financial Risks: Currency Fluctuation and Inflation As firms do business in foreign markets, they may face currency fluctuations, different rates of inflation, different accounting practices and a host of similar financial risks. Key Learning Point: Let me remind you that while many financial risks exist in international markets, most risks are predictable and therefore manageable. Firms hedge against currency fluctuations, for example. Very often the real risk lies in sudden and unpredictable changes in the economic environment in the host country. Political Risks Lets discuss the political risks associated with international strategies and how they can be measured. Just as the political environment forms an important part of the analysis in the firms domestic market, it affects a firms international strategies. The effect can be felt at the macro level, such as when a country becomes hostile to all foreign investment. Rapid political changes are a fact of life in many countries and foreign companies have to constantly be aware of seismic shifts in governmental thinking. Political changes do not have to be to the disadvantage of foreign firms. When faced with a severe foreign exchange shortage in 1991, the Indian government, at the behest of the World Bank, opened up the country for foreign investment. The effect can also be felt at the micro or firm level as the following example illustrates. Example: EDS Faces Political Risk in Iran When the Shah of Iran was deposed in the late 1970s and fundamentalists took control of the country, EDS, the U.S. software firm founded by Ross Perot, was forced out and its assets were expropriated. The company had been entrusted with the task of creating a social security system for Iran. When EDS demanded payment for work done, the Iranian government responded by kidnapping a group of EDS executives. The Iranians demanded a ransom that was exactly equal to what EDS was demanding as payment for services rendered! Ross Perot mounted a heroic rescue attempt to get his executives out of the country. This incident formed the basis of a made-for-television movie called On Wings of Eagles. Summary of Issues in International Strategies We now understand that international strategies are a special case of diversification strategies. In other words, these diversification strategies happen outside the firms domestic borders. This means that like any other diversification, international strategies must make sense from the point-of-view of economies of scope. On a regular basis some of you read about these transactions and some may be working in an organization that is involved in M&A activity. One of the most important learning points is for you to understand is that as firms go international they are faced with two opposite imperatives 1) to be locally responsive or 2) go for economies of scale via international integration. The VRIO framework allows us to see if a firms international strategy is a source of sustained competitive advantage. While international strategies are commonplace in todays world, a firm can bring unique resources and capabilities to international markets. This not only makes it rare, it also makes direct imitation difficult and costly. There are, however, substitutes in the form of strategic alliances and wholly owned subsidiaries. Firms must organize themselves to take advantage of international opportunities. They have several options to do so but the option must match their strategy of either local responsiveness or international integration.