CH-7-8 Merger and Acquisition Strategies – Strategic Management: Concepts and Cases: Competitiveness and Globalization : Chapter Notes

This Document Contains Chapters 7 to 8 Chapter 7 Merger and Acquisition Strategies LEARNING OBJECTIVES 1. Explain the popularity of merger and acquisition strategies in firms competing in the global economy. 2. Discuss reasons why firms use an acquisition strategy to achieve strategic competitiveness. 3. Describe seven problems that work against achieving success when using an acquisition strategy. 4. Name and describe the attributes of effective acquisitions. 5. Define the restructuring strategy and distinguish among its common forms. 6. Explain the short- and long-term outcomes of the different types of restructuring strategies. CHAPTER OUTLINE Opening Case Strategic Acquisitions and Accelerated Integration of Those Acquisitions Are a Vital Capability of Cisco Systems THE POPULARITY OF MERGER AND ACQUISITION STRATEGIES Mergers, Acquisitions, and Takeovers: What Are the Differences? REASONS FOR ACQUISITIONS Increased Market Power Overcoming Entry Barriers Strategic Focus Cross-Border Acquisitions by Firms from Emerging Economies: Leverage Resources to Gain a Larger Global Footprint and Market Power Cost of New Product Development and Increased Speed to Market Lower Risk Compared to Developing New Products Increased Diversification Reshaping the Firm’s Competitive Scope Learning and Developing New Capabilities PROBLEMS IN ACHIEVING ACQUISITION SUCCESS Integration Difficulties Inadequate Evaluation of Target Large or Extraordinary Debt Inability to Achieve Synergy Too Much Diversification Managers Overly Focused on Acquisitions Too Large EFFECTIVE ACQUISITIONS RESTRUCTURING Downsizing Downscoping This Document Contains Chapters 7 to 8 Leveraged Buyouts Strategic Focus Strategic Positioning of Private Equity Buyout Firms (General Partners) Restructuring Outcomes SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES VIDEO CASE LECTURE NOTES Chapter Introduction: With continued merger and acquisition activity, this chapter is very important. Much of the chapter’s material is summarized in Figure 7.1, which can be used to help students mentally organize what they learn in the chapter about mergers and acquisitions by examining reasons of acquisitions and problems in achieving success. OPENING CASE Strategic Acquisitions and Accelerated Integration of Those Acquisitions Are a Vital Capability of Cisco Systems The Opening Case on Cisco Systems sets up the central theme for Chapter 7—acquisition strategy. The next stage of Cisco’s evolution appears to be “the Internet of everything” connecting people, processes, data, and things. Throughout its history Cisco Systems has used acquisition strategy to build network products and strategically extend their reach into new areas – related and unrelated. In the Opening Case, several of Cisco’s recent acquisitions are listed. It should be noted that in the IT sector, 90 percent of acquisitions fail. However, Cisco’s failure rate is only one in three – still significant, but far below industry norms. Cisco has developed a distinct ability to integrate acquisitions. In addition to due diligence to make sure they price they pay for companies is reasonable, it also develops a detailed plan for possible post-merger integration to ensure that anticipated value is achieved. Teaching Note: In fast-cycle industries, like those built around information technology, companies often lack the time to develop businesses or capabilities that it needs to complement their existing businesses or capitalize on changing external conditions in a timely manner. Acquisitions can help firms achieve their objectives much faster than other options. To drive this point home, ask students why Cisco doesn’t just develop internally the businesses/capabilities that it obtains through acquisitions. Then, ask students why they think the target firms agreed to be acquired. Students should realize that truly successful acquisitions provide benefits to both parties. 1 Explain the popularity of acquisition strategies in firms competing in the global economy. In the latter half of the 20th century, acquisition became a prominent strategy used by major corporations to achieve growth and meet competitive challenges. Even smaller and more focused firms began employing acquisition strategies to grow and enter new markets. However, acquisition strategies are not without problems; a number of acquisitions fail. Thus, the chapter focuses on how acquisitions can be used to produce value for the firm’s stakeholders. THE POPULARITY OF MERGER AND ACQUISITION STRATEGIES Acquisitions have been a popular strategy among US firms for many years. Some believe that this strategy played a central role in the restructuring of US businesses during the 1980s, 1990s, and into the 21st century. Increasingly, acquisition strategies are becoming more popular with firms in other nations (e.g., those of Europe). In fact, about 40 to 45 percent of the acquisitions in recent years have been made across country borders (i.e., where a firm headquartered in one country acquires a firm headquartered in another country). Merger and acquisition trends: • There were five waves of mergers and acquisitions in the 20th century, the last two in the 1980s and 1990s. • There were 55,000 acquisitions valued at $1.3 trillion in the 1980s. • Acquisitions in the 1990s exceeded $11 trillion in value. • World economies (especially the US economy) slowed in the new millennium, reducing M&As completed. • Mergers and acquisitions peaked in 2000 at about $3.4 billion and fell to about $1.75 billion in 2001. • The global volume of announced acquisition agreements was up 41 percent from 2003 to $1.95 trillion for 2004, the highest level since 2000, and the pace in 2005 was significantly above the level of 2004. • Although the frequency of acquisitions has slowed, their number remains high. • In the latest acquisition boom between 1998 and 2000, acquiring firm shareholders experienced significant losses relative to the losses in all of the 1980s. A firm may make an acquisition to do the following: • Increase its market power because of a competitive threat • Enter a new market because of an available opportunity • Spread the risk due to the uncertain environment • Shift its core business into more favorable markets (e.g., because of industry or regulatory changes) Evidence suggests that at least for acquiring firms, acquisition strategies may not result in desirable outcomes. Studies have found that shareholders of acquired firms often earn above- average returns from an acquisition, whereas shareholders of acquiring firms are less likely to do so. In approximately two-thirds of all acquisitions, the acquiring firm’s stock price falls immediately after the intended transaction is announced, indicating investors’ skepticism about the likelihood that the acquirer will be able to achieve the synergies required to justify the premium. Mergers, Acquisitions, and Takeovers: What Are the Differences? Before starting the discussion of the reasons for acquisitions, problems related to acquisitions, and long-term performance, three terms should be defined because they will be used throughout this chapter and Chapter 10. A merger is a transaction where two firms agree to integrate their operations on a relatively co-equal basis because they have resources and capabilities that together may create a stronger competitive advantage. An acquisition is a transaction where one firm buys a controlling or 100 percent interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio. Whereas most mergers represent friendly agreements between the two firms, acquisitions sometimes can be classified as unfriendly takeovers. A takeover is an acquisition—and normally not a merger—where the target firm did not solicit the bid of the acquiring firm and often resists the acquisition (a hostile takeover). 2 Discuss reasons why firms use an acquisition strategy to achieve strategic competitiveness. REASONS FOR ACQUISITIONS Teaching Note: You may find it helpful to refer students to Figure 7.1, which lists the reasons for acquisitions (discussed more fully in the sections that follow). Increased Market Power As discussed in Chapter 6, a primary reason for acquisitions is that they enable firms to gain greater market power. Acquisitions to meet a market power objective generally involve buying a supplier, a competitor, a distributor, or a business in a highly related industry. Though a number of firms may feel that they have an internal core competence, they may be unable to exploit their resources and capabilities because of a lack of size. Horizontal Acquisitions When a competitor in the same industry is acquired, a firm has engaged in a horizontal acquisition. Horizontal acquisitions increase a firm’s market power by exploiting cost-based and revenue-based synergies. Research suggests that horizontal acquisitions of firms with similar characteristics result in higher performance than when firms with dissimilar characteristics combine their operations. Examples of important similar characteristics include strategy, managerial styles, and resource allocation patterns. Horizontal acquisitions are often most effective when the acquiring firm integrates the acquired firm’s assets with its own assets, but only after evaluating and divesting excess capacity and assets that do not complement the newly combined firm’s core competencies. Vertical Acquisitions A vertical acquisition has occurred when a firm acquires a supplier or distributor that is positioned either backward or forward in the firm’s cost/activity/value chain. Related Acquisitions When a target firm in a highly related industry is acquired, the firm has made a related acquisition. Teaching Note: Remind students that, as discussed in Chapter 6, during the 1960s and 1970s, both horizontal and related acquisitions were discouraged as they were regularly challenged by agencies of the federal government. The ability of firms to make horizontal acquisitions increased in the 1980s because of changes in the interpretation and enforcement of antitrust laws and regulations by the courts and the Justice Department. It is important to note that acquisitions intended to increase market power are subject to regulatory review, as well as analysis by financial markets. Overcoming Entry Barriers As discussed in Chapter 2, barriers to entry represent factors associated with the market and/or firms operating in the market that make it more expensive and difficult for new firms to enter the market. It may be difficult to enter a market dominated by large, established competitors. As noted in Chapter 2, such markets may require: • Investments in large-scale manufacturing facilities that enable the firm to achieve economies of scale so that it can offer competitive prices • Significant expenditures in advertising and promotion to overcome brand loyalty toward existing products • Establishing or breaking into existing distribution channels so that goods are convenient to customers When barriers to entry are present, the firm’s best choice may be to acquire a firm already having a presence in the industry or market. In fact, the higher the barriers to entry into an attractive market or industry, the more likely it is that firms interested in entering will follow acquisition strategies. Entry barriers firms face when trying to enter international markets are often great. Commonly, acquisitions are used to overcome entry barriers in international markets. It is important to compete successfully in these markets since global markets are growing faster than domestic markets. Also, five of the emerging markets (China, India, Brazil, Mexico, and Indonesia) are among the fastest growing economies in the world. STRATEGIC FOCUS Cross-Border Acquisition by Firms from Emerging Economies: Leverage Resources to Gain a Larger Global Footprint and Market Power In the Strategic Focus a number of cross-border acquisitions, in which the acquiring firm is from an emerging market country, and the target firm is from a developed market country, are identified. Many of these recent acquisitions are focusing on consumer markets (as opposed to infrastructure) where acquirers bring technologies from the target firms into their own domestic markets where the middle class is large and growing. Examples include acquirers from Spain, China, Mexico, Egypt, India, and Brazil. Through these types of acquisitions, emerging market firms are able to enter foreign developed country markets as well as industries