Strategic Management: Unit-Iv

MBA III YEAR - PAPER-II
Prof. G. Ram Reddy Centre for Distance

Education
Osmania University -Hyderabad
UNIT-IV
STRATEGIC MANAGEMENT
BY..
Prof. NEELAKANTAM TATIKONDA
PRINCIPAL - SUPRABHATH PG COLLEGE
Editor-in-Chief, ITIHAS The Journal of Indian Management
Founder Secretary –Global Association for Continuum of Business management
Cell No:9849845301
E-Mail: neelakantamtati@gmail.com
Neelakantam Tatikonda 1
Charles Baden-Fuller and John Stopford’s
Crescendo Model of rejuvenation:
• This model helps to solve the problem associated

with maturity of a firm.
• The basic philosophy behind the model is that
maturity is a mindset, and with a system and
process the problem can be solved.
• The model is based on case studies of many
MNC’s like komatsu, Caterpiller etc
• Four Stages for Rejuvenation:
• Galvanize: create a top team dedicated to renewal.
• Simplify: cut unnecessary and confusing
complexity
• Build: develop new capabilities
• Leverage: maintain momentum and stretch the
advantages.
Diversification Strategy
Objectives
• Define corporate strategy, describe some of the
reasons why firms diversify, identify and describe
different types of corporate diversification, and
assess the advantages and disadvantages
associated with each.
• Identify sources of synergy in diversified firms
while also describing why synergies are so
difficult to achieve.
Objectives (cont.)
• Explore the complex relationship between

diversification and firm performance.
• In particular, explore the influence of managers
and managerial thinking on the relationship
between diversification and performance.
Introduction
• Definition of Corporate Strategy
– Address the question: “What is the appropriate
scale and scope of the enterprise?”
• Influences how large and how diversified firms will be.
• Successful corporate strategies are not only the product of
successful definition
– Also the result of organizational capabilities or
competencies that allow firms to exploit potential
economies/synergies that large size or diversity can
offer.
Introduction (cont.)
• Why Firms Diversify

– To grow
– To more fully utilize existing resources and capabilities.
– To escape from undesirable or unattractive industry
environments.
– To make use of surplus cash flows.
• Horizontal or related diversification

– Strategy of adding related or similar
product/service lines to existing core business,
either through acquisition of competitors or
through internal development of new
products/services.
• Horizontal or related diversification

– Advantages
• Opportunities to achieve economies of scale and scope.
• Opportunities to expand product offerings or expand into new
geographical areas.
Disadvantages of related diversification
• Complexity and difficulty of coordinating different but related
businesses.
Conglomerate or unrelated diversification
– Firms pursue this strategy for several reasons:
• Continue to grow after a core business has matured or started
to decline.
• To reduce cyclical fluctuations in sales revenues and cash
flows.
– Problems with conglomerate or unrelated
diversification:
• Managers often lack expertise or knowledge about their firms’
businesses.
Introduction: The Basic
Issues
Diversification decisions involve two basic issues:
• Is the industry to be entered more attractive than

the firm’s existing business?
• Can the firm establish a competitive advantage

within the industry to be entered? (i.e. what
synergies exist between the core business and
the new business?)
Aim of Corporate
Strategy: Synergy
• Aim of diversification should be to create value or
wealth in excess of what firms would enjoy
without diversification.
• Synergy: the value of the combined firm after
acquisition should be greater than the value of the
two firms prior to acquisition.
– Obtained in three ways:
• Exploiting economies of scale.
– Unit costs decline with increases in production.
Aim of Corporate Strategy:
Synergy
• Exploiting economies of scope.
– Using the same resource to do different things.
• Efficient allocation of capital.
– Many assets in acquired firms are undervalued -- managers
seek to exploit these opportunities and improve their
operations and add value to their businesses.
Relatedness in
Diversification
Synergy in diversification derives from two main types of

relatedness:
• Operational Relatedness-- synergies from sharing
resources across businesses (common distribution
facilities, brands, joint R&D)
• Strategic Relatedness-- synergies at the corporate level
deriving from the ability to apply common management
capabilities to different businesses.
Problem of operational relatedness:- the benefits in terms

