Strategic Formulation

1. Strategic Formulation HCAD 5390

2. Strategies

3. Strategies

4. Adaptive Strategies

5. Adaptive Strategies Expansion Adaptive Strategy: • Orientation toward growth • Expand, cut back, status quo? • Concentrate within current industry, diversify into other industries? • Growth and expansion through internal development or acquisitions, mergers, or strategic alliances?

6. Adaptive Strategies Basic Growth Strategies: Concentration • Current product line in one industry • Vertical Integration • Market Development • Product Development • Penetration Diversification • Into other product lines in other industries

7. Adaptive Strategies Expansion of Scope Basic Concentration Strategies: Vertical growth Horizontal growth

8. Adaptive Strategies Vertical growth • Vertical integration • Full integration • Taper integration • Quasi-integration • Backward integration • Forward integration

9. Adaptive Strategies

10. Adaptive Strategies Horizontal Growth • Horizontal integration

11. Advantages Operational focus on a single familiar industry or market. Current resources and capabilities add value. Growing with the market brings competitive advantage. Disadvantages No diversification of market risks. Vertical integration may be required to create value and establish competitive advantage. Opportunities to create value and make a profit may be missed. Concentration on a Single Business

12. Adaptive Strategies Basic Diversification Strategies: • Concentric Diversification • Conglomerate Diversification

13. Adaptive Strategies Concentric Diversification • Growth into related industry • Search for synergies

14. Adaptive Strategies

15. Adaptive Strategies Unrelated (Conglomerate) Diversification • Growth into unrelated industry • Concern with financial considerations

16. Adaptive Strategies

17. Incentives Resources Managerial Motives Reasons for Diversification Reasons to Enhance Strategic Competitiveness • Economies of scope/scale • Market power • Financial economics

18. Incentives Resources Managerial Motives Reasons for Diversification Incentives with Neutral Effects on Strategic Competitiveness • Anti-trust regulation • Tax laws • Low performance • Uncertain future cash flows • Firm risk reduction

19. Incentives to Diversify External Incentives: • Relaxation of anti-trust regulation allows more related acquisitions than in the past • Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions • After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments

20. Incentives to Diversify Internal Incentives: • Poor performance may lead some firms to diversify an attempt to achieve better returns • Firms may diversify to balance uncertain future cash flows • Firms may diversify into different businesses in order to reduce risk

21. Resources and Diversification • Besides strong incentives, firms are more likely to diversify if they have the resources to do so • Value creation is determined more by appropriate use of resources than incentives to diversify

22. Reasons for Diversification Incentives Resources Managerial Motives Managerial Motives (Value Reduction) • Diversifying managerial employment risk • Increasing managerial compensation

23. Managerial Motives to Diversify Managers have motives to diversify • diversification increases size; size is associated with executive compensation • diversification reduces employment risk • effective governance mechanisms may restrict such motives

24. Bureaucratic Costs and the Limits of Diversification • Number of businesses • Information overload can lead to poor resource allocation decisions and create inefficiencies. • Coordination among businesses • As the scope of diversification widens, control and bureaucratic costs increase. • Resource sharing and pooling arrangements that create value also cause coordination problems. • Limits of diversification • The extent of diversification must be balanced with its bureaucratic costs.

25. Relationship Between Diversification and Performance Performance Dominant Business Related Constrained Unrelated Business Level of Diversification

26. Restructuring:Contraction of Scope • Why restructure? • Pull-back from overdiversification. • Attacks by competitors on core businesses. • Diminished strategic advantages of vertical integration and diversification. • Contraction (Exit) strategies • Retrenchment • Divestment– spinoffs of profitable SBUs to investors; management buy outs (MBOs). • Harvest– halting investment, maximizing cash flow. • Liquidation– Cease operations, write off assets.

27. Why Contraction of Scope? • The causes of corporate decline • Poor management– incompetence, neglect • Overexpansion– empire-building CEO’s • Inadequate financial controls– no profit responsibility • High costs– low labor productivity • New competition– powerful emerging competitors • Unforeseen demand shifts– major market changes • Organizational inertia– slow to respond to new competitive conditions

28. The Main Steps of Turnaround • Changing the leadership • Replace entrenched management with new managers. • Redefining strategic focus • Evaluate and reconstitute the organization’s strategy. • Asset sales and closures • Divest unwanted assets for investment resources. • Improving profitability • Reduce costs, tighten finance and performance controls. • Acquisitions • Make acquisitions of skills and competencies to strengthen core businesses.

