Corporate Scope

Deepak Somaya
Agenda

Introduction
Vertical Scope
Horizontal Scope (Diversification)
Managing Integrated Firms
Introduction: Corporate
Scope

Deepak Somaya & Joseph Mahoney

Revisit: Corporate Strategy
“Corporate strategy is the pursuit of competitive
advantage through the configuration and
coordination of a company's multi-business
activities”
Involves decisions and actions about:
The scope of the firm
Coordinating synergies across businesses
Corporate transactions
What is Corporate Scope?

Put simply, the “footprint” of the company

What activities or businesses is a company
engaged in, and how should they be managed?
What is Corporate Strategy?
• Corporate Strategy
• Corporate strategy is the way a company creates value
through the configuration and coordination of its multi-market
activities
• Quest for competitive advantage when competing in multiple
industries
• Example: General Electric’s wide-range of products and services
• Corporate strategy concerns the scope of the firm
1. Industry value chain (vertical integration)
2. Products and services (horizontal integration or diversification)
3. Geographic scope (regional, national, global markets)
Dimensions of Corporate Scope

Vertical Integration
(stages of industry Scope of the firm
value chain)
determines the
Geographic Scope
(regional, national,
boundaries along these
global markets) 3 dimensions

Horizontal Integration
(products and services)
Corporate Scope: 3 Dimensions

Vertical: what stages of value chain (or network)?

Horizontal: what range of products and services?
Geographic: where in the world to compete?
Vertical Scope

Pepsico acquired bottlers in 2009, as did Coca-Cola in

2010 (forward integration)
Horizontal Scope
GE’s Changing Horizontal Scope

Jack Welch Henry Lawrence ”Larry” Culp Jr

GE Annual and Quarterly reports

© 2012 Hamilton83 / CC-BY-SA 3.0 / Wikimedia: JackWelchApril2012

References
• Hamilton83. (2012). Jack Welch [Photograph].
Retrieved from
https://commons.wikimedia.org/wiki/File:JackW
elchApril2012.jpg
Vertical Scope

Deepak Somaya
Vertical Scope & Vertical Integration

Which parts of the value chain (or value network)

should a company operate in?
Should the same company be integrated across
specific stages of the value chain (or network)?
Vertical Integration Terminology

Vertical and Horizontal integration

Forward and Backward integration
Value Chain and Vertical Integration
Vertical Integration? An example

The University of Illinois contracts with Coursera

to host its online courses (MOOCs) instead of
using its own platform
Is this a good idea?
What are the pros and cons of outsourcing
such a critical function in online education?
Motivations for Outsourcing

Resources and capabilities (lack of)

Ability to aggregate demand (scale)
Responsive to market and technology trends
Motivations for Vertical Integration
Market power
Entry barriers
Downstream or upstream price maintenance
Improving quality, cost
Planning, coordinating, control
Investments in specialized assets
Transaction Cost Economics
Theory about the scope of the firm
Oliver Williamson (Nobel Prize 2009)
Transaction costs
Associated with economic exchanges
Negotiating, monitoring, enforcing contracts
Administrative costs
Oliver Williamson
Associated with organizing within a hierarchy
Bureaucracy, weak incentives, sclerotic
© 2009 Prolineserver / CC-BY-SA-3.0 / Wikimedia: Noble Price 2009-Press Conference KVA-42
Source: Oliver E. Williamson, Markets and hierarchies: A study in the internal organizations / Free Press, 1983
Comparative Organizational Analysis
De-link two Issues:
1. What is the objective? What
market power, resources,
efficiencies, etc., are being
sought?
2. What organizational form
(outsourcing or vertical
Oliver Williamson
integration) best achieves the
objective?
© 2009 Prolineserver / CC-BY-SA-3.0 / Wikimedia: Noble Price 2009-Press Conference KVA-42
Source: Oliver E. Williamson, Markets and hierarchies: A study in the internal organizations / Free Press, 1983
Make or Buy? Core ideas
For any objective, there is a way to achieve it by
vertical integration (make) or by the market (buy)
“All organizational forms are flawed”
Examine the relative (dis)advantages
Williamson’s main mantra
Markets provide better adaptation, while
hierarchies (firms) provide better coordination
3 Key Transaction Costs

Adverse Selection
Information asymmetries (ex ante)
“Lemons problem” (Akerlof, Nobel Prize 2009) George
Akerlof
Moral Hazard
Information asymmetries (ex post)
“Abuse” of a benefit
Hold Up problem (Williamson)
Asset specificity
Uncertainty and Opportunism Ex ante: based on forecasts rather than actual results
Ex post: based on actual results rather than forecasts
© 2007 Yan Chi Vinci Chow / CC-BY-3.0 / Wikimedia: George Akerlof
3 Key Administrative Costs
Weak incentives
Expectation of continuity
Zone of indifference (fiat)
Principal-Agent problem
Owner-manager, or manager-subordinate
Performance is unobservable
Lack of dynamism
Impossible to “selectively intervene”
Main Takeaway

When to vertically integrate?

