MGMT 4800 Final

Question 1

What is the Strategic Management Process?

Answer 1

A sequential set of analyses and choices that can increase the likelihood that a firm will choose a good strategy (a strategy that generates a competitive advantage).

Question 2

What is the first-mover advantage (VRIO)?

Answer 2

the first firm that is able to exploit a particular resource). → Over time, any competitive advantage that the first mover obtained would be competed away as other firms imitate the resources needed to compete. → Strengths and distinctive competence

Question 3

What are the two critical assumptions of RBV?

Answer 3

(1) The Assumption of Firm Resource Heterogeneity:
Different firms may possess
different bundles of resources and
capabilities, even if they are
competing in the same industry. →
For a given business activity, some
firms may be more skilled in
accomplishing this activity than
other firms

(2) The Assumption of Resource Immobility:
Some of these resource and
capability differences among firms
may be long lasting because it may
be very costly for firms without
certain resources and capabilities
to develop or acquire them. →
Some companies (e.g. Toyota,
Apple) continue to enjoy
advantages over their competition
despite competitors have made
progress in addressing their
disadvantages.

Question 4

What is Forward Vertical Integration?

Answer 4

Suppliers cease to be supplier only and become both suppliers and rivals

when a firm incorporates more stages of the value chain within its boundaries and those stages bring it closer to the end of the value chain (i.e. closer to interacting directly with final customers)

Question 5

What is cost leadership?

Answer 5

A firm that chooses a cost leadership strategy focuses on gaining advantages by reducing its costs below those of all its competitors

Focuses on reliability and low prices

Examples: Walmart, Casio, BIC, Fiat

Question 6

What is Backward Vertical Integration?

Answer 6

buyers become both buyers and rivals, locking in a certain percentage of an industry’s sales

when a firm incorporates more stages of the value chain within its boundaries and those stages bring it closer to the beginning of the value chain (i.e. closer to gaining access to raw materials)

Question 7

What is a strategy?

Answer 7

theory about how to gain “competitive advantages”. → A good strategy is a strategy that actually generates such advantages.

Question 8

What components of a firm’s organization are relevant to the question of organization (VRIO)?

Answer 8

(1) Formal Reporting Structure – A description of whom in the organization reports to whom (often embodied in a firm’s organizational chart).

(2) Management Control Systems – A range of formal and informal mechanisms to ensure that managers are behaving in ways consistent with a firm’s strategies (e.g. Formal Management Controls and Informal Management Controls)

(3) Compensation Policies – The ways that firms pay employees, creating
incentives for employees to behave in certain ways

Question 9

What are the types of internal resources?

Answer 9

Tangible and Intangible

Question 10

What are the two business level strategies?

Answer 10

(1) Cost Leadership
(2) Product Differentiation

Question 11

What are the sources of cost advantages?

Answer 11

(1) Economies of scale exist when the increase in firm size (measured in terms of volume of production) is associated with lower costs

(2)With higher production volume, firms can:

(1) use specialized machines;
(2) build larger plants;
(3) increase employee 
 specialization; and 
(4) spread “overhead costs” (non- 
  labor expenses required to 
  operate a business from rent to 
  marketing costs) across more 
  units produced.

which can lower per-unit production costs.

(3) Experience Differences & Learning-Curve Economies

(4) Differential “Low-Cost” Access to Productive Inputs

(5) Technological Advantages (two types) Independent of Scale

(6) Policy Choices

Question 12

What are the six interrelated elements of the general environment?

Answer 12

(a) technological change,
(b) demographic trends,
(c) cultural trends,
(d) the economic climate,
(e) legal and political conditions, and
(f) specific international events

Question 13

What are the six components of the macro-environment

Answer 13

1.Political Factors
2.Economic Conditions
3.Sociocultural Forces
4.Technological Factors
5.Envitonmental Forces
6.Legal and Regulatory Factors

Question 14

What are the six activities of the Generic Value Chain?

Answer 14

(1) Technology Development;
(2) Product Design;
(3) Manufacturing;
(4) Marketing;
(5) Distribution; and
(6) Service

Question 15

What are the rare sources of cost advantage?

Answer 15

1. Learning-curve economies of scale
2. Differential low-cost access to productive inputs
3. Technological “software”:

Question 16

What are the imitability of sources of cost advantage?

Answer 16

1. economies of scale and diseconomies of scale are relatively easy-to-duplicate bases
2. Although cost advantages based on learning-curve economies are rare
   (especially in emerging economies), they are usually not costly to duplicate.
3. Because technological hardware can usually be purchased across supply markets, it is not likely to be difficult to duplicate
4. It is unusual, but not impossible, for policy choices, per se, to be a source of sustained competitive cost advantages for a firm

Question 17

What are the four RBV categories of a firm’s resources?

Answer 17

(1) Financial Resources
(2) Physical Resources
(3) Human Resources
(4) Organizational Resources

Question 18

What are the four barriers to entry?

Answer 18

(1) Economies of scale;
(2) Product differentiation;
(3) Cost advantages independent of scale; and
(4) Government regulation of entry.

Question 19

What are the forms of imitation (VRIO)?

Answer 19

Direct duplication – Imitating firms can attempt to directly duplicate the resources possessed by the firm with a competitive advantage. ↔ If the cost of this direct duplication is too high, then a firm with these resources and capabilities may obtain a sustained competitive advantage.

Substitution – Imitating firms can also attempt to substitute other resources for a costly-to-imitate resource possessed by a firm with a competitive advantage.

Question 20

What are the factors in Porter’s Five Forces?

