Summary

Strategic Management for

PM

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CHAPTER 1 WHAT IS STRATEGY AND THE STRATEGIC MANAGEMENT PROCESS?
Strategy Related Terms
- Strategy theory about how to gain competitive advantages (fit between strategy and
developments in the industry/environment is necessary for success)
- Strategic Management Process sequential set of analysis that can increase the likelihood
of a company to adopt a successful strategy

- Mission: long term purpose of a company (what it wants to be in the future)

- Objectives: specific measurable targets used to evaluate success in fulfilling mission (high
quality objectives are closely related to mission and can be easily measured)
- External Analysis: identify threats and opportunities in the competitive environment
- Internal Analysis: identify internal strengths, weaknesses and areas for improvement

- Strategic Choice: theory for gaining competitive advantage should aim for supporting

strengths, avoid or nullify threats and avoid organizational weaknesses

- Strategy Implementation: adopting practices and policies that are in line with the
organizations strategy (formal organizational structure, formal/informal management
systems, compensation policies)

A strategic group is a group of organizations following the same strategy in the same industry. In
between strategic groups are mobility barriers
in order to do so. The competitiveness within strategic groups is usually higher than between them,
they also tend to differ in their level of profitability.

What is Competitive Advantage?

Competitive Advantage when a firm creates more economic value than its competitors (economic
value: difference between perceived benefits of a customer buying a product and the full economic
cost of producing the product)

Competitive advantages can be sustained or temporary (most are temporary because more profit
attracts competition and provides an incentive for innovation)

Competitive Parity two firms create the same economic value

2
Competitive Disadvantage when a firm creates less economic value than its competitors

Means of Measuring a Competitive Advantage

Accounting Measures
and loss reports / balance sheets

- Profit Ratio Profit / Size

- Liquidity Ratio ability to meet short-term financial obligations
- Leverage Ratio level of financial flexibility; e.g. debt / assets
- Activity Ratio inventory turnover

Different ratios work better in different industries and ratios are only useful in comparison to others.

Economic Measures cost of capital instead of comparing to

the average level of return in the industry.

- Cost of Capital: capital in organizations originates from equity (capital from individuals) and
debt (capital from banks). Together these sources of capital have a certain cost (also called
the weighted average cost of capital, WACC) which is the minimum level of performance a
company has to reach in order to sustain itself.

Emergent vs. Intended Strategies

Intended strategies are well-informed and defined strategies employed by organizations to achieve a
competitive advantage. However, some companies have a hard time just employing the original
strategy. Due to changes in the industry or new upcoming opportunities, emergent strategies can
manifest over time. These are different form the original one and sometimes build upon completely
different factors.

3
CHAPTER 2 EVALUATING A FIRM S EXTERNAL ENVIRONMENT
Understanding the General Environment
The general environment describes large developments in the organizations context that impact its
performance to some degree.

- Technological Change new machinery, innovation

- Cultural Trends changes in values and norms, what is deemed desirable
- Demographic Trends distribution of individuals in a society in terms of age,
ethnicity, marital status
- Economic Climate health of economic system in which organization operates
- Legal Political Conditions las and legal systems/relationship between organization
and government
- Specific International Events civil wars, political coups, terrorism

Understanding the Industry in which the Organization operates

An industry lling a similar need with a similar production

They are assessed with the Five Forces Model:

(1) Threat from New Competition (companies that threaten to start operating in an industry)

Forces weakening this threat:

1. Economies of Scale: entering an industry may mean to create higher supply than
demand leading to less profit for all firms, less incentive to join industry
2. Product Differentiation: brand identification + customer loyalty make it difficult for
new producers to win customers over
3. Cost advantages independent of scale:
i. Superior technology
ii. Managerial know-how
iii. Favorable access to raw materials
iv. Learning curve advantages
4. Government policy as a barrier (e.g. secondary education/electricity production)

(2) Threat from Existing Competitors (intensity of competition)

Forces weakening this threat:

1. Large number of competing firms of roughly the same size

2. Slow industry growth
3. Differentiation of products difficult
4. Capacity added in large increments

(3) Threat of Substitute Products

Forces increasing this threat:

1. Availability of substitutes
2. Low switching costs between products

4
 3. High similarity of substitute product

(4) Threat of Supplier Leverage (How much power du suppliers have?)

Forces increasing this threat:

1. Supplier industry dominated by only a small number of firms

2. Suppliers sell unique/differentiated products
3. Suppliers are not threatened by substitutes
4. Suppliers threatens forward vertical integration (starting to compete in the industry
of the customer)
5. Firm is not an important customer of the supplier
i. High switching cost for firm

(5) (How much power do customers have?)

Forces increasing this threat:

1. Small number of buyers

2. Products are undifferentiated and standard
3. Products sold to buyers are a significant percentage of their willingness to pay
4. Buyers economic capabilities are limited
5. Buyers threaten backwards vertical integration (supplying themselves)

This model shows (I) the most prevalent threats in industries, (II) the overall level of threat in an
industry and (III) anticipates the average level of performance of firms in an industry.

