Strategic Management - Cases & Examples

(Barney/Hesterly, Strategic Management and Competitive Advantage)

Strategic Management in General

Disney Strategic Management In1984,Disneysstockpricehadbeenflatforadecade.Earningspersharewereonly $0.06. Disney had profits that year of $242 million. By this point in time Disney had become primarily a theme park company. Seventy seven percent of its profits came from theme park operations that year. Twenty two percent of profits came from consumer products (licensing Mickey Mouse, Donald Duck, etc.). Only one percent of profits came from filmed entertainment in 1984. Indeed, Disney had become a different company from what Walt Disney and his brother Roy O. Disney left behind. In 1971 when Roy O. Disney died(hebecameCEOwhenWaltdiedin1966),50%ofthecompanysprofitscamefrom filmed entertainment. TheDisneyboardwasdissatisfiedwiththefirmsdirectionanditsfinancialperformance. Michael Eisner was hired as the CEO of Disney in 1984. He had extensive experience in the entertainment industry including a stint as the president of Paramount Pictures. Eisner recognized the value of both the filmed entertainment legacy of the firm and the theme park operations that had been developed by that time. Eisner soon focused on the animation and movie studios. He also opened the Disney vault to exploit the relatively untappedvalueofDisneysanimatedclassics.Profitsfromfilmedentertainmentwentfrom about $2.4 million in 1984 to $845 million in 1994. Eisner spent considerable time during the early days of his tenure touring the theme parks to see what the company really had. He decided to upgrade the theme parks and increase admission prices. Profits from the theme parks went from $186 million in 1984 to $688 million in 1994. Consumer products went from profits of $53 million in 1984 to $433 million in 1994, a natural result of the success of the companysfilmedentertainmentandthemeparkoperations. The impressive part of these changes and results is that Eisner, to quite an extent, used resources that Disney already possessed such as animation and live studios. Animators were challenged to create new and exciting contentsomething that had not happened in a long time. Some of the Disney classics pulled from the vault were converted to the VHS formatanddistributedtothehomemarket.ItstruethatthetimingoftheadventoftheVHS format and the proliferation of home video was fortunate for Disney. But, itsalsotruethat Eisner deployed the resources of Disney in a different way from how they had been used in theyearsleadingupto1984.DisneyanimatorscreatedTheLittleMermaidin1989hadbox office receipts of $83.5 million. It won an Oscar. Beauty and the Beast was released in 1991, setting new box office records for an animated film ($145.8 million). The Lion King came out in 1994 and has had box office sales of over $328.5 million and has sold over 30 million copies in the home video market. All three of these animated films did extremely well at the box office, the video store, and the toy store. Intime,Eisneralsodiversifiedthefirmsportfolioextensively.DisneyboughtABCtelevision, which included ESPN, hotels, professional sports teams (Anaheim Angels and the Mighty Ducks), a cruise ship, and developed a chain of retail stores. Licensing of Disney characters,

old and new, was aggressively expanded. In the early 1990s Disney characters were a common, and highly prized, toy includedinkidsmealsatfastfoodrestaurantsandasprizes inbreakfastcerealsboxes.From1984to1994,Disneysmarketcapitalizationincreased from$2billionto$28billion.Nowthatsstrategy! The Disney story is not so stellar during the second halfofEisners20yearreignatDisney. Eisner has done battle with disenchanted board members and executives, most notably, Roy Disney who coincidentally was instrumental in hiring Eisner in 1984. Earnings per share peaked in 1997 at $0.95 and dipped to $-0.02 in 2001. Critics contend that the reason for the decline in performance is that Eisner has pushed out executives and board members that providedchecksandbalancestohispower.DisneysfailedrelationshipwithPixarisoften cited as a contributingfactortoDisneyswoes.Otherreasonsforthedeclineareclearly outsideEisnerscontrol.TheterroristattacksofSept.11,2001,keptpeopleawayfrom theme parks, especially foreign visitors. Earnings per share had climbed to $1.06 by the endofthefirstquarterofDisneysfiscal 2005, suggesting a Disney recovery. Disney is benefiting from increased attendance at its themeparks,whichislikelyafunctionofpeopleswillingnesstoresumeleisuretravel. Disney is expanding internationally with a theme park opening in Hong Kong in September of 2005.ABCsperformanceisimprovinglargelyduetothesuccessoftwonewseries: Desperate Housewives and Lost. Eisner announced that he will resign in September of 2006.IfDisneysrecovery continues he may be able to retire with the strategic genius status he once enjoyed. (Huey & McGowan, Fortune 4/17/1995, 131(7): 44-55; Wessel, Orlando Sentinel, March 15, 2004).

