porter five force mba - IV

Ch2-1

The External Environment:Opportunities, Threats, Industry

Competition, and Competitor Analysis

The External Environment:Opportunities, Threats, Industry

Competition, and Competitor Analysis

Ch2-2

Political/Legal

Political/Legal

EconomicEconomic

TechnologicalTechnological

GlobalGlobal

DemographicDemographicSocioculturalSociocultural

CompetitiveCompetitiveEnvironmentEnvironment

Industry Environment

Industry Environment

Components of the General EnvironmentComponents of the General Environment

Ch2-3

SWOT Analysis

• Strengths

• Weaknesses

• Opportunities

• Threats

Ch2-4

The purpose of SWOT Analysis

• It is an easy-to-use tool for developing an overview of a company’s strategic situation– It forms a basis for matching your

company’s strategy to its situation

Ch2-5

The purpose of Five-Forces Analysis

• The five forces are environmental forces that impact on a company’s ability to compete in a given market.

• The purpose of five-forces analysis is to diagnose the principal competitive pressures in a market and assess how strong and important each one is.

Ch2-6

Threat of New

Entrants

Threat of New

Entrants

Threat of New

Entrants

Threat of New

Entrants

Porter’s Five Forces Model of CompetitionPorter’s Five Forces Model of Competition

Ch2-7

Threat of New EntrantsThreat of New Entrants

Barriers to Entry

Barriers to Entry

Expected RetaliationExpected Retaliation

Government PolicyGovernment Policy

Economies of ScaleEconomies of Scale

Product DifferentiationProduct Differentiation

Capital RequirementsCapital Requirements

Switching CostsSwitching Costs

Access to Distribution ChannelsAccess to Distribution Channels

Cost Disadvantages Independent Cost Disadvantages Independent of Scaleof Scale

Ch2-8

Bargaining Power of Suppliers


Threat of New

Entrants

Threat of New

Entrants

Threat of New

Entrants


Ch2-9

Bargaining Power of SuppliersBargaining Power of Suppliers

Suppliers exert power in the industry by:Suppliers exert power in the industry by:

* Threatening to raise* Threatening to raiseprices or to reduce qualityprices or to reduce quality

Powerful suppliers can squeeze industry profitability if firms are unable to recover cost increases

Powerful suppliers can squeeze industry profitability if firms are unable to recover cost increases

Suppliers are likely to be powerful if:Suppliers are likely to be powerful if:

Supplier industry is dominated by a Supplier industry is dominated by a few firmsfew firms

Suppliers’ products have few substitutesSuppliers’ products have few substitutes

Buyer is not an important customer to Buyer is not an important customer to suppliersupplier

Suppliers’ product is an important Suppliers’ product is an important input to buyers’ productinput to buyers’ product

Suppliers’ products are differentiatedSuppliers’ products are differentiated

Suppliers’ products have high Suppliers’ products have high switching costsswitching costs

Supplier poses credible threat of Supplier poses credible threat of forward integrationforward integration

Ch2-10

Bargaining Power of Buyers


Threat of New

Entrants

Threat of New

Entrants

Threat of New

Entrants




Ch2-11

Bargaining Power of BuyersBargaining Power of Buyers

Buyers compete with the supplying

industry by:

Buyers compete with the supplying

industry by:

* Bargaining down prices* Bargaining down prices

* Forcing higher quality* Forcing higher quality

* Playing firms off of* Playing firms off ofeach othereach other

Buyer groups are likely to be powerful if:Buyer groups are likely to be powerful if:

Buyers are concentrated or purchases Buyers are concentrated or purchases are large relative to seller’s salesare large relative to seller’s sales

Purchase accounts for a significant Purchase accounts for a significant fraction of supplier’s salesfraction of supplier’s sales

Products are undifferentiatedProducts are undifferentiated

Buyers face few switching costsBuyers face few switching costs

Buyers’ industry earns low profitsBuyers’ industry earns low profits

Buyer presents a credible threat of Buyer presents a credible threat of backward integrationbackward integration

Product unimportant to qualityProduct unimportant to quality

Buyer has full informationBuyer has full information

Ch2-12

Threat of Substitute Products


Threat of New

Entrants

Threat of New

Entrants

Threat of New

Entrants






Ch2-13

Threat of Substitute ProductsThreat of Substitute Products

Products with similar function limit the prices firms can charge

Products with similar function limit the prices firms can charge

Keys to evaluate substitute products:Keys to evaluate substitute products:

Products with improving Products with improving price/performance tradeoffs price/performance tradeoffs relative to present industry relative to present industry productsproducts

Example:Example:

Electronic security systems in Electronic security systems in place of security guardsplace of security guards

Fax machines in place of Fax machines in place of overnight mail deliveryovernight mail delivery

Ch2-14



Threat of New

Entrants

Threat of New

Entrants

Threat of New

Entrants

Rivalry Among Competing Firms

in Industry

Rivalry Among Competing Firms

in Industry






Ch2-15

Rivalry Among Existing CompetitorsRivalry Among Existing Competitors

Intense rivalry often plays out in the following ways:Intense rivalry often plays out in the following ways:

Jockeying for strategic positionJockeying for strategic position

Using price competitionUsing price competition

Staging advertising battlesStaging advertising battles

Making new product introductionsMaking new product introductions

Increasing consumer warranties or serviceIncreasing consumer warranties or service

Occurs when a firm is pressured or sees an opportunityOccurs when a firm is pressured or sees an opportunity

Price competition often leaves the entire industry worse offPrice competition often leaves the entire industry worse off

Advertising battles may increase total industry demand, but Advertising battles may increase total industry demand, but may be costly to smaller competitorsmay be costly to smaller competitors

Ch2-16

CutthroatCutthroat competitioncompetition is more likely to occur when: is more likely to occur when:

Rivalry Among Existing CompetitorsRivalry Among Existing Competitors

Numerous or equally balanced competitorsNumerous or equally balanced competitors

Slow growth industrySlow growth industry

High fixed costsHigh fixed costs

Lack of differentiation or switching costsLack of differentiation or switching costs

High storage costsHigh storage costs

Capacity added in large incrementsCapacity added in large increments

High strategic stakesHigh strategic stakes

High exit barriersHigh exit barriers

Diverse competitorsDiverse competitors

Ch2-17

The Five Forces are Unique to Your Industry

• Five-Forces Analysis is a framework for analyzing a particular industry.– Yet, the five forces affect all the other

businesses in that industry.

Ch2-18

The auto manufacturing industry is considered to be highly capital and labor intensive. The major costs for producing and selling automobiles include:1.Labor2.Materials3.Advertising 4.Original Equipment Manufacturers (OEMs) 5.Replacement Parts Production and Distribution 6.Rubber Fabrication

Ch2-19

Key Players In North America, the automobile production market is dominated by what's known as the Big Three:

1.General Motors - Produces Chevrolet, Pontiac, Buick and Cadillac, among others. 2.Chrysler - Chrysler, Jeep and Dodge.

3.Ford Motor Co - Ford, Lincoln and Volvo.

Ch2-20

Two of the largest foreign car manufacturers are:

1.Toyota Motor Co 2.Honda Motor Co

Ch2-21

Porter's 5 Forces Analysis

1.Threat of New Entrants. It's true that the average person can't come along and start manufacturing automobiles. Historically, it was thought that the American automobile industry and the Big Three were safe. But this did not hold true when Honda Motor Co. opened its first plant in Ohio. The emergence of foreign competitors with the capital, required technologies and management skills began to undermine the market share of North American companies.

Ch2-22

2. Power of Suppliers The automobile supply business is quite

fragmented (there are many firms). Many suppliers rely on one or two automakers to buy a majority of their products. If an automaker decided to switch suppliers, it could be devastating to the previous supplier's business. As a result, suppliers are extremely susceptible to the demands and requirements of the automobile manufacturer and hold very little power.

Ch2-23

3.Power of Buyers. Historically, the bargaining power of automakers went

unchallenged. The American consumer, however, became disenchanted with many of the products being offered by certain automakers and began looking for alternatives, namely foreign cars. On the other hand, while consumers are very price sensitive, they don't have much buying power as they never purchase huge volumes of cars.

Ch2-24

4.Availability of Substitutes.