Limits of the Five Forces Model

- Highly dependent on properly defining and identifying the industry an organization operates
in in
- Unclear weighting of forces (is one more important than another?)
- Could actually be an oversimplification of actual circumstances in an industry

Industry Lifecycle and Environmental Opportunities

(1) Emerging Industries
a. New industry based on break-through technology or product
b. No product standard has been reached
c. No dominant firm has emerged
d. New customers come from non-consumption not from competitors

Strategic Opportunities:

- First mover advantages

- Technology
- Locking up assets

5
 - Creating switching costs

(2) Fragmented Industries / Growth Industries

a. Large number of firms
b. Low cost of entry
c. Diseconomies of scale

Strategic Opportunities:

- Consolidation: decreasing number of competitors through ownership, creating economies of

scale

(3) Mature Industries

a. Slowing growth in demand
b. More international competition
c. Technology standards have been established

Strategic Opportunities:

- Differentiate products
- Improve service quality
- Improve processes

(4) Declining Industries

a. Absolute decline in sales over time
b. Firms start to exit the industry
c. Firms stop investing in maintenance

Strategic Opportunities:

- Becoming the market leader (purchasing competitors

- Market niche: reduce scope of operations and narrowing t down to a specific segment of the
industry
- Harvest: systematic withdrawal, extracting a much value as possible
- Divestment: selling product lines, facilities, patents to enter new industries

6
CHAPTER 3 EVALUATING A FIRM S INTERNAL CAPABILITIES
Resource Based View of the Firm
Model focusing on the tangible and intangible resources and capabilities controlled by a firm as a
source of competitive advantage.

- Resources can be tangible or intangible

o Financial Resources
o Human Resources
o Physical Resources
o Organizational Resources
- Capabilities are skills and knowledge which enable the productive use of resources (on their
own, capabilities do not lead to a competitive advantage)

Two critical assumptions in this model are:

- Resource Homogeneity in certain activities some businesses may be more skilled and
effective than others
- Resource Immobility some advantages can be long-lasting because it is costly for others
to copy them or find suitable substitutes

Implications of the Resource Based View

- Only imitating competitors (benchmarking) is a valuable tool for firms at a comparative
disadvantage. However, to obtain a comparative advantage, a firm must discover the unique
potential of its own resources and capabilities and implement a strategy/structure aimed at
exploiting them
- Socially complex attributes of a firm are likely to be a source of sustained competitive
advantage as they ae difficult to imitate

The VRIO Framework of Resources

(I) Value? Does a resource enable the exploitation of an external opportunity or
neutralize a threat? Does it increase revenue and decrease costs or a combination of the
two?

(II) Rarity? How many competing firms already possess a particular valuable resources
and capabilities?
i. In competitive parity, this criterion can lead to a competitive advantage

(III) Imitability? Do firms without the resource or capability face a cost disadvantage in
obtaining or developing it compared to the firm that already possess it?
i. Competing firms can imitate or substitute a valuable resource of their
competitors, choice depends on cost of imitation/substitution

What makes resources difficult to imitate?

- Historical conditions: being the first to acquire a resource (path-dependent advantage)
- Causal ambiguity: It is not properly understood how certain resources/capabilities lead to a
competitive advantage (complex relationships, structure, organizational culture
- Social complexity: socially complex structures like relationships, culture is understood but
cannot or is very expensive t be copied
- Patents: can prevent imitation in some industries

7
 (IV) Organization? Is a firm organized to exploit the full competitive potential of its
resources and capabilities?
i. Formal reporting structure
ii. Management control systems: Are managers acting in line with the
organizational strategy?
iii. Formal management controls: budgeting, reporting activities
iv. Informal management controls: culture, willingness to monitor one another
v. Compensation policies: ways in which employees are paid

This last aspect is crucial as it can negate any potential advantage by being aligned in a
counterproductive way.

Valuable Rare Costly to Exploited by the Competitive Implications

imitate? Organization?
No / / No Comparative Disadvantage
Yes No / Yes Comparative Parity
Yes Yes No Yes Temporary Comparative Advantage
Yes Yes Yes Yes Sustained Comparative Advantage

Imitation and Competitive Dynamics in an Industry

Competitive Dynamics: interplay of decisions, how decisions made by one firm influence the decision
made by another firm

Generally, competing firms have three ways of responding to a strategic change in a competing
businesses strategy:

(I) Not responding preferred strategy when:

a. Capabilities to respond are missing
b. Responding would damage ongoing operations
c. Tacit cooperation (implicitly reducing rivalry in an industry) is in place. This can be
the case in industries with the following characteristics:
i. Small number of firms (easy coordination)
ii. Homogeneous products (no incentive to cheat on partners)
iii. High barriers to entry (profit does not cause more competition)
(II) Changing Tactics tactic ( )
a. Copying strategies, decisions, products (reverse manufacturing) or services from
competitors, adjusting prices, publishing new product lines
(III) Changing Strategies changing the entire strategy of an organization (going through
the strategic management process (Chapter 1) again in reaction to consumer taste
changes. Technological developments

8
CHAPTER 4 COST-LEADERSHIP
Cost Leadership, a Business Level Strategy
Business level strategy: actions taken by a firm to gain a competitive advantage in a single market or
industry

Cost-leadership: focus on gaining advantages by reducing costs below those of competitors

Sources of a cost advantage:

1. Size differences and economies of scale

Economies of scale increase in firms size (volume of production) is associated with lower
costs (average costs per unit). The company with the largest production volume at the lowest
possible price is the price leader in the industry

Why does a higher volume of production lead to decreased costs?