Black & Decker - Strategic Choices Black & Decker makes small kitchen appliances and power tools for the home and industrial markets. Black & Decker must decide how each of these businesses will be positioned within their respective industries. These are business level strategic choices. There are different circumstances and conditions in each of these businesses. Conditions in the external environment may affect each of these businesses in a different way. Internal analysis may revealthatBlack&Deckersresourcessuggestpositioningthesmall kitchen appliances business one way and positioning the home power tools business another way. Corporate level strategic choices are made as managers decide which businesses should form the corporate whole. Black & Decker must decide which businesses to buy or develop. Thus, Black & Decker would be making a corporate level strategic decision if they were to decide to enter the luggage business. They would be making a business level strategic decision if they were to decide to position their luggage at the very high end of the market and charge a premium price.

The Confederate Army - Good Strategy, Bad Implementation The Confederate Army at the Battle of Gettysburg arguably had the better strategy. However they did not have the ability to successfully carry out that strategy because their supply train was still several days behind them. The soldiers were able to move more quickly than the supply train. The Confederate Army had moved into a superior position (that virtually guaranteed success) before the Union Army could amass a sufficient number of troops.

However, the Confederate generals knew that with the Union Army moving towards Gettysburg, the Confederates would have a difficult time winning the battle in time. They knew that if the battle was not decided very quickly, the Confederates would run short on supplies and likely lose the battle. At this point, General Robert E. Lee understood that if he waited for the supply train the advantage of his timing and positioning would be lost. He also understood that if he turned and ran his soldiers would be so demoralized that they would have effectively lost the war at that point. He decided to attack. The results were disastrous for both sides. The battle lasted several days. Tens of thousands of soldiers lost their lives. The Confederate Army was defeated even though it had had the superior strategy.

Apple Competitive Advantage and Strategic Management Process

ConsiderApplesiPod.Applesmissionstatementreadsinpart,Appleisalsospearheading the digital music revolution with its iPod portable music players and iTunes online music store.AreasonableobjectiveforAppleasitembarkeduponthispartofitsmissionwould havebeen,developastylish,highlyfunctionaldigitalmusicdevice.Applesexternal analysis would have shown that there were competing technologies developing. An important part of their external analysis must have revealed that if a firm wanted to succeed with a hardware offering, it also neededareliablecontentprovider.Applesinternalanalysis wouldhaverevealedthatthefirmdefinitelyhadtheR&Danddesigncapabilities.Apples marketing capabilities, in conjunction with its advertising agencies, were obviously capable as evidenced by their history with other products. Strategic choices were made about developing the iPod and bringing it to market along with the iTunes service. Implementation issues surrounding the development and launch have been handled well. The ease of use of the iTunes service is indicative of attention to implementation issues. Apple appears to be achievingcompetitiveadvantagewithitsiPodproduct.Applesearningspersharehavegone from $0.12 in Q4 of 2003, to $0.28 in Q4 of 2004, to $0.75 in Q1 of 2005. Apple recently announced the 300 millionth download on its iTunes service. Apple appears to have applied the principles of the strategic management process to the development and introduction of the iPod.

Cellular Telephone Sustainable Competitive Advantage

Cellular telephone service providers quickly match the offerings of competitorsfree nights and weekends, multiple phone family plans, nationwide long distance, variable usage plans, etc. Any one of these plan features would likely be a source of competitive advantage if a single firm could offer it without be quickly imitated. When these features were first offered, consumers had preferences for one company over another. After the major competitors all offered these features there was no advantage to offering the features.