outside their domestic market. However, research indicates that emerging market acquirers (especially government-owned entities) tend to pay a higher purchase premium and must contend with more political scrutiny than firms from other developed countries. Emerging market cross-border acquisitions of developed country firms are likely to continue as emerging market economies have significant financial reserves. In addition to the economics of these deals, acquirers are able to bring acquired technologies/knowledge back to their domestic markets. Teaching Note: Students may be surprised that cross-border acquisitions of the type described in the Strategic Focus are taking place. The more accepted scenario is one in which developed market acquirers purchase firms in emerging markets. Though emerging market acquirers may have the resources and opportunity to engage in cross-border acquisitions of developed market companies, capabilities to manage/integrate the acquired firms is another issue. Ask students to identify the skill sets/capabilities that emerging market acquirers should possess to ensure that their developed market acquisitions perform at acceptable levels. Cross-Border Acquisitions Acquisitions between companies with headquarters in different countries are called cross- border acquisitions. Teaching Note: Chapter 9 examines cross-border alliances and the justification for their use. Cross-border acquisitions and cross-border alliances are alternatives firms consider while pursuing strategic competitiveness. Compared to a cross-border alliance, a firm has more control over its international operations through a cross-border acquisition. Historically, US firms have been the most active acquirers of companies outside their domestic market. However, in the global economy, companies throughout the world are choosing this strategic option with increasing frequency. In recent years, cross-border acquisitions have represented as much as 40 percent of the total number of acquisitions made annually. Some trends in cross-border acquisitions: • Because of relaxed regulations, the amount of cross-border activity among nations within the European community also continues to increase. • Many large European corporations have approached the limits of growth within their domestic markets and thus seek growth in other markets. • Many European and US firms participated in cross-border acquisitions across Asian countries that experienced a financial crisis due to significant currency devaluations in 1997, and this facilitated the survival and restructuring of many large Asian companies such that these economies recovered more quickly than they would have otherwise. Acquisitions represent a viable strategy for firms that wish to enter international markets because: • This may be the fastest way to enter new markets • They provide more control over foreign operations than do strategic alliances with a foreign partner Cost of New Product Development and Increased Speed to Market Acquisitions also may represent an attractive alternative to developing new products internally due to the cost and time required to start a new venture and achieve a positive return. Also of concern to firms’ managers is achieving adequate returns from the capital invested to develop and commercialize new products—an estimated 88 percent of innovations fail to achieve adequate returns. Perhaps contributing to these less-than-desirable rates of return is the successful imitation of approximately 60 percent of innovations within four years after the patents are obtained. Because of outcomes such as these, managers often perceive internal product development as a high-risk activity. Internal development of new products is often perceived by managers to be costly and to represent high risk investments of firm resources. Although sometimes costly, it may be in the firm’s best interest to acquire an existing business because: • The acquired firm has established sales volume and customer base, thus yielding predictable returns. • The acquiring firm gains immediate market access. In addition to representing attractive prices, large pharmaceutical firms have used acquisitions to supplement products in the pipeline with projects from undervalued biotechnology companies; thus, this is one way to appropriate new products. Lower Risk Compared to Developing New Products As discussed earlier, internal product development processes can be risky, in that entering a market and earning an acceptable return on investment requires significant resources and time. All the same, acquisition outcomes can be estimated easily and accurately (as compared to the outcomes of an internal product development process), causing managers to view acquisitions as carrying lowering risk. Teaching Note: Not long ago, P&G acquired premium dog and cat food manufacturer Iams Co. to support the launch of its pet products into supermarket chains and mass merchandisers such as Walmart. Having assessed the potential of Iams in the marketplace, P&G managers were confident they would achieve positive results through their strategy; thus, they may have considered entry into the premium pet-food market through acquisition to be less risky than entering the market via internal product development. Because acquisitions recently have become such a common means of avoiding risky internal ventures, they could become a substitute for innovation, which has a serious downside (e.g., the decline of Cisco systems). Teaching Note: Although they often enable firms to offset the risk of internal ventures and of developing new products, acquisitions are not without risks of their own. Acquisition-related risks are discussed later in this chapter. Increased Diversification It should be easier for firms to develop new products and/or new ventures within their current markets because of market-related knowledge, but firms that desire to enter new markets may find that current product-market knowledge and skills are not transferable to the new target market. Acquisitions also may have gained in popularity as a related or horizontal diversification strategy (enabling rapid moves into related markets or to expand market power) and as an unrelated diversification strategy because of the changes in regulatory interpretation and enforcement of antitrust laws discussed in Chapter 6. Using acquisitions to diversify a firm is the quickest and often the easiest way to change its portfolio of businesses—e.g., Goodrich evolved from a tire maker to a top-tier aerospace supplier through 40+ acquisitions. Firms must be careful when making acquisitions to diversify their product lines because horizontal and related acquisitions tend to contribute more to strategic competitiveness, and thus they are more successful than diversifying acquisitions. Teaching Note: Remember, related diversification seeks lower costs through economies of scope, synergy, and resource sharing, whereas unrelated diversification hopes to realize financial economies and better internal resource allocation among diverse businesses. Reshaping the Firm’s Competitive Scope To reduce intense rivalry’s negative effect on financial performance, a firm may use acquisitions as a way to restrict its dependence on a single or a few products or markets. Teaching Note: The following are examples of auto manufacturers that have gone through acquisitions to reduce dependence of too few businesses: • General Motors acquired Electronic Data Systems and Hughes Aerospace to lessen its dependence on the domestic automobile market (where its market share had declined from approximately 50 percent in 1980 to less than 30 percent 10 years later) and escape intense competition with Japanese automakers. However, GM later sold these businesses to focus its efforts on its core automobile business. • DaimlerChrysler considered expanding into financial and computer services, aftermarket sales, and electronics and satellite systems to pursue more desirable operating margins in areas that are more attractive than are alliances or acqhuisitions in car manufacturing. • Ford management considered making the company the world’s leading consumer services business that specializes in the automotive sector by tapping all sectors in after-sales markets, including repairs, replacement parts, and product servicing. To evaluate its success in reshaping the firm’s competitive scope through diversification, Ford would measure its performance against world-class consumer firms, regardless of industry (i.e., rather than using the traditional yardsticks of rival automakers). Learning and Developing New Capabilities Some acquisitions are made to gain capabilities that the firm does not possess—e.g., acquisitions used to acquire a special technological capability. Acquiring other firms with skills and capabilities that differ from its own helps the acquiring firm learn new knowledge and remain agile, but firms are better able to learn these capabilities if they share some similar properties with the firm’s current capabilities. One of Cisco System’s primary goals in its early acquisitions was to gain access to capabilities that it did not currently possess through its commitment to learning. The firm developed an intricate process to quickly integrate the acquired firms and their capabilities (knowledge) after an acquisition is completed. Figure Note: Figure 7.1 presents the reasons for making acquisitions and the problems encountered. A comment that problems are discussed in ensuing sections is appropriate. 3 Describe seven problems that work against developing competitive advantage using an acquisition strategy. PROBLEMS IN ACHIEVING ACQUISITION SUCCESS Research suggests that perhaps 20 percent of all mergers and acquisitions are successful, approximately 60 percent produce disappointing results, and the last 20 percent are clear failures. Successful acquisitions generally involve a well-conceived strategy in selecting the target, the avoidance of paying too high a premium, and employing an effective integration process. A number of problems accompany an acquisition strategy. Acquisition-related problems shown in Figure 7.1 that are discussed in this section are: • Difficulties integrating the two firms after the acquisition is completed • Paying too much for the target (acquired) firm or inappropriately or inadequately evaluating the target • The cost of financing the acquisition, related to large or extraordinary debt • Overestimating the potential for gains from capabilities and/or synergy • Excessive or too much diversification • Management being preoccupied or overly focused on acquisitions • The combined firm becoming too large Integration Difficulties Integration problems or difficulties that firms often encounter can take many forms. Among them are: • Melding disparate corporate cultures • Linking different financial and control systems • Building effective working relationships (especially when management styles differ) • Problems related to differing status of acquired and acquiring firms’ executives The importance of integration success should not be underestimated. Without successful integration, a firm achieves financial diversification, but little else. Consider these points. • The post-acquisition integration phase may be the single most important determinant of shareholder value creation (or value destruction) in mergers and acquisitions. • Managers should understand the large number of activities associated with integration processes. Teaching Note: Several years ago, Intel acquired Digital Equipment’s semiconductors division. On the day Intel began to integrate the acquired division into its operations, six thousand deliverables were to be completed by hundreds of employees working in dozens of countries. FIGURE 7.1 Reasons for Acquisitions and Problems in Achieving Success Seven reasons for acquisitions are presented in the left column whereas seven problems in achieving acquisition success are presented in the right hand bubble-column of Figure 7.1. To summarize, the seven reasons that firms (and managers) implement acquisition strategies are to: • Increase market power • Overcome entry barriers • Reduce the cost of new product development and increase speed to market • Lower risk compared to developing new products • Increase diversification • Avoid excessive competition • Learn and develop new capabilities The seven reasons for poor performance of acquisitions or problems faced in attempts to achieve success are: • Integration difficulties • Inadequate evaluation of target • Large or extraordinary debt • Inability to achieve