of economies of scope may be dwarfed by the
administrative costs involved in their exploitation.
Problems in Exploring
Potential Synergies
• Poor understanding of how diversification
activities will “fit” or be coordinated with existing
businesses.
• Acquisition process is fraught with risks.
– Managers might fail to conduct an adequate strategic
analysis of acquisition candidate.
• Will often try to complete the deal too quickly before other
potential buyers begin a bidding war.
• Managers will often focus on the attractive features of a
candidate, while giving less attention to the negative features.
Potential Synergies (cont.)
– Even after making an acquisition, managers must still
integrate the new business into their company’s
existing portfolio of businesses.
• Differences in organizational cultures.
• Should new business be standalone operation or should it be
merged into one of the existing businesses?
Potential Synergies (cont.)
• Problems associated with internal development of
new businesses.
– Most problems due to considerable time and
investment required to launch new business.
• On average, most new product lines require 10 years before
generating positive cash flows and net income.
– Difficult to assess the risks associated with new
investment opportunity.
The Trend Over Time: Diversified
Companies among the Fortune 500
70.2 63.5 53.7 53.9 39.9 37.0
29.8 36.5 46.3 46.1 60.1 63.0
1949 1954 1959 1964 1969 1974

Percentage of Specialized Companies (single-business,
vertically-integrated and dominant-business)
Percentage of Diversified Companies (related-business
and unrelated business)
BUT Since late 1970’s, diversification has declined.
Diversification and Performance:
The Score
• What is relationship between diversification and
firm performance?
– Academics, consultants, and financial community have
dim view of diversification.
– Some studies suggest that diversification beyond a
core business leads to lower performance.
Diversification and Performance:
Empirical Evidence
• Diversification trends have been driven by beliefs rather

than evidence:- 1960s and 70s diversification believed to be
profitable; 1980s and 90s diversification seen as value
destroying.
• Empirical evidence inconclusive-- no consistent findings on
impact of diversification on profitability, or on related vs.
unrelated diversification.
• Some evidence that high levels of diversification
return on net assets (%)
detrimental to profitability
• Diversifying acquisitions, 3
on average, destroy share- 2

holder value for acquirers
1
• Refocusing generates 1 2 3 4 5 6
index of product diversity
positive shareholder returns
Diversification and
Performance: The Score
– Exhibit summarizes findings of study that sought to
determine how much various factors, including industry
attractiveness, business strategy, and corporate
strategy contribute to performance.
• Findings suggest that industry attractiveness and business
strategy together explain more than 99% of variation of
business unit performance.
– Corporate strategy has no apparent effect on performance!
Diversification and
– Additional studies conclude that corporate strategy
rarely makes significant contribution to shareholder
value.
– Recent study is shown in Exhibit below:
Low- High-
Performing Performing
Firms Firms
Less
Diversified 47 46
46 47
Diversification and
– Exhibit suggests:
• Categorization of firms into the 4 diversification-performance
groups is remarkably balanced.
– High-performing firms are just as likely to be more
diversified as they are to be less diversified.
– Low-performing firms are just as likely to be less diversified
as they are to be more diversified.
• No significant performance differences between high-
performing more or less diversified firms.
Diversification and
• Summary
– Though diversification has been disastrous for many
firms, diversified firms can also be successful.
– Studies have found no obvious differences between
high- and low-performing diversified firms along several
important strategic dimensions.
Motives for
Diversification
GROWTH --The desire to escape stagnant or declining industries
has been one of the most powerful motives for
diversification (tobacco, oil, defense).
--But, growth satisfies management not shareholder
goals.
--Growth strategies (esp. by acquisition), tend to
destroy shareholder value
RISK --Diversification reduces variance of profit flows
SPREADING --But, does not normally create value for
shareholders, since shareholders can hold diversified
portfolios.
--Capital Asset Pricing Model shows that
diversification lowers unsystematic risk not
systematic risk.
PROFIT --For diversification to create shareholder value, the act

of bringing different businesses under common owner-
ship must Neelakantam
somehowTatikonda
increase their profitability. 25
Diversification and Shareholder Value:
Porter’s Three Essential Tests
If diversification is to create shareholder value, it must meet

three tests:
1. The Attractiveness Test: diversification must be directed

towards actual or potentially-attractive industries.
2. The Cost of Entry Test : the cost of entry must not capitalize
all future profits.
3. The Better-Off Test: either the new unit must gain