- Specialized machines can be highly effective at producing large quantities of products at a
lower cost
- Larger plants can be build
- Employee specialization is possible in large production facilities
- Overhead costs (maintenance costs of production) can be spread across more units

2. Size differences and avoiding diseconomies of scale

As firms grow too large, diseconomies of scale emerge which prevent the company from
maintaining the cost-leadership. Sources of diseconomies of scale are:

- Physical limits to production volume

- Managerial diseconomies manager lose oversight of processes with growing firm size
- Worker demotivation specialized workers lose connection to their work process and
become alienated, alienated workers are less productive and raise costs
- Distance to markets and suppliers large distances lead to increased transportation costs
which may negate savings from otherwise effective production processes

3. Differences in experience and learning curve advantages

Whenever the cost of accomplishing a business activity falls as a function of how many times

4. Differential low-cost access to productive inputs

Productive inputs are supplies used by a firm to conduct its business activities.

- Historical being in the right place at the right time

- First mover advantages
- Differences in natural resources/endowment country and regional differences
5. Technological advantages independent of scale
- Technological hardware advantages: machines robots
- Technological software advantages: relationship quality, organizational culture

9
 6. Policy choices
- Choices about which products will be produced
- Devotion of the overall company to cost-cutting (implementing policies that decrease costs)

The Value of Cost-Leadership

- Creating barriers of entry (new competition unlikely)
- Substitutes less attractive to customers as they are more expensive
- Cost leaders are usually large customers of suppliers, giving them strong bargaining power
(see Walmart)

Rarity of Cost Leadership

Rare sources of cost leadership: first mover advantages, learning curve advantages, differential
access to productive inputs, differences in technological software

Less rare sources of cost leadership: economies of scale, cost advantages based on avoiding
diseconomies of scale, technological hardware, policy choices

Imitability of Cost Leadership

Easy to duplicate sources:

- Economies of scale can easily be copied

- Avoiding diseconomies of scale as well

May be costly to duplicate:

- Learning curve advantages

- Technological hardware
- Policy choices

Costly to duplicate sources:

- Differential access to productive inputs is path-dependent and therefore hard to imitate

- Technological software is difficult to duplicate

Organizing to Implement Cost Leadership

Organizational structure, management controls and compensation policies should be aligned with
the strategy

Structure: usually a leader implements a functional structure with as flat as possible reporting
structures (resolving around the CEO as the main multifunctional individual in the organization)

CEO responsibilities: strategy formulation, coordinating functions in the organization

Management Controls: cost-control systems, quantitative goals and performance measurements

Compensation Policies: higher pay when costs are low, overall giving incentives for cutting costs and
working efficiently

10
CHAPTER 5 PRODUCT DIFFERENTIATION STRATEGY
Product Differentiation
Products are perceived to be different than their substitutes and competitors in a way that is
meaningful to the customer. This can be done through:

1. services
1. Altering product features
2. Product complexity (for how many different tasks the product can be
used)
3. Time of product introduction (first-mover advantage)
4. Location of services (e.g. McDonalds)

2. Focusing on the relationship between a firm and its customers

1. Enabling product customization
2. Consumer marketing: marketing a product to a specific group of
people
3. Reputation of a firm (e.g. Apple)

3. Focusing on links within and between firms

1. Linkages between functions effective internal structure
2. Links with other firms e.g. profiting from the reputation of
another firm
3. Product mix providing advantages by selling a specific set of
interrelated products (e.g. PlayStation + games)
4. Distribution channels
product
5. Service & support providing extraordinary levels of support to
customers

Value of Product Differentiation

Product differentiation neutralizes the following threats to a company:

- Threat of new entry increased entry costs

- Threat of rivalry differentiation by definition avoids rivalry
- Threat of substitutes differentiation makes the initial product of the firm more
desirable than alternatives
- Threat of supplier power firms that differentiate can easily redirect increased costs
onto customers
- Threat of buyer power buyers influence is lessened as they can only obtain a
strongly differentiated product from the one company that produces it

11
Rarity of Product Differentiation
Developing a good product differentiation strategy needs creativity. The firms that are most able to
exert this creativity / who invest in research and development as well as innovation, will be able to
differentiate their products and services more easily.

Imitability of Product Differentiation

Easy to duplicate:

- Differentiation based on only changing product features can easily be copied and only serve
as a source of temporary competitive advantage. Specific forms of consumer marketing are
also easily imitated.

Potentially costly to duplicate:

- Product mix, links with other firms (more difficult when based on socially complex
relationships), product customization and complexity (easy to copy unless based on complex
interactions of individuals within or between companies)

Usually costly to duplicate:

- Links between functions (based on organizational culture complex social construct),

timing and location(path-dependent), reputation (usually uncertain and not well understood
how it arose as well as path-dependent), distribution channels (usually path-dependent),
service and support (socially complex, specialized employees with experience)
o These are most likely to serve as a source of sustained competitive advantage

Organizing to Implement Product Differentiation

1. Organizational Structure
a. Employing a similar structure as in low-cost leadership, but with usually more layers
(sometimes even as far as a matrix-structure)
i. Main feature: cross-functional, cross- -

(facilitating creativity)

2. Management Controls
a. Broad decision latitude that does not impede creativity but at the same time ensures
that decisions are made in line with the organizations mission and objectives
b. Employing a policy of experimentation firms engage in several research and
development efforts at once to identify future opportunities; overall open climate
that allows for creativity

12
 3. Compensation Policies
a. Rewards for risk taking, not punishment for failure (creative flair)
b. Evaluation of employees should take the multidimensional nature of facilitating an
effect product differentiation strategy into account ( multidimensional
performance measurement)

Implementing Cost-Leadership and Product Differentiation simultaneously?

