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Vertical
Integration
Chapter 6
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Vertical Integration
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Questions of Outsourcing?
What is offshoring?
Is outsourcing or offshoring good?
What are the ethical implications foroutsourcing?
What are the ethical implications for
offshoring? What are the implications for different
stakeholder groups?
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Strategic Management & Competitive Advantage Barney & Hesterly 4
Vertical Integration
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Logic of Corporate Level Strategy
Corporate level strategy should create value:
2) such that businesses forming the corporate whole
are worth more than they would be underindependent ownership
3) that equity holders cannot create through
portfolio investing
a corporate level strategy should create
synergies that are not available in equity
markets
vertical integration = value chain economies
1) such that the value of the corporate whole increases
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Strategic Management & Competitive Advantage Barney & Hesterly 5
Vertical Integration
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What is Vertical Integration?
Leprino Foods(Mozzarella Cheese)
Where your pizza comes from
Dairy Farmers(milk)
Crop Farmers(Alfalfa & Corn)
Seed Companies(Alfalfa & Corn)
Food Distributors
Pizza Chains
End Consumer
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Strategic Management & Competitive Advantage Barney & Hesterly 6
Vertical Integration
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Barney & Hesterly 6
What is Vertical Integration?
Leprino Foods(Mozzarella Cheese)
Dairy Farmers(milk)
Crop Farmers(Alfalfa & Corn)
Seed Companies(Alfalfa & Corn)
Food Distributors
Pizza Chains
End Consumer
BackwardVertical
Integration
Forward
Vertical
Integration
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Vertical Integration
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Value Chain Economies
Dairy Farmers(milk)
Food Distributors
BackwardVertical
Integration
Forward
Vertical
Integration
Leprino Foods(Mozzarella Cheese)
The Logic of Value Chain Economies
the focal firm is able to
create synergy with the
other firm(s)
the focal firm is able tocapture above normal
economic returns
(avoid perfect competition)
cost reduction
revenue enhancement
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Vertical Integration
Strategic Management & Competitive Advantage Barney & Hesterly 8
Vertical Integration
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Competitive Advantage
If a vertical integration strategy meets the
VRIO criteria
Is it Valuable?
Is it Rare?
Is it costly to Imitate?
Is the firm Organized to exploit it?
it may create competit ive advantage.
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Vertical Integration
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Value of Vertical Integration
Market vs. Integrated Economic Exchange (Coase, 1937)
economic exchange should be conducted in the formthat maximizes value for the focal firm
markets and integrated hierarchies are forms in which
economic exchange can take place
thus, firms assess which form is likely to generate
more value
Integration makes sense when the focal firm can
capture more value than a market exchange provides
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Vertical Integration
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Value of Vertical Integration
Three Value Considerations
Leverage
Capabilities
Exploit
Flexibility
Manage
Opportunism
firm capabilities
may be sources
of competitive
advantage inother businesses
if not, then dont
integrate exchange
opportunism
may be checked
by internalizing
(TSI)
internalizing must
be less costly than
opportunism
internalizing is
usually less
flexible
flexibility is
prized when
uncertainty is
high
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Strategic Management & Competitive Advantage Barney & Hesterly 11
Vertical Integration
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Rarity of Vertical Integration
Integration vs. Non-Integration
a firms integration strategy may be rare because
the firm integrates or because the firm does not
integrate
thus, the question of rareness does not
depend on the number of forms observed
a firms integration strategy is rare or common with
respect to the value created by the strategy
l
l
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Vertical Integration
Strategic Management & Competitive Advantage Barney & Hesterly 12
Vertical Integration
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Imitability of Vertical Integration
Form vs. Function
the form, per se, is usually not costly to imitate
the value-producing function of integration may
be costly to imitate, if:
the integrated firm possesses resource
combinations that are the result of:
historical uniqueness
causal ambiguity social complexity
small numbers prevent further integration
capital requirements are prohibitive
V i l I i
V i l I i
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Strategic Management & Competitive Advantage Barney & Hesterly 13
Vertical Integration
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Imitability of Vertical Integration
Modes of Entry
acquisition and internal development are alternative
modes of entry into vertical integration
strategic alliances can be viewed as a substitute for
vertical integrationwithout the costs of ownership
thus, one firm may acquire a supplier while acompetitor could imitate that strategy through
internal development
in both cases, the boundaries of the firm would
encompass the new business
V ti l I t ti
V ti l I t ti
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Strategic Management & Competitive Advantage Barney & Hesterly 14
Vertical Integration
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Organizing Vertical Integration
Functional Structure (U-Form)
Accounting Finance Marketing HR Engineering
Conflict
C
onflict
Original
Business
New
Business
Original
Business
New
Business
New
Business
New
Business
New
Business
Original
Business
Original
Business
Original
Business
Cooperation
Coopera
tion
CEOs Role
V ti l I t ti
V ti l I t ti
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Strategic Management & Competitive Advantage Barney & Hesterly 15
Vertical Integration
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Organizing Vertical Integration
Management ControlsWhat needs to be controlled in a vertically integrated
firm?