competitive advantage from its link with the corporation, or
vice-versa. (i.e. synergy must be present)
Introduction: The Tasks of Corporate
Strategy In the Multibusiness Corporation
• Determining the company’s business portfolio--

diversification, acquisition, divestment
• Allocating resources between the different businesses
• Formulating strategy for the different businesses
• Controlling business performance
• Coordinating the businesses and creating overall

cohesiveness and direction for the company
The Divisionalized Firm in Practice
• Constraints upon decentralization. Few diversified companies

achieve clear division of decision making between corporate
and divisional levels. On-going dialogue and conflict exists
between corporate and divisional managers over both strategic
and operational issues.
• Standardization of divisional management. Despite potential for
divisions to differentiate strategies, structures and styles---
corporate systems may impose uniformity.
• Managing divisional inter-relationships. Managing relationships
between divisions requires more complex structures e.g..
matrix structures where functional and/or geographical
structure is imposed on top of a product/market structure.
Crucial Role of Managers
• Successful diversification strategies result from
the ability of managers to develop skill and
competency at MANAGING diversification.
• Managers must develop two important types of
mental models:
– Must have well-developed understandings of their
firm’s diversity and relatedness that define their
companies.
• Understandings of how their firm’s businesses are related are
important for 2 reasons:
– They will influence how managers describe their
organizations to important stakeholders.
– Managers’ understandings also describe or suggest how
their businesses are related to each other.
– Must also have well-developed beliefs about how
diversification should be managed in order to achieve
synergies.
• How to coordinate the activities of businesses in order to
achieve synergies.
• How to allocate resources to the various businesses in a
diversified firm.
• Whether various functional activities such as engineering,
finance and accounting, marketing and sales, production, and
research and development should be centralized at the
corporate HQ or be decentralized and operated by SBU
managers.
• How to compensate and reward business unit managers so that
their goals and objectives are best aligned with those of the
organization.
• The “Learning Hypothesis”
– Managers learn from trial and error.
• They evaluate success of past strategic decisions.
• These acquired beliefs become embedded in an organization’s
routine operating procedures.
– Usually difficult for rivals to imitate.
– By engaging in a number of acquisitions over time,
managers can come to develop an expertise about how
the acquisition process should be managed.
• Those firms with management teams that have more experience
at managing diversification will enjoy higher performance than
those firms that do not have that experience.
– Evidence suggests that firm’s stock market performance is
directly related to diversification experience (see exhibit on
following slide).
Exhibit: Five-Year Stock Market Performance of
Four Bank Holding Companies that Are Active
Acquirers
Banc One 44%
NationsBank 118%
Norwest 142%
First Bank 195%
Wells Fargo 234%
0% 50% 100% 150% 200% 250%
Conclusions
• Size alone does not guarantee firms an
advantage.
– Coordination required to exploit economies of
scale and scope is not without cost.
– Size creates additional challenges and
difficulties, including problems of
communication and coordination.
• Higher levels of diversification are not
incompatible with high performance -- nor
do they necessarily imply that firms will
suffer lower performance levels.
• Critical factor in determining success is the level
of management expertise in formulating and
implementing corporate strategy.
– More difficult for diversified firms.
– Managers of large diversified firms possess a variety of
well-developed mental models that provide them with
powerful understandings of how to manage their firms.
Mergers and
Acquisitions
Types of Takeovers
Mergers and Acquisitions
Types of Takeovers
General Guidelines
Takeover
– The transfer of control from one ownership group to
another.
Acquisition
– The purchase of one firm by another
Merger
– The combination of two firms into a new legal entity
– A new company is created
– Both sets of shareholders have to approve the transaction.
Amalgamation
– A genuine merger in which both sets of shareholders must
approve the transaction
– Requires a fairness opinion by an independent expert on
the true value of the firm’s shares when a public minority
exists
Types of Takeovers
Cash Transaction
– The receipt of cash for shares by shareholders in
the target company.
Share Transaction
– The offer by an acquiring company of shares or
a combination of cash and shares to the target
company’s shareholders.
Going Private Transaction (Issuer bid)
– A special form of acquisition where the
purchaser already owns a majority stake in the
target company.
Securities Laws
Pertaining to Takeovers
General Intent of the
Legislation
Transparency – Information Disclosure
• To ensure complete and timely information be available
to all parties (especially minority shareholders)
throughout the process while at the same time not letting
this requirement stall the process unduly.
Fair Treatment
• To avoid oppression or coercion of minority
shareholders.
• To permit competing bids during the process and not
have the first bidder have special rights. (In this way,
shareholders have the opportunity to get the greatest and
fairest price for their shares.)
• To limit the ability of a minority to frustrate the will of a
majority. (minority squeeze out provisions)
Exempt Takeovers
• Private companies are generally exempt from