Southwest Airlines Sources of Competitive Advantage

For more than two decades Southwest Airlines has consistently achieved economic performance superior to the rest of the airline industry. An analysis of Southwest reveals three potential sources of competitive advantage:

 a set of human resource practices that has resulted in a workforce that is different from other airlines. The workforce is highly cross functionalto the point of pilots sometime handling baggage. Employees are willing to do whatever is necessary to turn planes around at gates in about half the time it takes other airlines. On average, the workforce is paidlessthanotherairlinespayandyet,Southwestsemployeeturnoverisextremelylow. a fleet of aircraft consisting of a single model - the Boeing 737. This policy creates efficiency in maintaining the aircraft and ensuring that every flight crew can handle every aircraft in the company. a network of short non-hub-to-hub routes. These routes allow Southwest to use airports that have lower gate fees and less congestion than the larger metropolitan airports used by other major airlines. Itseasytoseethatthesedifferencesfromotherairlinesmaybesourcesofcompetitive advantage for Southwest. Thus, we can see that Southwest has superior economic performance and we can see that there are several plausible sources of competitive advantage. However, we cannot measure the competitive advantage directly. Rather, we rely on economic performance as an indicator of sources of competitive advantage possessed by Southwest.

Resources and Capabilities

Softsoap Internal Analysis for Market Entry Softsoap wasthebrainchildofMinnetonkasCEO,RobertTaylor.Theideaofputtingliquid hand soap in a pump container for home use was novel at the time. Taylor knew that the most likely competitors would be large companies like Procter & Gamble who were good at developing and marketing new products for the home and personal care markets. Had Taylor forged ahead without any form of internal analysis he would have rightly developed a great product. He knew the liquid soap would be easy to manufacture and that he could buy the pumps from one or both of the two existing pump manufacturers. Procter & Gamble, and probably others, would have quickly imitated his product and most likely driven him out of business. These other manufacturers were many times larger than Minnetonka. However, Taylor engaged in a form of internal analysis by recognizing that even though these larger companies had a resource advantage when it came to manufacturing and marketing the liquid soap, they had no advantage when it came to the pump bottles. He recognized that if he bought all the pump bottle production of the two manufacturers he would have an advantage over firms much larger than Minnetonka. Taylor bought all the pumps the two manufacturers could produce in a year. He paid more for these orders of pumps than Minnetonka was worth at the time. The strategy worked. He had a 12-18 month lead over his much larger competitors in which he was able to establish the Softsoap brand and capture market share. (Brandenburger & Nalebuff, 1995, The Right Game: Use Game Theory to Shape Strategy, Harvard Business Review.)

Coca-Cola - Resources and Capabilities Coca-Cola has a distinctive red can with a trademarked white wave image that goes around the can. These are physical resources. Coca-Cola has access to substantial working capital

(cash). This is a financial resource. Coca-Cola has talented marketing professionals. These are individual human resources. Coca-Cola also has well established set of reporting structures, reward systems, communications systems, and IT systems. These are organizational resources. Coca-Cola has the ability to put these various resources together in an effective marketing campaign. This is a capability. Thus we would correctly refer to Coca-Colasmarketing capability as one of its resources right along with its other physical, capital, human, and organizational resources.

Caterpillar Historical Conditions During WWII the U.S. government found a need for heavy construction equipment throughout the world. In most, but not all, cases this equipment was needed to support military operations. Break downs could impair important military operationsoften with dire consequences. Therefore, the U.S. government had a keen interest in being able to get replacement parts anywhere in the world within 24-48 hours. The government chose to help Caterpillar establish this worldwide capability. The interests of the government were wellserved during the war. However, after the war there was a continuing need for heavy equipment in rebuilding efforts around the world. Caterpillar was uniquely suited to fill this need. As rebuilding efforts gave way to industrial and infrastructure expansion, Caterpillar continued to enjoy a unique position in the market. The cost faced by competitors in imitating this global capability vastly outweighed the benefit. Caterpillar was the obvious choice for heavy equipment because its service was so reliable. It was a unique set of historical conditions that brought Caterpillar to this point.

