Knowledge Objectives

1. Knowledge Objectives • Build on our understanding of related/unrelated diversification • Understand the rationales, risks and rewards of acquisitions • Understand strategic alliance types, rationales, and governance • Vertical and horizontal alliances • Skill sharing, cost sharing, market entry

2. Mergers and Acquisitions (some terminology) • Merger:a strategy through which two firms agree to integrate their operations on a relatively co-equal basis • Acquisition:a strategy through which one firm buys a controlling interest in another firm with the intent of making the acquired firm a subsidiary business within its own portfolio • Takeover:a special type of an acquisition strategy wherein the target firm did not solicit the acquiring firm’s bid

3. Rationales for Acquisitions & Mergers? • Industry Lifecycle (e.g., Whirlpool, Maytag) • Technological Trajectories (e.g., Google, YouTube)

4. Some notable acquisitions • AOL acquired Time Warner for $164B (2003) • eBay acquired Skype for $2.6B (2005) • Newscorp acquired MySpace.com for $580M (2005)

5. Siemens AG (NYSE:SI) announced Tuesday it will acquire a 28% stake in Archimede Solar Energy S.p.A. Siemens indicated it may seek a majority stake in the Italian company. The deal expands the German industrial giant's presence in the solar power sector, where is the market leader in steam turbine generators for solar thermal power plants. • ASE's technology made it an attractive target. The company is the sole producer of solar receivers that use molten salt rather than oil as the heat transfer fluid. Siemens says it can create more efficient solar thermal power plants by combining that technology with its own, positioning for what it believes will be heated demand for solar power over the next decade Source: Deal.com 3/25/09

6. Acquisitions Google bought YouTube ($1.65B in 2006) Why? • Google bought a rival. • YouTube had four times as many hits as Google Video • YouTube streamed nine times as many clips as Google Video. • Google’s choice to buy rather than build marked a big strategic change. (Economist, 10/14/06, p82).

7. Google Acquires YouTube ?? • 1st – what industry is Google in? • 2nd – what is the Google “system” • 3rd – logic of the acquisition? • YouTube=45% of video users

8. Acquisitions Acquisitions = alternatives … to internal development of resources and capabilities • PROBLEM: there is “no market” to price resources and capabilities – value depends on combination of acquirer and target; difficult to evaluate in advance (Barney, 1986). • Acquirers pay large premiums over the eventual value of the targeted capabilities – though shareholders of targeted firms gain • Acquiring firms fail to achieve strategic and financial objectives in a majority of cases. • Difficulties in integrating distinct organizations and cultures frequently result in the destruction of the targeted capabilities (Madhok, 1997).

9. Learn and develop new capabilities Reshape firm’s competitive scope Overcome entry barriers Increase diversification Acquisitions Cost of new product development Increase speed to market Increase market power Lower risk compared to developing new products Reasons for Making Acquisitions

10. Google Industry

11. Reasons for Making Acquisitions: Increase Market Power • Factors increasing market power • Enables firm to sell goods or services above competitive levels of value; • Lowers costs of primary or support activities below those of its competitors • derived from how the size of the firm augments resources and capabilities • Market power is increased by • horizontal acquisitions • vertical acquisitions • related acquisitions

12. Reasons for Making Acquisitions: Overcome Entry Barriers • Barriers include • economies of scale (established competitors) • differentiated products • LT customer relationships that create product loyalties with competitors • acquisition of an established company • Can be more effective than entering the market de novo, i.e., offering an unfamiliar good or service • provides a new entrant with immediate market access

13. Reasons for Making Acquisitions: Product Cost & Speed to Market • Significant investments of a firm’s resources are required to • Develop new products internally • introduce new products into the marketplace • Acquisition of a competitor may result in • more predictable returns (near term) • faster market entry • rapid access to new capabilities

14. Reasons for Making Acquisitions: Accelerate product development • Acquisitions to improve ST product portfolios are more easily valued, vs. those of LT product development • Managers may view acquisitions as lowering risk in this area – why?

15. Reasons for Making Acquisitions: Diversification • easier to develop and introduce new products in the firm’s current markets (shared resources) • Lack of market/product knowledge makes “organic” development difficult • uncommon for many firms to use internal development for new products to diversify in high tech. • acquisitions are quick and easy way to diversify a firm and change its product/market portfolio

16. Reasons for Making Acquisitions: Competitive Scope • use acquisitions to reduce dependence on one or more products or markets (become a “generalist firm”) • i.e., reducing a company’s dependence on specific markets alters the firm’s competitive scope

17. Reasons for Making Acquisitions: Exploration • Acquisitions may enable a firm to learn – to gain capabilities currently unavailable to the firm • Acquisitions may be used to • acquire a special technological capability • broaden a firm’s knowledge base • Overcome knowledge-based inertia (i.e., local search)