provincial securities legislation.
• Public companies that have few
shareholders in one province may be subject
to takeover laws of another province where
the majority of shareholders reside.
Exemption from Takeover
Requirements for Control Blocks
• Purchase of securities from 5 or fewer

shareholders are permitted without a tender
offer requirement provided the premium over
the market price is less than 15%
Creeping Takeovers
The 5% Rule
The 5% rule
• Normal course tender offer is not required as long
as no more than 5% of the outstanding shares are
purchased through the exchange over a one-year
period of time.
• This allows creeping takeovers where the
company acquires the target over a long period of
time.
Securities Legislation
Critical Shareholder Percentages
1. 10%: Early Warning

• When a shareholder hits this point a report is sent to OSC
• This requirement alters other shareholders that a potential
acquisitor is accumulating a position (toehold) in the firm.
2. 20%: Takeover Bid
• Not allowed further open market purchases but must make a
takeover bid
• This allows all shareholders an equal opportunity to tender
shares and forces equal treatment of all at the same price.
• This requirement also forces the acquisitor into disclosing
intentions publicly before moving to full voting control of the
firm.
Neelakantam
15 - 46
Tatikonda
Securities Legislation
Critical Shareholder Percentages Continued …
3. 50.1%: Control
• Shareholder controls voting decisions under normal
voting (simple majority)
• Can replace board and control management
4. 66.7%: Amalgamation
• The single shareholder can approve amalgamation
proposals requiring a 2/3s majority vote (supermajority)
5. 90%: Minority Squeeze-out
• Once the shareholder owns 90% or more of the
outstanding stock minority shareholders can be forced
to tender their shares.
• This provision prevents minority shareholders from
frustrating the will of the majority.
The Takeover Bid Process
Moving Beyond the 20% Threshold
• Takeover circular sent to all shareholders.

• Target has 15 days to circulate letter to shareholders with the
recommendation of the board of directors to accept/reject.
• Bid must be open for 35 days following public announcement.
• Shareholders tender to the offer by signing authorizations.
• A Competing bid automatically increases the takeover window
by 10 days and shareholders during this time can with drawn
authorization and accept the competing offer.
The Takeover Bid Process
Prorated Settlement and Price
• Takeover bid does not have to be for 100 %

of the shares.
• Tender offer price cannot be for less than the
average price that the acquirer bought
shares in the previous 90 days. (prohibits
coercive bids)
• If more shares are tendered than required
under the tender, everyone who tendered
shares will get a prorated number purchased.
Friendly Acquisition
The acquisition of a target company that is willing to be

taken over.
Usually, the target will accommodate overtures and

provide access to confidential information to facilitate
the scoping and due diligence processes.
Friendly Acquisitions
The Friendly Takeover Process
1. Normally starts when the target voluntarily puts itself into

play.
• Target uses an investment bank to prepare an offering
memorandum
– May set up a data room and use confidentiality agreements to
permit access to interest parties practicing due diligence
– A signed letter of intent signals the willingness of the parties to
move to the next step – (usually includes a no-shop clause and a
termination or break fee)
– Legal team checks documents, accounting team may seek
advance tax ruling from CRA
– Final sale may require negotiations over the structure of the deal
including:
» Tax planning
» Legal structures
2. Can be initiated by a friendly overture by an acquisitor
seeking information that will assist in the valuation
process.
()
15-1 FIGURE
Information
memorandum
Confidentiality Main due Ratified

agreement diligence
Sign letter Final sale

of intent agreement
Approach
target
Friendly Takeovers
Structuring the Acquisition
In friendly takeovers, both parties have the opportunity

to structure the deal to their mutual satisfaction
including:
1. Taxation Issues – cash for share purchases trigger capital
gains so share exchanges may be a viable alternative
2. Asset purchases rather share purchases that may:
• Give the target firm cash to retire debt and restructure financing
• Acquiring firm will have a new asset base to maximize CCA
deductions
• Permit escape from some contingent liabilities (usually excluding
claims resulting from environmental lawsuits and control orders
that cannot severed from the assets involved)
3. Earn outs where there is an agreement for an initial purchase
price with conditional later payments depending on the
performance of the target after acquisition.
Hostile Takeovers
A takeover in which the target has no desire to

be acquired and actively rebuffs the acquirer and
refuses to provide any confidential information.
The acquirer usually has already accumulated an

interest in the target (20% of the outstanding
shares) and this preemptive investment
indicates the strength of resolve of the acquirer.
Hostile Takeovers
The Typical Process
The typical hostile takeover process:

1. Slowly acquire a toehold (beach head) by open market purchase
of shares at market prices without attracting attention.
2. File statement with OSC at the 10% early warning stage while not
trying to attract too much attention.
3. Accumulate 20% of the outstanding shares through open market
purchase over a longer period of time
4. Make a tender offer to bring ownership percentage to the desired
level (either the control (50.1%) or amalgamation level (67%)) -
this offer contains a provision that it will be made only if a certain
minimum percentage is obtained.
During this process the acquirer will try to monitor

management/board reaction and fight attempts by them to put
into effect shareholder rights plans or to launch other
defensive tactics.
Hostile Takeovers
Capital Market Reactions and Other Dynamics
Market clues to the potential outcome of a hostile takeover

attempt:
1. Market price jumps above the offer price

• A competing offer is likely or
• The bid price is too low
2. Market price stays close to the offer price
• The offer price is fair and the deal will likely go through
3. Little trading in the shares
• A bad sign for the acquirer because shareholders are reluctant to
sell.
4. Great deal of trading in the shares
• Large numbers of shares being sold from normal investors to
arbitrageurs (arbs) who are, themselves building a position to
negotiate an even bigger premium for themselves by coordinating a
response to the tender offer.
Hostile Takeovers
Defensive Tactics
Shareholders Rights Plan

• Known as a poison pill or deal killer
• Can take different forms but often
 Gives non-acquiring shareholders get the right to buy 50 percent more shares
at a discount price in the event of a takeover.
Selling the Crown Jewels

• The selling of a target company’s key assets that the acquiring company
is most interested in to make it less attractive for takeover.
• Can involve a large dividend to remove excess cash from the target’s
balance sheet.
White Knight
• The target seeks out another acquirer considered friendly to make a
counter offer and thereby rescue the target from a hostile takeover
Motives for Takeovers
Classifications Mergers
and Acquisitions
1. Horizontal
• A merger in which two firms in the same industry combine.
• Often in an attempt to achieve economies of scale and/or scope.
2. Vertical
• A merger in which one firm acquires a supplier or another firm
that is closer to its existing customers.
• Often in an attempt to control supply or distribution channels.
3. Conglomerate
• A merger in which two firms in unrelated businesses combine.
• Purpose is often to ‘diversify’ the company by combining
uncorrelated assets and income streams
4. Cross-border (International) M&As
• A merger or acquisition involving a Canadian and a foreign firm a
either the acquiring or target company.
Mergers and Acquisition
Activity
• M&A activity seems to come in ‘waves’ through
the economic cycle domestically, or in response
to globalization issues such as:
– Formation and development of trading zones or blocks
(EU, North America Free Trade Agreement
– Deregulation
– Sector booms such as energy or metals
Motivations for Mergers and Acquisitions
Creation of Synergy Motive for M&As
The primary motive should be the creation

