4.9. Choice of growth mode

Question 1

2 fundamental question existing firms need to ask themselves?

Answer 1

• Do we want to enter the market?
• If “yes”, how should we enter that market?
– Grow and learn how to make it
– Buy a company that already does it
– Form a partnership and together learn how to make it

Question 2

Tests before entering a new market

Answer 2

• Attractiveness test
• Cost of entry test - investment required
• The better off test
• Best alternative test - consider organic growth, acquisition and alliance as substitutes

Question 3

External solution/growth

Answer 3

Ownership:
1. Acquisition
2. Mergers of equals
3. Minority investment
Partnership:
1. joint venture
2. alliance

Question 4

Define acquisition

Answer 4

one company buys the majority (more than 50%) of another companies ownership stakes (shares)
- blockholder has control

Question 5

Define minority investment

Answer 5

acquiring company buys less than 50% of another company

- little control, not a blockholder

Question 6

Define mergers of equals

Answer 6

shareholders of both firms surrender their shares and get issued new shares

Question 7

Define partial ownership (special case)

Answer 7

• Two companies, A and B, see an advantage in establishing corporate ties
• Company A buys 10% equity shares of company B, and company B buys 7% of company (usually just enough to get board representation)
• If this happens among many firms, then we have a business group
e.g. slides, allianz, deutsche bank, dresdner bank,…
sort of collusion, monopoly

Question 8

Define joint venture

Answer 8

agreement between two firms (usually for a limited time); both contribute equity, both share costs and revenues
– also known as “equity alliance”
third independent entity
usually to develop technology

Question 9

Define alliance

Answer 9

agreement to work together on a specific project (no equity involved)
usually to share knowledge/resources

Question 10

Define collusion

Answer 10

attempts by two or more firms to
reduce competition in an industry and set prices
(above competitive levels)
technically illegal

Question 11

Why grow organically?

Answer 11

• Costs structure (e.g.scale)
• Complete control
• Employee motivation
• Minimize (certain) risks that occur with ’external’ choices
– Over-payment risk (acquisition)
– Retention risk (acquisition)
– Coordination and cooperation risk (acquisition and alliance)
– Information spillover, loss of secrecy (alliance)

Question 12

Factors affecting decisions whether to ally or acquire?

Answer 12

1. Types of synergies - how interrelated are the tasks you are working on?
2. Nature of resources - soft and hard resources, are you in a labour intensive industry?
3. Extent of redundant resources - how similar are your skills?
4. Degree of market uncertainty
5. Level of competition

Question 13

Types of synergies

Answer 13

1. Modular: manage resources independently and pool only the results for greater profits
2. Sequential: one company completes its tasks and passes on the results to a partner to do its bit, customise resources to some extent
3. Reciprocal: executing tasks through iterative knowledge sharing process, combine and customise resources

Question 14

Acquire when…

Answer 14

1. Synergies are reciprocal, rather than modular and sequential
2. Key resources are “hard” assets rather than people
3. Large redundancies among two firms’ assets
4. Relatively low product/market uncertainty
5. Several potential rival acquirers

Question 15

Additional reasons to consider alliance over acquisition

Answer 15

• feasibility: partner if you cannot acquire
• valuation uncertainty: partner if price tag of target is high
• scope: partner if narrowly defined what you want to achieve
• time horizon: partner if short term
• post-deal risks: partner if high integration risks - given companies’ competencies and culture

Question 16

Impact of acquisitions on shareholder’s value

Answer 16

• Acquisition by a competitor: positive
• Acquisition of a competitor: negative
  => overpayment

Question 17

Define franchise

Answer 17

Agreement where one party (the franchiser) grants another party (the franchisee) the right to use its trademark, business systems and processes, to produce a good or service according to certain specifications.

Question 18

Benefits of franchise

Answer 18

Benefits for franchiser:
– Franchise fees/ royalties allow to grow the brand, improve quality and support corporate HQ
– No need to take out debt
Benefits for franchisee:
– Higher success chances than starting a new business
– Cost advantage(bargaining power as a group)
– A network of peers to learn best practices(manual for training, space layout, equipment use)

Question 19

Partner through a joint venture when…

Answer 19

1. Synergies are “sequential” (one company
   completes one one process and hands it to
   another)
   – Biotech firm makes new drugs, pharma firm knows how to get them FDA approved
2. Key resources are “soft” assets (people)
3. Some redundancy of assets might help to
   effectively work together but this is not vital
4. High market uncertainty acceptable (we only invested a bit of $ so we can take a risk)
5. It’s acceptable if there is ‘medium’ competition (because the hope is that through the alliance we may develop our own solution so we hope not to have to rely on an acquisition)

Question 20

Partner (non-equity alliance) when…

Answer 20

1. Synergies are “modular”, i.e. can be achieved without close collaboration
   – Airlines and hotels partner to allow customers to use points from each others
   loyalty programs
2. Key resources are “hard” assets (the logic is that there is often not enough permanence and investment to make people work together effectively)
3. Low redundancy of assets (as we see next, alliances are often used to “explore” completely new areas so scale, scope are not the driver here)
4. Low competition from other acquirers

Question 21

Key notes about merge/acquisitions and partnerships, what do financial markets want?

Answer 21

Financial Markets Prefer M&A to

Exploit and Partnerships to Explore