LECTURE NOTES Session 4 & 5: EWA, a historical perspective, correct use of tools, horizontal & vertical integration, diversification

A) Early warning analysis:1) Strategic Risks There are seven types of key strategic risks:- a) industry b) customer c) technology d) brand e) competitor f) project g) stagnation

2) The history and evolution of strategic thought can be traced to evolution of business on the whole, which is a combination of physical and social technology. EVOLUTION OF PHYSICAL AND SOCIAL TECHNOLOGY Stage of Evolution Strategic Thought Steam engine, railroad None Railway as an org, telegraph, joint stock firms, Functional division of labor, steamships, audit firms, textile and steel mills business expansion Electric power, telephone, aviation, Strategic control systems, multidivisional orgs multi-product firms Mass production firms, wireless, rapid evolution Advent of bureaucratic of aircraft, automobiles, locomotives controls, hierarchies, management accounting Expansion of US and European firms, advent of The I/O theory, theory of firm, matrix organizations, jet age, fuel injection strategy as a process, engines, long distance telephony, stock horizontal and vertical exchanges, M&A activities integration, diversification, mergers Competition from Japan, advent of wireless Competitive strategy, five telecom, internet, quality management systems, forces and value chain advent of the digital age, outsourcing, the framework, defining the personal computer and the micro-chip strategy-structure relationship, advent of SWM paradigm Virtual corporations, boundary less orgs, flat Global strategy, emerging structures, bio and Nano technologies, global market strategies, fused integration of financial markets, advent of social strategy, shaping strategy, networks, cloud computing, dot-com firms, open and reverse innovation, participatory strategy, the concept of share value (opposite of shareholder wealth maximization)

Era 1791-1825 1825-1880 1880-1920 1920-1950

1950-1980

1980-1995

1995-today

3) The three revolutions Period 1795-1895 1895-1995 1995Description First revolution Second revolution Third revolution Energy source Steam Oil Renewable energies Communication Telegraph Telephone Internet, mobile, cloud computing

THE REAL CRISIS EVERYONE OVERLOOKED:The peaking of oil production The International Energy Agency (IEA) stated in its 2010 world energy outlook report that, global peak production of oil probably occurred in 2006 at 70mb/day. From 2006 onwards then, to even maintain this level will require an investment of 8 trillion dollars over next 25 years to pump difficult to capture remaining oil from existing fields and search for new fields increasingly harder to find. This implies that oil from 2006 onwards can only get costlier. The rise of oil prices and the ripple effect In 2007 Chinas growth rate was 14.2% and Indias growth rate was 9.6%, bringing 1/3 rd of the global population into the oil era, over last 10 years of continuous growth. In July 2008, the price of oil rose to $ 147/barrel. The prices of commodities had begun rising much earlier than that. By 2008 end, the price of soybeans and barley had doubled, wheat had tripled and rice quintupled. The FAO reported that nearly one billion are going hungry. Price of construction materials, medicines and packaging materials and other long list of items shot up, leading to a sudden steep decline in purchasing power. In July 2008, the banks stopped credit and two months later the financial market crashed. In 2001, the price of oil was at $24/barrel. In seven years of time, it rose six times to $147. An oscillating end game Every time there are economic attempts for recovery, outputs will rise, so will the consumption and once again the oil prices will rise to $150 or beyond to even $200, forcing a steep rise in prices of all commodities, thus once again leading to another plunge in purchasing power. The infrastructure mismatch:While in other two revolutions, the growth of communication succeeded growth of energy infrastructure and allied growth in financial and other industries followed. Whereas in case of the third revolution, the communications technology have already arrived, whereas the energy infrastructure inform of renewable and cheap energies is yet to arrive! This caused a massive mismatch starting from 1990s. The third generation communication technologies were imposed on the second generation energy infrastructure. It did rationalize overheads and improved productivity. It also paved way for many financial innovations that were at least 15-20 years ahead of their time, which triggered a boom in the banking sector inform of exotic instruments and a massive demand for a breed called MBA-finance.

The resultant asset-liability mismatch While the 3G ICT infrastructure enabled scores of financial innovations, the asset-liability mismatch was growing at an alarming pace. Since 1990s majority of the manufacturing firms were facing declining profit margins, due to a steep rise in input costs and competition. This of course led to a series of mergers and acquisitions, based on economies of scale and scope. However economies of scale and scope only gave temporary cost advantages, sooner or later a disruptive innovation or a unique business model from an unknown competitor eroded the advantages of economies of scale and scope. Thus, the process of creating viable financial assets from real assets (earning power of firms) was eroding fast, resulting in poorer asset quality, which degraded over a period of time due to inflation and decreased earnings. The poor asset quality combined with rapid pace of financial innovations resulted in a unsustainable assetliability mismatch by 2008 and everything came to a halt finally by Sept/Oct 2008. The whole financial system came to a halt. 4) How industries change? Theres no such thing as lucrative industry, every industry goes thru a cycle of rise, prosperity and decline, on the other hand some industries never die, and they keep evolving, such as automobiles. Whereas some die out and give way to newer industries, such as typewriters gave way to PCs and PCs now may give way to cloud computing. Its important to understand how industries change, and how evolution of industry affects strategic planning. Any industry comprises of two core tenets: - assets and processes. The trajectory of change depends on which of these two are threatened and to what extent.