No general prescription
Attributes of “the transaction” are key
Align “governance mode” with these attributes
References
• Chow, Y. (2007). Geroge A. Akerlof, Nobel
economics Laureate, at Berkeley [Photograph].
Retrieved from
https://commons.wikimedia.org/wiki/File:Georg
e_Akerlof.jpg
• Prolineserver. (2009). Oliver E. Williamson
[Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Nobel
_Prize_2009-Press_Conference_KVA-42.jpg
Horizontal Scope
(Diversification)

Deepak Somaya
Horizontal Scope & Diversification

Which products or services (businesses) should a

company operate in?
Should the same company be integrated across a
set of businesses?
Diversification: An example

What are some advantages of having a business

school as part of a diversified university such as
the University of Illinois? What are some
disadvantages?
Horizontal Scope Terminology

Horizontal mergers
Diversification
Related (and unrelated) diversification
Unrelated v. Related Diversification
Corporate conglomerates = collections of unrelated
businesses
A brief history of conglomerates (or explain “Wall Street”
the movie)

© 1987 American Entertainment Partners / Amercent Films / 20th Century Fox

References
• Pressman, E. (Producer), & Steon, O.
(Director). (1987). Wall Street [Motion Picture].
United States: American Entertainment
Partners & Amercent Films
BCG Growth-Share Matrix (1970s)
Using the BCG Matrix

HI QUESTION STAR
MARK
Growth Rate / Cash Use /
Market Attractiveness

DOG CASH COW

X
$$$
X
LO
LO Market Share / Cash Generation / Company Strength HI
ITT Corporation
“Telephones, hotels, insurance - it’s all the same. If you know the numbers
inside out, you know the company inside out.” -- Harold Geneen

n off Harold Geneen

u
Sp 1995 (CEO 1959-77)
in

Source: International Telephone and Telegraph / Wikipedia: Harold Geneen

ITT 2011 Breakup
ITT again split into three parts – water technology (Xylem), defense
(Exelis), and engineered parts (“new” ITT)

Engineered parts was the Star SBU within ITT; others were cash cows
“The only unforgivable sin in business is to run out of cash”
-- Harold Geneen
ITT Breakup
Why did the stock market reward ITT (~20% for splitting up)?
How will New ITT (Star SBU) finance itself?
Comparative Organization

Two modes for ITT’s businesses (SBUs) to operate:

In one company, with internal cash transfers
As separate companies using financial markets for
investing and raising cash
Which one is more efficient? Why? It seems like …
Financial markets allocate cash more efficiently
Diversified firms have bureaucratic inefficiencies
References
• Harold Geneen. (n.d.). Retrieved from
https://en.wikipedia.org/wiki/File:Harold_Genee
n.jpg
Performance
Diversification and Performance
DIVERSIFICATION
DISCOUNT!

Single Dominant Related Unrelated

Business Business Diversifie Diversifie
Firms Firms d Firms d Firms

Diversification
Breaking up conglomerates (1980s)
Diversification discount: Value of a diversified firm is less
than its SBUs separately
Gecko’s strategy: Create value by taking over and
breaking up conglomerates with a diversification discount

Jack Welch

Diversification premium: Value of a diversified firm is

greater than its SBUs separately (related diversification)
© 1987 American Entertainment Partners / Amercent Films / 20th Century Fox
© 2012 Hamilton83 / CC-BY-SA 3.0 / Wikimedia: JackWelchApril2012
Motivations for Diversification
Market power
Reducing competition (antitrust concerns?)
Synergies: Essentially, economies of scope
Scale common resources: brands, IT systems, etc.
Redeploy slack resources: supply chain, distribution,
talent, etc.
Reduce risks; empire building
Pursue profitable opportunities
 Comparative Organizational Analysis
Williamsonian analysis applied to the multi-business firm:
De-link the objective (market power, synergies, etc.)
from the organizational form that best achieves these
objective(s)?
Consider “market arrangements” (alliances, contracts,
etc.) as alternatives to integration.

Oliver E. Williamson

© 2009 Prolineserver / CC-BY-SA-3.0 / Wikimedia: Noble Price 2009-Press Conference KVA-42

Source: Oliver E. Williamson, Markets and hierarchies: A study in the internal organizations / Free Press, 1983
Comparative Organizational Analysis
Implications for Horizontal Scope

Diversification must satisfy two key tests:

The better off test: Does the combination of businesses
create value (do synergies exist)?
The ownership test: To access this value, does the
same company need to own the businesses
(comparative organizational analysis)?
Resources and Relatedness

Resources are often critical for synergies

If they are “firm-specific” (not available in the market)
Resources may either be scaled or redeployed across
businesses
Relatedness in diversification implies relatedness
in the underlying (firm-specific) resources
References
• Hamilton83. (2012). Jack Welch [Photograph].
Retrieved from
https://commons.wikimedia.org/wiki/File:JackWelchApri
l2012.jpg
• Pressman, E. (Producer), & Steon, O. (Director).
(1987). Wall Street [Motion Picture]. United States:
American Entertainment Partners & Amercent Films
• Prolineserver. (2009). Oliver E. Williamson
[Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Nobel_Prize_2
009-Press_Conference_KVA-42.jpg
Managing Integrated Firms

Deepak Somaya
Broad Approach So Far

Separate benefits sought from governance modes

Integration as an alternative to “market forms”
Comparative organizational analysis
Strategy extends beyond make-buy …

Why haven’t Pepsico and Coca-Cola always owned

their bottlers?

How do Pepsico and Coca-Cola manage independent

bottlers, or their integrated bottling business?
And beyond diversification versus not …

How should Alphabet (Google) and Amazon manage

units that could easily be independent companies?
Diversification Approaches Vary

More autonomous to more coordinated

Even market incentives can be replicated to a degree
Approach depends on nature of synergies
Resource scaling (or sharing) may require more coordination and
more operating control of units
Resource redeployment (or transferring) may allow more
autonomy and financial control of units
A Spectrum of Organizational Modes
Conclusion

Corporate scope: vertical and horizontal scope

Comparative organizational analysis (a spectrum of
choices)
Adaptation (markets) versus coordination (hierarchies)
Diversification discount and premium, relatedness and
resources
BCG matrix and the history of conglomerates
References
• Chow, Y. (2007). Geroge A. Akerlof, Nobel economics Laureate, at
Berkeley [Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:George_Akerlof.jpg
• Hamilton83. (2012). Jack Welch [Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:JackWelchApril2012.jpg
• Harold Geneen. (n.d.). Retrieved from
https://en.wikipedia.org/wiki/File:Harold_Geneen.jpg
• Pressman, E. (Producer), & Steon, O. (Director). (1987). Wall Street
[Motion Picture]. United States: American Entertainment Partners &
Amercent Films
• Prolineserver. (2009). Oliver E. Williamson [Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Nobel_Prize_2009-
Press_Conference_KVA-42.jpg
Corporate Transactions