There are two general opinions about this:

NO:

- The organizational requirements for both strategies to work effectively contradict each other
o Companies have to dedicate themselves to one of these strategies, to avoid being
stuck in the middle

YES (Differentiation increased market shares low-cost leadership)

- Successfully differentiated products and services are likely to see an increase in their volume
of sales which in turn enables economies of scale, leveraging cost reduction
- Managing the contradictions of these two strategies requires a complex organizational
structure with many complex social relationships between employees
o Therefore, a company that manages to achieve this mix is likely to have a sustained
competitive advantage

13
CHAPTER 6 VERTICAL INTEGRATION
Vertical Integration
Moving forward or backward along a firms value chain

Backward vertical integration: firm incorporates more steps of the value chain within its boundaries
and these bring it closer to the beginning of the value chain (raw materials)

Forward vertical integration: bringing the firm closer to the end of the value chain (customer)

Usually both of these moves are made without the intention of selling intermediate products or
services outside of the value chain.

Value of Vertical Integration how vertical integration can create / protect value for a firm
1. Vertical Integration & Opportunism

Opportunism: one firm in an exchange is unfairly exploited (for example in a supplier-buyer

relationship)

In exchanges, some parties make transaction-specific investments (investment that has way more
value on this specific exchange relationship but not outside of it). Such investments make firms
vulnerable to opportunistic behavior.

higher transaction specific investments in a future exchange are the more

likely a firm should opt for vertical integration.

2. Vertical Integration and Firm Capabilities

Firms in general should only vertically integrate into business activities where they possess valuable,
rare and costly to imitate resources and capabilities.

3. Vertical Integration and Flexibility

Firms should not vertically integrate into highly uncertain business activities (instead they should use
strategic alliances: these are more flexible and still enable a firm to later dedicate more resources
into that activity)

Rarity of Vertical Integration

Firms with rare and costly to imitate resources and capabilities in a certain business activity can gain
a (temporary) competitive advantage.

Firms that resolve an uncertainty of a certain business activity first, gain a competitive advantage by
being the first to increase their investment and dedication into a certain activity (being able to
acquire resources, contracts and other path-dependent things before the competition can).

14
At the same time, it can also be rare for a company to e the first to realize that pulling out of a
certain business activity is the most optimal move (vertical dis-integration).

Imitability of Vertical Integration

Resources required to create a successful vertical integration can be easily manipulated insofar they
are not path-dependent, socially complex or causally ambiguous (not properly understood).

as its ability to implement a

vertical integration strategy are major factors in determining whether other firms are able to
imitate the strategy.

Organizing to Implement Vertical Integration

1. Organizational Structure

Typically, a functional structure is adapted and the vertical integration is implemented in one of the
functions of the firm. The CEO needs manage potential conflicts between functions that could arise
as a consequence of the vertical integration.

2. Management Controls

Budgets: managers are usually evaluated on their ability to meet budget expectations which causes a
tendency of managers to overly focus on short-term goals rather than long-term investments. In
order to fight this tendency, firms can implement qualitative evaluation mechanisms or implement
open and participative budgeting processes.

3. Compensation Policies
- Opportunism based vertical integration
o In order for companies to reach their full economic potential, their employees need
to make firm-specific investments (e.g. relationships)
But these make an employee dependent on one specific company so they
may refrain from making such investments
In a new vertically integrated part of a firm, it is therefore helpful to
provide compensation policies that facilitate employees to make
these investments
E.g. cash bonus / stock grant based on individual performance
- Capabilities
o Providing an incentive for employees to form socially complex connections and
relationship can further help a firm to create a hard and costly to imitate vertical
integrations strategy
Compensation policies that help are e.g. collective bonuses based on team
performance
- Flexibility
o Creation of flexibility depends on employees being willing to engage in activities that
have fixed and known downside risks and significant upside potential

15
o Providing employees with compensations which reflect those attributes can help to
facilitate their courage to implement such activities
E.g. providing employees with the option of purchasing the organizations
stocks at a fixed price

16
CHAPTER 7 CORPORATE DIVERSIFICATION
When a firm operates in multiple markets or industries at the same time, it implements a corporate
diversification strategy.

- Product Diversification Strategy: operating in multiple industries

- Geographic Market Diversification Strategy: operating in multiple geographic markets
- Product-Market Diversification Strategy: bot above types simultaneously

(I) Limited Corporate Diversification

i. Single business firms (firms operating in only one industry or market)
ii. Dominant business firms (one major business in one market or industry in
addition to a small subsidiary

(II) Related Corporate Diversification (less than 70% of revenue originates from a single
market or product)
i. Related-constrained (businesses of company share large number of input,
product technology, distribution channels, customers, etc.)
ii. Related-linked (some businesses of the company share certain features,
sometimes production technology, sometimes customers; different links
between each of the business)

(III) Unrelated Corporate Diversification (less than 70% revenue from a single business)
i. Businesses share only few if any common attributes

Value of Corporate Diversification

Corporate diversification is economically valuable when (I) there exists a valuable economy of scope
along the businesses of a company and (II) it is less costly for managers in a firm to realize the
economies of scope than for outside equity holders on their own.

