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

Beverage s

Foods

Frito-Lay North America Frito-Lay International

Quaker North America

Pepsi-Cola North America Gatorade/Tropicana North America PepsiCo Beverages International

Snack Foods

Frito-Lay North America Lays Ruffles Doritos Santitas Fritos Cheetos Rold Gold Funyuns Sunchips Cracker Jack Chesters popcorn Grandmas cookies Munchos Smartfood Baken-ets fried pork skins Oberto meat snacks

Snack Foods

Frito-Lay International Bocabits wheat snacks Crujitos corn snacks Fandangos corn snacks Hamkas snacks Niknaks cheese sticks Quavers potato snacks Sabritas potato chips Twisties cheese snacks Walkers potato crisps Walkers Square potato snacks Walkers Monster Munch Corn snacks Miss Vickies potato chips Gamesa cookies Dippas Sonrics sweet snacks

Snack Foods

Frito-Lay International Bocabits wheat snacks Crujitos corn snacks Fandangos corn snacks Hamkas snacks Niknaks cheese sticks Quavers potato snacks Sabritas potato chips Twisties cheese snacks Walkers potato crisps Walkers Square potato snacks Walkers Monster Munch Corn snacks Miss Vickies potato chips Gamesa cookies Dippas Sonrics sweet snacks

Beverage s

Pepsi-Cola North America Pepsi-Cola Mountain Dew Slice Mug Sierra Mist FruitWorks Lipton Dole Aquafina Frappuccino SoBe AMP

Beverage s

Gatorade/Tropicana North America Gatorade Propel Tropicana Dole juices

Beverage s

PepsiCo Beverages International Loza juices and nectars Copella juices FruiVita juices Tropicana 100 juices

Foods

Quaker North America Quaker Oats Capn Crunch cereal Life cereal Quisp cereal King Vitaman cereal Mothers cereal Quaker rice cakes and granola bars Rice-A-Roni side dishes Near East couscous/pilafs Aunt Jemima mixes & syrups Quaker grits

Foods

Business Level Strategies

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

Quaker North America Quaker rice cakes and granola bars Rice-A-Roni side dishes Near East couscous/pilafs Aunt Jemima mixes & syrups Quaker grits

Quaker Oats Capn Crunch cereal Life cereal Quisp cereal King Vitaman cereal Mothers cereal

Snack Foods

Beverage s

Foods

Corporate Level Strategy

1) 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 Thursday 3/31 Friday Monday Tuesday Wednesday Thursday 4/1 4/4 4/5 4/6 4/7 4:00 pm 6:30 pm 8:30 am 9:30 am 11:30 am 8:00 pm 8:30 am 11:00 am 1:00 pm 6:00 pm 8:30 am 9:00 am 2:30 pm 5:00 pm 4:00 pm 6:30 pm 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 Firm Shareholders

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 Acquisitions
30 - 40% average acquisition premium Acquiring firms 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 Retailing Cruise Lines

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 Electronics Tyco Telecommunications Tyco Fire and Security Tyco Safety Products Tyco Healthcare Tyco Plastics Tyco Adhesives Tyco Flow Control Tyco Electrical and Metal Products Tyco 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 firms businesses Conglomerate Diversification - no relatedness between businesses

Unrelated/Conglomerate Diversification
Attempts 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 Porters 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

Boston Consulting Group Matrix

Relative Market Share

Stars
Growth Rate

Question Marks Dogs

Cash Cows

BCG Matrix for PepsiCo - Early 1990s

Relative Market Share

High

Taco Bell Pizza Hut Frito Lay KFC

Growth Rate

10% Low

Soft Drinks

High

1.0

Low

BCG Matrix for PepsiCo - Early 1990s

Relative Market Share
Pizza Hut

High

Taco Bell

Growth Rate

5%
KFC

Frito Lay Soft Drinks

Low

High

.75

Low

GE 9 Cell Matrix
High

Competitive Strengths

Low

High

Invest Grow

Attractiveness

Hold

Harvest Divest
Low

GE 9 Cell Matrix for Pepsico

High

Competitive Strengths

Low

High Snack Foods

Attractiveness

Soft Drinks

Low

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 healthcare 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 economyclass 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 Cokes and Dells Board Nancy Reagan sat on Revlons board Hank Aaron sat on Cokes board Sally Ride sat on three boards Martha Stewart and Kim Alexis sat on Drugstore.com Al Haig and Colin Powell sat on AOLs 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

Executive Compensation - 2002

Median CEO pay rose 14% to $13.2 million is a year when S&P was down over 22% One companys stock slides 71%, CEO compensation falls 12% .. to only $82 million .. Dennis Kozlowski Tycos 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.

Steve Jobs, Apple David Cote, Honeywell Pat Russo, Lucent Scott McNealy, Sun Microsystems

78.1M 68.5M

-34.6 -27.3% -27.7 -75.4% -74.7%

John Chamber, Cisco 54.8M 38.2M 31.7M

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