Deepak Somaya
Agenda

Introduction
Mergers and Acquisitions
Divestitures
Alliances and Contracts
A Portfolio View
Introduction: Corporate
Transactions

Deepak Somaya
Corporate Strategy
Corporate strategy is the pursuit of competitive
advantage through the configuration and
coordination of a company's multi-business
activities
Involves decisions and actions about:
The scope of the firm
Coordinating synergies across businesses
Corporate transactions
Corporate Transactions

Corporate transactions involve actions with other

entities that change or manage the scope of the
firm
Mergers and Acquisitions (M&A)
Divestitures (Sale, Carve-out, Spin-out)
Alliances and Contracts
Organic Growth versus Transactions

Companies can grow organically from within

Corporate transactions provide another, less
incremental approach to changing scope
Always involves another firm; not unilateral
Corporate Transactions Resources

BCG M&A Report (annual)

Analysis and research, different topics (not just M&A)
Institute for Mergers, Acquisitions and Alliances
(IMAA)
https://imaa-institute.org/mergers-and-acquisitions-statistics/

Thomson ONE / Securities Data Corporation

Data on M&A, divestitures and strategic alliances ($$)
Mergers and Acquisitions

Deepak Somaya & Joseph Mahoney

Mergers & Acquisitions (M&A)

Merger – combining two companies

Friendly approach; similar size
Acquisition – purchase or takeover
Can be friendly or unfriendly
Hostile takeover
Are M&As Value Creating?

Acquirers need to pay a premium over the target’s

market value
Value goes to the target (shareholders)
Impacts on acquirer’s stock price?
Short-run: on average, neutral
Long-run: significant declines (on average)

Agrawal, A. and Jaffe, J.F., 2000.

Value Destruction in M&A ($ Bn)

Shareholder value destroyed based on post-merger analysis

of stock price, compared to overall stock market
Why firms do M&As?

Access new markets, technologies, etc.

Superior acquisition and integration capability
Overcome competitive disadvantages
Good for managers [principal–agent problem]
Managerial hubris
 Why not just acquire good targets?

The “efficient market wall”:

Investors (and other acquirers) impute the value of targets,
which is reflected in the targets’ market value (stock price)
Thus, acquirers are only expected to make (risk adjusted)
market rates of return from M&As
Unless … the acquirer has some unique ability to see and
generate value from the target

Burton G. Malkiel, A random walk down Wall Street: The best investment advice for the new century / Norton, W. W. & Company, Inc, 2000
 And it could be even worse
The “winner’s curse”:
In a competitive bidding war (auction), the acquirer has to be the
highest bidder to get the target
To justify a high bid, the acquirer would typically have a more
optimistic valuation of the target
If potential acquirers get the valuation right on average, winning
bidders would typically over-value the target

Richard Thaler
Nobel Prize 2017
© 2015 Chatham House / CC BY 2.0 / Wikimedia: Richard Thaler Chatham
Richard H. Thaler, The winner’s curse: Paradoxes and anomalies of economic life / Free Press, 2012
References
• Agrawal, A. and Jaffe, J.F., 2000. The post-merger
performance puzzle. In advances in mergers and
acquisitions (pp. 7-41). Emerald Group Publishing
Limited. Retrieved from
https://www.emerald.com/insight/content/doi/10.10
16/S1479-361X(00)01002-4/full/html
• House, C. (2015). Richard Thaler Chatham
[Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Richard_T
haler_Chatham.jpg
Value Creating M&As?

Organizational Capabilities play a key role

Developing New Capabilities: Stretching
Applying Own Capabilities: Leveraging
Often described as “synergies”
An advantage from combining two businesses
Why related diversification is value-creating
Evidence from M&A Deals

Stretching: acquirer seeks to fill a gap in its existing capabilities.

Leverage: acquirer applies current capabilities to incoming products and services.
Limited-fit: acquirer largely ignores capabilities.
The unique case of private equity

Acquire … improve … sell

Highly leveraged

How do private equity firms create value from the

targets they acquire?
Post-Merger Challenges …
After M&A, firms often find that synergies don’t
materialize… because of:
Poor evaluation and weak due diligence
Weak integration plan (deal mentality)
Taking on too much debt or risk
Integration difficulties
Operational
Organizational (cultural)
A Three-part Test for M&As

Firms should only engage in an M&A if:

The combined business has the potential for valuable
synergies
This value is not dissipated by the cost of acquisition
There is a strong, credible, post-merger plan for
realizing the synergies
Attributes of successful M&As
Complementary resources and capabilities
Stretching/Leveraging synergies

Objective evaluation and bidding

Avoid overpaying; ready for implementation

Maintain financial slack

Leverage may be good, but avoid cash crunch

Well-managed implementation plan

Identify right managers; include target’s views
Divestitures

Deepak Somaya
Divestitures

Transactions that break up and separate a

business unit from a company
Not selling assets of a business
Spin (split) offs, Carve outs, Unit sales
Divestiture Modes
Spin off: Separation of a business unit from a parent
company, where shares of the unit are distributed pro
rata to the parent’s shareholders
Split off: Similar to spin off; except parent’s shareholders
may exchange parent’s shares for that of the unit
Carve out: Partial sale of a business unit’s shares to
investors (parent typically retains control)
Unit sale: Sale of a business unit to another firm,
including private equity firms
Spin Offs from ITT
Parents’ Stock Return (Announcement)

Source: BCG M&A Report, Thomson ONE data (1990-2014)

Divestiture Mode Characteristics

Unit Sale Spin-off Carve-out

Equity Transferred 100% 100% ~21%

Cash Received YES NO YES
Time Taken 6-9 months 12+ months 12-18 months
Unit Revenues $ 0.5 Bn. $ 2.9 Bn. $ 1.1 Bn.
Deals per Year 689 48 32
Deal Size $ 0.4 Bn. $ 3.0 Bn. $ 1.9 Bn.