Exploiting operational economies of scope

- Shared activities:
o being able to share certain activities with multiple / among multiple businesses can
reduce costs of a diversified firm
o
consumers
RISKS:
Management of shared activities demanding
Potentially sharing bad reputation hurts performance
- Core competencies

17
 o Collective knowledge accumulated over time in the organization about how to
coordinate diverse production processes and integrate multiple streams of
technology\
RISKS:
Managers may make up non-existent core competencies of a firm to
justify the decisions (invented competencies)

Exploiting financial economies of scope

- Capital allocation:
o A diversified firm has access to information of its businesses that enable it to
evaluate the appropriate amount of investment into a business more easily than
external sources fewer funding errors capital allocation advantage
RISKS:
Type of diversification influences efficiency of capital allocation
Managers of businesses may lie about performance to acquire more
fund
Managers in charge of allocation ay escalate their commitment
- Risk reduction
o Diversifying into businesses with independent cash flows reduces risks (businesses
can compensate for one another)
- Tax advantages
o By operating multiple businesses underneath the same overarching company, firms
can manage to reduce the amount of taxes they have to pay.

Exploiting anticompetitive economies of scope

- Multipoint competition (competition between two firms takes place in multiple industries)
o Mutual forbearance may appear (actively avoiding competitive activity), only if losses
that appear due to engaging in a certain activity
- Diversification and market power
o Firms may partake in predatory pricing: lowering prices of one business below
competitive level by subsidizing it with profits from another business)
Deep-pocket model applying monopoly pressure in other businesses

Managers may also diversify their businesses solely to obtain higher bonuses

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Value of Related vs Unrelated Diversification
Related Unrelated
Advantages Economies of Scope Large Small
Internal Capital Market Large Large
Competition Reduction Large Medium
Risk Reduction Small Large
Disadvantage Management Costs Large Small
Lost focus Small Large

Porters (ABC) Essential Test

- Attractiveness test: 5-forces analysis Are profits to be expected when entering the
industry?
- Better-off test: Are there actual synergies between the businesses?
- Cost of entry test: Do entry barriers nullify profitability prospects?

If these tests are passed, it is likely that a diversification strategy will create stockholder value.

Rarity of Diversification
Economies of scope and their rarity depends to a high degree on the companies and businesses with
the diversified firm at hand. Should these firms possess rare, valuable and costly to imitate resources
and capabilities, then other diversified firms may not be able to obtain similar firms for their
diversified businesses.

Imitability of Diversification
Costly to duplicate:

- Core competencies
- Internal capital allocation (require sophisticated information processing)
- Multipoint competition (cooperation between firms in form of mutual forbearance is socially
complex)
- Deep pockets model / predatory pricing (requires immense financial options)

Easy to duplicate:

- Shared activities
- Risk reduction
- Tax advantages
- Employee compensation

Disadvantages of Corporate Diversification

- Increased management costs (coordination costs optimal allocation; monitoring costs
enforcing rules)
- Loss of focus may become a problem in a firm that has become too diversified (especially in
unrelated corporate diversification)
- Rising agency costs

19
o Management entrancement (managers create business situations that can only be
run by themselves to secure their position)
o Empire building (diversification is only implemented by managers because they want
to increase their status and salary, not due to acting in accordance with the
organizations mission)

20
CHAPTER 8 ORGANIZING TO IMPLEMENT CORPORATE DIVERSIFICATION
General Information about Organizational Structures
Organizational structures divide information processing into manageable blocks (span of control).

- Functional Structure (U-form)

o + high specialization possible as well as efficiency
o cumulative control loss and lack of strategic focus

- Product / Area Division Structure (M-form)

o + product / area focus possible, reduced top management overload
o loss of synergies and efficiency

- Matrix Structure
Activities are grouped along several dimensions at the same time
o + simultaneous focus on performance in several dimensions
o unity of command is lost / dual authority confusion

In practice, one usually only finds hybrid structures (mixtures of multiple types).

Organizational Structure in Corporate Diversification

A diversified firm usually displays a M-structure (multidivisional) each business is represented by a
division that acts as a true profit and loss center / the individual divisions usually display a U-form
(functional structure)

Management Controls and Implementing Corporate Diversification

(I) Evaluating divisional performance

Main problem here is the ambiguity of divisional performance

difficult to decide how much a division has actually contributed to its own success
To correctly judge a divisions performance, the experience of senior
executives and other experts is needed to detangle the web of divisions

Additionally, the following accounting measures can be used:

Common hurdle rate certain level of performance / profit that all
divisions have to reach
Comparing the performance of a division / business with others in its
industry

(II) Allocating Corporate Capital

Managers have a strong incentive to lie about the performance of their division to secure
funds and the continuation of support from stakeholders.

21
 As a solution a company can implement an independent corporate accounting function
or:

Zero-based budgeting divisions have to compete for capital by presenting

(III) Transferring Intermediate Products

Intermediate products and services are traded between divisions with the help of a
transfer-pricing-system

Market-based: Transfer prices equal the value forgone by not selling the
good or service to the external market
Negotiation: divisions negotiate about prices with one another
Cost: costs are determined by the overarching firm
Dual Pricing: products and services are provided at different prices to
different divisions

Compensation Policies
Again, the overall aim of compensation policies is to provide managers with enough incentives to
make decisions which are consistent with stakeholder interests as well as the overall mission of the
firm and its objectives.

