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Making Sense of Irrational Decisions

Making Sense of Irrational Decisions. Tyler Chamberlin ESRC Centre for Research on Innovation and Competition University of Manchester, and School of Management, University of Ottawa. Outline. Market Innovations Convergence of Telecom and Data Networking Firms

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Making Sense of Irrational Decisions

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  1. Making Sense of Irrational Decisions Tyler Chamberlin ESRC Centre for Research on Innovation and Competition University of Manchester, and School of Management, University of Ottawa Graduate Student Session 7th Annual ISRN Conference - Toronto

  2. Outline • Market Innovations • Convergence of Telecom and Data Networking Firms • Critique of Carpenter, Lazonick and O’Sullivan (2003) • Lunch! Graduate Student Session 7th Annual ISRN Conference - Toronto

  3. Background • Creative Destruction in Technologically-Intensive and Dynamic Industries: Competition, Market Innovations and Corporate Strategy • Methodology • Three case studies of acquisitions between 1998 and 2000 • 30 interviews and analysis of publicly available information (annual reports, company information, secondary information) Graduate Student Session 7th Annual ISRN Conference - Toronto

  4. Starting Point • Over any significant period of time, the composition of leading firms in the economy changes • Creative Destruction • Usually described in terms of a process of market entry and exit…but does this have to be? Graduate Student Session 7th Annual ISRN Conference - Toronto

  5. Creative Destruction • For firms, creative destruction implies a limited lifespan • For the economy, creative destruction involves costs of adjustment (economic and social) • Question: Could we have the benefits of creative destruction without all the costs of market exit? Graduate Student Session 7th Annual ISRN Conference - Toronto

  6. Market Innovations • Schumpeter’s definition is almost only considered with respect to product or process innovations, but there are also organizational innovations, materiale innovations and market innovations • Schumpeter’s definition of market innovations tended to imply a geographic orientation to the definition of markets, whereas, organizational innovations implied a re-organization of industry Graduate Student Session 7th Annual ISRN Conference - Toronto

  7. Product Differentiation Graduate Student Session 7th Annual ISRN Conference - Toronto

  8. Market Innovations • Incremental market innovations involve adapting an existing product to serve a new set of customers • Radical market innovations involve the development of an entirely new strategic orientation for the firm, a redefinition of what the firm is fundamentally all about Graduate Student Session 7th Annual ISRN Conference - Toronto

  9. The Convergence of ICT • Telecommunications and Data Networking firms, in the early to mid-1990’s were distinct and separate industries, however Cisco Systems started to develop telecom competences and clearly articulated their desire to move into telecom markets • Packet switched networks versus circuit switched networks • IP networks Graduate Student Session 7th Annual ISRN Conference - Toronto

  10. The Convergence of ICT (cont.) • The rate at which technologies were being developed and the explosive growth of the internet led, coupled with market deregulation internationally led to an extremely dynamic (if not chaotic!) environment • Acquisitions became the method of converging technologies, which constituted a market innovation, the creation of what Fransman refers to as the infocommunications industry Graduate Student Session 7th Annual ISRN Conference - Toronto

  11. The Boom and Bust • The demand to build the infrastructure of the internet was voracious, however, in-part driven by technological innovations within the infocommunications industry the infrastructure soon exceed the need for bandwidth Graduate Student Session 7th Annual ISRN Conference - Toronto

  12. Irrational Decisions • The market capitalization of Nortel went from approximately $20 B (US) to over $300 B (US) over a three year period and Cisco briefly became the most valuable firm in the world in 2000 • Firms without products were being acquired for billions of dollars between 1998-2000 • John Chambers realized total remuneration of $375 million between 1991 and 2002, John Roth realized just over $100 million in the year 2000 Graduate Student Session 7th Annual ISRN Conference - Toronto

  13. Value of Acquisitions • Pooling of interest provisions allowed firms to acquire (provided acquisitions were made entirely with stock) targets without having to apply the goodwill charge to the acquiring firm’s Balance Sheet • Carpenter, Lazonick and O’Sullivan (2003) suggest that this accounting provision provided an unfair advantage for American firms over, for example European firms • This meant that earnings per share would not be diluted and as such American firms had an advantage, for example, over European firms • Furthermore, the growth of the American equity market provided an opportunity to raise money that further advantaged US firms Graduate Student Session 7th Annual ISRN Conference - Toronto

  14. Graduate Student Session 7th Annual ISRN Conference - Toronto

  15. European Advantages • European firms could write off goodwill against equity rather than earning • Firms could also deduct amortization against taxes, in some jurisdictions further disadvantaged American firms • Finally, the arguments of Carpenter, Lazonick and O’Sullivan all hang upon their belief that technology-based firms worry about earnings per share, a fundamentally misplaced belief • Firms did not issue dividends and are focused on stock price growth not the traditional earnings per share metric Graduate Student Session 7th Annual ISRN Conference - Toronto

  16. Carpenter, Lazonick and O’Sullivan (2003) • Why, then, in the New Economy boom, did strategic decision makers in the optical networking companies eschew the opportunity of selling stock to strengthen their cash balances?” (Carpenter, Lazonick and O’Sullivan, 2003, pg. 1025) Graduate Student Session 7th Annual ISRN Conference - Toronto

  17. How much money do you need? • In 2000, Nortel had current liabilities of $9,058 million (US) versus $16,530 million (US) in current assets • $1.6 billion (US) in cash! • Consider the message to the market had Nortel, Cisco, Alcatel or Lucent started to stockpile even larger amounts of cash • Investors in technology firms understand the volatility of these industries and accept the rewards that it implies, along with the risks Graduate Student Session 7th Annual ISRN Conference - Toronto

  18. Conclusions • The cash values involved were unreal and based-on fundamentally irrational decisions by the entire financial system • What is interesting about this time was the strategic decisions that represented a radical market innovation in the form of the development of the infocommunications industry • Cisco’s ability to execute an acquisition strategy more effectively than the abilities of Nortel, Alcatel or Lucent to execute a similar strategy • Potential of Intel… Graduate Student Session 7th Annual ISRN Conference - Toronto

  19. Thank you! chamberlin@management.uottawa.ca Graduate Student Session 7th Annual ISRN Conference - Toronto

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