Section 5

Corporate Level Strategy: Creating Value through Diversification

Vertical Integration

Forward or backwards– Full integration– Taper integration

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

Risks– Costs– Rapid technological changes– Demand predictability

Alternatives to Vertical Integration

Competitive bidding Long term contracts or strategic alliances

– Hostage taking– Credible commitments– Maintaining market discipline

Outsourcing

Cost reduction and differentiation Hold-ups, scheduling and hallowing out

Snack Foods Beverages

Foods

Frito-Lay North AmericaFrito-Lay International

Pepsi-Cola North AmericaGatorade/Tropicana North AmericaPepsiCo Beverages International

Quaker North America

Snack Foods

Frito-Lay North America

Lay’sRuffles DoritosSantitasFritos CheetosRold Gold

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

Snack Foods

Frito-Lay International

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

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

Snack Foods

Frito-Lay International

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

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

Beverages

Pepsi-Cola North America

Pepsi-ColaMountain DewSliceMugSierra MistFruitWorks

Lipton Dole Aquafina Frappuccino SoBe AMP

Beverages

Gatorade/Tropicana North America

GatoradePropelTropicanaDole juices

Beverages

PepsiCo Beverages International

Loóza juices and nectarsCopella juicesFrui’Vita juicesTropicana 100 juices

Foods

Quaker North America

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

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

Foods

Quaker North America

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

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

Business Level Strategies

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

Snack Foods Beverages

Foods

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

Where did they go?

Crafting Corporate Strategy

Moves to enter new businesses

Boosting combined performance of the businesses

Capturing synergies and turning them into competitive advantages

Establishing investment priorities and steering resources into business units

How to Diversify?

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

organizational capabilities

How to Diversify?

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

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

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

Who Makes a Geo?

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

Geo Prizm = Toyota Corolla

Geo Tracker = Suzuki Sidekick

Geo Metro = Suzuki Esteem or Swift w/hatchback

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

How to Diversify?

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

Alternative 10 point option

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

Extra Credit – 10 points

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

Extra Credit – 10 points

Bring one of the items listed below:

New/gently used backpacks or suitcases

Socks - 5 pairs

Shampoo and Conditioner – 3 pints

New/gently used sporting equipment

Refill bottle of 409/All purpose cleaner

Laundry detergent

Extra Credit Drop off

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

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

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

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

11:30 am – 8:00 pm

Acquisitions

Reasons of Acquisitions

Increase Market Power

Overcome Entry Barriers

Increased Speed

Lower Risk

Avoid Competition

Acquisitions

Reasons of Acquisitions

Increase Market Power

Overcome Entry Barriers

Increased Speed

Lower Risk

Avoid Competition

Problems with Acquisitions

Integration of two firms

Overpayment/Debt

Overestimation of Synergy

Overdiversification

Managerial energy absorption

Become too large

Substitute for innovation

Acquisitions

Reasons of Acquisitions

Increase Market Power

Overcome Entry Barriers

Increased Speed

Lower Risk

Avoid Competition

Problems with Acquisitions

Integration of two firms

Overpayment/Debt

Overestimation of Synergy

Overdiversification

Managerial energy absorption

Become too large

Substitute for innovation

Results

Poor Performance

Who Wins?

Acquired FirmShareholders

Monday October 27th WSJ

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

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

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

Failures of Acquisitions30 - 40% average acquisition premium

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

30 - 50% of acquisitions are later divested

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

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

marginal returns, 17% substantial returns

Why, then, do executives acquire?

Often, for personal reasons

Firm size and executive compensation are related

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

reduced as returns are less volatile

Levels of Diversification

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

Less ambiguity

Ear to the ground re: industry and competition

Eggs in one basket

Related Diversification at Disney

Entertainment/Production

Theme Parks

Resorts

Entertainment/Broadcasting

Cruise Lines

Retailing

Levels of Diversification (cont.)

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

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

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

Vertical Integration

Benefits

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

– greater control over operations

– access to new business/technologies

– reduce procurement and sales efforts

Risks

– increased overhead, capital and administrative costs

– loss of flexibility

– unbalanced capacities

– reaction of competitors

Tyco ElectronicsTyco Telecommunications

Tyco Fire and SecurityTyco Safety Products

Tyco HealthcareTyco Plastics

Tyco AdhesivesTyco Flow Control

Tyco Electrical and Metal ProductsTyco Fire and Building Products

Tyco Infrastructure Services

Tyco

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

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

Levels of Diversification (cont.)

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

Conglomerate Diversification - no relatedness between businesses

Unrelated/Conglomerate DiversificationAttempts to create value through the management of

vertical relationships among the businesses

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

Effective control systems

Restructuring - buy low, sell high– spinoffs– turnaround

Creating Value through Restructuring

Good, consistent job of making good investments

Favorable negotiations

Shrewd selling at the top

Shifting investment to high growth/return businesses

When/Why to Diversify?

To create shareholder value

Porter’s Three Point Test

1) Attractiveness Test

2) Cost of Entry Test

3) Better off Test

Should pass all 3

Portfolio analysis

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

GE- Nine Cell Matrix

Gro

wth

Rat

eRelative Market Share

StarsQuestion

Marks

CashCows

Dogs

Boston Consulting Group Matrix

Gro

wth

Rat

e

Relative Market Share

1.0High Low

Soft Drinks

FritoLay

KFC

PizzaHut

TacoBell

Low

High

10%

BCG Matrix for PepsiCo - Early 1990s

Gro

wth

Rat

e

Relative Market Share

.75High Low

Soft Drinks

FritoLay

KFC

PizzaHutTaco

Bell

Low

High

5%

BCG Matrix for PepsiCo - Early 1990s

Competitive StrengthsA

ttra

ctiv

enes

s

Invest Grow

Low

High

LowHigh

HarvestDivest

Hold

GE 9 Cell Matrix

Competitive StrengthsA

ttra

ctiv

enes

s

Low

High

LowHigh

GE 9 Cell Matrix for Pepsico

Soft Drinks

Snack Foods

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

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

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

Board of Directors

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

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

Board of Directors

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

Nancy Reagan sat on Revlon’s board

Hank Aaron sat on Coke’s board

Sally Ride sat on three boards

Martha Stewart and Kim Alexis sat on Drugstore.com

Al Haig and Colin Powell sat on AOL’s board

Board Involvement

Mostly little or no involvement

Boards tend to be dominated by management

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

• outsiders often weak, unknowledgeable

– effective board process

Trends in Governance

Institutional investors becoming increasingly powerful

Special interests groups and social institutional owners

Internationalization of board composition

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

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

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

….. to only $82 million

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

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

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

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

Executive Compensation - 2002

Steve Jobs, Apple 78.1M -34.6

David Cote, Honeywell

68.5M -27.3%

John Chamber, Cisco 54.8M -27.7

Pat Russo, Lucent 38.2M -75.4%

Scott McNealy, Sun Microsystems

31.7M -74.7%

Executive Compensation

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

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

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

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

Executive Compensation

Bonuses, incentives and stock ownership

– difficulty in evaluating decision making

• financial objectives used

– lengthy feedback period

– beyond managerial control

– managerial manipulation

Stock Options

– riding the stock market wave

– strike period is too long

– growth, not cost-cutting, should be rewarded

– require holding the stock after exercise

– make exercise conditional on certain criteria

Corporate Social Performance

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

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

can gain competitive advantages• Corporations, which control resources beyond

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