Be careful and thorough when analyzing this factor: we are not just talking about the threat of someone buying a different car. You need to also look at the likelihood of people taking the bus, train or airplane to their destination. The higher the cost of operating a vehicle, the more likely people will seek alternative transportation options

Ch2-25

5.Competitive Rivalry. Highly competitive industries generally earn low

returns because the cost of competition is high. The auto industry is considered to be an oligopoly, which helps to minimize the effects of price-based competition. The automakers understand that price-based competition does not necessarily lead to increases in the size of the marketplace; historically they have tried to avoid price-based competition, but more recently the competition has intensified - rebates, preferred financing and long-term warranties have helped to lure in customers, but they also put pressure on the profit margins for vehicle sales.

Ch2-26

BOSTON CONSULTING GROUP MATRIX

Ch2-27

INTRODUCTIONBOSTON CONSULTING GROUP (BCG)

MATRIX is developed by BRUCE HENDERSON of the BOSTON CONSULTING GROUP IN THE EARLY 1970’s.

According to this technique, businesses or products are classified as low or high performers depending upon their market growth rate and relative market share.

Ch2-28

Relative Market Share and Market Growth

To understand the Boston Matrix you need to understand how

market share and market growth interrelate.

Ch2-29

MARKET SHARE

• Market share is the percentage of the total market that is being serviced by your company, measured either in revenue terms or unit volume terms.

• RELATIVE MARKET SHARE

• RMS = Business unit sales this year Leading rival sales this year

• The higher your market share, the higher proportion of the market you control.

Ch2-30

MARKET GROWTHRATE

• Market growth is used as a measure of a market’s attractiveness.

• MGR = Individual sales - individual sales this year last year Individual sales last year • Markets experiencing high growth are ones where the

total market share available is expanding, and there’s plenty of opportunity for everyone to make money.

Ch2-31

THE BCG GROWTH-SHARE MATRIX

• It is a portfolio planning model which is based on the observation that a company’s business units can be classified in to four categories:

Stars Question marks Cash cows Dogs

• It is based on the combination of market growth and market share relative to the next best competitor.

Ch2-32

Ch2-33

STARSHigh growth, High market share

• Stars are leaders in business.

• They also require heavy investment, to maintain its large market share.

• It leads to large amount of cash consumption and cash generation.

• Attempts should be made to hold the market share otherwise the star will become a CASH COW.

Ch2-34

CASH COWS Low growth , High market share

• They are foundation of the company and often the stars of yesterday.

• They generate more cash than required.

• They extract the profits by investing as little cash as possible

• They are located in an industry that is mature, not growing or declining.

Ch2-35

DOGSLow growth, Low market share

• Dogs are the cash traps.

• Dogs do not have potential to bring in much cash.

• Number of dogs in the company should be minimized.

• Business is situated at a declining stage.

Ch2-36

QUESTION MARKSHigh growth , Low market share

• Most businesses start of as question marks.• They will absorb great amounts of cash if the

market share remains unchanged, (low).• Why question marks?• Question marks have potential to become star

and eventually cash cow but can also become a dog.

• Investments should be high for question marks.

Ch2-37

WHY BCG MATRIX ?

To assess : Profiles of products/businesses The cash demands of products The development cycles of products Resource allocation and divestment

decisions

Ch2-38

MAIN STEPS OF BCG MATRIX

• Identifying and dividing a company into SBU.• Assessing and comparing the prospects of each

SBU according to two criteria :

1. SBU’S relative market share.

2. Growth rate OF SBU’S industry.• Classifying the SBU’S on the basis of BCG

matrix.• Developing strategic objectives for each SBU.

Ch2-39

BCG MATRIX WITH CASH FLOW

Ch2-40

BENEFITS

• BCG MATRIX is simple and easy to understand.

• It helps you to quickly and simply screen the opportunities open to you, and helps you think about how you can make the most of them.

• It is used to identify how corporate cash resources can best be used to maximize a company’s future growth and profitability.

Ch2-41

LIMITATIONS

• BCG MATRIX uses only two dimensions, Relative market share and market growth rate.

• Problems of getting data on market share and market growth.

• High market share does not mean profits all the time.

• Business with low market share can be profitable too.