cooperation and competition among and between
functions
the integration of new businesses into theexisting business
managers efforts to achieve the desired valuechain economies
time horizon of managers
V ti l I t ti
V ti l I t ti
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Vertical Integration
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Organizing Vertical Integration
Management Controls
BudgetsBoard
Committees
separating strategic andoperational budgets
strategic: inputs
& outputs
operational: outputs
provide oversight anddirection to managers
help ensure that strategic
direction is maintained
These mechanisms focus management attention
on achieving value chain economies
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Vertical Integration
Vertical Integration
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Strategic Management & Competitive Advantage Barney & Hesterly 18
Vertical Integration
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International Expansion
Cost
(Capital at Risk)
ControlExporting
Licensing
Franchising
Strategic All iance
Greenfield Investment
Low High
High
Acquisition
The Cost Control Tradeoff
VerticallyIntegrated
Not Vertically Integrated
Somewhat
Vertically
Integrated
Vertical Integration
Vertical Integration
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Vertical Integration
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Summary
Vertical Integration
makes sense when value chain economies
can be created and captured
may allow a firm to leverage capabilities
may be a response to the threat of opportunism
and uncertainty
as a form of exchange per se, is not rare nor
costly to imitate
Vertical Integration
Vertical Integration
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Vertical Integration
Strategic Management & Competitive Advantage Barney & Hesterly 20
Vertical Integration
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Summary
Vertical Integration
is an important consideration in the decision
to expand internationally (range of possibilities)
makes sense when done for the right reasons,
under the right circumstances
can be a costly mistake if done wrong
Ownership is costlyintegrate only when the
benefits outweigh the costs of integration!
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Organizing to
Implement
CorporateDiversification
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Chapter 8
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Organizing to Implement Corporate Diversification
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Organizing to Implement Corporate Diversification
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Implementation Issues
How Information Flows
Where and By Whom are Decisions Made
How to Influence the Behavior of People
how can the interests of employees
be aligned with the interests of the firm?