of synergy.
Synergy value is created from economies of

integrating a target and acquiring a
company; the amount by which the value of
the combined firm exceeds the sum value of
the two individual firms.
Creation of Synergy
Motive for M&As
Synergy is the additional value created (∆V) :
[ 15-1] V  VAT -(V A  VT )
Where:
VT = the pre-merger value of the target firm
VA - T = value of the post merger firm
VA = value of the pre-merger acquiring firm
Value Creation
Motivations for M&As
Operating Synergies
Operating Synergies
1. Economies of Scale
• Reducing capacity (consolidation in the number of firms in the
industry)
• Spreading fixed costs (increase size of firm so fixed costs per unit
are decreased)
• Geographic synergies (consolidation in regional disparate operations
to operate on a national or international basis)
2. Economies of Scope
• Combination of two activities reduces costs
3. Complementary Strengths
• Combining the different relative strengths of the two firms creates a
firm with both strengths that are complementary to one another.
Value Creation
Motivations for M&A
Efficiency Increases and Financing Synergies
Efficiency Increases
– New management team will be more efficient and add
more value than what the target now has.
– The combined firm can make use of unused
production/sales/marketing channel capacity
Financing Synergy
– Reduced cash flow variability
– Increase in debt capacity
– Reduction in average issuing costs
– Fewer information problems
Value Creation
Motivations for M&A
Tax Benefits and Strategic Realignments
Tax Benefits
– Make better use of tax deductions and credits
• Use them before they lapse or expire (loss carry-back, carry-forward
provisions)
• Use of deduction in a higher tax bracket to obtain a large tax shield
• Use of deductions to offset taxable income (non-operating capital
losses offsetting taxable capital gains that the target firm was unable
to use)
• New firm will have operating income to make full use of available
CCA.
Strategic Realignments
– Permits new strategies that were not feasible for prior to the
acquisition because of the acquisition of new management skills,
connections to markets or people, and new products/services.
Managerial Motivations
for M&As
Managers may have their own motivations to pursue M&As.
The two most common, are not necessarily in the best interest
of the firm or shareholders, but do address common needs of
managers
1. Increased firm size
– Managers are often more highly rewarded financially for building a bigger
business (compensation tied to assets under administration for example)
– Many associate power and prestige with the size of the firm.
2. Reduced firm risk through diversification
• Managers have an undiversified stake in the business (unlike
shareholders who hold a diversified portfolio of investments and don’t
need the firm to be diversified) and so they tend to dislike risk (volatility
of sales and profits)
• M&As can be used to diversify the company and reduce volatility (risk)
that might concern managers.
Empirical Evidence of
Gains through M&As
• Target shareholders gain the most
– Through premiums paid to them to acquire their shares
• 15 – 20% for stock-finance acquisitions
• 25 – 30% for cash-financed acquisitions (triggering capital gains
taxes for these shareholders)
– Gains may be greater for shareholders will to wait for ‘arbs’ to
negotiate higher offers or bidding wars develop between multiple
acquirers.
• Between 1995 and 2001, 302 deals worth US$500.
– 61% lost value over the following year
– The biggest losers were deals financed through shares which lost
an average 8%.
Empirical Evidence of Gains
through M&As
Shareholder Value at Risk (SVAR)
• Shareholder Value at Risk (SVAR)

– Is the potential in an M&A that synergies will not be
realized or that the premium paid will be greater than
the synergies that are realized.
• When using cash, the acquirer bears all the risk
• When using share swaps, the risk is borne by the
shareholders in both companies
• SVAR supports the argument that firms making