synergy • Too much diversification • Managers overly focused on acquisitions • Too large Note: Problems encountered as firms try to successfully achieve their objectives and create value from acquisitions are discussed in detail in the next sections of this chapter. It is important to maintain the human capital of the target firm after the acquisition to preserve the organization’s knowledge. Turnover of key personnel from the acquired firm can have a negative effect on the performance of the merged firm. Teaching Note: The following are examples of firms and the steps they took to preserve human capital through the acquisition process. • When AllliedSignal acquired Honeywell, the firm set an aggressive timetable to merge their operations into a $24 billion industrial powerhouse in six months, despite the great diversification involved. This required a team to develop and implement the integration. • Rapid integration is one of the guidelines that DaimlerChrysler uses for successful firm integration in a global merger or acquisition. Managers are encouraged to deal with unpopular issues immediately and honestly so employees will be able to anticipate the effects the integration is likely to have on them. • Cisco Systems is quick to integrate acquisitions with its existing operations. Focusing on small companies with products and services related closely to its own, some believe that the day after Cisco acquires a firm, employees in that company feel as though they have been working for Cisco for decades. Inadequate Evaluation of Target Due diligence is a process through which a firm evaluates a target firm for acquisition. In an effective due-diligence process hundreds of items are examined in areas as diverse as the financing for the intended transaction, differences in cultures between the acquiring and target firm, tax consequences of the transaction, and actions that would be necessary to successfully meld the two workforces. Due diligence is commonly performed by investment bankers, accountants, lawyers, and management consultants specializing in that activity, although firms actively pursuing acquisitions may form their own internal due-diligence team. Teaching Note: For the reasons below, firms often pay too much for acquired businesses: • Acquiring firms may not thoroughly analyze the target firm, failing to develop adequate knowledge of its true market value. • Managers’ overconfidence may cloud the judgment of acquiring firm managers. • Shareholders (owners) of the target must be enticed to sell their stock, and this usually requires that acquiring firms pay a premium over the current stock price. • In some instances, two or more firms may be interested in acquiring the same target firm. When this happens, a bidding war often ensues and extraordinarily high premiums may be required to purchase the target firm. Teaching Note: Some acquirers overpaying for target firms include the following: • British retailer Marks & Spencer paid $750 million for Brooks Brothers of the United States, but the acquisition was still unsuccessful after more than ten years of integration. • Sony paid a 28 percent premium for CBS Records and a 60 percent premium for Columbia Pictures. • Bridgestone paid a 60 percent premium for Firestone, and its winning bid was 38 percent higher than a competing bid from Pirelli. • National City Corporation agreed to acquire First of America for a price that was 3.8 times book value and 22.9 times First’s estimated 1998 earnings— National City’s stock fell 5.9 percent. • First Union Corp. paid 5.3 times book value when it acquired CoreStates Financial Corp. • Federated paid $10 per share for Broadway Department Stores when Broadway’s stock was selling for $2 per share, a 400 percent premium in a transaction valued at $1.6 billion to acquire Broadway’s prime West Coast real estate locations. Firms sometimes allow themselves to enter a “bidding war” for a target even though they realize their current bids exceed the parameters identified through due diligence. Large or Extraordinary Debt In addition to overpaying for targets, many acquirers must finance acquisitions with relatively high-cost debt. In the 1980s, investment bankers developed a new financing instrument for acquisitions, the junk bond. Junk bonds represented a new financing option in which risky investments were financed with money (debt) that provided a high return to lenders (bond holders). Junk bonds offer relatively high rates, some as high as 18 to 20 percent during the 1980s. Teaching Note: Junk bonds are considered by many to be a new financing option, not because they are new, but because they represented the first instances in which non-investment grade (below a B rating) securities were used to raise funds by companies whose securities were normally rated as investment grade. Teaching Note: A number of well-known and well-respected finance scholars argue in favor of firms utilizing significantly high levels of leverage because debt discourages managers from misusing funds (for example, by making bad investments) because debt (and interest) repayment eliminates the firm’s “free cash flow.” Inability to Achieve Synergy Acquiring firms also face the challenge of correctly identifying and valuing any synergies that are expected to be realized from the acquisition. This is a significant problem because to justify the premium price paid for target firms, managers may overestimate both the benefits and value of synergy. To achieve a sustained competitive advantage through an acquisition, acquirers must realize private synergies and core competencies that cannot easily be imitated by competitors. Private synergy refers to the benefit from merging the acquiring and target firms that is due to the unique assets that are complementary between the two firms and not available to other potential bidders for that target firm. Teaching Note: As pointed out earlier, the average return to acquiring firm shareholders is near zero, and many of these lead to negative returns for acquiring firm shareholders. Firms experience transaction costs when using acquisition strategies to create synergy. Direct costs include legal fees and charges from investment bankers. Managerial time to evaluate target firms and then to complete negotiations and the loss of key managers and employees post-acquisition are indirect costs. Too Much Diversification In general, firms using related diversification strategies outperform those using unrelated diversification strategies. However, conglomerates (i.e., those pursuing unrelated diversification) can also be successful. In the drive to diversify the firm’s product line, many firms overdiversified during the 60s, 70s, and 80s. As detailed in Chapter 6, information processing requirements are greater for a related diversified firm (compared to its unrelated counterparts) due to its need to effectively and efficiently coordinate the linkages and interdependencies on which value-creation through activity sharing depends. In addition to increased information processing requirements and managerial expertise, overdiversification may result in poor performance when top-level managers emphasize financial controls over strategic controls. Teaching Note: Controls are discussed in more detail in Chapters 11 and 12. Financial controls may be emphasized when managers feel that they do not have sufficient expertise or knowledge of the firm’s various businesses. When this happens, top-level managers are not able to adequately evaluate the strategies and strategic actions taken by division or business unit managers. As a result, • When they lack a rich understanding of business units’ strategies and objectives, top- level managers tend to emphasize the financial outcomes of strategic actions rather than the appropriateness of the strategy itself. • This forces division or business unit managers to become short-term performance- oriented. • The problem is more serious when manager compensation is tied to short-term financial outcomes. • Long-term, risky investments (such as R&D) may be reduced to boost short-term returns. • In the final analysis, long-term performance deteriorates. Teaching Note: The experiences of many firms indicate that overdiversification may lead to ineffective management, primarily because of the increased size and complexity of the firm. As a result of ineffective management, the firm and some of its businesses may be unable to maintain their strategic competitiveness. This results in poor performance. As noted earlier in this chapter, acquisitions can have a number of negative effects. They may result in greater levels of diversification (in products, markets, and/or industries), absorb extensive managerial time and energy, require large amounts of debt, and create larger organizations. As a result, acquisitions can have a negative impact on investments in research and development and thus on innovation. Reducing the emphasis on R&D and on innovation may result in the firm losing its strategic competitiveness unless the firm operates in mature industries in which innovation is not required to maintain competitiveness. Managers Overly Focused on Acquisitions If firms follow active acquisition strategies, the acquisition process generally requires significant amounts of managerial time and energy. For the acquiring firm this takes the form of: • Searching for viable candidates • Completing effective due diligence • Preparing for negotiations with the target firm • Managing the integration process post-acquisition The desire to merge is like an addiction in many companies: Doing deals is much more fun and interesting than fixing fundamental business problems. Due diligence and negotiating with the target often include numerous meetings between representatives of the acquirer and target, as well as meetings with investment bankers, analysts, attorneys, and in some cases, regulatory agencies. As a result, top-level managers of acquiring firms often pay little attention to long-term, strategic matters because of time (and energy) constraints. Too Large Firms can reach economies of scale by growing. But after a certain size is achieved, size can become a disadvantage as firms reach a point where they suffer from what is called “diseconomies of scale.” This implies that problems related to excess growth may be similar to those that accompany overdiversification. Other actions taken to enable more effective management of increased firm size include increasing or establishing bureaucratic controls, represented by formalized supervisory and behavioral controls such as rules and policies designed to ensure consistency across different units’ decisions and actions. On the surface (or in theory), bureaucratic controls may be beneficial to large organizations. However, they may produce overly rigid and standardized behavior among managers. The reduced managerial (and firm) flexibility can result in reduced levels of innovation and less creative (and less timely) decision making. 4 Name and describe the attributes of effective acquisitions. EFFECTIVE ACQUISITIONS Research has identified attributes that appear to be associated consistently with successful acquisitions: • When a firm’s assets are complementary (highly related) with the acquired firm’s assets and create synergy and, in turn, unique capabilities, core competencies, and strategic competitiveness • When targets were selected and “groomed” through earlier working relationships (e.g., strategic alliances) • When the acquisition is friendly, thereby reducing animosity and turnover of key employees • When the acquiring firm has conducted due diligence • When management is focused on research and development • When acquiring and target firms are flexible/adaptable (e.g., from executive experience with acquisitions) • When integration quickly produces the desired synergy in the newly created firm, allowing the acquiring firm to keep valuable human resources in the acquired firm from leaving Table Note: The attributes or characteristics of successful acquisitions and their results are summarized in Table 7.1. TABLE 7.1 Attributes of Successful Acquisitions Successful acquisitions generally are characterized by the following attributes and results: • Target and acquirer having complementary assets and/or resources that result in a high probability of achieving synergy and gaining competitive advantage • Making friendly acquisitions to facilitate integration speed and effectiveness and reducing any acquisition premium • Effective due diligence - target selection and negotiation processes that result in the selection of targets having resources and assets that are complementary to the acquiring firm’s core business, thus avoiding overpayment • Maintaining financial slack to make acquisition financing less costly and easier to obtain • Maintaining a low to moderate debt position, which lowers costs and avoids the trade-offs of high debt and lowers the risk of failure • Possessing flexibility and skills to adapt to change to facilitate integration speed and achievement of synergy • Continuing to invest in R&D and emphasizing innovation to maintain competitive advantage Note: The table also lists seven “results” of successful acquisitions. Teaching Note: One way to teach the finer points of the M&A process is to see its parallels with marriage and courtship. Though the source is rather dated now, Jemison & Sitkin (1986, Academy of Management Review) offered an interesting analysis based on this framework. Their points are too extensive to comment on here, but reference to their writings is helpful. 