Source: BCG M&A Report, Thomson ONE data

Reasons for divestitures

Why might a firm wish to divest a unit? List all the

reasons you can think of.
Why divest a business unit?
Raise cash for parent
Low profitability of unit
Reduce risk or liability
Lack of strategic fit (low synergies)
Refocus on core business(es) [parent]
Free up and redeploy resources / capabilities
Free up entrepreneurial / innovative potential [unit]
Returns to Raising Cash

Source: BCG M&A Report, Thomson ONE data (1990-2014)

Shedding Non-Core Businesses

Source: BCG M&A Report, Thomson ONE data (1990-2014)

 The Legendary Xerox PARC
Remarkable at Innovation
GUI, Ethernet, Internet, laser printer, bitmap,
mouse (SRI), WYSIWYG text editor, fully-
formed OOP, …

No commercial
success!!

© 2006 Coolcaesar / CC BY-SA 3.0 / Wikimedia:Parcentrance

© 2007 Carlo Nardone / CC BY-SA 2.0 / Wikimedia: Xerox Alto I
© 2006 Ken Banks / CC BY 2.0 / Wikimedia: Palo Alto Research Center 2006
Divestiture and Xerox PARC?
35 projects spun off from Xerox PARC
11 succeeded; combined market value 2x of
Xerox

Freeing units from parent company constraints

may allow them to succeed
One key reason is the freedom to pursue new
business models
H. Chesbrough, Business history review, 2002.
Divestiture and Innovation

Corredor, S. 2017.
How to manage divestitures?
Be open to divesting units; actively evaluate them
Be clear about the goals of any given divestiture
Identify the right divestiture mode
Ensure units (and parent firms) have the right
resources (or the rights to resources)
Pay attention to post-divestiture governance
mechanisms (leadership, board, cultural reset, …)
References
• Banks, K. (2006). Palo Alto Research Centre [Online image].
Retrieved from
https://commons.wikimedia.org/wiki/File:Palo_Alto_Research_Cen
tre_2006.09.29.jpg
• Coolcaesar. (2006). The entrance to Xerox PARC in Palo Alto,
California [Online image]. Retrieved from
https://commons.wikimedia.org/wiki/File:Parcentrance.jpg
• Nardone, C. (2007). Xerox Alto Workstation [Online image].
Retrieved from
https://commons.wikimedia.org/wiki/File:Xerox_Alto_I_(1973)_wor
kstation_console_(606x808_pixel_bitmap_display,_keyboard,_5-
key_chorded_keyboard,_and_3-button_mouse)_-
_Computer_History_Museum_(2007-11-
10_23.09.48_by_Carlo_Nardone).jpg
Strategic Alliances

Deepak Somaya
A Spectrum of Organizational Modes
Strategic Alliance Types
Relational contract: long-term contract for
services or products from another company.
Licensing: contractual arrangement for access to
technology, typically in exchange for royalties.
Equity Alliance: strategic alliance where at least
one firm invests in the other.
Joint Venture: strategic alliance that establishes
a new separate legal entity that firms co-invest in.
Why firms do strategic alliances?
Accessing capabilities or markets more quickly
(and surely)
Reducing asset commitment and increasing
flexibility
Learning from partner; upgrading own resources
Sharing costs and risks (also rewards)
Building cooperation around a common standard
Microsoft-AT&T Alliance

“AT&T Communications and Microsoft Corp. are embarking on an

extensive, multiyear alliance where the two companies will apply
technologies, including cloud, AI, and 5G, to improve how people live
and work today and in the future.”
Problems with strategic alliances
Competitors gain access to capability, technology,
markets (learning races)
Managing joint investments, risks, responses
Conflict, opportunism, disputes
Adverse selection problems (partner, contributions)
Moral hazard (monitoring)
Hold-up (renegotiation)
Making alliances work

Partner Selection

Alliance Structure

Managing Alliances
What Do Good Partners Look Like?
Partner Selection
Good partnerships help all participants advance their
strategic goals
Good partners have complementary assets (create
value); seek different benefits (reduce conflict)
Good partners contribute valuable assets to the
alliance
Good partners accept a fair distribution of benefits
Do your homework; research potential partners
Alliance Structure

Two broad approaches:

Contractual terms: purchase / supply terms,
warranties, milestones, fees / royalties, technology
grant-backs …
Credible commitments: “hostages”, equity stakes,
sunk investments, exclusivity …
Alliance Structure
Walling off key
technology

Contractual
Manage Risk, safeguards
Opportunism,
Conflict by … Seeking credible
commitments

Agreements and
governance
Managing Alliances

A good alliance structure works well if the future of the

alliance is largely predictable … rarely the case …

Relational governance: informal trust, reciprocity,

joint actions, and convergent expectations supported
by reputations and repeated interaction

Easier if you have the right partner and a good

structure in place
Managing Alliances
Build and reinforce trust

Learn from your partner

Adapt structure and management over time

Does the alliance still provide strategic overlap?
Do the partners still contribute valuable assets?
Are safeguards and relational trust still in place?
Adapt alliance or exit?
A Portfolio View

Deepak Somaya
Variety of Corporate Transactions

Companies commonly engage in multiple

corporate transactions
Important to consider interdependencies
Modify and deploy the corporate resource base
Intertemporal Effects

Learning and capability augmentation

Creating and freeing up re-deployable resources
Inter-unit resource redeployment
Real options for future transactions
Corporate transaction capabilities
 Contemporaneous Effects

Complementarities or synergies OR resource re-

deployment opportunities
E.g., between M&As, or alliance + M&A
Inter-organizational networks
Firm

alliance networks (also divestitures?)