Organizing to Implement Corporate Diversification
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Organizing to Implement Corporate Diversification
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The Need for Organizational Structure
Information Processing Requirements
as organizations become larger and more complex,
information processing requirements exceed
individual capacity
bounded rationality
satisficing
organizational structure divides information
processing into manageable blocks (span of control)
Organizing to Implement Corporate Diversification
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Organizing to Implement Corporate Diversification
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The Agency Relationship
A Trade Off
M-Form Structure
Divides Information
Processing Requirements
Into Manageable Blocks
Divides Owners
From Managers
Interests of Owners and
Managers May Diverge
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Organizing to Implement Corporate Diversification
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Individual
Shareholders
Institutional
Shareholders
Senior
Executives
Corporate
Staff
Division
General
Managers
SharedActivity
Managers
The Agency Relationship
Board
Of
Directors
Managing Agency
Dual
Role
Principals Monitors Agents
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Organizing to Implement Corporate Diversification
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The Office of the President
Chairmanof the
Board(monitoring)
ChiefExecutive
Officer(strategy formulation)
Chief
Operating
Officer(strategy implementation)
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Organizing to Implement orporate Diversification
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Information Filtering
information about the divisions businesses
is filtered as it rises to the senior executive
the senior executive can manage the informationflow
information flow should not exceed the
bounded rationality of managers at any
level in the organization
information should flow should be matched
with decision-making authority
The Office of the President
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Organizing to Implement Corporate Diversification
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g g p p
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Refocusing
Corporate level strategy may call forexiting a business
a conglomeration discount may exist
the corporation may lack necessary skills
expected economies of scope may not exist
the corporation may need funds for core activities
Divest
AssetsSpin-offor,
MBO
IPO
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g g p p
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International Implementation
Global
Strategy Multi-DomesticStrategy
Centralized Hub:
facilitates globalintegration
exploits a
global product
exploits scale
economies
Decentralized Federation:
highly autonomous units very responsive locally
Coordinated Federation:
less autonomous
some shared activities
between divisions
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Strategic Management & Competitive Advantage Barney & Hesterly 13
g g p p
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International Implementation
Transnational
Structure
facilitates both local responsiveness
and global integration
country managers are responsible for
exploiting economies of scope
corporate HQ constantly scans the
globe looking for best practices
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Summary
Successful implementation is a matter of:
appropriately breaking information processing
into manageable blocks
aligning the interests of owners and managers
These can be accomplished through:
Organizational Structure
Management Controls
Compensation Policies
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Strategic
Alliances
Chapter 9
Strategic Alliances
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Mission Objectives
External
Analysis
Internal
Analysis
Strategic
Choice
Strategy
Implementation
Competitive
Advantage
The Strategic Management Process
Corporate Level
Strategy
Which Businesses
to Enter?
Vertical Integration
Diversification
Strategic Alliances
mode of entry
Strategic Alliances
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Strategic Alliances Defined
Strategic Alliance:
Any cooperative effort between two or more
independent organizations to develop,
manufacture, or sell products or services
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Strategic Alliances
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Three Types
Of
Alliances
Nonequity
Alliance
Contracts
licensing supply &
distribution
agreements
Joint
Venture
Equity
Alliance
Cross Equity
Holdings
partners own
stakes in
eachother
Joint Equity
Holdings
independent
firm is
created
Strategic Alliances
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How Strategic Alliances Create Value
Improve Current Operations
Shaping the Competitive Environment
Facilitating Entry and Exit
Value
Creation
Strategic Alliances
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How Strategic Alliances Create Value
Improving Current Operations
Exploiting economies of scale
a partner brings increased market share
and/or manufacturing capacity
Learning from partners
a partner brings technology and/or
market knowledge
Risk and cost sharing
a partner bears a portion of the risk and/or
cost of the alliance
Strategic Alliances
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How Strategic Alliances Create Value
Creating a Favorable Competitive Environment
Facili tating technology standards
Facilitating tacit collusion
partners may agree on a standard and avoid
a market battle for the standard
partners may communicate within an alliance
in subtle, legal ways whereas the same
communication between competitors outside
an alliance would be illegal
Network Industries
increasing returns to scale
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Strategic Alliances
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Challenges to Value Creation and Allocation
Incentives to Misappropriate Value (Cheat)
An alliance is an exchange context in which:
partner inputs may be difficult to monitor
actual value creation may be difficult to monitor
value appropriation (allocating the value) may be:
difficult to monitor
subject to power dynamics
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Strategic Alliances
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Sustained Competitive Advantage
Are strategic alliances rare?
As a form of organizing economic exchange, NO!
The sources of value creation within alliances
may be rare.
However,
firms may form a combination of complementary
resources within an alliance that is rare
the stock of such complementary resources may
be limited so that first movers have a rare combination
Strategic Alliances
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Sustained Competitive Advantage
Are strategic alliances costly to imitate?
As a form of organizing economic exchange, NO!
However,
The resource combinations that create value in
alliances may be very costly, if not impossible,
to imitate if:
the organizational form per se is easily duplicated
the value creating combination depends on
social complexity (trust), causal ambiguity,
and/or historical uniqueness
Strategic Alliances
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Sustained Competitive Advantage
Are strategic alliances substitutable?