18. Resulting firm is too large Inadequate evaluation of target Target firms preoccupied with acquisitions Acquisitions Large or extraordinary debt Overdiversification Integration difficulties Inability to achieve synergy Problems With Acquisitions

19. Problems With Acquisitions Integration Difficulties • melding disparate corporate cultures • linking different financial and control systems • building effective relationships (when management styles differ) • resolving status of acquired firm’s executives • losing key personnel weakens firm’s capabilities and reduces value of acquisition

20. Problems With Acquisitions Inadequate Target Evaluation • Due diligence requires hundreds of issues be closely examined, including • financing the intended transaction • Cultural differences between acquirer and target • tax consequences • Organizational and incentive actions necessary to integrate human resources • Ineffective due-diligence • Results in excessive premiums for the target company

21. Problems With Acquisitions Large Debt • Firm may take on significant debt to acquire a company (LBO) • High debt • increases likelihood of bankruptcy • downgrades the firm’s credit rating • Creates opportunity costs - precludes investment in activities that contribute to value creation

22. Problems With Acquisitions Inability to Achieve Synergy • Synergy exists when assets are worth more when used in conjunction with each other than when they are used separately • transaction costs (i.e., aligning incentive systems) attend acquisition strategies • Firms underestimate indirect costs when evaluating a potential acquisition

23. Problems With Acquisitions Overdiversification • Increased diversification requires more complex structures to interpret & integrate information • Increased scope created can cause reliance on financial rather than strategic controls to evaluate BU performance and potential • Acquisitions may become substitutes for innovation (good or bad?)

24. Problems With Acquisitions Acquisition Uncertainties • Target firms may slow down or operate in “suspended animation” during an acquisition • Executives may hesitate to make decisions with long-term consequences until negotiations have been completed • Acquisition process can create a short-term perspective and a greater aversion to risk among top-level executives in a target firm

25. Problems With Acquisitions Too Large • Additional bureaucratic costs can exceed the benefits of the economies of scale and additional market power • Integrating larger targets = more bureaucratic controls • controls can lead to rigid behavior / reduced adaptation, sacrificing innovation and responsiveness

26. Attributes of Effective Acquisitions Attributes Results Complementary Assets or Resources Buying firms with assets that meet current needs to build competitiveness Friendly Acquisitions Friendly deals make integration go more smoothly Careful Selection Process Deliberate evaluation and negotiations are more likely to lead to easy integration and building synergies Maintain Financial Slack Provide enough additional financial resources so that profitable projects would not be foregone

27. Attributes of Effective Acquisitions Attributes Results Low-to-Moderate Debt Merged firm maintains financial flexibility Sustain Emphasis on Innovation Continue to invest in R&D as part of the firm’s overall strategy Has experience at managing change and is flexible and adaptable Flexibility

28. Technology Trajectory as an S-Curve (Foster, 1986) • Slow initial innovation rate • Accelerates until it reaches diminishing returns

30. Technical Standards for Personal Computers

31. TECHNOLOGICAL CHANGE AND INDUSTRY STRUCTURE: INTEGRAL PRODUCT VERTICAL INDUSTRY MODULAR PRODUCT HORIZONTAL INDUSTRY NICHE COMPETITORS TECHNICAL ADVANCES HIGH- DIMENSIONAL COMPLEXITY SUPPLIER MARKET POWER PRESSURE TO DIS-INTEGRATE PRESSURE TO INTEGRATE ORGANIZATIONAL RIGIDITIES PROPRIETARY SYSTEM PROFITABILITY Fine & Whitney, “Is the Make/Buy Decision Process a Core Competence?”

32. Double helix view: communications industry (MIT CFP program)

33. Modularity, innovation, and Organizational Effects Redesign Automobile cruise control Hybrid Autos Components Electric seats FWD vs. RWD vs. All WD Refine Stable Changed Component links Adapted from Henderson & Clark, 1990

34. Alternative to Acquisitions: Cooperative Strategy • Cooperative strategy is a strategy in which firms • work together • to achieve a shared objective • Cooperating with other firms is a strategy that • creates value for a customer • exceeds the cost of constructing customer value in other ways • establishes a favorable position relative to competition

35. Strategic Alliance • A strategic alliance is a cooperative strategy in which • firms combine some of their resources and capabilities to create a competitive advantage • A strategic alliance involves • exchange and sharing of resources and capabilities • co-development or distribution of goods or services • Independent firms

36. Firm B Resources Capabilities Core Competencies Resources Capabilities Core Competencies Firm A Mutual interests in designing, manufacturing, or distributing goods or services Combined Resources Capabilities Core Competencies Strategic Alliance