B) Correct Use of Tools:Understanding the CONTEXT, in which strategy is suggested, is very important. The five different contexts, in which strategy is formulated, are:a) b) c) d) e) As a plan from point A in present to point B in future how? As a ploy to fool or outwit competition As a pattern consistency in behavior or actions, thru which a strategy emerges As a position take a position in the market As a perspective visualize the future, very common in hi-tech industries

CORPORATE STRATEGY- Horizontal & Vertical Integration, Diversification. 1) What is Corporate Strategy? In simple words, corporate strategy comprises asking two questions: a) Where do we go from here? What business you are into? b) How do we reach there? Answering these questions can either lead to a business expansion, make-buy decision, launch of a new product, acquiring a firm or striking an alliance with another firm. Corporate strategy affects the entire organization. Good management is more asking pertinent questions rather than offering a solution through a fixed model/framework. HORIZONTAL INTEGRATION 1) Bank Mergers in India Bank mergers in India are a good example. HDFC took over Centurion Bank of Punjab in 2008, although CBOP was a healthy bank. At the time of takeover, HDFC had an asset base of 131439 crore, 1100 branches and 21477 employees. The equivalent figure for CBOP was 25,404 crore 390 branches and 7,500 employees. CBOP started as centurion bank, then it absorbed BOP and Lord Krishna bank. 2) Krafts Acquisition of Cadbury Acquire Cadbury in Feb 2010 for a final price of 19.4 billion US $. This is a merger, that is a horizontal integration, and expanding market in India and make the combine a world leader in chocolates and confectionaries in terms of revenue and scale of operations.

3) The fall and rise of Pharmacia and Upjohn In 1990s, due to withdrawal of Govt. subsidies on health care in many European and developing nations, the drug manufacturers were forced to lower the drug prices, as the absence of subsidies meant that patients were no longer in position to afford them. This led a series of mergers like that of Glaxos acquisition of Burroughs-Welcome, Rhone Poulencs merger with Rohrer and Bristol-Myers merger with Squibb. These mergers represented quite a few business synergies in terms of a reduced sales force, complimentary research knowledge and reduced procurement costs. However conventional economic wisdom, fails to take into account, the managerial and organizational challenges that any merger or acquisition entails. This is not to say, that one should completely discard economics or sound financial judgment, however once a decision based on economics is taken, it should be followed up by addressing a series of OB and HR issues, ignoring which can result in a failure of the merger. Pharmacia was a firm based on Stockholm, which had a strong European presence, but lacked a strong US presence. Upjohn was a Michigan based firm, which had a number of successful drugs and lacked a strong research base, which was Pharmacias strong point. The two firms sought to merge and take advantage of each others strengths. After the merger the synergies were expected on integrated research operations and a reduced sales force by 10%. However the HR and OB issues were ignored and when an Upjohn based manager took charge of the merged entity a series of OB issues came up, such as in reporting and an emphasis on numbers. This frustrated many of the old scientists of Pharmacia and they left the firm, which in turn led to an erosion of intellectual capital and the firms share price dropped by 25% within one year in 1996-97, after the merger. Fred Hassan from American home products took charge of the firm in 1997 and he managed to resolve many cultural and structural issues that impeded the firms growth. 4) The AOL-Time Warner merger AOL was a leading internet service provider in 2000 with 29 million customers, at that time it was more popular than MSN or Yahoo. Time-Warner was a leading cable operator in USA in 2000 with strong media brands like CNN, HBO and TNT. Time-Warners publishing arm had 35 magazines with 200 million circulations. The firm also had some of the best equipped movie production studios in USA. The merger of a large internet service provider with a large multi-media firm was expected to bring out a series of business synergies, such as entertainment going on line, and a larger number of subscribers for news and media products. The expected synergies have not realized so far on as projected and this famous merger still remains a question mark.