Substitutes forStrategic Alliances
Internal
Development:
Going It Alone
Mergers &
Acquisitions
If: no partner
is available
transaction-specific
investment is high
low uncertainty about
the investment
If: there are no
anti-trust issues
low uncertainty about
the investment
firms can be
integrated easily
value of combined firms is
not tied to independence
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Strategic Alliances
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Trust Firm Reputations
Informal
Organizing Strategic Alliances
Governance Responses to the Challenges of
Value Creation and Allocation
the shadow of the
future constrainscheating
may allow partners
to exploit opportunitiesthat would be infeasible
with other mechanisms
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Strategic Alliances
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International Expansion
Alliances may be attractive because:
local market knowledge is usually critical
governments may require a local partner
international expansion may be:
fraught with uncertainty
high risk
expensive
alliance investment may be more easily reversed
than internal development or acquisition
Strategic Alliances
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Summary
create alliances that will produce gains
from tradecomplementary resources
identify the sources of value creation
assess the likelihood of challenges to value
creation and allocation
adopt appropriate governance responses tothe challenges to value creation and allocation
Successful alliance managers will:
Strategic Alliances
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Competitive Advantage - Barney & Hesterly
Summary
Alliances may generate competitive advantage if: combinations of complementary resources
meet the VRIO criteria
governance responses meet the VRIO criteria
The Big Challenge of Strategic Alliances:Maximizing gains from trade while
minimizing the threat of cheating
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Mergers and
Acquisitions
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Chapter 10
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Mergers & Acquisitions
Mergers and Acquisitions
Logic of Corporate Level Strategy Applies
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Logic of Corporate Level Strategy Applies
Corporate level strategy should create value:
2) such that businesses forming the corporate wholeare worth more than they would be underindependent ownership
3) that equity holders cannot create throughportfolio investing
1) such that the value of the corporate whole increases
Mergers & Acquisitions
Mergers and Acquisitions
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Mergers & Acquisitions Defined
Mergers Acquisitions
two firms are combined ona relatively co-equal basis
one firm buys anotherfirm
the words are often used interchangeably even
though they mean something very different
merger sounds more amicable, less threatening
Mergers & Acquisitions
Mergers and Acquisitions
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parent stocks are usuallyretired and new stock issued
name may be one of theparents or a combination
can be a controllingshare, a majority, orall of the target firmsstock
can be friendly orhostile
Mergers Acquisitions
Mergers & Acquisitions Defined
usually done througha tender offer
one of the parents usuallyemerges as the dominantmanagement
Mergers & Acquisitions
Mergers and Acquisitions
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Mergers & Acquisitions Defined
Types of M&A Activity
FTCCategories
Vertical
Horizontal
Product Extension
Market Extension
Conglomerate
suppliers or customers
competitors
complementary products
complementary markets
everything else
Related
Unrelated
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Mergers and Acquisitions
Do Mergers and Acquisitions Create Value?
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Do Mergers and Acquisitions Create Value?
The Logic
Related M&A Activity
value creation would be expected due tosynergies between divisions
economies of scale
economies of scope
transferring competencies
sharing infrastructure, etc.
Mergers & Acquisitions
Mergers and Acquisitions
Do Mergers and Acquisitions Create Value?
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Do Mergers and Acquisitions Create Value?
The Empirical Evidence
this reflects the markets assessment of theexpected value of the merger or acquisition
these studies look at what happens to the price
of both the acquirers stock and the targets stock
thus, we can see who is capturing any expectedvalue that may be created
Research is based on stock market reaction to theannouncement of M&A activity
Mergers & Acquisitions
Mergers and Acquisitions
Do Mergers and Acquisitions Create Value?
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Do Mergers and Acquisitions Create Value?