© 2012 Brewbooks / CC BY-SA 2.0 / Flickr: A social network visualization

Conclusion

Corporate transactions are a critical dimension of

corporate strategy
M&As, Divestitures, and Strategic Alliances
M&As often destroy value; apply three-part test for value-
creating M&As
Divestitures and alliances create value if managed well
A portfolio view of corporate transactions is helpful
References
• Brewbooks. (2012). A Social Network Visualization [Graphic Illustration].
Retrieved from https://www.flickr.com/photos/brewbooks/7358153986
Global Strategy

Deepak Somaya
Agenda

Globalization
Foreign Market Entry
National Origins of Competitive Advantage
MNE Strategies
Globalization

Deepak Somaya
Globalization

A process of closer integration and exchange

between countries and peoples worldwide
Economic globalization focuses on trade, investment
flows, movement of labor, and multinational firms
Globalization: Trade as Share of GDP

© 2018 Our World in Data / CC BY 4.0 / https://ourworldindata.org/trade-and-globalization

Globalization: Foreign Direct Investment
($ Billion)

© 2010 Sitris / CC BY-SA 3.0 / Wikimedia: IDE in total 1970 2009

Causes of Globalization

Advanced telecommunications
Reduced transportation costs
Falling trade and investment barriers
Growth of MNEs and FDI
Globalization: Technological Factors

© 2018 Our World in Data / CC BY 4.0 / https://ourworldindata.org/trade-and-globalization

Falling Trade Barriers (U.S. Tariffs)

© 2017 James 4 / CC BY-SA 4.0 / Wikimedia: Average Tariff Rates in USA (1821-2016)
Globalization: Exports as Share of GDP

© 2018 Our World in Data / CC BY 4.0 / https://ourworldindata.org/trade-and-globalization

MNEs and FDI
Multinational Enterprises (MNEs)
Conduct operations in at least two countries
Procurement, production, or sale/distribution
< 1% of firms; employ 19% of U.S. workforce
74% of private sector R&D spending

Foreign Direct Investment (FDI)

Investments in “productive” activities abroad
Contrast with foreign portfolio investments (FPI)
References
• Dambrans, K. (2013). iRobot braava 380. [Photograph]. Retrieved from https://www.flickr.com/photos/janitors/12811655685

• Elbilforening, N. (2015). Two Tesla model S cars participating in the 2015 EV Festival in Geiranger, Norway. [Photograph].
Retrieved from https://commons.wikimedia.org/wiki/File:Elbilfestival_i_Geiranger_two_Tesla_Model_S_electric_cars.jpg

• James 4. (2017). U.S. average tariff rates (1821-2016). [Image]. Retrieved from
https://commons.wikimedia.org/wiki/File:Average_Tariff_Rates_in_USA_(1821-2016).png

• Nohau. (2012). A photograph of the new robot vacuum cleaner iRobot Roomba 700 Series. [Image]. Retrieved from
https://commons.wikimedia.org/wiki/File:Робот_пылесос_Roomba_780.jpg

• Ortiz-Ospina, E., Beltekian, D., & Roser, M. (2018). All of our world in data. Retrieved from https://ourworldindata.org/trade-
and-globalization

• Planet Labs. Inc. (2017). Tesla gigafactory, Sparks, Nevada on August 8, 2017. [Phtograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Tesla%27s_Gigafactory_on_2017-08-08_by_Planet_Labs.jpg

• Rameshng. (2011). McDonald‘s, Total mall, Old airport road, Bangalore, India. [Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Snap_from_total_Mall_in_old_airport_road_-_Bangalore_8167.JPG

• Sitris. (2010). Total world inward FDI flows from 1970 to 2016 (US dollars at current prices in billions). [Image]. Retrieved
from https://commons.wikimedia.org/wiki/File:IDE_in_total_1970_2009.JPG#file
Foreign Market Entry

Deepak Somaya
The Global Firm and Global Strategy

Shift our focus from broader economy-wide

developments to the international activities of
individual firms.
Globalization Varies …
Percentage of Sales from International Markets
0 10 20 30 40 50 60

Nike
Levi's
PVH Corp.
VF Corp.
Ralph Lauren
Wolverine World Wide
Hanesbrands
Under Armour
Perry Ellis International
Carter's
G-III Apparel Group

Company 10Ks and Moody’s estimates. Source: https://preview.tinyurl.com/y5qra773

Why Go International?

iRobot Roomba iRobot Braava 380

Why would iRobot, manufacturer of the robotic

Roomba vacuuming and Braava mopping
systems want to expand internationally?
© 2012 Nohau / CC BY-SA 3.0 / Wikimedia: Робот пылесос Roomba 780
© 2013 Dambrans, K. / CC BY-SA 2.0 / Flickr: iRobot Braava 380
Reasons Firms Go International
Access a larger market
OECD countries and emerging markets (e.g., China, India)
Access better or lower-cost factors
Labor, natural resources, technology, logistics
Reduce overall business risk
Leverage core capabilities
Develop new capabilities
Location-specific advantages; learning and spillovers
How to Enter Foreign Markets

“Modes of Entry”
Exporting
Licensing (Franchising)
Strategic Alliance
Joint Venture
Wholly-Owned Subsidiary
Market Entry Modes

Exporting:
Sale into foreign markets
Direct exports or export via an agent
Licensing or Franchising:
Contract with a local partner
Transfer intangibles (technology, knowhow, IP)
Monitor performance
Market Entry Modes