29. Adaptive Strategies Maintenance of Scope Enhancement Status Quo

30. Market Entry Strategies • Acquisition:a strategy through which one organization buys a controlling interest in another organization with the intent of making the acquired firm a subsidiary business within its own portfolio • Licensing:a strategy where the organization purchases the right to use technology, process, etc. • Joint Venture:a strategy where an organization joins with another organization(s) to form a new organization

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

32. Reasons for Making Acquisitions: Increased Market Power • Factors increasing market power • when a firm is able to sell its goods or services above competitive levels or • when the costs of its primary or support activities are below those of its competitors • usually is derived from the size of the firm and its resources and capabilities to compete • Market power is increased by • horizontal acquisitions • vertical acquisitions • related acquisitions

33. Reasons for Making Acquisitions: • Barriers to entry include • economies of scale in established competitors • differentiated products by competitors • enduring relationships with customers that create product loyalties with competitors • acquisition of an established company • may be more effective than entering the market as a competitor offering an unfamiliar good or service that is unfamiliar to current buyers • Cross-border acquisition Overcome Barriers to Entry

34. Reasons for Making Acquisitions: • Significant investments of a firm’s resources are required to • develop new products internally • introduce new products into the marketplace • Acquisition of a competitor may result in • lower risk compared to developing new products • increased diversification • reshaping the firm’s competitive scope • learning and developing new capabilities • faster market entry • rapid access to new capabilities

35. Reasons for Making Acquisitions: Lower Risk Compared to Developing New Products • An acquisition’s outcomes can be estimated more easily and accurately compared to the outcomes of an internal product development process • Therefore managers may view acquisitions as lowering risk

36. Reasons for Making Acquisitions: Increased Diversification • It may be easier to develop and introduce new products in markets currently served by the firm • It may be difficult to develop new products for markets in which a firm lacks experience • it is uncommon for a firm to develop new products internally to diversify its product lines • acquisitions are the quickest and easiest way to diversify a firm and change its portfolio of businesses

37. Reasons for Making Acquisitions: Reshaping the Firms’ Competitive Scope • Firms may use acquisitions to reduce their dependence on one or more products or markets • Reducing a company’s dependence on specific markets alters the firm’s competitive scope

38. Reasons for Making Acquisitions: Learning and Developing New Capabilities • Acquisitions may gain capabilities that the firm does not possess • Acquisitions may be used to • acquire a special technological capability • broaden a firm’s knowledge base • reduce inertia

39. Resulting firm is too large Inadequate evaluation of target Managers overly focused on acquisitions Acquisitions Large or extraordinary debt Too much diversification Integration difficulties Inability to achieve synergy Problems With Acquisitions

40. Problems With Acquisitions Integration Difficulties • Integration challenges include • melding two disparate corporate cultures • linking different financial and control systems • building effective working relationships (particularly when management styles differ) • resolving problems regarding the status of the newly acquired firm’s executives • loss of key personnel weakens the acquired firm’s capabilities and reduces its value

41. Problems With Acquisitions • Evaluation requires that hundreds of issues be closely examined, including • financing for the intended transaction • differences in cultures between the acquiring and target firm • tax consequences of the transaction • actions that would be necessary to successfully meld the two workforces • Ineffective due-diligence process may • result in paying excessive premium for the target company Inadequate Evaluation of Target

42. Problems With Acquisitions • Firm may take on significant debt to acquire a company • High debt can • increase the likelihood of bankruptcy • lead to a downgrade in the firm’s credit rating • preclude needed investment in activities that contribute to the firm’s long-term success Large or Extraordinary Debt

43. Problems With Acquisitions • Synergy exists when assets are worth more when used in conjunction with each other than when they are used separately • Firms experience transaction costs (e.g., legal fees) when they use acquisition strategies to create synergy • Firms tend to underestimate indirect costs of integration when evaluating a potential acquisition Inability to Achieve Synergy

44. Problems With Acquisitions • Diversified firms must process more information of greater diversity • Scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate business units’ performances • Acquisitions may become substitutes for innovation Too Much Diversification

45. Problems With Acquisitions • Managers in target firms may operate in a state of virtual suspended animation during an acquisition • Executives may become hesitant to make decisions with long-term consequences until negotiations have been completed • Acquisition process can create a short-term perspective and a greater aversion to risk among top-level executives in a target firm Managers Overly Focused on Acquisitions

46. Problems With Acquisitions • Additional costs may exceed the benefits of the economies of scale and additional market power • Larger size may lead to more bureaucratic controls • Formalized controls often lead to relatively rigid and standardized managerial behavior • Firm may produce less innovation Too Large

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

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

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

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