Ch2-42

Snack Foods Beverages

Foods

Frito-Lay North AmericaFrito-Lay International

Pepsi-Cola North AmericaGatorade/Tropicana North AmericaPepsiCo Beverages International

Quaker North America

Ch2-43

Snack Foods

Frito-Lay North America

Lay’sRuffles DoritosSantitasFritos CheetosRold Gold

Funyuns Sunchips Cracker Jack Chester’s popcornGrandma’s cookiesMunchos Smartfood Baken-ets fried pork skinsOberto meat snacks

Ch2-44

Snack Foods

Frito-Lay International

Bocabits wheat snacksCrujitos corn snacksFandangos corn snacksHamkas snacksNiknaks cheese sticksQuavers potato snacksSabritas potato chips Twisties cheese snacks

Walkers potato crispsWalkers Square potato snacksWalkers Monster Munch Corn snacks Miss Vickie’s potato chipsGamesa cookiesDippasSonric’s sweet snacks

Ch2-45

Snack Foods




Ch2-46

Beverages

Pepsi-Cola North America

Pepsi-ColaMountain DewSliceMugSierra MistFruitWorks

Lipton Dole Aquafina Frappuccino SoBe AMP

Ch2-47

Beverages

Gatorade/Tropicana North America

GatoradePropelTropicanaDole juices

Ch2-48

Beverages

PepsiCo Beverages International

Loóza juices and nectarsCopella juicesFrui’Vita juicesTropicana 100 juices

Ch2-49

Foods


Quaker OatsCap’n Crunch cerealLife cerealQuisp cerealKing Vitaman cerealMother’s cereal

Quaker rice cakes and granola barsRice-A-Roni side dishesNear East couscous/pilafsAunt Jemima mixes & syrupsQuaker grits

Ch2-50

Foods




Business Level Strategies

How are we going to compete and gain a competitive advantage in each of our businesses?

Ch2-51

Snack Foods Beverages

Foods

Corporate Level Strategy1) What businesses do we want to compete in?2) How do manage effectively across businesses

Ch2-52

Ch2-53

Ch2-54

54

Learning Outline

• Understand organizational strengths and weaknesses

• Understand the relationship between organizational resources, organizational capabilities, core competencies, and distinctive organizational capabilities

• Understand the Value Chain– Outsourcing

• How to do an Internal Analysis

• How to evaluate S&Ws

Ch2-55

55

SWOT Analysis

OrganizationStrengthsWeaknesses

Opportunities

Threats

Ch2-56

56

The Road to Competitive Advantage

OrganizationalResources

Financial assetsPhysical assetsHuman resourcesIntangible assetsStructural-cultural assets

OrganizationalCapabilities

Organizational processes and routines

Accumulated knowledgeActual work activities

CoreCompetencies

Distinctive OrganizationalCapabilities

Competitive Advantage

Performance Results

Ch2-57

57

The road to distinctive organizational capabilities


Organizational Capabilities •Fundamental building block for

developing core competencies • Organizational processes and

routines to get the work done

CoreCompetencies


ResourcesTangible

Intangible

Ch2-58

58



Organizational Capabilities •Fundamental building block for

developing core competencies •Organizational processes and

routines to get the work done

CoreCompetencies

Core Competencies•Fundamental skills and capabilities•Exploitable by organization•Major value-creating capabilities•Not a source of competitive advantage


Ch2-59

59

Types of Core Competencies

• After-sale service capability• Skills in manufacturing a high quality

product (BMW)• System to fill customer orders accurately

and swiftly (Amazon; Dell)• Expertise in integrating multiple

technologies to create families of new products (W.L. Gore)

Ch2-60

60



CoreCompetencies

Core Competencies •Not a source of competitive advantage •Fundamental skills and capabilities •Exploitable by organization •Major value-creating capabilities


Distinctive Organizational Capabilities

•Special and unique capabilities •Distinguish from competitors •Sustainable competitive advantage •Outperform competition

Ch2-61

61

Honda’s Distinctive Capability

Expertise in gasoline engine

technology and small engine

design

Ch2-62

62

Procter & Gamble’s Distinctive Capabilities

Superb marketing-distribution skills

and R&D capabilities in five core

technologies - fats, oils, skin

chemistry, surfactants, emulsifiers

Ch2-63

Company Countryof Origin

Original core Business Key skills

Growth path

Honda Japan Motor cycles Piston engine designand development

Cars, lawnmowers, smallgenerators

Gillette USA Shaving products

Advertisingeffectiveness

Other toiletries, e.g. deodorants

McDonald's USA Hamburger restaurants

Site selection; Quality

standardization

Extension of openinghours to includebreakfast; productinnovation (fish, pizza,salads)

Ch2-64

United does offer more space in its Economy Plus seats. But only travelers who pay full fare or who are elite members of the miles program can get them. Its regular economy-class seats measure in at 31 inches of seat pitch.