5 Define the restructuring strategy and distinguish among its common forms. RESTRUCTURING Restructuring refers to changes in the composition of a firm’s set of businesses and/or financial structure. From the 1970s into the 2000s, divesting businesses from company portfolios and downsizing accounted for a large percentage of firms’ restructuring strategies. Restructuring is a global phenomenon. During this period, restructuring can take several forms: • Downsizing, primarily to reduce costs by laying off employees or eliminating operating units • Downscoping to reduce the level of firm unrelatedness • Leveraged buyouts to restructure the firm’s assets by taking it private Sometimes firms use a restructuring strategy because of changes in their external and internal environments. For example, opportunities sometimes surface in the external environment that are particularly attractive to the diversified firm in light of its core competencies. In such cases, restructuring may be appropriate. Downsizing Once thought to be an indicator of organizational decline, downsizing is now recognized as a legitimate restructuring strategy and has been one of the most common restructuring strategies adopted by US firms. Downsizing represents a reduction in the number of employees, and sometimes in the number of operating units, but may or may not represent a change in the composition of the businesses in the firm’s portfolio. In the late 1980s, early 1990s, and early 2000s, thousands of jobs were lost in private and public organizations in the United States. One study estimates that 85 percent of Fortune 1000 firms have used downsizing as a restructuring strategy. Moreover, Fortune 500 firms terminated more than one million employees, or 4 percent of their collective workforce, in 2001 and into the first few weeks of 2002. This trend continued in many industries. For instance, in 2007, Citigroup signaled that it cut 15,000 jobs and up to five percent of its workforce overtime, in the process taking a $1 billion charge. Firms use downsizing as a restructuring strategy for different reasons. The most frequently cited reason is that the firm expects improved profitability from cost reductions and more efficient operations. Downscoping Compared to downsizing, downscoping has a more positive effect on firm performance. Downscoping refers to the divestiture, spin-off, or other means of eliminating businesses that are unrelated to the firm’s core business. In other words, downscoping refocuses the firm on its core businesses. Whereas downscoping often includes downsizing, the former is targeted so that the firm does not lose key employees from core businesses (because such losses can lead to the loss of core competencies). As indicated by the discussion of overdiversification earlier in the chapter, reducing the diversity of businesses in the portfolio enables top-level managers to manage the firm more effectively because: • The firm is less diversified as a result of downscoping • Top-level managers can better understand the core and related businesses Note: Indicate to students that the requirements and characteristics of strategic leadership by a firm’s top management team are discussed more fully in Chapter 12. Teaching Note: There are many examples of downscoping strategies. Two of these with which students are likely to be familiar are the following: • General Motors’ successful spin-off of EDS • PepsiCo’s spin-off of its fast-food businesses (Taco Bell, Pizza Hut, KFC) US firms use downscoping as a restructuring strategy more frequently than do European companies. However, there has also been an increase in downscoping by Asian and Latin American firms as they adopt Western business practices. Teaching Note: Research has shown that refocusing is not usually successful unless the firm has adequate resources to have the flexibility to formulate the necessary strategies to compete effectively. Leveraged Buyouts A leveraged buyout (LBO) refers to a restructuring action whereby the management of the firm and/or an external party buys all of the assets of the business, largely financed with debt, and thus takes the firm private. Often, LBOs are used as a restructuring strategy to correct for managerial mistakes or because managers are making decisions that primarily serve their personal interests rather than those of shareholders. In other words, a firm is purchased by a few (new) owners using a significant amount of debt (in a highly leveraged transaction) and the firm’s stock is no longer traded publicly. In general, the new owners restructure the private firm by selling a significant number of assets (businesses) both to downscope the firm and to reduce the level of debt (and significant debt costs) used to finance the acquisition. A primary intent of the new owners is to improve the firm’s efficiency. This enables them to sell the firm (outright to another owner or by a public stock underwriting), thus capturing the value created through the restructuring. It is not uncommon for those buying a firm through an LBO to restructure the firm to the point that it can be sold at a profit within a five- to eight-year period. There are three types of leveraged buyouts: management buyouts (MBO), employee buyouts (EBO), and whole-firm buyouts where another firm takes the firm private (LBO). Research has shown that management buyouts can also lead to greater entrepreneurial activity and growth. STRATEGIC FOCUS Strategic Positioning of Private Equity Buyout Firms (General Partners) Private equity (PE) is equity capital which is not traded on public equity exchanges. It can include investments in early stage development by “Angel Investors” and venture capitalists but is more readily known for late stage buyout or acquisition. Most firms use the capital provided by limited partners to leverage money from banks and debt markets. Figure 7.2 illustrates the strategic positioning of private equity firm general partner portfolios. FIGURE 7.2 Strategic Positioning of Private Equity Firm General Partner Portfolios Figure 7.2 presents a matrix with Financial Structure Emphasis and Portfolio Firm Scope as the key dimensions. Financial Structure Emphasis is further divided into Limited Partner Equity (top – long term orientation) and Debt Provided by Banks (bottom – short term orientation). Portfolio Firm Scope is further divided into Focused (left – single industry) and Diversified (right – wide range of industries). Lower left quadrant focuses on short-term equity players where buyout firms seek to restructure the target firm quickly and put the firm back on the market through an IPO or sale to another company. Upper left quadrant represents niche players with more investment from limited partners with longer-term equity positions. SCF Partners collaborates with entrepreneurial owners of buyout firms to implement reforms and pursue complementary acquisitions to build the size and breadth of services for portfolio firms while keeping entrepreneurial owners in place. Upper right quadrant represents diversified players with focused groups of portfolio firms that pursue more of a related diversification approach among portfolio firms. These players have operational expertise that is provided to the firms and the holding period is longer than average. Lower right quadrant represents PE firms with a focus on short-term efficiency but with large and diversified portfolios of firms. As these large firms grow in size, they grow beyond the scope of particular industries and need to diversify to find new deals. PE firms provide advantages and disadvantages to portfolio firms. Advantages include stronger alignment between owners and managers, managers can take a longer perspective, firms provide necessary growth capital to companies that may not be able to get it from other sources, exit opportunities and improved liquidity for small and medium sized businesses. Disadvantages include high debt loads that prevent portfolio firms from pursuing potentially valuable opportunities. In addition, advantages PE firms provide to the economy include the consolidation and rationalizing of industries, helping to catalyze restructuring and removing excess capacity in mature industries when needed, the enhancement of diversification opportunities for limited partner institutional investors, and a broadened market for corporate control. Teaching Note: Over the years, a good deal of attention has be focused on acquisitions and PE firms have been involved in many deals. Students should be aware of both the risks and rewards of private equity in this activity and how characteristics of financial structure and portfolio firm scope shape future actions. 6 Explain the short- and long-term outcomes of the different types of restructuring strategies. Restructuring Outcomes Downsizing often does not lead to higher firm performance; in fact, research has shown that downsizing contributed to lower returns for both US and Japanese firms. The stock markets in the firms’ respective nations evaluated downsizing negatively. Investors concluded that downsizing would have a negative effect on companies’ ability to achieve strategic competitiveness in the long term. Investors also seem to assume that downsizing occurs as a consequence of other problems in a company. Teaching Note: In free-market based societies, downsizing has generated a host of entrepreneurial opportunities for individuals to operate their own businesses. In fact, as discussed in Chapter 13, start-up ventures in the United States are growing at three times the rate of the national economy. Downsizing tends to result in a loss of human capital in the long term. Losing employees with many years of experience with the firm represents a major loss of knowledge. As noted in Chapter 3, knowledge is vital to competitive success in the global economy. Thus, in general, research evidence and corporate experience suggest that downsizing may be of more tactical (or short-term) value than strategic (or long-term) value. Downscoping generally leads to more positive outcomes in both the short and the long term than does downsizing or engaging in a leveraged buyout (see Figure 7.2). Downscoping’s desirable long-term outcome of higher performance is a product of reduced debt costs and the emphasis on strategic controls derived from concentrating on the firm’s core businesses. In so doing, the refocused firm should be able to increase its ability to compete. Although whole-firm LBOs have been hailed as a significant innovation in the financial restructuring of firms, there can be negative trade-offs. • The resulting large debt increases the financial risk of the firm • The intent of the owners to increase the efficiency of the bought-out firm and then sell it within five to eight years can create a short-term and risk-averse managerial focus • These firms may fail to invest adequately in R&D or take other major actions designed to maintain or improve the company’s core competence. Figure Note: Restructuring alternatives—downscoping, downsizing, and leveraged buyouts—and short- and long-term outcomes are summarized in Figure 7.3. FIGURE 7.3 Restructuring and Outcomes As illustrated in Figure 7.3, • Downsizing reduces labor costs, but the long-term results are a loss of human capital and lower performance. • Downscoping reduces debt costs and emphasizes strategic controls, which result in higher performance. • Leveraged Buyouts provide an emphasis on strategic controls but increases debt costs; the long-term outcome is an increase in performance, but also greater firm risk. Chapter 8 International Strategy LEARNING OBJECTIVES 1. Explain incentives that can influence firms to use an international strategy. 