WordPerfect Social Complexity The WordPerfect word processing software was developed by college professor, Alan Ashton, and Bruce Bastian, a student. Originally these two came together to use a computer to map out and coordinate themovementsoftheuniversitysmarchingband.They continued to work together in creating a word processor for an office on campus. One thing led to another and within a short time, they had developed a software package that was better than anything available on the market at the time. This unique social relationship between Ashton and Bastian led to the early development of the software. It would be virtually impossible to imitate this relationship. However, WordPerfect benefited even more from another form of social complexity. Early on, Ashton and Bastian realized that the programmers were their bread and butter. They allowed the programmers to have the best of everythingoffices, bonuses, extremely flexible hours, etc. Soon a set of relationships developed among these programmers such that development efforts aimed at improving the product were naturally well-coordinated. These programmers were able to develop new features in the product that were astonishing for their time, especially for the legal profession. Theimmenseamountoftypingdonebyattorneysofficestaffswasgreatlyreducedand simplifiedbyWordPerfectstechnology.Forseveralyears,noothersoftwarecompanywas able to match the innovation of WordPerfect. Much of this innovation was the result of the social relationships among the programmers.

Vertical Integration
Amazon and the Publishing Industry The book publishing industry traditionally was characterized by a long value chain. The publisher contracted with authors to write books and entered into agreements with commercial printers (such as R.R. Donnelley and Quebecor) to print the books. Books were distributed to bookstores through wholesalers such as Ingram and Baker & Taylor. The major problem with this value chain was the amount of unsold books returned by booksellers. Publishers faced return rates as high as 30 percent, which added significantly to their costs. Seeing this inefficiency as an opening, Amazon changed the value chain. By going directly to publishers, Amazon was able to lower costs by cutting out wholesalers. More importantly, they placed orders with publishers after customers ordered from their website. This allowed Amazon to reduce drastically the returns to publishers (from 30% to 3%) and use this to bargain for better prices from them. Amazon backward integrated by bypassing the wholesaler and going directly to the publisher. (Laseter,Houston,WrightandPark.Amazonyourindustry:ExtractingValuefromtheValue Chain,Strategy+ Business, First Quarter 2000)

BirdsEyeandtheFrozenFoodsIndustry Transaction-specific Investment Birds Eye, the U.S. frozen foods maker, wanted to expand to the U.K. in the 1950s, attracted by the large market and the absence of a frozen food industry. One of the first products they sought to introduce in the U.K. was frozen vegetables. They contracted with farmers to grow vegetables for them. Their U.S. experience had taught them of the need to process the vegetables within 90 minutes of harvest. Processing vegetables after 90 minutes typically resulted in the product lacking freshness. Because the farmlands were on the outskirts of London, there were no processing plants in existence within the 90 minutes radius. Birds Eye contacted a number of processors and asked them to invest in a facility near the farmlands. Birds Eye could not find a single taker. Why would this happen? Investing near the farmlands is a transaction-specific investment. Its value would be great only in the context of serving Birds Eye and nobody else. Why would a processor make such a transaction-specific investment when the possibility of opportunistic behavior by Birds Eye is great? After the investment is made, Birds Eye could take advantage of this sunk cost by paying less to the processor. Birds Eye was forced to vertically integrate into owning processing plants because of this problem. (Colis and Grant. 1992. Birds Eye and the U.K. Frozen Food Industry, Harvard Business School Case)

Seat Manufacturer Vertical Integration and Capabilities A company that manufacturers seats for auditoriums and stadiums faced a difficult problem. The company manufactured seats to order and delivered the seats to firms that specialized in installation. The company won plaudits for the quality of its seats. However, they faced numerous complaints regarding poor installation. This motivated the company to consider

the possibility of vertically integrating into the installation activity. When they analyzed the situation, they realized that none of the capabilities that were valuable in the manufacturing business (design, quality, etc.) created a competitive advantage in the installation business. Indeed, they had to develop new capabilities (managing a temporary, unskilled work force to generate efficiency, for example) to succeed in the installation business. The company decided against vertical integration!