Ch2-65

65

From Distinctive capabilities to competitive advantage

DistinctiveOrganizational

Capabilities

• Contributes toSuperior CustomerValue

• Can Be Usedin a Varietyof Ways

• Is Difficultfor Competitorsto Imitate

Ch2-66

66

Capabilities vs. Core Competenciesvs. Distinctive Capabilities

• A company capability is the product of organizational learning and experience and represents real proficiency in performing an internal activity

• A core competence is a well-performed internal activity that is central (not peripheral or incidental) to a company’s competitiveness and profitability

• A distinctive Capability is a competitively valuable activity that a company performs better than its rivals

Ch2-67

67

Value Chain Analysis

MARG

IN

MARGIN

SupportActivities{

Procurement

Technological Development

Human Resource Management

Firm Infrastructure

Primary Activities{Inbo

und

Logi

stic

s

Ope

ratio

ns

Out

boun

d Lo

gist

ics

Mar

ketin

g an

d Sa

les

Serv

ice

Ch2-68

68

From Value Chain Analysisto Competitive Advantage

Sustainable competitive advantage can be created by

1.Managing value chain activities better than rivals and/or

2.Developing distinctive value chain capabilities to serve customers!

Ch2-69

69

Other types of Internal Analysis

• Internal audit– Look at all functional areas and see which are

performing well

• Capabilities assessment profile– Analyze capabilities to identify potential

sources of competitive advantage

Ch2-70

70

Appeal of Outsourcing

• Outsourcing non-critical activities allows a firm to concentrate its energies and resources on those value-chain activities where it– Can create unique value

– Can be best in the industry

• Advantages to outsourcing– Decrease internal bureaucracies

– Flatten organization structure

– Provide firm with heightened strategic focus

Ch2-71

71

How do you do an internal analysis?

Step 1

Step 2

Step 3

Step 4

Step 5

Prepare current product-market profile.

Identify sources of competitiveadvantage and disadvantage inthe main product-market segments.

Describe all the organizationalcapabilities and competencies.

Sort the core capabilities andcompetencies according tostrategic importance.

Identify and agree onthe key capabilitiesand competencies.

Ch2-72

72

Identify Strategy-Critical Activities

• Which activities are strategy-critical depends – Particulars of a firm’s strategy– Value-chain make-up– Competitive requirements– External market conditions

• Identify strategy-critical activities– What business processes have to be performed extra well

or in timely fashion to achieve competitive advantage?– In what value-chain activities would poor work performance

impair strategic success?

Ch2-73

73

Criteria to Judge Organizational Strengths and Weaknesses

Are organizational resources and capabilitiesstrengths or weaknesses?

Past Performance Trends

Specific Goals or Targets

Comparison Against Competitors

Personal Opinions of StrategicDecision Makers or Consultants

Ch2-74

PRACTICAL USE

• MAHINDRA & MAHINDRA

• HLL

• IES

Ch2-75

BCG MATRIX

scorpio

Jeepbalero

Ch2-76

CONCLUSION

Though BCG MATRIX has its limitations it is one of the most FAMOUS AND SIMPLE portfolio planning matrix ,used by large companies having multi-products.

Ch2-77

Section 5

Corporate Level Strategy: Creating Value through

Diversification

Ch2-78

Vertical Integration

• Forward or backwards– Full integration– Taper integration

• Benefits– Barrier to entry– Specialized assets– Protecting product quality– Improved scheduling

• Risks– Costs– Rapid technological changes– Demand predictability

Ch2-79

Alternatives to Vertical Integration

• Competitive bidding

• Long term contracts or strategic alliances– Hostage taking– Credible commitments– Maintaining market discipline

Ch2-80

Outsourcing

• Cost reduction and differentiation

• Hold-ups, scheduling and hallowing out

Ch2-81

Snack Foods Beverages Foods

Frito-Lay North AmericaFrito-Lay International

Pepsi-Cola North AmericaGatorade/Tropicana North AmericaPepsiCo Beverages International