cash deals are much more careful about the
acquisition price.
Top 10 billion dollar mergers and acquisitions India:
•Tata Steel’s mega takeover of European steel major Corus for $12.2 billion. The biggest ever
for an Indian company. This is the first big thing which marked the arrival of India Inc on the
global stage. The next big thing everyone is talking about is Tata Nano.
•Vodafone’s purchase of 52% stake in Hutch Essar for about $10 billion. Essar group still
holds 32% in the Joint venture.
•Hindalco of Aditya Birla group’s acquisition of Novellis for $6 billion.
•Ranbaxy’s sale to Japan’s Daiichi for $4.5 billion. Sing brothers sold the company to Daiichi
and since then there is no real good news coming out of Ranbaxy.
•ONGC acquisition of Russia based Imperial Energy for $2.8 billion. This marked the turn
around of India’s hunt for natural reserves to compete with China.
•NTT DoCoMo-Tata Tele services deal for $2.7 billion. The second biggest telecom deal after
the Vodafone. Reliance MTN deal if went through would have been a good addition to the list.
•HDFC Bank acquisition of Centurion Bank of Punjab for $2.4 billion.
•Tata Motors acquisition of luxury car maker Jaguar Land Rover for $2.3 billion. This could
probably the most ambitious deal after the Ranbaxy one. It certainly landed Tata Motors into
lot of trouble.
•Wind Energy premier Suzlon Energy’s acquistion of RePower for $1.7 billion.
•Reliance Industries taking over Reliance Petroleum Limited (RPL) for 8500 crores or $1.6
billion.
Divestment
• Strategy is not always about growth and
diversification
• The strategic choice of a firm might be to reduce
the sale of operations (downsizing) or disposal of
parts of the organisation
• This involves the selling off part of the business
or pulling out of certain product or market areas
Internal and external
• Internal divestment
– Organic reduction or winding down
– The closure of a plant or division or the deletion of a
product line as part of a strategy of rationalisation
• External divestment
– The sale of part of the business enterprise
– Divestment is the opposite of acquisition
– Demerger is the opposite of merger
Demerger/divestment
• This is the process of disposing of part of an
organisation’s activities by selling it
• This might take the form of selling off a strategic
business unit (SBU) such as a subsidiary
company or a division
• A SBU is a stand alone “business with a
business” and it is relatively easy to sell it off
• One major reason for divestment/ demerger to
concentrate on core activities
• Hence the process can be seen as the strategy of
re-focusing the corporation
Negative reasons for
demerger
• To eliminate an underperforming division
• To remove a division with poor prospects
• To dispose of an unwanted acquisition
• To deflect a hostile takeover
• Lack of resources to invest in the business
Positive reasons for
demerger
• To facilitate a change in strategic focus
• To get back to basics by re-focussing on core
activities
• To concentrate on core activities
• To eliminate peripheral activities
• Because of the lack of synergy between the
subsidiary and the core business
• To raise finance investment in core business
activities
• Buying and selling subsidiaries can be profitable
But there are problems
• If the disposal is motivated by a desire to get rid of a
underperforming division there will be problems in finding
a buyer willing to pay a reasonable price
• In some cases the parent is so keen to rid itself of the
underperforming division that it accepts a price below fair
value
• For example: BMW sold the Rover group for just £10 to rid
itself of the debts associated with Rover
• It is possible that the buyer of such a SBU believes that it
will be more successful than the previous owners but, as
in the Rover case, the belief might be unjustified
Barriers to exit
• In essence, a barrier to exit is anything which makes it
difficult or costly to exit from an industry or market. This
includes:
– Possible cost of redundancies
– The difficulty of finding a buyer
– Psychological barrier of not wishing to admit failure
– Misconception that carrying on is a low risk strategy
– Marketing considerations such as reputation for breadth of
coverage
– Ignorance of the distinction between a sunk costs (which should
be ignored) and decision relevant costs. As result, a mentality
develops of “we have spent the money and so must continue”
Examples of demerger
• Boots disposed of Halfords because it did not fit
in with core activities
• WH Smith sold its large stake in the Focus Do It
All chain of DIY stores
• The Dutch electrical goods company Philips sold
off its white goods (domestic appliances) division
to Whirlpool, a US firm
• The demerger of WH Smith (retail) and WH Smith
(wholesale)
Selecting candidates for
disposal
• Select subsidiaries outside the core business
• Use portfolio analysis e.g. GE matrix
• Investigate
• Current position in terms of the product life cycle
• Current market position
• Opportunities for competitive advantage
• Future potential for cash generation
• Future investment needs
• Ability to find a buyer willing to pay an acceptable
price
• Synergy (or the absence of synergy)
Finding the core
• Business activities can be divided into:
• Peripheral activities:
– Not essential to the core purpose of the business
– Are not a source of competitive advantage
– Are prime candidates for demerger
• Supportive activities
– Essential but not a core activity
– Failure in this area would cause serious damage to the business
• Strategic activities
– An actual or potential source of competitive advantage
• Core activities
– The central or core activity(ies) of the business
– What company is “all about”
– Should not be sold off or outsourced
Case study: ICI and
Zeneca
• ICI decided to
– Focus on its core area of speciality chemicals
– Dispose of parts of the company that did not fit into the
realigned structure
– Therefore, the pharmaceutical division was floated off
as Zeneca
• It was felt that Zeneca would be able to compete
in the very competitive pharmaceutical industry
without the encumbrance of being part of a widely
diversified group
Case study: British Gas &
Centrica
• British Gas was a nationalised corporation until
the 1980s but was privatised by the Thatcher
government
• In 1997 British Gas was divided into British Gas
and Transco. In essence, the pipeline part of the
operation was removed from British Gas and
placed under Transco
• At this point, British Gas diversified by acquiring
a series of related and unrelated businesses (e.g.
the AA, Onetel, the Dyno group)
• In recent years British Gas has sold off some
unrelated acquisitions (AA
Neelakantam in 2004 and Onetel in 81
Tatikonda
The strategy of re-
focusing
• The British Gas case is an example of the strategy
of refocusing
• This involves identifying the core activity and the
synergies that exist between divisions
• The non-core activities become candidates for
demerger
• Neither the AA breakdown service nor the mobile
phone business were core activities whereas
energy in its various forms is central to British
Gas
Unbundling
• In a merger or takeover involving large diversified
companies it is likely the some of the businesses
acquired do not fit the strategic view of the new
company
• As a result, it is common for external growth to be
followed by some disposal of peripheral business
• Example: Granada Television owned subsidiaries
involved in other aspects of the leisure
businesses, including some motorway service
areas
• In 2001 the catering arm was demerged from
Granada and sold to the Compass Group Plc. The
motorway service areas are now called Moto
Types of buyers
• Sphere of influence buyers:
– Firms for which the acquisition would present
horizontal or vertical integration
• Related industry buyers:
– Neither competitors nor upstream or downstream in the
supply chain but a company in a related industry where
skills are transferable and synergy exists
• Management buy out (MBO)
– Purchase by existing team of managers; usually funded
by a venture capitalist
• Management buy-in (MBI)
– Where a business is acquired by a group of external
investors and management team
Management buyout
• This involves disposal of assets by selling them
to current managers (usually backed by a venture
capital firm)
• The advantages is that existing managers:
– Understand the market
– Will retain network of contacts
– Understand the culture
– Will be committed and motivated
• Examples: management buyout of Charles Letts
(diaries), Dollar and Aitchison (opticians), Parker
Pens and Standard Fireworks
Advantages of divestment
• Elimination of underperforming divisions
• Disposal of unwanted acquisitions
• Both the parent and the demerged company can
focus on core activities
• Each business is able to respond independently
to its own markets
• Smaller units are easier to control and co-ordinate
• As a result they have the potential to perform
better
• Profits can be gained from selling off subsidiaries
• Provides an opportunity
Neelakantam to raise finance for core 86
Tatikonda
Disadvantages of
divestment
• It involves disposal of assets
• Results in a reduction in asset base of the firm
• It might lead to in a loss of economies of scale
• And a loss of synergy