22
CHAPTER 9 STRATEGIC ALLIANCES
Strategic alliance: two or more independent organizations cooperate in development, manufacture
or sales of products and services

Types of Strategic Alliances

- Non-equity alliance independent organizations do not take equity positions, the alliance is
purely managed through contracts
o Licensing agreements (firm allows another to sell one of its brands)
o Supply agreements
o Distribution agreements (firm agrees to distribute the products of another firm)

- Equity alliance contracts are supplemented by equity investments of one partner in the
other (sometimes reciprocated)

- Joint venture cooperating firms create a legally independent firm in which both invest
money and whose profits are shared among the original firms. At the same time, their
interests are aligned as well.

Here the degree of interdependence and interconnectedness of the firm increases as we descend in
the list.

Value of Strategic Alliances

Opportunities associated with strategic alliances fall into three large categories:

1. Improving current operations

a. Exploiting economies of scale by combining volumes of production
i. Especially when optimal volume of production cannot be reached alone or when
monopoly regulations forbid a single firm from reaching a certain production
volume
b. )
i. First firm that reaches its designated goal in the alliance is in an advantageous
position and could decide to underinvest from that point onwards
c. Sharing costs and risks in e.g. research anddevelopment

2. Creating a favorable competitive environment

a. Setting technology standards in an industry (e.g. Windows)
b. Facilitating tacit collusion
i. collusion subtype of cooperation; usually illegal reducing supply and
increasing prices, trying to exert monopoly power in an otherwise competitive
market

3. Facilitating entry and exit

a. Low-cost entry into new industries / industry segments

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 i. Avoiding entry costs by making use of machinery or other investments that
another firm has already made in the past
b. Low-cost exit
i. Forming an alliance to enable interested buyers to full assess the value the firm
and its assets
c. Managing uncertainty in a certain segment
i. Attaining real options
the option of increasing investments in the future, in case one of the companies
turns out to be really profitable)

Threats to Alliances
(I) Adverse Selection
Potential partners misrepresent the value of the skills and abilities they bring to the
alliance. The less tangible their contribution, the harder it is to assess/identify this
behavior.

(II) Moral Hazard

Partners provide to the alliance skills and abilities of lower quality than they promised.
This is often a unforeseen consequence of changing conditions in the market

(III) Holdup
Partners exploit the transaction-specific investments made by the other firm in the
alliance. Sometimes strategic alliance can also keep holdups from happening, however,
this requires the creation of an explicit management framework and contracts.

Rarity of Strategic Alliances

The rarity of a single strategic alliance can be determined by the rarity of the specific skills, abilities,
competencies of the individual firms. In addition to that, the submerging synergies and overall
uniqueness of the alliance partners can further increase the rarity of a specific alliance.

Imitability of Strategic Alliances

Successful alliances are commonly based on socially complex relationships. Some partners firms are
more capable of forming strategic alliances than others because of their distinct openness and
relationship building skills as well as experience in building and maintaining alliances.

Any alliance that relies on social relationships, has unique synergies or is mainly maintained due to
the experience of certain individuals is likely to be difficult and especially costly to imitate.

Organizing to Implement Strategic Alliances

The value of a strategic alliance cannot be realized by all organizations. In order to realize the value
of strategic alliances the following can help:

(I) Explicit contracts and legal sanctions

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 a. Anticipating certain cheating potentials, predicting possibilities for cheating or other
threats to alliances can help to prevent these by making explicit legal agreements
and contracts
(II) Equity Investments
a. If allied firms make equity investments in one another, that strongly reduces their
incentive to cheat on one another as such behavior would damage the invested
money
(III) Firms Reputation
a.
information about the cheater quickly spreads through the industry
b. Firms with a good reputation are more likely to be chosen as partners by other firms
(IV) Joint ventures
a.
the new firm and therefore is damaging to all partners of a joint venture. This makes
cheating in a joint venture less likely, sometimes making it the best opion for two
firms to cooperate
(V) Trust
a. Joint ventures that are based on trust can develop into unforeseeable directions and
remain highly flexible over time as explicit contracts may not be needed for the
successful management of the alliance
i. Trust is socially complex and takes time to develop, an alliance built on trust
is therefore both rare and costly to imitate

Why do Alliances fail?

- Interfirm rivalry cooperation leads to competition, misunderstandings create conflict
- Managerial complexity of organizing the interactions of companies in a strategic alliance
- Cultural dissimilarity may lead to misunderstandings and conflict as well

Most commonly though alliances fail because firms value individual and short-term gains from
cheating in an alliance more than the potential for long-term relationships and collective gains from
cooperating.

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CHAPTER 10 ACQUISITIONS AND MERGERS
What are Mergers and Acquisitions?
Acquisition: One firm purchases another one (either by going in debt or with existing capital). This

controlling share

o Friendly acquisition: management of target firm wants its firm to be acquired

o Unfriendly acquisition: managers of target do not want their firm to be acquires (also
called hostile takeover)

Acquisitions can take place through direct negotiations when a target firm is privately held (not
selling shares on the public market) or closely held (selling only very few shares on the public
market).