Strategic Alliance:
Local partner; active coordination
Broader scope of joint activities (e.g., R&D, marketing)
International Joint Venture:
Jointly-owned independent company
Contributed resources ($ and others)
Manage jointly, and share in profits
Market Entry Modes

Wholly-owned subsidiary:
Establish a 100% owned unit in a foreign country

Greenfield: build the unit from scratch

Brownfield: acquire fixed assets and reuse
Acquisition: buy a local company and integrate
Modes of Foreign Market Entry

Higher
Ownership
& Control

Reduced Risk
& Costs (&
Returns)
References
• Dambrans, K. (2013). iRobot Braava 380
[Photograph]. Retrieved from
https://www.flickr.com/photos/janitors/1281165
5685
• Nohau. (2012). A photograph of the new robot
vacuum cleaner iRobot Roomba 700 Series
[Image]. Retrieved from
https://commons.wikimedia.org/wiki/File:Робот
_пылесос_Roomba_780.jpg
Entry Mode Choice

iRobot Roomba iRobot Braava 380

Flag of the People’s Republic of China

If iRobot, in expanding into the Chinese market,

formed a joint venture with a Chinese company,
what are some pros and cons of this decision?
© 2012 Nohau / CC BY-SA 3.0 / Wikimedia: Робот пылесос Roomba 780
© 2013 Dambrans, K. / CC BY-SA 2.0 / Flickr: iRobot Braava 380
What’s different about International?

Is expanding internationally no different than

expanding geographically? What additional
challenges do you anticipate when a company
expands to another country relative to (say)
another state?
Challenges in Foreign Markets

Regulations
Trade & investment barriers
Different institutions
Different culture (language)
Currency
Animosity, politics, anti-foreign bias
“Liability of Foreignness”

More costly doing business abroad due to

Cultural and socio-economic unfamiliarity
Geographic distance
Institutional voids and legal risks
Economic conditions and risks
Currency differences and risks
Political biases and instability
How to Internationalize?
Choose entry mode based on ability to cope with
liabilities of foreignness
Over time, firms learn to overcome these liabilities
“Stages model” of internationalization
Expand into similar, proximate markets first
Use lower risk market entry modes
Over time, learn and expand into more distant markets
with higher risk entry modes
“Born Global” Firms

Increasingly, firms are “international from birth”

Overcoming foreign entry challenges by using:
Global communication networks (internet)
Global flows of talent and entrepreneurs
Local advantages in resources and knowledge
Government policies to overcome barriers

McCormick and Somaya, Global Strategy Journal, 2020

National Origins of
Competitive Advantage

Deepak Somaya
National Competitive Advantage

Are some countries more competitive than others

in certain industries?
Seems strange to ask when competitive advantage is
mainly driven by intangibles (human capital,
technology)
So, raw materials and location should not matter
And, seemingly open access to intangibles worldwide
National Competitive Advantage
And yet, countries appear to have competitive
advantage in certain industries
Automobiles – Germany and Japan
Computer manufacturers – China & Taiwan
Consumer electronics – Japan & South Korea
Mining companies – Australia
Movies – USA and India
Financial services – United Kingdom
Porter’s Diamond Model
National Competitive Advantage

Factor conditions
A nation’s endowments in terms of national, human,
and other resources, as well as supportive
infrastructure and institutions.
Demand conditions
Specific characteristics (and high expectations) of
demand in a firm’s domestic market
National Competitive Advantage

Competitive intensity
Highly competitive environments tend to stimulate firms
to outperform others (e.g., German car industry)
Related and supporting industries
Leadership in related and supporting industries fosters
world-class competitors in downstream industry
Complementarity
Applying the Framework

Saudi Arabia – Vision 2030: Focal areas

Logistics
Energy
Mining
Industry
According to Porter’s Diamond Model, which of
these efforts are most likely to succeed?
Implications for Global Strategy

Identifying potential sources of competition

Understanding your own competitive advantages
relative to foreign competitors
Tapping into foreign country advantages (location
decisions)
Co-creating a supportive ecosystem (cluster)
MNE Strategies

Deepak Somaya & Joseph Mahoney

A Key Tension in MNE Strategy

Cost Reduction
MNEs can reduce operating costs in international
business by using scale and deploying common
resources across their global operations (e.g., Tesla)
Local Responsiveness
MNEs can grow market share if they tailor their
offerings to local customer preferences and host-
country requirements (e.g., McDonalds)
 Images for previous slide

Two Tesla Model S cars participating in the

2015 EV Festival in Geiranger, Norway McDonald‘s, Total Mall, Old Airport road,
Bangalore, India

Tesla Gigafactory, Sparks, Nevada on August 8,

2017
International Business Strategies
Four MNE Strategies

1. International strategy
Leveraging home-based core competencies
Selling the same products or services in both domestic
and foreign markets
Example: Selling Starbucks coffee internationally
Four MNE Strategies

2. Localization (product differentiation) strategy

Maximize local responsiveness via a
multi-domestic strategy
Consumers will perceive them to be domestic
companies
Example: Nestlé’s customized product offerings in
international markets
Four MNE Strategies

3. Global (cost leadership) strategy

Economies of scale and location economies
Pursuing a global division of labor based on best-of-
class capabilities reside at the lowest cost
Example: Lenovo’s R&D in Beijing, Shanghai, and
Raleigh; production center in Mexico, India, and China
Four MNE Strategies