Wal-Mart Suppliers Capabilities and Transaction-specific Investment In its 2004 Annual Report, Hershey Foods indicated that Wal-Mart accounted for 22 percent of total sales in the year 2003. Wal-Mart was responsible for 16 percent of Procter and Gambles2004revenues.Itisverylikelythatsimilarpercentagescanbefound for many of Wal-Martsleadingsuppliers.Wal-Mart clearly has tremendous bargaining power over these companies. Many of these companies have well-staffed offices in Bentonville, Arkansas, where Wal-Martscorporateheadquartersislocated.Theseare transaction-specific investments made by these companies to serve one customer, Wal-Mart. The opportunism minimization logic would indicate that these firms should forward integrate into retailing to reduce the possibility of losses due to Wal-Martsopportunistic behavior. But, do these firms have the resources to obtain a competitive advantage in retailing? Not likely. So, forward integration into retailing does not make sense from a capabilities viewpoint.

Corporate Diversification
Beatrice Companies Diversification Failure Since its founding as a regional dairy company in 1891, Beatrice Companies grew to be a $12.5 billion diversified producer of a variety of products ranging from grocery products to chemicals by 1985. A succession of CEOs had propelled the company through a series of acquisitionstodiversifythecompanysactivities.Asadiversifiedcompany,previousleaders ran Beatrice as a decentralized operation and made no attempt to coordinate activities among the businesses. When James Dutt became CEO in 1979, he decided on an aggressive strategy of corporate marketing and attempted to create synergy among the business units. This proved to be an extremely difficult task and the company ran into financial problems. A leveraged buy out firm, Kohlberg Kravis Roberts (KKR) acquired Beatrice and sold it piece by piece. Diversification proved not to be a value creating strategy for Beatrice largely because the management was never able to exploit potential synergies between divisions. This example helps to illustrate the importance of implementation issues in the context of diversification strategies. (Colis and Stuart, Beatrice Companies 1985, Harvard Business School Case)

Delta Airlines Example Limited Corporate Diversification) Single Business Delta Airlines is an example of a single-business firm. Its 2008 annual report states that in each of the last four fiscal years, passenger revenues accounted for 92 percent of total revenues, while cargo revenues provided the rest (Delta Airlines Annual Report, 2008).

Bic, Newell, Disney Examples Related Corporate Diversification Bic, the French Company, produces products such as disposable razors, cigarette lighters, and pens. The company pursues a related-constrained diversification strategy because all their products share significant commonalities in the areas of plastic injection molding, retail distribution, and brand name. Newell Rubbermaid is a good example of a related-linked firm. After Newell Company acquired Rubbermaid, the company is organized into five segments: cleaning and organization; home and family; home fashions; office products; and, tools and hardware. All five segments share common distribution channels supermarkets (such as Wal-Mart) and office supply stores (Staples, Office Depot, etc.). The products are sold under various brand names (Sharpie, Levolor) and do not typically share common technology or inputs across segments. Disney was a related-constrained firm till about the early 1990s. The company had evolved from a single-business to a dominant-business to a diversified firm under the leadership of Michael Eisner and his predecessors. When Disney started making movies for mature audiences and acquired ABC television, it moved into a more related-linked mode.

Gulf+Western, ITT Examples Unrelated Corporate Diversification When Charles Bluhdorn was CEO of a company called Gulf+Western in the 1950s, he diversified into a host of industries: motion pictures (Paramount Pictures, the makers of The Godfather, Chinatown, and other movies), clothing, cigars, zinc mines, auto parts, and sugar, among others! ITT owned 250 or more unrelated businesses!

Procter & Gamble Example Imitability of Diversification If Procter and Gamble acquired Gillette to exploit economies of scope based upon shared sales force, for example, Colgate-Palmolive can do the same.