For publicly held firms, the firm attempting to acquire usually makes a tender offer (offering to buy
shares of the target firm at a price above the current one). The surplus that stakeholder can acquire
by selling their shares in such a situation is called acquisition premium.

Merger: Assets of two similar sized firms are combined mergers usually start out as friendly but in
the long run can develop into a more acquisition like state

Antitakeover tactics employed by Managers in an Unfriendly Takeover

Stakeholder wealth-decreasing antitakeover tactics:

- Greenmail repurchasing stocks from the bidder at a premium

- Standstill agreement bidding firm agrees to not take over the target firm
- Poison Pills target firm managers take action to make acquisition more expensive (e.g.
promising their shareholders large compensations in case the firm is acquired)

Stakeholder wealth-neutral antitakeover tactics:

- Shark repellants: variety of minor changes in firm governance that make a firm more difficult
to acquire
- Pac man defense: starting to purchase stocks of the bidding firm
- Crown jewel sale selling only specific parts of the company instead of the whole
- Lawsuits delaying the acquisition process

Stakeholder wealth-increasing antitakeover tactics:

- White knight: search for another bidding firm that the management prefers
- Golden parachutes: promising managers substantive cash payments in case they lose their
jobs during the acquisition (reduces resistance majorly)

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Value of Mergers and Acquisitions
If there are economies of scope between bidding firm and target firm, the value of the target firm
increases above its market value for the bidding firm. Therefore the value of an acquisition depends
on the relatedness of target and bidding firm.

The unrelated case

- The acquisition of a completely unrelated company is not likely to provide economic profits
economies of scope are unlikely to form. Ultimately, therefore, the company is only
purchased at its exact market value ass the bidding firm is not willing to pay any value above
the market price.

The related case

- of potential sources of strategic relatedness

o Technical economies
Scale economies that occur when physical processes in a firm are altered so
that the same input leads to more output (e.g. companies combing their
volumes of production)
o Pecuniary economies
Economies achieved by firms ability to dictate prices by exerting market

o Diversification economies
Economies achieved by covering risk attributes relative to performance or
increasing performance relative to risk attributes (e.g. portfolio management
by operating in more than just one business, a firm can more easily
compensate for bad times in one of its businesses)

Advantages of Mergers and Acquisitions

(I) Potential Reduction in production / distribution costs
i. Economies of scale
ii. Adoptions of more effective technology for production
iii. Acquiring new distribution channels

(II) Gaining market power

i. Reduced competition increased profits
ii. However, reducing competition in this way also reduces it for competitors in
the industry
iii. Many countries have antitrust laws which forbid such behavior

(III) Avoiding bankruptcy cost

i. Bankruptcy has high costs (e.g. loss of consumer confidence)
ii. When combining multiple unrelated cash flow, companies become less
prone to bankruptcy

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 (IV) Revenue enhancement through gained expertise or unused potential
i. Firms often need expertise in particular areas to compete more efficiently
(acquiring talent can be one of the most cost-efficient way)
ii. Being able to use unused management or production potential

(V) Lower threat of opportunism

i. Transaction specific investments are made at less risk in an acquisition /
merger

Other Reasons for Mergers and Acquisitions?

(I) Ensure Survival
i. If competitors generate profits and increase their efficiency through
acquisitions, failing to do the same can lead to a firm having a competitive
disadvantage
(II) Free cash flow
i. Cash flow amount of cash that a firm has to invest after all positive net
present-value investments have been made)
ii. When stockholders do not want more money from a company, investing in
acquisitions is one of the best ways to use free cash
(III) Agency problems
i. Through acquisitions, managers can lower the probability of firm bankruptcy
(especially if cash flows within the firm are unrelated)
(IV) Managerial hubris
i. Unrealistic beliefs of managers that think that they are able to better
manage a target firm than its original management (this usually leads to
decreasing the value of the target firm after the acquisition)
(V) Potential for economic profits
i. Even though most of the time the bidding company does not obtain a
competitive through acquisitions, sometimes they do due to unforeseen
events in the future. This is an incentive for some managers to acquire a
company even though its future value is uncertain

Mergers and Acquisitions and Competitive Advantage

Profits from implementing a merger or acquisition strategy are possible when the market for
corporate control (market that comes into existence when several firms actively seek to acquire
another firm) is imperfectly competitive. This is the case when one firm possess and economy of
scope with the target firm, such as:

- Valuable, Rare and Private Economies of Scope

o One firm possess resources or capabilities which, in combination with the target frim
create a combined market value that is larger than the combined market value of all
other bidding firms with the target firms
Such resources and capabilities are optimally unknown to other bidders

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 - Unexpected, valuable economies of scope
o Good luck on the side of the bidding firm, increased combined market value only
becomes visible after the acquisition

Implications for Bidding and Target Firm Managers

Target firm mangers should do the following to maximize the amount f money paid for their
company:

- Seek information from bidders about private economies of scope and the true economic
value of the combined firms
- Invite other bidders to join the competition once information about potential economies of
scope has been acquired
- Delay the bidding process to increase competition

Bidding firm managers should do the following to maximize the profits acquired through the
acquisition:

- Find and identify rare and valuable economies of scope

- Keep information about the economies of scope hidden from other bidders as well as the
target firm
- Close the deal as quickly as possible once a firm has been evaluated to offer possible
economies of scope
-

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CHAPTER 11 INTERNATIONAL STRATEGIES
International strategies are a case of corporate strategy firm produces or sells its goods or services
outside the domestic market

Value of International Strategies

(I) Gain access to new customers for current products or services

The following are consideration that need to be made before going international:

a. Are customers willing to buy?