The Empirical Evidence
Acquiring
Firms
Target
Firms
M&A Activity creates value, on average, as follows:
no value created value increases byabout 25%
related M&A activity creates more value thanunrelated M&A activity
M&A activity creates value, but target firms capture it
Mergers & Acquisitions
Mergers and Acquisitions
Entrepreneurship in M & As (p 318)
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Entrepreneurship in M & As (p.318)
Business Angels
Venture Capital Firms (VC)
Initial Public Offering (IPO)
Cashing Out
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Mergers and Acquisitions
Why is M&A Activity So Prevalent?
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Why is M&A Activity So Prevalent?
If managers know that acquiring firms do notcapture any value from M&As, why do theycontinue to merge and acquire?
AgencyProblems
ManagerialHubris
managers benefit from increases in size managers benefit from diversification
managers believe they can beat the odds
Mergers & Acquisitions
Mergers and Acquisitions
Why is M&A Activity So Prevalent?
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Why is M&A Activity So Prevalent?
If managers know that acquiring firms do notcapture any value from M&As, why do theycontinue to merge and acquire?
Above NormalProfits
proposed M&A activity may satisfy
the logic of corporate level strategy
managers may see economies thatthe market cant see
some M&A activity does generateabove normal profits (expected andoperational over the long run)
Mergers & Acquisitions
Mergers and Acquisitions
Competit ive Advantage
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Yes, if managers abilities meet VRIO criteria
Competit ive Advantage
Can an M&A strategy generate sustained
competitive advantage?
2 Managers may be good at doing deals
1 Managers may be good at recognizing & exploitingpotentially value-creating economies with other firms
3 Managers may be good at both
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Mergers and Acquisitions
Competit ive Advantage
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Competit ive Advantage
Recognizing and Exploiting Economies of Scope
Costly-to-ImitateEconomies
Firm A
Firm B
Firm C
Bidders Target
if the economybetween A & Cis costly to imitate,it doesnt matter
if other firms know
Firm A can still earna $2,000 profit
Mergers & Acquisitions
Mergers and Acquisitions
Competit ive Advantage
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Competit ive Advantage
Recognizing and Exploiting Economies of Scope
Firm A
Firm B
Firm C
Bidders Target
UnexpectedEconomies
Firm C has a marketvalue of $10,000
Firm A buys Firm Cfor $10,000
Firm C turns out to beworth $12,000
Mergers & Acquisitions
Mergers and Acquisitions
Competit ive Advantage
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p g
Doing the Deal
Bidding FirmsPerspective
Search forRare Economies
Limit Information
to Other Bidders
Limit Informationto the Target
Avoid BiddingWars
Close theDeal Quickly
Seek Thinly
Traded Markets
Mergers & Acquisitions
Mergers and Acquisitions
Competit ive Advantage
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p g
Doing the Deal
Target FirmsPerspective
Seek Informationfrom Bidders
Invite Other Bidders toJoin in Bidding Contest
Delay, But Do NotStop the Acquisition
Mergers & Acquisitions
Mergers and Acquisitions
Implementation Issues
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Implementation Issues
Structure, Control, and Compensation
M&A activity requires responses to these issues:
m-form structure is typically used
management controls & compensation policiesare similar to those used in diversification strategies
Managers must decide on the level of integration:
target firm may remain somewhat autonomous
target firm may be completely integrated
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Mergers & Acquisitions
Mergers and Acquisitions
Target Response Strategies to a
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g p gTakeover Attempt
Reduce the wealth of target firm equity holders. Greenmail
Standstill Agreements
Poison Pills Do not affect wealth of target firm equity holders.
Shark Repellents
Pac Man Defense
Crown Jewel Sale Law Suits
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Mergers & Acquisitions
Mergers and Acquisitions
International Issues
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Cultural Issues
Time OrientationLong-term Short-term
Goal OrientationAggressive Passive
Uncertainty OrientationAcceptance Avoidance
Power Orientation ToleranceRespect
Social OrientationIndividualism Collectivism
(Hofstede, 1980)
Mergers & Acquisitions
Mergers and Acquisitions
Summary
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M&A activity is a mode of entry for vertical
integration and diversification strategies
M&A activity can create economic value atannouncement, but target firms usually capturethat value
A firms M&A strategy should satisfy thelogic of corporate level strategy
M&A activity can create value over the long term