5) Pfizers takeover of Wyeth In 2009 Jan, Pfizer took over Wyeth Laboratories for $68 billion. The acquisition makes strategic sense by expanding the company into a range of new areas, and by helping make up for an expected loss of more than $12 billion in annual revenues once its Lipitor patent expires in 2011. Its hoped that combined revenues & joint sourcing will cut down costs, increase profits and will also result in personnel cost savings. Vertical Integration 1) Vertical disintegration of pharmaceutical industry Traditionally, pharma companies did everything in house. The pharma industry comprises three core activities. A) R&D b) production and c) marketing. Of late, the pharma companies are outsourcing the bulk production to developing or emerging markets, where labor is cheap. They are tying up with bio-tech firms to combine drug discovery with genomics, as these two have very intimate connections and keeping the marketing and branding part to themselves. Launching a world Class JV:A research conducted in 1991 found that only 51% of the JVs are successful. The same research was repeated in 2001 and more than 2000 alliances were examined to find that still only 53% of the alliances/JVs are successful. What then are the major challenges in executing a successful JV/Alliance? Lets check them out:a) b) c) d) Divergent strategic focus of partners Separate reporting systems, measurement metrics and processes Elusive economies of scale Different organizational cultures

How to execute a successful JV/Alliance? a) b) c) d) e) f) Spell out common goals clearly State the first year goals in details Create clear protocols for decision making Specify the extent of agreement and services or resources to be shared Establish clear transfer pricing mechanisms Spell out organizational commitments, take care of agency issues and influence costs

2) Pfizer-Microsoft-IBM JV In 2001, these three giants came together to announce a very unusual JV: - to make physicians paperwork an easy affair. Its a known fact that medical practitioners spend a lot of time on paperwork. Pfizer was supposed to build the physicians network, MS to provide the software and IBM the critical network devices. Together they were supposed to build a web enabled platform that will greatly ease the physicians paperwork and also share knowledge over the web about similar cases. 3) McDonalds-Toys-R-Us JV Toys-R-Us formed in alliance with Big Mac in 1990 to penetrate the Japanese market through Mac outlets. Toys-R-Us penetrated the European, Hong Kong and the South East Asian market in 1980s; however it was not able to access the Japanese market. Japans retail store law dictated that the firm obtains permission from MITI before building its stores. This law however protected the small Japanese merchants from large western retailers. Toys-R-Us concluded that it needed a local partner. Now opening stores in japan needed in depth knowledge of the Japanese real estate and site selection expertise and deep business connections. Had the firm decided to go independently, it would have been a costly and long drawn process to acquire this knowledge. Tying up with Big Mac in Japan made sense to bypass the process. Accordingly Mac took a 20% share in the alliance and Toys-R-Us opened its stores within premises of 11 Big Mac outlets. 4) Millennium Pharma tying up for profits If managed well, alliances can become an important source of competitive success. MP started as a small firm in 1993. By 2002 it grew with a market cap of 3.8 billion $. In 1997 it entered into an alliance with Monsanto, related to agricultural use of genomics. In addition to transfer of analysis of gene function through software, MP also helped create a new subsidiary for Monsanto Cereon Genomics. This firm would replicate the MP technology in agricultural settings. Two years later MP entered into another deal with Bayer for five years, which enabled to speed up drug productivity using genomics. Finally Aventis and MP signed a deal, where MP became a full time partner to participate for the entire drug value chain from discovery to marketing. The key to success of MP alliances lay in the fact that the firm was able to hold the feet of its much larger partners to fire, holding them responsible for failure to meet deadlines and reach milestones.

5) Comcast NBCU merger In Dec 2009, with a $30 billion deal to take control of NBC Universal (NBCU), Philadelphiabased Comcast is looking to integrate its cable pipes with many of the channels it distributes. Under a deal announced on December 4, Comcast will own 51% of NBCU. General Electric, the network's previous owner, will own 49%. The new joint venture that will emerge, pending approval from the Federal Communications Commission (FCC) and Department of Justice (DOJ), features a vast array of programming assets ranging from CNBC and USA Network to NBC Sports, Versus and E! Entertainment Television. The move will also make Comcast-NBCU a top-10 web property with 82 million unique visitors and sites like iVillage, Daily Candy, movie ticketing site Fandango and Hulu (an online video service that provides TV shows and movies from more than 190 content providers) in the fold. Comcast's strategy -- vertical integration -- is guided by the idea that one company can control multiple parts of a revenue chain, such as entertainment. In Comcast's case, the NBCU acquisition means it would own the content it distributes. Apple has popularized vertical integration by controlling the software and hardware in its products to deliver a better customer experience The decision to make or buy is a key strategic decision, keeping in line with the firms overall vision for next 10 years and may be reversed, according to business conditions. At times, a firm may have to strike a very close degree of coordination with its suppliers, thus resulting in a strategic alliance or joint venture. When a SA or JV is more beneficial to a total buy out? A SA or JV is more beneficial, when a high degree of coordination is needed to ensure consistent supplies, yet the economies of scale simply are not significant enough to justify a takeover. Session 5:- Diversification 1) From American Can to Primerica This firm is a classic case in completely unrelated diversification. In 1950s this firm made tin cans, required in packaging soft drinks, beers and other beverages. But forward integration by aluminum producers and backward integration by food companies, eroded American Cans market share by 1960s. In 70s the firm went into music business, direct mailing and by 1980s it was unrelated diversified firm. In 1980 the firm sold many of its unprofitable businesses and acquired Associated Madison an insurance firm. During next seven years it acquired many financial service businesses and in 1987 changed the name from American Can to Primerica. It sold off its 4 decade old can business. Finally in 1998 the firm merged with Citi Corp and ceased to exist as an independent firm.