4. Transnational strategy
Combination of localization strategy (responsiveness)
with global strategy (low-cost position)
Example: German multimedia conglomerate
Bertelsmann; Haier in appliances; ABB in engineering
products and services
MNE Strategies: Benefits and Risks
Features Benefits Risk
• Often the first in • Leveraging core competence. • No or limited local
International internationalizing. • Economies of scale. responsiveness.
Strategy • Used by MNEs with relatively • Low-cost implementation • Highly affected by exchange
large domestic markets (e.g., through: rate fluctuations.
MNEs from U.S., Germany, • Exporting or licensing (for • IP embedded in product or
Japan). products) service could be
• Well-suited for high-end • Franchising (for services) expropriated.
products (such as machine • Licensing (for trademarks)
tools) and luxury goods that
can be shipped across the
globe.
• Products and services tend to
have strong brands.
• Main competitive strategy
tends to be differentiation
since exporting, licensing,
and franchising add
additional costs.
MNE Strategies: Benefits and Risks
Features
• Used by MNEs to compete in
Localization host countries with large
(multidomestic) and/or lucrative but
idiosyncratic domestic
Strategy markets (e.g., Germany,
Japan, Saudi Arabia)
• Often used in consumer
products and food industries.
• Main competitive strategy is
differentiation.
• MNE wants to be perceived
as local company.
Benefits Risk
• Highest-possible local • Duplication or key business
responsiveness. functions in multiple
• Reduced exchange-rate countries leads to high cost
exposure. of implementation.
• Little or no economies of
scale.
• Little or no learning across
different regions.
• Higher risk of IP
expropriation.
MNE Strategies: Benefits and Risks
Features Benefits Risk
• Used by MNEs that are • Location economies: global • No local responsiveness.
Global- offering standardized division of labor based on • Little or no product
Standardization products and services (e.g., wherever best-of-class differentiation.
computer hardware or capabilities reside at lowest • Some exchange-rate
Strategy business process cost. exposure.
outsourcing). • Economies of scale. • “Race to the bottom” as
• Main competitive strategy is wages increase.
price. • Some risk of IP expropriation.
MNE Strategies: Benefits and Risks
Features
• Used by MNEs that pursue
Transnational an integration strategy at the
Strategy business level by
simultaneously focusing on
product differentiation and
low cost.
• Mantra: Think globally, act
locally.
Benefits
• Attempts to combine
benefits of localization and
standardization strategies
simultaneously by creating a
global matrix structure.
• Economies of scale, location,
and learning.
Risk
• Global matrix structure is
costly and difficulty to
implement, leading to high
failure rate.
• Some exchange-rate
exposure.
• Higher risk or IP
expropriation.
Conclusion

Global strategy is essential in an era of globalization

Foreign market entry mode choices
Stages model of internationalization and born globals
Porter’s Diamond model of national competitive advantage
Four MNE strategic choices in the global marketplace
References
• Elbilforening, N. (2015). Two Tesla Model S cars participating in the 2015
EV Festival in Geiranger, Norway [Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Elbilfestival_i_Geiranger_two_Tesl
a_Model_S_electric_cars.jpg
• Planet Labs. Inc. (2017). Tesla Gigafactory, Sparks, Nevada on August 8,
2017 [Phtograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Tesla%27s_Gigafactory_on_2017-
08-08_by_Planet_Labs.jpg
• Rameshng. (2011). McDonald‘s, Total Mall, Old Airport road, Bangalore,
India [Photograph]. Retrieved from
https://commons.wikimedia.org/wiki/File:Snap_from_total_Mall_in_old_airp
ort_road_-_Bangalore_8167.JPG
Stakeholders and Corporate
Governance

Deepak Somaya
Agenda

Introduction
The Public Firm
Corporate Social Responsibility
Mechanisms of Governance
Recent Developments
Introduction

Deepak Somaya
Stakeholders and the Enterprise
External Stakeholders: Internal Stakeholders:
Customers Managers
Suppliers Shareholders
Governments Bondholders
Unions Employees
Communities Board members
General public
An Age of Shareholder Primacy

Over the last few decades, much higher focus on

the obligations of companies to shareholders
In part, reflects a real dilemma in public corporations
Driven by a neo-liberal intellectual worldview
Reinforced by the reality of modern financial markets
The Public Firm

Joseph Mahoney
Strategic Management and The Role of
Business in Society
• The public stock company is the backbone of
our economy.
• Four characteristics of public firms:
• Limited liability for investors
• Transferability of investor interest
• Legal personality
• Separation of ownership (stock owners) and control
(managers)
The Public Stock Company: Hierarchy of
Authority
State Charter

Shareholders

Board of
Directors

Management

Employees
Strategic Management and The Role of
Business in Society
• 21st century already has had two financial
crises
• Accounting scandals: Enron, WorldCom, Tyco…
• Global financial crisis: real estate bubble burst
• Lessons
• Managerial actions affect economy
• Ethical business produces wealth, but unethical practices
destroy it
• Stakeholder management is needed
Question for Discussion
• Consider the case of a pharmaceutical company
that discovers a drug that can cure a disease
prevalent in Africa. Suppose this drug is projected
to provide very low economic returns if the
pharmaceutical company distributes the drug in
Africa.
• Should the pharmaceutical company go ahead with the
distribution of the drug? On what basis do you defend
your decision?
• Please reflect on this question and post your response
in the Discussions for this video.
Stakeholder Impact Analysis
Step 1 Who are our stakeholders?

Step 2 What are our stakeholders’ interests and claims?

Step 3 What opportunities and threats do our stakeholders present?

What economic, legal, ethical, and philanthropic

Step 4
responsibilities do we have to our stakeholders?