Ch2-82

Snack Foods

Frito-Lay North America

Lay’sRuffles DoritosSantitasFritos CheetosRold Gold

Funyuns Sunchips Cracker Jack Chester’s popcornGrandma’s cookiesMunchos Smartfood Baken-ets fried pork skinsOberto meat snacks

Ch2-83

Snack Foods




Ch2-84

Snack Foods




Ch2-85

Beverages

Pepsi-Cola North America

Pepsi-ColaMountain DewSliceMugSierra MistFruitWorks

Lipton Dole Aquafina Frappuccino SoBe AMP

Ch2-86

Beverages

Gatorade/Tropicana North America

GatoradePropelTropicanaDole juices

Ch2-87

Beverages

PepsiCo Beverages International

Loóza juices and nectarsCopella juicesFrui’Vita juicesTropicana 100 juices

Ch2-88

Foods




Ch2-89

Foods




Business Level Strategies

How are we going to compete and gain a competitive advantage in each of our businesses?

Ch2-90

Snack Foods Beverages Foods

Corporate Level Strategy1) What businesses do we want to compete in?2) How do manage effectively across businesses

Ch2-91

Where did they go?

Ch2-92

Crafting Corporate Strategy

Moves to enter new businesses

Boosting combined performance of the businesses

Capturing synergies and turning them into competitive advantages

Establishing investment priorities and steering resources into business units

Ch2-93

How to Diversify?

1) Internal Development - corporate entrepreneurship– able to appropriate a larger portion of wealth– avoids complexities of multiple partners– time consuming and requires diversity of

organizational capabilities

Ch2-94

How to Diversify?

2) Strategic Alliances and Joint Ventures– entering a new market via the combination of

complementary resources - do more together– cost reduction– development/diffusion of technology

Problems with– appropriate partners - skills and compatibility– trust and commitment– communication

Ch2-95

Who Makes a Geo?

Geo Storm was actually manufactured by Isuzu. The Storm is the Isuzu Impulse.

Geo Prizm = Toyota Corolla

Geo Tracker = Suzuki Sidekick

Geo Metro = Suzuki Esteem or Swift w/hatchback

No Geo cars were actually made by General Motors. They were all imported from foreign manufacturers.

Ch2-96

Ch2-97

Ch2-98

How to Diversify?

3) Merger & Acquisition - acquisition of assets and capabilities of another company– high tech & technology intensive– access to products– consolidation– access to segments

Ch2-99

Alternative 10 point option

• In lieu of making a donation, you may write a 5 page, double spaced paper on how a specific company proactively pursues corporate responsible activities.

Ch2-100

Extra Credit – 10 points

• Girls’ and Boys’ Town, the original Father Flanagan's Boys' Home, is a leader in the treatment and care of abused, abandoned and neglected girls and boys. Throughout its 86-year history, the nonprofit, nonsectarian organization has provided these children with a safe, caring, loving environment where they gain confidence to get better and learn skills to become productive citizens.

Ch2-101

Extra Credit – 10 points

Bring one of the items listed below:

New/gently used backpacks or suitcases

Socks - 5 pairs

Shampoo and Conditioner – 3 pints

New/gently used sporting equipment

Refill bottle of 409/All purpose cleaner

Laundry detergent

Ch2-102

Extra Credit Drop off

BA1 Building - Room 307 Times: Wednesday 3/30 4:00 pm – 6:30 pm

Thursday 3/31 8:30 am – 9:30 am11:30 am – 8:00 pm

Friday 4/1 8:30 am – 11:00 amMonday 4/4 1:00 pm – 6:00 pmTuesday 4/5 8:30 am – 9:00 am

2:30 pm – 5:00 pmWednesday 4/6 4:00 pm – 6:30 pmThursday 4/7 8:30 am – 9:30 am

11:30 am – 8:00 pm

Ch2-103

Ch2-104

Ch2-105

Acquisitions

Reasons of Acquisitions

Increase Market Power

Overcome Entry Barriers

Increased Speed

Lower Risk

Avoid Competition

Ch2-106

Acquisitions




Increased Speed

Lower Risk

Avoid Competition

Problems with Acquisitions

Integration of two firms

Overpayment/Debt

Overestimation of Synergy

Overdiversification

Managerial energy absorption

Become too large

Substitute for innovation

Ch2-107

Acquisitions




Increased Speed

Lower Risk

Avoid Competition

Problems with Acquisitions

Integration of two firms

Overpayment/Debt

Overestimation of Synergy

Overdiversification

Managerial energy absorption

Become too large

Substitute for innovation

Results

Poor Performance

Who Wins?