2. Identify three basic benefits firms achieve by successfully implementing an international strategy. 3. Explore the determinants of national advantage as the basis for international business- level strategies. 4. Describe the three international corporate-level strategies. 5. Discuss environmental trends affecting the choice of international strategies, particularly international corporate-level strategies. 6. Explain the five modes firms use to enter international markets. 7. Discuss the two major risks of using international strategies. 8. Discuss the strategic competitiveness outcomes associated with international strategies particularly with an international diversification strategy. 9. Explain two important issues firms should have knowledge about when using international strategies. CHAPTER OUTLINE Opening Case An International Strategy Powers ABB’s Future IDENTIFYING INTERNATIONAL OPPORTUNITIES Incentives to Use International Strategy Three Basic Benefits of International Strategy INTERNATIONAL STRATEGIES International Business-Level Strategy International Corporate-Level Strategy Strategic Focus Mondelez International a Global Leader in Snack Foods Markets ENVIRONMENTAL TRENDS Liability of Foreignness Regionalization CHOICE OF INTERNATIONAL ENTRY MODE Exporting Licensing Strategic Alliances Acquisitions New Wholly Owned Subsidiary Dynamics of Mode of Entry Strategic Focus Mexico’s FEMSA Building Its International Prowess RISKS IN AN INTERNATIONAL ENVIRONMENT Political Risks Economic Risks STRATEGIC COMPETITIVENESS OUTCOMES International Diversification and Returns Enhanced Innovation THE CHALLENGE OF INTERNATIONAL STRATEGIES Complexity of Managing International Strategies Limits to International Expansion SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES VIDEO CASE LECTURE NOTES Chapter Introduction: This chapter examines opportunities facing firms as they seek to develop and exploit core competencies by diversifying into global markets. In addition, it addresses different problems, complexities, and threats that might accompany use of the firm’s international strategies. Although national boundaries, cultural differences, and geographical distances all pose barriers to entry into many markets, significant opportunities draw businesses into the international arena. A business that plans to operate globally must formulate a successful strategy to take advantage of these global opportunities. Furthermore, to mold their firms into truly global companies, managers must develop global mind-sets. Especially in regard to managing human resources, traditional means of operating with little cultural diversity and without global sourcing are no longer effective. These themes are all emphasized in the chapter. OPENING CASE An International Strategy Powers ABB’s Future ABB is a large global competitor in the power and automation technologies industries. It has built its success using geographic diversification around the world. However, ABB’s recent troubles (due to poor performance in some countries) underscore some of the difficulties encountered by firms with international operations. In response, ABB is closing, or limiting, operations in some of these countries. As a result of these moves, and strong performance of its North American businesses, performance is trending in a positive direction. Most of ABB’s recent growth has come from acquisitions but it has entered into a joint venture recently with a Chinese firm to design and manufacture high voltage instrument transformers. Teaching Note: ABB is a strong global brand with a promising future. The Opening Case profiles some of the ways the company has grown and some of the challenges that are inherent in global business. While students may not be very familiar with ABB and its products, they should be able to identify and discuss some issues encountered by other firms with international operations. Ask them to identify instances in which firms have had to deal with problems/issues arising out of international operations. Although national boundaries, cultural differences, and geographical distances all pose barriers to entry into many markets, significant opportunities draw businesses into the international arena. • Global firms must formulate a successful strategy to take advantage of international opportunities. • Managers must develop global mind-sets. • Operating with little cultural diversity and without global sourcing is no longer effective. • Global firms must develop relationships with suppliers, customers, and partners, and then learn from these. Figure Note: Figure 8.1 provides an overview of the various choices and outcomes of strategic competitiveness. FIGURE 8.1 Opportunities and Outcomes of International Strategy The following opportunities and outcomes of international strategy are illustrated in Figure 8.1: • Firms should first identify international opportunities related to increasing market size, return on investment, economies of scale and learning, and location-related advantages. • Once international opportunities have been identified, firms must develop international strategies based on firm resources and capabilities. • A mode of entry should be selected to take advantage of the firm’s core competencies. • A firm’s ability to realize strategic competitiveness is tempered by management’s ability to manage effectively and efficiently a complex organization with locations in multiple countries and the economic and political risks that accompany firm internationalization. • The strategic outcomes from the process can include better performance and more innovation. 1 Explain incentives that can influence firms to use an international strategy. IDENTIFYING INTERNATIONAL OPPORTUNITIES International strategy refers to selling products in markets outside of the firm’s domestic market to expand the market for their products. Incentives to Use International Strategy This is explained by Vernon’s adaptation of the product life cycle concept formulated to explain internationalization. 1. A firm introduces an innovation (new product) in its domestic market. 2. Product demand develops in other countries and exports are provided from domestic operations. 3. As demand increases, foreign rivals produce the product; then firms justify investing in production abroad. 4. As products become standardized, firms relocate production to low-cost countries. Some firms implement an international strategy to secure critical resources, such as petroleum reserves (for the oil industry), bauxite (for the manufacture of aluminum), or rubber (for tire manufacturing). Traditional motives persist, but other emerging motives also drive international expansion. • Pressure has increased for global integration of operations, driven mostly by universal product demand. • In some industries, technology drives globalization because the economies of scale necessary to reduce costs to the lowest level often require an investment greater than that needed to meet domestic market demand. • New large-scale, emerging markets such as China and India provide a strong internationalization incentive because of the potential demand in them. Companies seeking to expand operations internationally need to understand the pressure on them to respond to local, national, or regional customs, especially where goods or services require customization due to cultural differences or effective marketing to entice customers to try a different product. • Firms adapt products to local tastes as they move into new national markets. • Local repair/service capabilities are another factor that increases desire for local country responsiveness. • Transportation costs of large products and their parts may preclude a firm’s suppliers from following the firm into an international market. • Employment contracts and labor forces differ. Host governments demand joint ownership and frequently require a high percentage of local procurement, manufacturing, and R&D. These issues increase the need for local investment. Opportunities available to firms through an international strategy include: • Increasing the size of potential markets • Achieving greater returns on capital and/or investment in new product/process developments • Gaining economies of scale, scope, or learning • Gaining location-based competitive advantage Teaching Note: Firms expanding into international markets must recognize that many countries have characteristics that are unique and may differ significantly from the traditional European markets into which US firms have expanded. Thus, firms must recognize this and: • Be capable of managing multiple risks—e.g., financial, economic, political risks • Be aware of increased pressure for local country or regional responsiveness, especially where cultural differences require customization of goods or services • Weigh the potential advantages of enhancing the firm’s strategic competitiveness relative to the costs of meeting managerial challenges and product/geographic diversification requirements in international markets 2 Identify three basic benefits firms achieve by successfully implementing an international strategy. Three Basic Benefits of International Strategy Increased Market Size Expanding internationally enables firms to increase greatly the size of the potential market for their products. This may be of critical importance if the domestic market is too small to support scale-efficient manufacturing facilities. The size of a particular international market affects a firm’s willingness to invest in it with larger markets tending to provide higher returns and lower risk. The strength of the science base in a country also can affect a firm’s foreign R&D investments, so most firms prefer to invest more heavily in those countries with the scientific knowledge and talent that produce more effective new products and processes from their R&D. Economies of Scale and Learning By expanding the size and scope of their markets, firms may be able to achieve economies of scale in manufacturing (and in other operations, such as marketing, research and development, and distribution) by standardizing products across national borders and spreading fixed costs over a larger sales base. Teaching Note: Economies of scale are critical in the global auto industry. Honda has been a largely successful firm with substantial competencies in the manufacture of engines; however, it has sometimes struggled to compete against larger and more resource-rich auto makers (e.g., Ford and GM). To have a chance to survive, Honda achieved economies of scale in the development and application of its engines (e.g., by providing engines for many applications [e.g., lawnmowers, weed trimmers, snowmobiles] and forming an alliance with GM to produce engines). Thus, Honda may excel as an independent engine manufacturer. Firms may also be able to exploit core competencies in international markets through resource and knowledge sharing between units across country borders. This sharing generates synergy, which helps the firm produce higher-quality goods or services at lower cost. In addition, working across international markets provides the firm with new learning opportunities. Location Advantages Firms also may be able to achieve a comparative advantage and lower the basic costs of their products by locating facilities in low-cost markets for critical raw materials, cheap labor, key suppliers, energy, customers, and/or natural resources. Other factors that may impact location advantages are as follows: • The needs of intended customers • Cultural influences (if there is a strong match between the cultures involved, the liability of foreignness is lower than if there is high cultural distance) • Physical distances that influence the firms’ location choice and how facilities are managed 3 Explore the determinants of national advantage as the basis for international business-level strategies. INTERNATIONAL STRATEGIES International strategies available to firms are business-level and corporate-level (see Chapters 4 and 6). • Business-level strategy choices are generic, extending our earlier discussion of cost leadership, differentiation, focus, and integrated cost leadership/differentiation strategies. • Corporate-level strategies are dependent on the complexity and scope of product and geographic diversification, and these include multidomestic, global, and transnational (hybrid) strategies. International Business-Level Strategy Each business must develop a competitive