37. Types of Cooperative Strategies • Joint venture: two or more firms create an independent company by combining parts of their assets • Equity strategic alliance: partners who own different percentages of equity in a new venture • Nonequity strategic alliances: contractual agreements given to a company to supply, produce, or distribute a firm’s goods or services without equity sharing

38. Complementary Alliances Business-Level Cooperative Strategies: • complementary strategic alliances are designed to take advantage of market opportunities by combining partner firms’ assets in complementary ways to create new value • these include distribution, supplier or outsourcing alliances where firms rely on upstream or downstream partners to build competitive advantage

39. Margin Margin Margin Margin Service Service Marketing & Sales Marketing & Sales Technological Development Technological Development Human Resource Mgmt. Human Resource Mgmt. Support Activities Support Activities Outbound Logistics Outbound Logistics Firm Infrastructure Firm Infrastructure Procurement Procurement Operations Operations Inbound Logistics Inbound Logistics Primary Activities Primary Activities Business-Level Cooperative Strategies: Buyer • vertical complementary strategic alliance is formed between firms that agree to use their skills and capabilities in different stages of the value chain to create value for both firms • outsourcing is one example of this type of alliance Supplier Vertical Alliance

40. Margin Margin Margin Margin Service Service Marketing & Sales Marketing & Sales Technological Development Technological Development Human Resource Mgmt. Human Resource Mgmt. Support Activities Support Activities Outbound Logistics Outbound Logistics Firm Infrastructure Firm Infrastructure Procurement Procurement Operations Operations Inbound Logistics Inbound Logistics Primary Activities Primary Activities Business-Level Cooperative Strategies: Buyer Buyer Horizontal Alliance Potential Competitors • horizontal complementary strategic alliance is formed between partners who agree to combine their resources and skills to create value in the same stage of the value chain • focus on long-term product development and distribution opportunities • the partners may become competitors • requires a great deal of trust between the partners

41. Competition Response Alliances Complementary Alliances Business-Level Cooperative Strategies: • competition response strategic alliances occur when firms join forces to respond to a strategic action of another competitor • because they can be difficult to reverse and expensive to operate, competition response strategic alliances are primarily formed to respond to strategic rather than tactical actions

42. Competition Response Alliances Uncertainty Reducing Alliances Complementary Alliances Business-Level Cooperative Strategies: • uncertainty reducing strategic alliances are used to hedge against risk and uncertainty • these alliances are most noticed in fast-cycle markets • alliance may be formed to reduce the uncertainty associated with developing new product or technology standards (i.e., share the risk of uncertain R&D investments)

43. Competition Response Alliances Uncertainty Reducing Alliances Competition Reducing Alliances Complementary Alliances Business-Level Cooperative Strategies: • competition reducing strategic alliances may be created to avoid destructive or excessive competition • explicit collusion exists when firms directly negotiate production output and pricing agreements in order to reduce competition (illegal) • tacit collusion exists when several firms in an industry indirectly coordinate their production and pricing decisions by observing each other’s competitive actions and responses

44. Competition Response Alliances Uncertainty Reducing Alliances Competition Reducing Alliances Complementary Alliances Business-Level Cooperative Strategies: • mutual forbearance is a form of tacit collusion in which firms avoid competitive attacks against those rivals they meet in multiple markets • competition reducing strategic alliances may require governments to find ways to permit collaboration among rivals without violating antitrust laws

45. Corporate-Level Cooperative Strategies • Corporate-level cooperative strategies are designed to facilitate product and/or market diversification • diversifying strategic alliance • synergistic strategic alliance • franchising • Diversifying alliances and synergistic alliances allow firms • to grow and diversify their operations • through a means other than a merger or acquisition

46. Diversifying Alliances Corporate-Level Cooperative Strategies: • diversifying strategic alliance allows a firm to expand into new product or market areas without completing a merger or an acquisition • provides some of the potential synergistic benefits of a merger or acquisition, but with less risk and greater levels of flexibility • permits a “test” of whether a future merger between the partners would benefit both parties

47. Synergistic Alliances Diversifying Alliances Corporate-Level Cooperative Strategies: Synergistic Alliances • synergistic strategic alliances create joint economies of scope between two or more firms • create synergy across multiple functions or multiple businesses between partner firms

48. International Cooperative Strategies • Cross-border strategic alliance • an international cooperative strategy in which firms with headquarters in different nations combine some of their resources and capabilities to create a competitive advantage • a firm may form cross-border strategic alliances to leverage core competencies that are the foundation of its domestic success to expand into international markets

49. Stable Alliance Network Network Cooperative Strategies: Stable Alliance Network • long term relationships that often appear in mature industries where demand is relatively constant and predictable • stable networks are built for exploitation of the economies available between firms

50. Technological/market similarity and alliance governance