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MBA III YEAR - PAPER-II

Prof. G. Ram Reddy Centre for Distance

• This model helps to solve the problem associated

• Explore the complex relationship between

• Why Firms Diversify

• Horizontal or related diversification

• Horizontal or related diversification

Diversification decisions involve two basic issues:

• Is the industry to be entered more attractive than

• Can the firm establish a competitive advantage

Synergy in diversification derives from two main types of

Problem of operational relatedness:- the benefits in terms

1949 1954 1959 1964 1969 1974

• Diversification trends have been driven by beliefs rather

on average, destroy share- 2

PROFIT --For diversification to create shareholder value, the act

If diversification is to create shareholder value, it must meet

1. The Attractiveness Test: diversification must be directed

3. The Better-Off Test: either the new unit must gain

• Determining the company’s business portfolio--

• Allocating resources between the different businesses

• Formulating strategy for the different businesses

• Controlling business performance

• Coordinating the businesses and creating overall

• Constraints upon decentralization. Few diversified companies

Banc One 44%

First Bank 195%

Wells Fargo 234%

0% 50% 100% 150% 200% 250%

• Private companies are generally exempt from

• Purchase of securities from 5 or fewer

1. 10%: Early Warning

• Takeover circular sent to all shareholders.

• Takeover bid does not have to be for 100 %

The acquisition of a target company that is willing to be

Usually, the target will accommodate overtures and

1. Normally starts when the target voluntarily puts itself into

Confidentiality Main due Ratified

Sign letter Final sale

In friendly takeovers, both parties have the opportunity

A takeover in which the target has no desire to

The acquirer usually has already accumulated an

The typical hostile takeover process:

During this process the acquirer will try to monitor

Market clues to the potential outcome of a hostile takeover

1. Market price jumps above the offer price

Shareholders Rights Plan

Selling the Crown Jewels

The primary motive should be the creation

Synergy value is created from economies of

[ 15-1] V  VAT -(V A  VT )

• Shareholder Value at Risk (SVAR)

• SVAR supports the argument that firms making

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