strategy focused on its own domestic market. Business-level generic strategies are discussed in Chapter 4, but international business-level strategies have some unique features. • In an international business-level strategy, the home country of operation is often the most important source of competitive advantage. • The resources and capabilities established in the home country frequently allow the firm to pursue the strategy into markets located in other countries. • As a firm continues its growth into multiple international locations, research indicates that the country of origin diminishes in importance as the dominant factor. Figure Note: Porter’s Diamond of Advantage model can be used to introduce the discussion of Figure 8.3. FIGURE 8.3 Determinants of National Advantage As Figure 8.3 illustrates, four interrelated national or regional factors contribute to the competitive advantage of firms competing in global industries. • Factor conditions or the factors of production • Demand conditions • Related and supporting industries • Firm strategy, structure, and rivalry Note: Each of these factors is discussed in the following section. Perhaps the most basic factor in the model, factor conditions or factors of production, refers to the inputs necessary to compete in any industry. These include labor, land, natural resources, capital, and infrastructure (such as highway, postal, and communications systems). These factors can be subdivided into four categories: • Basic factors, such as labor and natural resources • Advanced factors, including digital communications systems and highly educated work forces • Generalized factors (required by all industries), such as highway systems and a supply of capital • Specialized factors that are most valuable in specific uses (e.g., skilled personnel employed at a port who specialize in the handling of bulk chemicals) Nations having both advanced and specialized factors are likely to be characterized by growth in new firms that are strong global competitors. Ironically, countries often develop advanced and specialized factors because they lack critical basic resources. • Some Asian countries, such as South Korea, lack abundant natural resources but offer a strong work ethic, a large number of engineers, and systems of large firms to create expertise in manufacturing. • Germany developed a strong chemical industry, partially because Hoechst and BASF spent years creating a synthetic indigo dye to reduce their dependence on imports, unlike Britain, whose colonies provided large supplies of natural indigo. The second factor that determines national advantage is demand conditions, which are characterized by the nature and size of buyers’ needs in the home market for the industry’s products or services. The size of the segment can create demand sufficient to justify the construction of scale-efficient facilities. Related and supporting industries are the third factor of the national advantage model. National firms may be able to develop competitive advantage when industries that provide either materials or components or that support the activities of the primary industry are present. • Italian firms are world leaders in the shoe industry because of the related and supporting industries present in Italy (e.g., a mature leather processing industry and design and manufacture of leather-working machinery). • In Japan, copiers and cameras are related, as are cartoon, consumer electronics, and video game industries. Growth in certain industries is fostered by the fourth factor—firm strategy, structure, and rivalry. As expected, patterns of firm strategy, structure, and competitive rivalry among firms in an industry vary between nations. • In Italy, the national pride of the country’s designers has spawned strong industries in sports cars, fashion apparel, and furniture. • In the United States, competition among computer manufacturers and software producers has favored the development of these industries. As described, the four basic factors of Porter’s Diamond of Advantage model emphasize the impact or influence of the environmental or structural attributes of a nation’s economy that may contribute to a national advantage for its firms in specific industries. In spite of the presence of the four factors and government support, the factors leading to national advantage are likely to result in a firm achieving competitive advantage only when the firm develops and implements strategies that enable it to take advantage of country- specific factors. 4 Describe the three international corporate-level strategies. International Corporate-Level Strategy The type of corporate-level strategy adopted by a firm has an impact on the selection and implementation of its international business-level strategy. Some corporate-level strategies provide individual country units with the flexibility to develop country-specific strategies, whereas others dictate all country business-level strategies from the home office and coordinate activities across units for the purposes of resource-sharing and product standardization. International corporate-level strategy can be distinguished from international business-level strategy by the scope of operations, in terms of both product and geographic diversification. Figure Note: The three types of international corporate-level strategies are illustrated in Figure 8.4, whereas relationships between structural arrangements and strategy type are discussed further in Chapter 11. FIGURE 8.4 International Corporate-Level Strategies As Figure 8.4 illustrates, a firm should choose its international corporate-level strategy based on the need for both local responsiveness and for global integration. • When the need for global integration is high and there is little need for local market responsiveness, the firm should adopt a global strategy. • When the need for global integration is low, but there is great need for local market responsiveness, the firm should adopt a multidomestic strategy. • When there is a great need for both global integration and local market responsiveness, the firm should adopt a transnational strategy. Multidomestic Strategy Multidomestic strategy is one where strategic and operating decisions are decentralized to the strategic business unit in each country in order to tailor products and services to the local market. The multidomestic strategy: • Assumes business units in different countries are independent of one another • Contends that markets differ and can be segmented by national borders • Focuses on competition within each country • Suggests products and/or services can be customized to meet individual market needs or preferences • Assumes economies of scale are not possible because of demand for market-specific customization Teaching Note: A few years back, Sony’s entertainment business changed its strategy from global to multidomestic when it decided to produce films and television programs for local markets around the world through production facilities and television channels in most larger Latin American and Asian countries. In 1999, Sony produced approximately 4,000 hours of foreign- language programs and about 1,700 hours of English-language programs. Sony now has more than 24 channels operating across 62 countries, and some of these channels are highly successful. The use of multidomestic strategies: • Usually expands the firm’s local market share because the firm can pay attention to the needs of local buyers • Results in more uncertainty for the corporation as a whole, because of the differences across markets and thus the different strategies employed by local country units • Does not allow for the achievement of economies of scale and can be more costly • Decentralizes a firm’s strategic and operating decisions to the business units operating in each country Global Strategy A global strategy is one where standardized products are offered across country markets and competitive strategy is dictated by the home office. The global strategy: • Assumes strategic business units operating in each country are interdependent • Attempts to achieve integration across business and national markets, as directed by the home office • Emphasizes economies of scale • Offers greater opportunities to use innovations developed at home or in one country in other markets • Often lacks responsiveness to local market needs and preferences • Is difficult to manage because of the need to coordinate strategies and operating decisions across borders • Requires resource-sharing and an emphasis on coordination across national borders Teaching Note: U.K.-based temporary energy provider, Aggreko, operates in 48 countries and employs a global strategy. The firm’s fleet of equipment is integrated globally, which allows it to shift equipment to different regions of the world to meet specific needs. Its global strategy also allows Aggreko to design and assemble its equipment in-house to meet the needs of its customers. Cemex: A Mini-Case Cemex is the third largest cement company in the world behind France’s Lafarge and Switzerland’s Holcim and the largest producer of Ready-mix, a prepackaged product that contains all the ingredients needed to make localized cement products. In 2005, Cemex acquired RMC for $4.1 billion. RMC is a large U.K. cement producer with two-thirds of its business in Europe. Cemex was already the number one producer in Spain through its acquisition of a Spanish company in 1992. In 2000 Cemex acquired Southdown, a large manufacturer in the US. Accordingly, Cemex has strong market power in the Americas as well as in Europe. Because Cemex pursues a global strategy effectively, its integration of its centralization process has resulted in a quick payoff for its merger integration process. To integrate its businesses globally, Cemex uses the Internet as one way of increasing revenue and lowering its cost structure. By using the Internet to improve logistics and manage an extensive supply network, Cemex can significantly reduce costs. Connectivity between the operations in different countries and universal standards dominate its approach. Transnational Strategy A transnational strategy is a corporate strategy that seeks to achieve both global efficiency and local (national market) responsiveness. • It is difficult to achieve because of requirements for both strong central control and coordination to achieve efficiency and local flexibility and decentralization to achieve local responsiveness. • A transnational strategy mandates building a shared vision and individual commitment through an integrated network to produce a core competence that would result in strategic competitiveness (that competitors would find difficult to imitate). • Effective implementation of a transnational strategy often produces higher performance than does implementation of either the multidomestic or global international corporate- level strategies. Teaching Note: Students sometimes find the transnational strategy difficult to grasp. This has prompted some to refer to this option as an “idealized form,” suggesting that this it not possible to achieve in reality. This also suggests, however, that this model represents a worthy goal for the international firm. It is worth asking students if they believe it will ever be possible to be truly transnational and ask what would be needed to make this a reality. Teaching Note: Refer back to Figure 8.4 to summarize relationships between the need for global integration and local responsiveness and international corporate-level strategies. STRATEGIC FOCUS Mondelez International a Global Leader in Snack Foods Markets In 2012, Kraft Foods split into two separate companies – North American grocery and international snack foods (named Mondelez and targeted at fast-growing international markets). The North American business sells established, profitable brands. Mondelez is built around ‘power’ brands (Oreo, Cadbury, Ritz) and local brands tailored to local markets. The separation into two businesses allows each to use its own strategy that best suits its products and conditions in its markets. Mondelez is reinvesting profits into emerging markets seeking additional growth. Despite revenue growth for Mondelez, net income has declined due to increasing coffee prices, reduction in demand for some products, and overall market volatility. Teaching Note: As is the case with many US-based firms, when markets mature they often become saturated, forcing growth to come from other places. In these instances international expansion into new and emerging markets becomes central to business success. Kraft Foods created Mondelez specifically to pursue international opportunities. Ask students to identify and discuss how Mondelez allows for better positioning of snack foods in international (emerging) markets. Ask them to identify other examples of firms that pursue international opportunities in a similar way (with a separate business or division focused on international growth. 