Acquired FirmShareholders

Ch2-108

Monday October 27th WSJ

• Bank of American – Boston Fleet Financial– BoA down $8.29, or 10%, BFF rose 23%

• Anthem – WellPoint Health Networks– Anthem down 8.2%, WellPoint up 8.8%

• United Health – MidAtlantic Med Services– UH down 4.9%, MAMS up 9.7%

Ch2-109

Failures of Acquisitions

30 - 40% average acquisition premium

Acquiring firm’s value drops 4% in the 3 months following acquisitions

30 - 50% of acquisitions are later divested

Acquirers underperform S&P by 14%, peers by 4%

3 month performance before and after– 30% substantial losses, 20% some losses, 33%

marginal returns, 17% substantial returns

Ch2-110

Why, then, do executives acquire?

Often, for personal reasons

Firm size and executive compensation are related

When do executives loss their jobs?– 1) Acquired - larger firms harder to acquire– 2) Performing poorly - employment risk is

reduced as returns are less volatile

Ch2-111

Levels of Diversification

Single Business Unit - vast majority of sales comes from a single business

Less ambiguity

Ear to the ground re: industry and competition

Eggs in one basket

Ch2-112

Ch2-113

Ch2-114

Related Diversification at Disney

Entertainment/Production

Theme Parks

Resorts

Entertainment/Broadcasting

Cruise Lines

Retailing

Ch2-115

Levels of Diversification (cont.)

Related Diversification - entering product markets that share some resource or capability requirements with the current business – horizonal relationships across businesses

Advantages of related diversification include: Leveraging Core Competencies Sharing Activities Market Power Vertical Integration - integration of preceding or

successive productive processes - Shaw Industries buying a fiber company or floor covering retailer.

Ch2-116

Vertical Integration

Benefits

– can not be held hostage – reduces buyer/supplier power

– greater control over operations

– access to new business/technologies

– reduce procurement and sales efforts

Risks

– increased overhead, capital and administrative costs

– loss of flexibility

– unbalanced capacities

– reaction of competitors

Ch2-117

Ch2-118

Tyco ElectronicsTyco TelecommunicationsTyco Fire and SecurityTyco Safety ProductsTyco HealthcareTyco PlasticsTyco AdhesivesTyco Flow ControlTyco Electrical and Metal ProductsTyco Fire and Building ProductsTyco Infrastructure Services

Ch2-119

Tyco

Limits itself to businesses that can be held strictly accountable for a few key financial measures

Mature, stable, low-tech industries which face certain environments and little R&D investments

Ch2-120

Levels of Diversification (cont.)

Unrelated Diversification - few similarities in the resources and capabilities required among the firm’s businesses

Conglomerate Diversification - no relatedness between businesses

Ch2-121

Unrelated/Conglomerate Diversification

Attempts to create value through the management of vertical relationships among the businesses

Approve plans and budgets, competent legal, financial, accounting, HR or other support function

Effective control systems

Restructuring - buy low, sell high– spinoffs– turnaround

Ch2-122

Creating Value through Restructuring

Good, consistent job of making good investments

Favorable negotiations

Shrewd selling at the top

Shifting investment to high growth/return businesses

Ch2-123

When/Why to Diversify?