What should we do to effectively

Step 5
address the stakeholder concerns?
Corporate Social
Responsibility

Joseph Mahoney
The Pyramid of Corporate Social
Responsibility
Question for Discussion
• Milton Friedman (1962) stated that “the only
social responsibility of business is to increase
profits so long as it stays within the rules of the
game.”
• Are philanthropic responsibilities part of the public
corporations responsibilities, or is its only social
responsibility to increase profits?
• Please reflect on this question and post your
response in the Discussions for this video.
Corporate Social Responsibility
• Milton Friedman circa 1962:
• “the only social responsibility of business is… to
increase profits so long as it stays within the rules of the
game”
• Today’s businesses tend to do more than just
making profits
• But does CSR help build competitive advantage?
• The answer might depend on where you do business…
• UAE, Japan, and India are less interested in CSR
• China, Brazil, and Germany are more interested in CSR
Global Survey of Attitudes Toward
Business
Corporate Social Responsibility
• Shared value-creation framework
• Expand customer base and bring in non-consumers
• Expand internal firm value chains by including more
non-traditional partners such as NGOs
• Focus on creating new regional clusters
• GE recognizes a convergence between
shareholders and stakeholders
• Empirical evidence supports that…“firms
can do well ($) by doing good (CSR)”
Corporate Governance
• Corporate governance represents the
relationship among stakeholders that is used to
determine and control the strategic direction
and performance of organizations.
• Agency costs are the sum of incentive costs,
monitoring costs, enforcement costs, and
individual financial losses incurred by
principals because it is impossible to use
governance mechanisms to guarantee total
compliance by the agent.
Corporate Governance
• Corporate governance
• Mechanisms to direct and control a firm
• Ensure the pursuit of strategic goal
• Address the principal–agent problem
• When corporate governance failed
• Accounting scandal
• Global financial crisis
• Bernard Madoff → Ponzi scheme
• Information asymmetry
• Insider information → ImClone and Galleon Group
Corporate Governance
• Agency theory
• Views a firm as a nexus of legal contracts
• Relationships among shareholders, managers, and
hierarchies
• Firms need to design work tasks
• Adverse selection
• Misrepresentation of a job
• Beyond his/her ability to do things
• Moral hazard
• Difficulty to ascertain whether the agent gives his/her
best
Mechanisms of Governance

Joseph Mahoney
Agency Problems
• Berle and Means in The Modern Corporation
inquired whether we have “any justification for
assuming that those in control of a modern
corporation will also choose to operate it in the
interests of the stockholders?” (1932, p. 121)
• What are the “institutions of capitalism” that
lessen the problem of the separation of
(shareholder) ownership (the risk-bearing
principals) from control (managerial decision-
making agents)?
Agency Problems
• What are the “institutions of capitalism” that lessen the
problem of the separation of ownership and control?
1. Takeovers (the market for corporate control);
2. Recruitment of executives from outside the firm;
3. Monitoring by boards of directors;
4. Compensation heavily weighted toward stock options;
5. Monitoring by institutional investors;
6. Debt (minimize free cash flow; e.g., LBOs);
7. Separate Chairperson and CEO; and
8. Internal control of Multidivisional — “miniature capital market”
Board of Directors
• Centerpiece of corporate governance
• Inside and outside directors
• General strategic oversight and guidance
• Selecting, evaluating, and compensating the CEO
• Overseeing CEO succession plan
• Recently problematic at both HP and Apple
• Providing guidance on executives and their compensation
• Reviewing, monitoring, and approving strategic initiatives
• Conducting a risk assessment and mitigation
• Ensuring a firm’s audited financial statements
• Ensuring a firm’s compliance with laws and regulations
Corporate Governance Around the World
• Difference in national institutions and culture
• “Free” market economies?
• State-directed capitalism (less freedom). Ex: China
• Free market capitalism (more freedom). Ex: U.S.
• Germany
• Stakeholder capitalism
• France
• Stakeholder capitalism
• China
• State-owned enterprises
Question for Discussion
• In 2011, there were 17 members of the board of
directors for General Electric, with a market
capitalization of about $325 billion. 15 members
were independent outside directors. One of the
inside directors was CEO Jeffrey Immelt (the Chair
of the Board of Directors)
• In roughly two-thirds of U.S. public firms, the CEO of the
company also serves as Chair of the Board of Directors.
What arguments can be made for and against splitting
the roles of CEO and Chair of the Board of Directors?
• Please reflect on this question and post your
response in the Discussions for this video.
Recent Developments

Deepak Somaya
Two Central Challenges

Over-emphasis on shareholders and return on

equity
Over-emphasis on measurable short-run financial
metrics
Broadening the Mission
Corporate social responsibility
Sustainability goals
Balanced scorecard
Financial: EVA, profitability, growth
Customer: differentiation, cost, quick response
Operations: products developed, order fulfillment,
demand management
Organizational: leadership, learning, ability to change
Ecosystem Strategies

Business ecosystem: An economic community

supported by a foundation of interacting
organizations and individuals—the organisms of
the business world
Examples: Malls, Toyota supplier-dealer network,
Apple, Amazon, Facebook, Silicon Valley, Coursera
Particularly salient for many modern platform
based businesses
Moore, 1993; 1996
Use of “Ecosystem” in Business

Source: Kapoor (2018). Articles mentioning the term “ecosystem” in corporate/industrial news (Factiva)
Protection from Shareholders

Old approaches: poison pills, etc.

Going / staying private
Private equity
Unicorns
Dual class shares
The parable of WeWork
WeWork, Midtown Manhattan, NYC

Co-Founder and CEO of WeWork, Adam Neumann speaks onstage during

TechCrunch Disrupt NY 2015
References
• Suresh, A. 2019. WeWork Office in Midtown Manhattan, NYC
[Photography]. Retrieved from
https://commons.wikimedia.org/wiki/File:WeWork_(48155566876).jpg
• TechCrunch. 2015. Co-Founder and CEO of WeWork, Adam Neumann
Speaks onstage during TechCrunch Disrupt NY 2015 [Photography].
Retrieved from
https://commons.wikimedia.org/wiki/File:TechCrunch_Disrupt_NY_2015_-
_Day_2_(17192687008).jpg