Strategic Alliances
Disney/McDonald Nonequity Alliance Disney has the capability to produce movies with compelling characters that children can identify with while McDonalds provides grassroots marketing. The Disney-McDonalds alliance is an example of a nonequity alliance. Neither McDonalds nor Disney invested in the equity of the other rather the two agreed to work with each other

for a certain period of time. Such agreements could involving licensing (where one firm allows the use of its design or brand name to another), supply agreements (agreeing to supply inputs), or distribution agreements (agreeing to sellanothercompanysgoods).

Disney/Pixar Equity Alliance When agreements to work with one another are supplemented with equity investments, equity alliances are formed. The Disney-Pixar alliance is an example. Back in 1986, Disney took a small equity position in Pixar as part of the terms of the strategic alliance. The alliance waspriortoDisneysacquisitionofPixarin2006.

Johnson&Johnson/Merck Joint Venture A special form of equity alliance is a joint venture. Here, the cooperating companies (the parents)createalegallyindependentfirminwhichtheyinvestandfromwhichtheyshare any profits created. For example, the two pharmaceutical companies, Johnson and Johnson and Merck created a joint venture (called Johnson and Johnson Merck Consumer Pharmaceuticals) to market over-the-counter pharmaceuticals such as Mylanta.

General Motors/Toyota Strategic Alliances and Economies of Scale Alliances may help improve operations because of learning opportunities. When firms work together, they can observe each other and transfer skills across firms. Such interactions help in learning. As the example of the NUMMI alliance between General Motors and Toyota points out, both firms wanted to learn from each other. General Motors wanted to learn lean production techniques. Toyota, on the other hand, wanted to learn to operate manufacturing plants in the U.S., particularly to adapt their famed production technology to U.S. workers.

Dreamworks Strategic Alliances and Economies of Scale Dreamworks SKG is the movie company formed by the trio of Stephen Spielberg, Jeffrey Katzenberg and David Geffen. From early on, the company decided to protect itself from the risk of a big budget movie failing at the box office. Established movie companies typically had a number of movies in various stages of production. Failure of one movie could be offset by succeeding releases. Also, old movies could be reissued in DVDs to provide a steady revenue stream. SinceDreamworksdidnothavealibraryofoldmoviesnora stream of movies under production, every big budget movie was a make or break event for the young company. The company decided to partner with other studios for such movies. By partnering, Dreamworks was able to reduce its exposure to the ups and downs of the movie business. Movies produced by Dreamworks under such alliances include The Gladiator, War of the Worlds, and Munich. Interestingly, this phenomenon is not limited to Dreamworks. The box office smash Titanic that cost more than $200 million was coproduced by 20th Century Fox and Paramount. (Variety, various issues).

Blue-ray Disc Strategic Alliance and Improvement of Competitive Environment Recently, there was a standards war for the next generation storage medium for video and data. One format was HD-DVD, led by Toshiba and NEC Corporation. The competing format was Blu-ray disc, led by a strategic alliance consisting of Sony, Sharp, Apple, TDK and a host of others. As compared to the HD-DVD format, Blu-ray has more information capacity but a higher initial cost. To avoid the example of Betamax, Sony, the leader of the Blu-ray format, formed the Blu-ray Disc Association (BDA). BDA was a strategic alliance of hardware producers such as Sony and Sharp, computer companies such as Apple and Dell, and content providers such as Disney and 20th Century Fox. The race between the two competing formats was to sign up as many content providers as they could to get the critical mass necessary to become the dominant standard. Paramount, Universal, and Warner had signed non-exclusive agreements to support HD-DVD, while Disney and Columbia supported the Blu-ray format. Each format was trying to woo content providers who were either undecided or had signed non-exclusive contracts with the other format. The Blu-Ray format won the standards war.

Smart Money Strategic Alliance and Risk Reduction of Market Entry When Dow Jones & Company (the publisher of The Wall Street Journal) wanted to enter the magazine market, it realized that its skills in producing a daily newspaper were not adequate to succeed in the monthly magazine market. It formed an alliance with the Hearst company (a successful publisher of magazines such as Cosmopolitan, Good Housekeeping, etc.) to pool the skills of the two organizations. The alliance partners developed a personal finance magazine called Smart Money that was one of the most successful magazine launches ever.