Numerous studies have been conducted since 1980s on performance of diversified, relatedly diversified and unrelatedly diversified firms and firms who only focused on their core competence. However, strong correlations between diversification and stock market or core competence and stock prices have not been found till date. 2) Bank-Am buys Continental The 1994 Bank-Am-Continental merger brought great business synergies, economies of scale and wider access to markets. However many mergers failed to realize the expected business synergies, a topic to be explored later on. 3) Pepsis diversifications Pepsi acquired Pizza hut and Taco Bell in 1970s, these diversifications have been successful globally. However later on it acquired KFC and KFC ran into stiff competition from MacDonalds in USA and against local fast food vendors in emerging markets. Globally, KFC hasnt been a successful acquisition for Pepsi. 4) Philip Morris One is a global MNC with a strong brand like Marlboro. The other was a Indian company with British origins, also with strong brands like Wills. ITC diversified into fashion clothing leveraging the WILLS brand (although not a market leader) and it diversified into the food business to overcome the negative image of being a cigarette maker. Wheres Philip Morriss acquisitions of Miller Brewing in 1969, Kraft foods in 1988, the 7-up brand in 1978, all have been unsuccessful diversifications. 5) Textron: the most diversified firm Their products Bell Huey Cobra choppers, Cessna aircraft, golf carts, wire and cable installation systems, aircraft runway maintenance equipment, windshield and washer systems for automobiles, financial services and unmanned robotic systems. 6) Diversifications in automobile industry There are six major segments that any automobile manufacturer can be present: a) passenger cars b) tractors c) two wheelers d) three wheelers e) commercial vehicles f) earth moving and construction equipment. Can you name any company present in all six segments?

7) Dells diversification strategy Dell launched its smartphone in 2010, which was a complete flop. Like IBM did and HP is trying to, Dell too is attempting to come out of its image of a pc and a server maker to an allencompassing IT products firm. Why do firms diversify? US firms and later on European firms and even later on a large number of Indian business houses diversified at a rapid rate. Many Indian business houses, during the period 1950-1990, diversified at a rapid rate in the License Raj era. They diversified in whichever area, they obtained licenses, irrespective of their core competence (or did they really have something called CORE COMPETENCE?). Families such as the Shrirams, Nandas, Goenkas, Chhabrias, Birlas, Tatas, Bangurs, Khaitans, diversified into every possible business. In a protected market, licenses meant that they had unrestricted and protected access to the market, allowing them to control the market. 1991 and end of License Raj, spelled doom for many such family business empires, only the Tatas and AV Birla group survived the churning and turmoil. Whereas diversification in USA and Europe were different right from 1960s. Many firms diversified, expecting ECONOMIES OF SCOPE or business synergy and the promise of expanded markets. Their ambition to grow and grow big led them to diversify at a rapid pace. Diversification can be of two types here: - a) related b) unrelated. Conventional wisdom and theory of core competence dictates that any diversification move be a related one, which can result in business synergy and higher profits and market share. However theres no concrete evidence to back this theoretical assertion. Food processing giants like Pepsi and Coke have diversified into the bottled water business, after Bisleri in India, however theres nothing to suggest that these diversifications have been profitable. On the other hand, Pepsis packaged snack business has been a profitable venture in India, where as Cadburys efforts to diversify in India into related product segments such as ice creams were a miserable failure. M&Ms efforts to diversify into cars from SUVs and Tractors havent been successful so far, where as the Tata group has a wide range of product platforms, starting from the 16 ton multi-wheel truck to the Nano. Tatas core competence has been diesel engines; once again the 1400 c c V2 engine had its share of technical issues. At international levels, Toyota has been immensely successful with both petrol and diesel engines, where as VWs core competence lies around diesel engines.On the whole theres no evidence to suggest or no set of golden rules to tell us, which is better? Related or unrelated diversification?