Product must address needs, wants and preferences of customers just like /
better than alternatives
b. Are customers able to buy?
Inadequate distribution channels
Trade barriers between countries
Customers lack wealth to afford good / service

The following are reasons for going abroad:

c. Extending the product lifecycle

Products with several lifecycle steps can be sold in different countries at
different steps of the lifecycle
d. Reaching economies of scale
Required volume of production for certain economies of scale can be
reached through expansion of sales into non-domestic markets

(II) Gain access to low cost factors of production

a. Raw materials (low-cost availability in non-domestic markets)
b. Labor (access to low cost labor abroad)

(III) Developing new core competencies

a. Learning from international operations
i. Success depends on:
1. Intent to learn (and how its communicated in the organization)
2. Transparency of partners
a. Different companies are more or less transparent leading to
different learning rates in alliances
3. Receptivity to learning
a. Firms differ in their ability to learn, depending on
organizational culture and culture

(IV) Leveraging Current core competencies

a. Gaining access to new products and customers in different customers in different
markets helps to make use of domestic competencies on a larger

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 (V) Manage Corporate risk on a wider market base
a. Barriers to international cash-flow makes it difficult for equity holders in one market
to diversify their portfolio over several industries / markets
b. Large privately held firms may find it optimal to broadly diversify

Balancing of Local Responsiveness and International Integration

Local Responsiveness

Addressing local needs/trends increasing demand for firms products and developing traditional
core competencies beyond the domestic borders to meet local needs

- Unable to realize full value of economies of scale and scope

International Integration

Realizing global economies of scale selling one standardized product on a global scale with little to
no variance across countries

- Requires tight integration of different businesses around the world (especially when realizing
a global value chain)
- Standardized products and services may not fulfill the same need in every country

Alternative: Transnational Strategy

Exploits advantages of both above-mentioned strategies; international operations are treated as an

integrated network of distributed and independent resources & capabilities

- The operations in countries are seen as experiments which when successful can lead to the
development of new core competencies
o Local Ideas, technology or management approaches may be standardized across the
international business if very successful

Financial and Political Risks

When going international, firms face many risks. Usually these are mainly categorized into political
and financial risks:

Financial:

- Currency fluctuations
- Different inflation rates in countries

Political:

- Changes in political situation

- Upheaval, rebellion
- Civil wars

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Companies that can manage such risks through negotiation tactics or other influences can obtain a
competitive advantage over other firms that are not able to conduct business in the same country.

Rarity of International Strategies

Today, international strategies are more common than they were in the past due to technological
advancements and the emergence of an international economy.

A international strategy can become rare due to the specific resources and capabilities that are
required to successfully implement it: only companies who possess these can implement them,
meaning that strategies based on rare competencies and skills will be more likely to be unique.

Imitability of International Strategies

Duplication:

- To the extent that firms are using path-dependent, socially complex and causally ambiguous
resources and capabilities, they have a competitive advantage which is costly to duplicate
o e.g. ability to develop detailed knowledge of local trends and tastes / ability to build
a network and distribution system in international markets

Substitutes:

- Instead of going international companies could also employ a corporate diversification

strategy within a large and geographically diverse market (e.g. USA)
o However not all advantages of international strategies can accrue to a company in
that way
E.g. risk reduction for equity holders across national borders can only be
employed when actually operating on an international scale

Organization of International Strategies

- Decentralized Federation (strategic & operational decisions delegated to country divisions)
o Maximizing local responsiveness
Avoids economies of scale / scope
Can be ineffective when certain functions are doing the same thing only in
different parts of the world

- Coordinated / Centralized Federation (operational decisions delegated to country divisions /

strategic decisions maintained at HQ)
o Balancing local responsiveness and international integration

- Centralized Hub (strategic & operational decisions maintained at HQ)

o Maximizing international integration
Specific national needs remain unaddressed / opportunities are forfeit
High coordination cost between individual parts of the company

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 - Transnational Strategy (strategic &operational decisions delegated to the operational entities
which are best at maximizing local responsiveness and international integration)
HQ constantly scans the overall business for resources and capabilities which
may become a source of competitive advantage

Advantages and Disadvantages of Different Approaches to Becoming International

Market Governance (Licensing):

- Pro:
o Contractual source of income
o Relatively low cost and limited risk
o Terms and conditions can be predetermined
- Con:
o Licensing technological know-how opens risk to imitation
o Except for new cusomers, no further advantages

Licensing and contracts are good tactics for early global market development.

Intermediate Market Governance (Strategic Alliance)

- Pro:
o Shared risk
o Pooling resources
o Forming the basis for future cooperation, developing alliance building capabilities
- Con:
o Difficult evaluation of partner contribution (especially when operating on a global
scale)
o Difficult to find a good and trustworthy partner
o Difficult to integrate and coordinate
o Disputes arrive more often and are harder to solve on a global scale

Hierarchical Governance (Mergers & Acquisition)

- Pro:
o Full control
o Integration & coordination costs (transaction costs)
o Rapid market entry
- Con:
o Substantial commitment/investment
o Negotiation complex and difficult
o Culture clash

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