Disney/Pixar Strategic Alliance and Managing Uncertainty Alliances help in managing uncertainty. Back in 1986, when George Lucas (of Star Wars fame) formed a small company, Pixar, to experiment making animated movies using computer technology, the future of this technology was unknown. Disney managed this uncertainty by forming an equity alliance with Pixar. For a small investment, Disney got the option to benefit from this technology if it became popular. It stood to lose its small investmentifthetechnologydidnotpanout.ThesuccessofPixarsmovies from Toy Story toTheIncrediblesmadeDisneysdecisionaprofitableone.

OPEC Incentives to Cheat One of the key challenges to a successful strategic alliance strategy is that partners often face strong incentives to misappropriate the value created within an alliance. These challenges arise primarily because of the difficulties of monitoring the actions of other partners. Partners may take advantage of other partners at several points in an alliance relationship: in contributions to the alliance, in performance within the alliance, and in allocating the value created in the alliance. OPEC is an alliance of oil producing nations. Partners in this alliance have a history of cheating on one another. OPEC meets and decides to limit output by a certain number of

barrels of production. OPEC members understand that if they limit output prices will rise and benefit all the members simultaneously. However, as prices rise each member has a strong incentive to cheat by increasing output and selling more oil at the higher prices. There is no mechanism in OPEC to closely monitor the sales of any one country in a timely way. The cheating on quotas becomes apparent in time, but the individual cheaters are usually able to profit for a while. This is a common problem in alliances. Collective action taken to improve the market for all members may be exploited (misappropriated) by individual members who take the opposite action.

Johnson&Johnson/Merck Rarity Johnson & Johnson is arguably the leader in marketing health care products directly to the end user, while Merck has an enviable track record in developing new drugs. This combination is rare in that it combines the skills of two industry leaders.

Imitability alliances can be imitated by direct duplication. If Firm A in an industry can form a marketing alliance, its competitor, Firm B can form a similar alliance. The test, though, is in combining thepartnersresourcesinsuchawaythatvaluecreationismaximized.Successfulalliances are typically characterized by complex social relationships between the partners. There is usually a great amount of trust and information exchange among the partners. This may be difficult to imitate by others. Some firms may have tremendous expertise in forming and managing alliances and may benefit from the learning curve. This may be difficult for others to imitate.

Mergers & Acquisitions

Procter&Gamble/Gillette Merger In contrast, a merger occurs when the assets of two similar-sized firms are combined. In addition, mergers are not typically unfriendly. James Kilts, the CEO of Gillette invited A.G. Lafley, the CEO of Procter and Gamble to merge the two companies. The merged firms may retain the name of one firm (the Gillette business was absorbed by Procter and Gamble and Gillette ceased to exist as an independent entity) or may create a new name (the merger of Newell and Rubbermaid resulted in a new firm called NewellRubbermaid). While a merger may start out as a transaction between equals, it may happen that in the course of time, one firm dominates the other. Thus, the management team at Newell controls the affairs of NewellRubbermaid. A.G. Lafley continues to be the CEO of Procter and Gamble that now includes Gillette. The point is that a merger may end up looking like an acquisition in terms of which firm has control.

Berkshire Hathaway Unrelated M&A and Value Although unrelated M&A activity will usually not create value, there are some examples in which value appears to have been created. Berkshire Hathaway is one such example. Unrelated companies are purchased and then managed with a strict philosophy and ample financial controls. This appears to be a matter of spreading a core competency (Berkshire Hathawaysmanagementstyle)acrossdifferentbusinesses.Therefore,inasensetherecan be economies of scope even in unrelated M&A activity.

Time Warner/AOL Vertical Merger A vertical merger involves a vertical integration move by the bidding company, either backwards in the industry value chain (e.g., a manufacturer buying a supplier) or forwards (e.g., a manufacturer buying a distributor). When Time Warner (a content creator) merged with AOL (a content distributor), it was a vertical (forward) merger.