5 Discuss environmental trends affecting the choice of international strategies, particularly international corporate- level strategies. ENVIRONMENTAL TRENDS Implementing a transnational strategy is difficult; however, firms are challenged to do so because of these facts: • There is an increased emphasis on local requirements, e.g., customization to meet government regulations within particular countries or to fit customer tastes and preferences. • Most multinational firms desire coordination and sharing of resources across country markets to hold down costs. • Some products and industries may be more suited than others for standardization across country borders. Liability of Foreignness Research shows that firms may focus less on truly global strategies and more on regional adaptation. Even Internet-based strategies now require local adaptation. Regionalization A firm competing in international markets must decide whether to compete in all (or many) world markets or to focus its efforts on a specific region or regions. Competing in many markets may enable the firm to achieve economies of scale because of the size of the combined markets, but only if customer preferences in multiple markets do not differ significantly. If customer preferences vary significantly among national markets, a firm might be better served by narrowing its focus to a specific region. A regional focus may enable the firm to better understand cultures, legal and social norms, and other factors that may be important to achieving strategic competitiveness. Teaching Note: At this point, it might useful to draw a parallel between competing in multiple national markets and owning businesses in multiple industries. Firms may be better positioned by focusing on a specific region where markets are more similar, thus allowing a degree of integration and resource sharing. In Chapter 7, a similar comment was made regarding disadvantages that often accompany overdiversification and the prescribed downscoping to refocus the firm more on related as opposed to unrelated diversification. Lands’ End Adjusts to the Liability of Foreignness: A Mini-Case The globalization of businesses with local strategies is demonstrated by the online operation of Lands' End, Inc. (now owned by Sears), which uses local Internet portals to offer its products for sale. Lands’ End, formerly a direct-mail catalog business, launched its web-based business in 1995. The firm established websites in the U.K. and Germany in 1999, and in France, Italy, and Ireland in 2000—all of this prior to initiating a catalog business in those countries. Not only are catalogs very expensive to print and mail outside the United States, but they also must be sent to the right people, and buying mailing lists is expensive. With limited online advertising and word-of-mouth, a website business can be built in a foreign country without a lot of initial marketing expenses. Once the online business is large enough, a catalog business can be launched with mailing targeted to customers who have used the business online. Sam Taylor, vice president of international operations for Lands’ End, indicated that the firm has a centralized Internet team (handling development, design, etc.) at the home office, but a local presence is also needed. So the firm hired local Internet managers, designers, marketing support, and so on, to gain insight into the nuances of local markets. He also explained that each additional website was cheaper to implement. For example, to set up the Websites for Ireland, France, and Italy, the firm cloned the U.K. site and partnered with Berlitz for French and Italian translations. This made the process cheaper—12 times less than the U.K. site for France and 16 times less for Italy. Lands’ End now gets 16 percent of its total revenues from Internet sales and ships to 185 countries, primarily from its Dodgeville, Wisconsin, corporate headquarters. This shows that smaller companies can sell their goods and services globally when facilitated by electronic infrastructure without having significant (brick-and-mortar) facilities outside of their home location. But significant local adaptation is still needed in each country or region. Regional strategies also are being promoted by groups of countries that have developed trade agreements to enhance the economic power of a region. Examples include the following: • Membership in the European Union (EU) is limited to Western European countries, but it is being expanded to include other Western European countries as well as countries in Central and Eastern Europe. • The North American Free Trade Agreement (NAFTA) is an integration designed to facilitate trade among the US, Canada, and Mexico (and it may be expanded to include some South American countries). • South America’s Organization of American States (OAS) is a system of country associations that developed trade agreements to promote the flow of trade across country boundaries within their respective regions. • CAFTA is a US trade agreement with Central American nations that is designed to reduce tariffs with five countries in Central America plus the Dominican Republic in the Caribbean. Teaching Note: The movement of investment funds has not been only from the US to Mexico as Mexican investors have made significant investments in the US, and some European firms have invested in Canada to gain access to this unified market. Most firms enter regional markets sequentially, beginning in markets with which they are more familiar. And they introduce their largest and strongest lines of business into these markets first, followed by their other lines of business once the first lines are successful. They also usually invest in the same area as their original investment location. 6 Explain the five modes firms use to enter international markets. CHOICE OF INTERNATIONAL ENTRY MODE Firms have a variety of alternative means of expanding internationally as indicated in Figure 8.5. Table Note: Students can refer to Figure 8.5 as you discuss each of the modes of entry into international markets. FIGURE 8.5 Modes of Entry and Their Characteristics Figure 8.5 presents five alternative entry modes available to firms for international expansion: • Exporting • Licensing • Strategic alliances • Acquisition • New wholly owned subsidiary (greenfield venture) The next section of this chapter discusses characteristics of each mode, including cost/control trade-offs. Exporting A common—but not necessarily the least costly or most profitable—form of international expansion is for firms to export products from the home country to other markets. • Exporters have no need to establish operations in other countries. • Exporters must establish channels of distribution and outlets for their goods, usually by developing contractual relationships with firms in the host country to distribute and sell products. However, exporting also has disadvantages: • Exporters may have to pay high transportation costs. • Tariffs may be charged on products imported to the host country. • Exporters have less control over the marketing and distribution of their products. Because of the potentially significant transportation costs and the usually greater similarity of geographic neighbors, firms often export mostly to countries that are closest to its facilities. Small businesses are the most likely to use exporting. One of the largest problems with which small businesses must deal is currency exchange rates, a challenge for which only large businesses are likely to have specialists. Licensing Through licensing, a firm authorizes a foreign firm to manufacture and sell its products in a foreign market. • The licensing firm (licensor) generally is paid a royalty payment on every unit that is produced and sold. • The licensee takes the risks, making investments in manufacturing and paying marketing/distribution costs. • Licensing is the least costly (and potentially the least risky) form of international expansion because the licensor does not have to make capital investments in the host countries. • Licensing is a way to expand returns based on previous innovations, even if product life cycles are short. Teaching Note: Counterfeiting is one risk to licensing strategies. Sony and Philips codesigned the audio CD. In the past, they licensed the rights to companies to make CDs and Sony and Philips collected 5 cents for every CD sold. However, the returns to Sony and Philips from CD sales were threatened by cheap counterfeit disks. Sales of counterfeit disks in China alone are estimated to exceed $1 billion annually. The costs or potential disadvantages of licensing include the following: • The licensing firm has little control over manufacture and distribution of its products in foreign markets. • Licensing offers the least revenue potential as profits must be shared between licensor and licensee. • The licensee can learn the firm’s technology and, upon license expiration, may create a competing product. Strategic Alliances Strategic alliances enable firms to: • Share the risks and resources required to enter international markets • Facilitate the development of new core competencies that yield strategic competitiveness Most strategic alliances represent ventures between a foreign partner (that provides access to new products and new technology) and a host country partner (that has knowledge of competitive conditions, legal and social norms, and cultural idiosyncrasies that enable the foreign partner to successfully manufacture or develop and market a competitive product or service in the host country market). Strategic alliances also present potential problems and risks due to (1) selection of incompatible partners and (2) conflict between partners. Several factors may cause a relationship to sour. Trust between the partners is critical and is affected by a number of fundamental issues: • The initial condition of the relationship • The negotiation process to arrive at an agreement • Partner interactions • External events • The country cultures involved in the alliance or joint venture Note: Strategic alliances are covered in much greater depth in Chapter 9. Teaching Note: British Telecommunications planned to create a virtual shopping mall in Spain through its joint venture with Banco Popular, a retail- focused Spanish bank. The two firms jointly developed a website for business-to-business transactions. They were to use BT’s portal in Spain to develop a client base of small- and medium-sized businesses. BT would provide the common portal free of charge for the first year and Banco Popular would charge only a nominal commission for brokering sales. Research suggests that alliances are more favorable when uncertainty is high and where cooperation is needed to access knowledge dispersed between partners and where strategic flexibility is important; acquisitions work best in situations with less need for flexibility and when the transaction supports economies of scale or scope. Acquisitions Cross-border acquisitions have also been increasing significantly. In recent years, cross- border acquisitions have comprised more than 45 percent of all acquisitions completed worldwide. As explained in Chapter 7, acquisitions can provide quick access to a new market. In fact, acquisitions may provide the fastest and often the largest initial international expansion of any of the alternatives. Beyond the disadvantages previously discussed for domestic acquisitions (Chapter 7), international acquisitions also can be quite expensive (because of debt financing) and require difficult and complex negotiations due to: • The same disadvantages as domestic acquisitions • The great expense that often requires debt financing • The exceedingly complex international negotiations for acquisitions—only about 20 percent of the cross-border bids made lead to a completed acquisition, compared to 40 percent for domestic acquisitions • Different corporate cultures • The challenges of merging the new firm into the acquiring firm, which often are more complex than with domestic acquisitions—i.e., different corporate culture, but also different social cultures and practices Teaching Note: Emphasize that firms often use multiple entry strategies. For