To create shareholder value

Porter’s Three Point Test

1) Attractiveness Test

2) Cost of Entry Test

3) Better off Test

Should pass all 3

Ch2-124

Portfolio analysis

• BCG Growth-Share Matrix– question marks, dogs, cash cows, stars

• GE- Nine Cell Matrix

Ch2-125

Gro

wth

Rat

eRelative Market Share

StarsQuestionMarks

CashCows

Dogs

Boston Consulting Group Matrix

Ch2-126

Gro

wth

Rat

e

Relative Market Share

1.0High Low

Soft Drinks

FritoLay

KFC

PizzaHut

TacoBell

Low

High

10%

BCG Matrix for PepsiCo - Early 1990s

Ch2-127

Gro

wth

Rat

e

Relative Market Share

.75High Low

Soft Drinks

FritoLay

KFC

PizzaHutTaco

Bell

Low

High

5%

BCG Matrix for PepsiCo - Early 1990s

Ch2-128

Competitive StrengthsA

ttra

ctiv

enes

s

Invest Grow

Low

High

LowHigh

HarvestDivest

Hold

GE 9 Cell Matrix

Ch2-129

Competitive StrengthsA

ttra

ctiv

enes

s

Low

High

LowHigh

GE 9 Cell Matrix for Pepsico

Soft Drinks

Snack Foods

Ch2-130

GM provides health care for 1.1 million workers and retirees, which adds about $1,500 to the average cost of every vehicle it sells in the U.S.

For 2005, GM has forecast $5.6 billion in health-care costs, up about $1 billion from 2004. It has blamed its recent fall in profit on the rising cost of providing medical care for workers and retirees.

Ch2-131

United does offer more space in its Economy Plus seats. But only travelers who pay full fare or who are elite members of the miles program can get them. Its regular economy-class seats measure in at 31 inches of seat pitch.

Ch2-132

Board of Directors

Governance mechanism of owners to oversee, evaluate and ratify the actions of management– setting corporate strategy, direction, mission,

values– hire/fire CEO/TMT– control, monitor, supervise TMT– review/approve resource allocations– protect shareholders interests

Ch2-133

Board of Directors

Sam Nunn- ex-Senator from Georgia sits on Coke’s and Dell’s Board

Nancy Reagan sat on Revlon’s board

Hank Aaron sat on Coke’s board

Sally Ride sat on three boards

Martha Stewart and Kim Alexis sat on Drugstore.com

Al Haig and Colin Powell sat on AOL’s board

Ch2-134

Board Involvement

Mostly little or no involvement

Boards tend to be dominated by management

Keys to board power– CEO/Chairman duality– insiders vs. outsiders

• outsiders often weak, unknowledgeable

– effective board process

Ch2-135

Trends in Governance

Institutional investors becoming increasingly powerful

Special interests groups and social institutional owners

Internationalization of board composition

Presiding and Lead Directors – 1/3 of S&P 500 – Presiding run meetings sans CEOs, Leads are actively involved

Ch2-136

Median CEO pay rose 14% to $13.2 million is a year when S&P was down over 22%

One company’s stock slides 71%, CEO compensation falls 12%

….. to only $82 million

….. Dennis Kozlowski – Tyco’s frequently indicted CEO

….. which is not as bad as what the CFO made - $136 million

Bob Nardelli at HD has a “target bonus” minimum of $3 million and could get as much as $82 million upon his exit.

James McNerney – “cause shall not include any one or more of the following: bad judgment or negligence.”

Executive Compensation - 2002

Ch2-137

Steve Jobs, Apple 78.1M -34.6

David Cote, Honeywell

68.5M -27.3%

John Chamber, Cisco 54.8M -27.7

Pat Russo, Lucent 38.2M -75.4%

Scott McNealy, Sun Microsystems

31.7M -74.7%

Ch2-138

Executive Compensation

Aligning the interests of shareholders and managers by rewarding them for pursuing their interests

Peter Drucker - “There are only bad and worse executive compensation packages. Most encourage the top management to milk the company”

Warren Buffett - “...mediocre CEOs are getting incredibly overpaid”

Top execs make over 200 times the average worker, up from 44 only 30 years ago.

Ch2-139

Executive Compensation

Bonuses, incentives and stock ownership– difficulty in evaluating decision making

• financial objectives used– lengthy feedback period– beyond managerial control– managerial manipulation

Stock Options– riding the stock market wave– strike period is too long– growth, not cost-cutting, should be rewarded– require holding the stock after exercise– make exercise conditional on certain criteria

Ch2-140

Corporate Social Performance

• Friedman – “The Social Responsibility of Business Is to Increase Its Profits“

• Corporations as Citizens• Corporations dependent upon its stakeholders• Corporations that are attentive to its

stakeholders can gain competitive advantages• Corporations, which control resources beyond

those held by individuals, have an even greater responsibility to be “good citizens”

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