J&J/Guidant Horizontal Merger When a firm acquires a former competitor, it engages in a horizontal merger. Johnson & JohnsonsacquisitionofGuidantisanexampleofahorizontalmergersince both firms producemedicaldevices.HorizontalmergerscomeunderFTCsscrutinybecausesuch mergers have immense competitive implications. The possibility of antitrust concerns (in other words, the possibility of the acquisition having an adverse impact on customers) may mean that either the acquisition will be disallowed by the FTC, or, as in the J&J-Guidant deal, theFTCmayinsistonJ&JdivestingsomeofGuidantsactivitiesaftertheacquisition.

Extension Mergers In a product extension merger, firms acquire complementary products through the M&A activity.AnexamplewouldbeUnileversacquisitionofBen&JerrysIceCreams. The motivation to access new geographic markets drives firms toward market extension mergers. Cadbury-Schweppes acquisition of 7UP allowed the U.K.-based company to enter the U.S. beverage market.

Wells Fargo Expected vs. Oprational Value In 1999, Zions Bank, a regional bank headquartered in Utah, announced its proposed acquisition of First Security Bank of Utah for $5.9 billion. After several months, shareholders ofZionsdecidedthattheacquisitionwasgrosslyovervaluedandtheypressuredZions management to terminate the acquisition. Wells Fargo, based in California, quickly stepped in and announced that it would acquire First Security for just over $3 billion (April, 2000). Wells Fargo proposed to buy First Security using Wells Fargo stock. The valuation was set at $43.69 for Wells Fargo stock and $15.50 for each share of First Security stock. Wells

Fargo agreed to trade 0.355 shares of Wells Fargo stock for each share of First Security stock. As predicted by M&A value creation research, when the deal was announced, Wells Fargo stockdroppedonthefirstday$0.25to$39.50.FirstSecuritysshares rose $1.19 to $13.38. (These numbers do not correspond to the valuation prices because stock prices were not the same as the valuation placed on the deal several weeks earlier). Ineffectthemarketwassaying,WethinkthisisagooddealforFirstSecurity shareholders butnotforWellsFargoshareholders.Infact,themarketwaspredictingthatWellsFargo would actually see a decrease in value over time because of this deal. The movement in stockpricesreflectedthemarketsexpectation. The dealwascompletedbyOctoberof2000.AlookatWellsFargosstockpricesand market capitalization tells a very different story. At the end of 1999, before the deal was announced, the stock price stood at $40.44 and the market capitalization was at $65.7 billion. A year later, after the acquisition, the stock price stood at $56.69 and the market capitalization was at $95.2 billion. To be fair, the stock market was rising rapidly during that time. But, in just a few months the market had rewarded Wells Fargo handsomely for the acquisition. The stock price had risen by more than the per share acquisition price of $15.50 and the market cap had risen by much more than the $3+ billion total price of the acquisition. Over the next four years Wells Fargo continued to acquire other financial concerns. None was as large as the First Security deal, but Wells Fargo was clearly following a corporate level strategy of acquisition. The internet bubble burst in 2001 and stock prices fell. But over time, an M&A strategy has seemed to work well for Wells Fargo. Stock prices and market capitalization changed from year to year as follows:

Year Stock 2001 2002 2003 2004

Year-end Price $43.60 $46.87 $58.89 $62.15

Market Capitalization $74.0 billion $82.0 billion $100.0 billion $105.0 billion

These numbers indicate that Wells Fargo is good at M&A activity. The company appears to be able to buy other banks and financial concerns and create operational value. Another interesting aspect of this example is that First Security was probably worth more to Wells Fargo than it was to Zions Bank. If Zions Bank had purchased First Security bank regulators would have forced Zions to close many branches in cities and small towns throughout Utah and neighboring states where First Security and Zions were both doing business. Wells Fargo did not face the same constraint because it was not currently doing business in most of those same cities and small towns. Thus, it would seem that the stock market may not always be accurate in its assessment of M&A activity.