example, Walmart has used multiple entry strategies as it globalizes its operations, ranging from joint ventures in China and Latin America to acquisitions in Germany and the U.K. New Wholly Owned Subsidiary Firms that choose to establish new, wholly owned subsidiaries are said to be undertaking a greenfield venture. This is the most costly and complex of all international market entry alternatives. The advantages of establishing a new wholly owned subsidiary include: • Achieving maximum control over the venture • Being potentially the most profitable alternative (if successful) • Maintaining control over the technology, marketing, and distribution of its products Though the profit potential is high, establishing a new wholly owned subsidiary is risky for two reasons: • This alternative carries the highest costs of all entry alternatives since a firm must build new manufacturing facilities, establish distribution networks, and learn and implement the appropriate marketing strategies. • The firm also may have to acquire knowledge and expertise relevant to the new market, often having to hire host country nationals (in many cases from competitors) and/or costly consultants. Dynamics of Mode of Entry The choice of a market entry strategy is determined by a number of factors. However, initial market development strategies generally are selected to establish a firm’s products in the new market. • Exporting does not require foreign manufacturing expertise; it only requires an investment in distribution. • Licensing also can facilitate direct market entry by enabling the firm to learn the technologies required to improve its products in order to achieve success in international markets or to facilitate direct entry. • Strategic alliances are also popular because the firm forms a partnership with a firm that is already established in the new target market and reduces risks by sharing costs with the partner. If intellectual property rights in an emerging economy are not well protected, the number offirms in the industry is growing fast, and the need for global integration is high, entry modes such as joint ventures or wholly owned subsidiary are preferred. Firms interested in establishing a stronger presence (in most instances, in the later stages of the firm’s international diversification strategy) and in controlling technology, marketing, and distribution adopt riskier, more costly entry strategies, such as acquisitions or greenfield ventures. However, the entry strategy should be matched to the particular situation. In some cases, a firm may pursue entry strategies in sequential order—beginning with exporting and ending with greenfield ventures. The entry mode decision should be based on the following conditions: • The industry’s competitive conditions • The target country’s situation • Government policies • The firm’s unique set of resources, capabilities, and core competencies STRATEGIC FOCUS Mexico’s FEMSA Building its International Prowess Coca-Cola FEMSA SAB is the largest Coke bottler in the world. In 2013 it enhanced its strength with the purchase of a Mexican regional bottler. It has also expanded its convenience store business, Oxxo, outside of Mexico. Oxxo is the largest and fastest growing convenience store chain in Latin America. While FEMSA continues to promote organic growth, most of its size increases have come from acquisitions. For example, it recently purchased a controlling interest in a Coke bottling plant in the Philippines and expanded its drug store business with the acquisition of a Mexican company. Teaching Note: FEMSA has used its cash reserves to strategically grow several of its businesses. While bottling Coke products is its core business, it is cultivating a retail presence through Oxxo and its drug store/pharmacy chain. While most students will be unfamiliar with FEMSA, they should be able to appreciate the corporate-level strategy that it is following and how it is growing its various businesses. 7 Discuss the two major risks of using international strategies. RISKS IN AN INTERNATIONAL ENVIRONMENT Political and economic risks complicate the management of international diversification. One reason is that these risks result in competitive conditions that may differ significantly from what was expected. Examples of political and economic risks related to international diversification are listed in Figure 8.6. Figure Note: Be sure to note any developments in the international risk situations noted in Figure 8.6 as well as the emergence of significant new issues. FIGURE 8.6 Risks in the International Environment This figure presents some specific examples of political and economic risks that multinational firms face. Political Risks Political risks are those related to instability in national governments and to war, civil or international. Teaching Note: For a useful way of identifying the political risk associated with different countries, see the map on page 105 of Small Business Management: An Entrepreneurial Emphasis, by Longenecker, Moore, Petty, and Palich (2006, SWCP). National government instability creates multiple potential problems for internationally diversified firms. Economic risks come up as governments react to a variety of events, reflected in uncertainty in terms of: • Economic risks and uncertainty created by government regulation • Existence of many, possibly conflicting, legal authorities or corruption • The potential nationalization of private assets Teaching Note: A number of national governments attempt to minimize political risk (to themselves) by requiring that a significant portion of profits from investments be reinvested only in that country (to achieve economic stability, which can reduce probability of political instability). Economic Risks Economic risks are interdependent with political risks; however, some economic risks are specific to international diversification. For example, differences and fluctuations in the value of the different currencies are a primary concern to internationally diversified firms. • For US firms, the value of international assets, liabilities, and earnings are affected by the value of the dollar relative to other currencies (e.g., as the dollar value increases, the value of foreign assets decreases). The value of the dollar may make US firms’ exports uncompetitive in international markets because of price differentials (and, in turn make imports from other countries more attractive to US customers). 8 Discuss the strategic competitiveness outcomes associated with international strategies particularly with an international diversification strategy. STRATEGIC COMPETITIVENESS OUTCOMES Once its international strategy and mode of entry have been selected, the firm turns its attention to implementation issues (see Chapter 11). It is important to do this because international expansion is risky and may not result in a competitive advantage (see Figure 8.1). The probability the firm will achieve success by using an international strategy increases when that strategy is effectively implemented. International Diversification and Returns Recall that in Chapter 6, the discussion centered on product diversification where a firm manufactures and sells a diverse variety of products. Based on the advantages discussed earlier, international diversification should be positively related to firm performance. Research has shown that, as international diversification increases, firms’ returns decrease and then increase as firms learn to manage international expansion. There are several reasons for the positive relationship between international diversification and performance. • Potential advantages from economies of scale and experience • Location advantages • Increased market size • The potential to stabilize returns Enhanced Innovation As mentioned in Chapter 1, developing new technology is critical to strategic competitiveness. In fact, Porter indicates that a nation’s competitiveness depends on the innovativeness of its industries and that firms achieve strategic competitiveness in international markets through innovation (see Figure 8.2). As stated earlier in this chapter, one of the advantages of international expansion is having larger potential markets. Larger markets allow firms to achieve greater returns on innovation, which yields lower R&D-related risk. Thus, international diversification provides firms with incentives to innovate. A complex relationship exists among international diversification, innovation, and performance. This leads, in fact, to the following circular relationship: • Some level of performance is necessary to provide the resources required to diversify internationally. • International diversification provides incentives (advantages) to firms to invest in R&D (innovation). • If done properly, R&D and the resulting innovations should improve firm performance. • Improved performance provides resources for continued international diversification and investments in R&D innovation. It also is possible that international diversification may result in improved returns for product-diversified firms (referred to as unrelated diversification) by increasing the size of the potential market for each of the firm’s products. But managing a firm that is both product and internationally diversified is very complex. Cultural diversity may enable a firm to compete more effectively in international markets. • Culturally diverse top management teams often have a greater knowledge of international markets. • An in-depth understanding of diverse markets among top-level managers facilitates inter- firm cooperation, the use of strategically relevant, long-term criteria to evaluate managerial and business unit performance, and improved innovation and performance. • 9 Explain two important issues firms should have knowledge about when using international strategies THE CHALLENGE OF INTERNATIONAL STRATEGIES Complexity of Managing International Strategies Managers of internationally diversified firms face a number of complex challenges. • Firms face multiple risks from being in several countries. • Firms can grow only so large before they become unmanageable. • The costs of managing large diversified firms may outweigh the benefits of diversification. • Global markets are highly competitive. • Firms must understand and effectively deal with multiple cultural environments. • Systems and processes must exist to manage shifts in the relative values of multiple currencies. • Firms must scan the environment to be prepared for potential government instability. Limits to International Expansion As mentioned before, firms generally earn positive returns by diversifying internationally. However, there are limits to the advantages of international diversification. • Greater geographic dispersion across country borders increases the costs of coordination between units and the distribution of products. • Trade barriers, logistical costs, cultural diversity, and other differences by country greatly complicate the implementation of an international diversification strategy. • Institutional and cultural factors can present strong barriers to the transfer of a firm’s competitive advantages from one country to another. • Marketing programs often have to be redesigned and new distribution networks established when firms expand into new countries. • Firms may encounter different labor costs and capital charges. • In general, it is difficult to effectively implement, manage, and control a firm’s international operations. Teaching Note: The complex nature of the management challenges that face internationally diversified firms is illustrated by the following cases: • Robert Shapiro, CEO of Monsanto, assumed that Europe was similar to the US, but the firm’s genetically engineered seeds have been strongly rejected in Europe. • Walmart made mistakes in some Latin American markets, for example, when it learned that giant parking lots do not draw huge numbers of car- less customers. And the lots were far from the bus stops used by many Mexicans, so potential customers could not easily transport their goods home. • Home Depot’s expansion into China fell flat due to the fact that, unlike in the U.S., the Do-It-Yourself market is very small. Customers in China are considered to be Do-It-For-Me buyers and Home Depot’s value proposition is not important to them. Instructor Manual for Strategic Management: Concepts and Cases: Competitiveness and Globalization Michael A. Hitt, R. Duane Ireland, Robert E. Hoskisson 9781285425184, 9781285425177, 9780538753098, 9781133495239, 9780357033838, 9781305502208, 9781305502147