Financial Strategies for Value Creation (IIP)

Question 01

How financial strategies can be useful for value creation? Kindly

make a rough draft by using hypothetical information/data to show
implementation of financial strategies to create value for firm and
shareholders. Justify your answers with suitable examples.

Answer 01

Value creation is basically the main objective of any enterprise. For

an enterprise creating value for its customers helps sell products and
services, while creating value for shareholders, in the form of increase
in stock price, ensuring the future availability of investment capital to
fund operations. From a financial perspective, value is said to be
created when a business earns revenue that exceeds expenses

The value creation is popularly recognized as a better management

target than strict financial measures of performance, many of which
tend to place cost-cutting that produces short-term results ahead of
investments that increases long-term competitiveness and growth.
The first step in achieving an enterprise-wide focus on value creation
is understanding the sources and drivers of value creation within the
industry and marketplace. Understanding value creation helps
managers focus capital and talent on the most profitable opportunities
for growth
If customers value innovation and high performance, then the skills,
systems, and processes that create new products and services with
superior functionality take on high value.
Consistent alignment of actions and capabilities with the customer
value proposition is the core of strategy execution.
Real value creation and long-term growth and profitability occurs
when companies develop a continuous stream of products and
services that offer unique and compelling benefits to a chosen set of
customers. This means that to maintain industry leadership, a
company must establish a sustainable process of value creation.

For example, when an investor purchases stock in Microsoft, or when

customers enter into a partnership with that particular company, they
are not basing their relationships on a particular product or set of
products. Rather, both constituencies are expressing their belief that
Microsoft will continue to develop processes that allow it to take
advantage of emerging technologies and changing market needs to
create useful, profitable products and services. That ability to develop
resources and effectively match them with opportunities is the core of
any well-run organization’s value to customers, and the basis of its
valuation by shareholders. That value creation process is, in turn, built
on the capabilities and motivation of the company’s employees.

Now some of the major themes that underlie successful value creation
strategies in the information economy are:

 Product and process innovation

 Detailed, real-time understanding of changing needs of well-
defined customer segments (frequently database enabled)
 Leveraging emerging technologies in existing markets (particularly
information technology)
 Leveraging technology or regulatory changes to create new
markets
 Reconfiguring company and industry value chains
 Creating win/win partnerships with customers, employees, and
suppliers
Question 02
Which financial strategy will be best for value creation when firms
are planning for expansion or diversification? Kindly use your
managerial approach or thoughts while suggesting financial strategies.
Justify your answers with suitable examples.

Answer
Firms using diversification strategies enter entirely new industries.
While vertical integration involves a firm moving into a new part of a
value chain that it is already within, diversification requires moving
into an entirely new value chain. Many firms accomplish this through
a merger or an acquisition, while others expand into new industries
without the involvement of another firm.
Diversification means going into an operation which is either totally
or partially unrelated to the present operations.
Before opting for diversification, the following basic questions must
be seriously considered:
(a) Whether it brings a positive synergy, to the company?
(b) Whether the market wants the new product or service which we
offer?
(c) Whether the product or service has a good growth potential?

Before selecting diversification strategy, one must have a clear

understanding of the new product/service, the technology and the
markets. Diversification strategies are used to expand firm’s
operations by adding markets, products, services or stages of
production to existing operations. The purpose of diversification is to
allow the company to enter lines of business that are somewhat
different from current operations.
Diversification spreads resources over several areas, similarly
decreasing the probability that the firm can be a strong force in any
area. Diversification refers to the directions of development which
take the organization away from both its present products and its
present markets at the same time.
Sometimes, a firm intends to grow externally when it takes over the
operations of another firm. Such growth may be possible via mergers,
takeovers, joint ventures, strategic alliances etc. Such growth is called
‘inorganic growth’. Firms generally prefer the external growth
strategies for quick growth of market share, profits and cash flows.
As per my understanding when a firm is planning to diversify then
below two strategies are the best available options.

Merger:

A merger refers to a combination of two or more companies into a

single company. This combination may be either through absorption
or consolidation. Merger is said to occur when two or more
companies combine into one company. Merger is defined as ‘a
transaction involving two or more companies in the exchange of
securities and only one company survives.’
When the shareholders of more than one company, usually two,
decides to pool the resources of the companies under a common entity
it is called ‘merger’. If as a result of a merger, a new company comes
into existence it is called as ‘amalgamation’. As a result of a merger,
one company survives and others lose their independent entity, it is
called ‘absorption’.
Motives for Merger:
The merger activities are as a result of following factors and
strategies, which are classified under three heads:
(a) Strategic motives,
(b) Financial motives, and
(c) Organizational motives.

Takeover:

A takeover generally involves the acquisition of a certain block of

equity capital of a company which enables the acquirer to exercise
control over the affairs of the company. The main objective of
takeover bid is to obtain legal control of the company. The company
taken over remains in existence as a separate entity unless a merger
takes place. Thus, a takeover is different from merger in that under a
takeover, the company taken over maintains its separate entity, while
under a merger both the companies merge to form single corporate
entity, and at least one of the companies loses its identity.

The element of willingness on the part of the buyer and seller

distinguishes an acquisition from a takeover. If there exists
willingness of the company being acquired, it is known as
‘acquisition’. If the willingness is absent, it is known as ‘takeover’.
Takeover may be defined as ‘a transaction or series of transactions
whereby an individual or group of individuals or company acquires
control over the management of the company by acquiring equity
shares carrying majority voting power’.
In takeover the acquirer must buy more than 50% of the paid-up
equity of the acquired company to enjoy complete control. But in
practice, however effective control maybe exercised with a smaller
shareholding, because the remaining shareholders scattered and ill-
organized are not likely to challenge the control of acquirer.

Sometimes the acquirer may have tacit support of the financial

institutions, banks, mutual funds, having sizable holding in the
company’s capital. The main objective of a takeover bid is to obtain
legal control of the company.

In takeover, the seller management is an unwilling partner and the

purchaser will generally resort to acquire controlling interest in shares
with very little advance information to the company which is being
bought. Where the company is closely held by small group of
shareholders, the controlling interest is obtained by purchasing the
shares of other shareholders.
Where the company is widely held i.e., in case of listed company, the
shares are generally traded in the stock market, the purchaser will
acquire shares in the open market. Takeover is a general phenomenon
all over the globe and companies whose stock prices are quoted less
and who are having latent potential for growth.
Basically, takeover is a business strategy of acquiring control over the
management of Target Company – either directly or indirectly. The
motive of acquirer is to gain control over the board of directors of the
target company for synergy in decision-making. The eagle eyes of
raiders are on the lookout for cash rich and high growth rate
companies with low equity stake of promoters.