Answer 20

1.New Entrants
2.Rivalry
3.Substitutes
4.Suppliers
5.Buyers

Question 21

What are the categories of the VRIO framework?

Answer 21

(1) Value,
(2) Rarity,
(3) Imitability, and
(4) Organization

Question 22

What are objectives?
What are the two types of objectives?

Answer 22

Objectives: Specific “measurable (quantifiable)” targets a firm can use to evaluate the extent to which it is realizing its mission.

High-quality objectives are tightly connected to elements of a firm’s mission and are relatively easy to measure and track over time.

Low-quality objectives either do not exist or are not connected to elements of a firm’s mission, are not quantitative, or difficult to measure or difficult to track over time.

There are two different types of objectives: Financial and Strategic objectives

Question 23

What are costly-to-imitate sources of cost advantage?

Answer 23

1. Differential access to low-cost productive inputs and technological software
2. Differential access to low-cost productive inputs often depends on the location of a firm: (1) Some locations are unique and cannot be duplicated (2) Even if a location is not unique, once its value is revealed, acquisition of that location is not likely to generate economic profits
3. The values, beliefs, culture, and teamwork that constitute technological software are socially complex and may be immune from competitive duplication.

Question 24

What are corporate-level strategies?

Answer 24

actions firms take to gain competitive advantage by operating in multiple markets or industries simultaneously

Question 25

What are business-level strategies?

Answer 25

actions firms take to gain competitive advantage in a single market or industry

Question 26

What are antitrust regulations?

Answer 26

Antitrust laws areregulations that encourage competition by limiting the market power of any particular firm.

This often involves ensuring that mergers and acquisitions don’t overly concentrate market power or form monopolies, as well as breaking up firms that have become monopolies.

Question 27

VRIO: Value

Answer 27

“Do resources and capabilities enable a firm to exploit an external opportunity or neutralize an external threat?”

If a firm answers this question with a Yes (or No), then its resources and
capabilities are valuable (they enable a firm to enhance its competitive position) and can be considered strengths (or weaknesses).

The value of a firm’s resources and capabilities will generally manifest
itself in either higher revenue or lower costs or both, once a firm starts using them to exploit opportunities or neutralize threats.

Use Value Chain Analysis to Identify Potentially Valuable Resources
and Capabilities

Because different firms may make different choices about which value
chain activities they will engage in, they can end up developing different sets of resources and capabilities

Question 28

VRIO: Rare

Answer 28

“How many competing firms already possess particular valuable resources and capabilities?” – “Is a resource currently controlled by only a small number of competing firms?”

Valuable but common (i.e. not rare) resources and capabilities are sources of competitive parity. → Under conditions of competitive parity, although no one firm gains competitive advantage, firms do increase their probability of survival.

Only when a resource is not controlled by numerous other firms, it is likely to be a source of competitive advantage

Question 29

VRIO: Organization

Answer 29

“Is a firm organized to exploit the full competitive potential of its resources
and capabilities?”

To fully realize the potential for competitive advantage, a firm must be organized to exploit its resources and capabilities.

Question 30

VRIO: Imitability

Answer 30

“Do firms without a resource or capability face a cost disadvantage in obtaining or developing it compared to firms that already possess it?”

Although firms with valuable and rare resources may gain the first-mover advantages (advantages that come to firms that make important strategic and technological decisions early in the development of an industry, p.49), they can be sources of sustained competitive advantage only if firms that do not possess them face a cost disadvantage in obtaining or developing them.

In other words, firms that possess and exploit costly-to-imitate, rare, and valuable resources in choosing and implementing their strategies may enjoy a period of sustained competitive advantage

Question 31

The imitability of product differentiation

Answer 31

Some bases of product differentiation (e.g. the use of product features) are almost always easy to duplicate.

Others (including product mix, links with other firms, product customization, product complexity, and consumer marketing) are sometimes be costly to duplicate

links between functions, timing, location, reputation, distribution channels, and service and support are usually costly to duplicate.

How costly it is to duplicate a particular basis of product differentiation depends on the kinds of resources and capabilities that basis uses.

Question 32

Rare bases for product differentiation

Answer 32

The rarity of a product differentiation strategy depends on the ability of individual firms to be “creative” in finding new ways in differentiate their products.

Question 33

Porters Five: Threats from Supplier Leverage

Answer 33

Suppliers can threaten the performance of firms in an industry by increasing the price of their supplies or by reducing the quality of those supplies.

Indicators of the threat of supplier leverage in an industry:
(1) Supplier’s industry is dominated by small number of firms
(2) Suppliers sell unique or highly differentiated products
(3) Suppliers are not threatened by substitutes
(4) Suppliers threaten Forward Vertical Integration
(5) Firms are not important customers for suppliers

Question 34

Porters Five: Threats from Substitute Products

Answer 34

Substitutes meet approximately the same customer needs, but do so in different ways

Substitutes place a ceiling on the prices firms in an industry can charge and on the profits firms in an industry can earn.

In the extreme, substitutes can ultimately replace an industry’s products and services

Question 35

Porters Five: Threats from New Competition

Answer 35

New competitors are motivated to enter into an industry by the superior profits that some incumbent firms in that industry may be earning. → Thereby increasing the level of industry competition and reducing the performance of incumbent firms.

The extent to which new competitors act as a threat to an incumbent firm’s performance depends on the “cost of entry”: If the cost of entry into an industry is greater than the potential profits a new competitor could obtain by entering, then entry will not forthcoming; If the cost of entry is lower than the return from entry, entry will occur until the profits derived from entry are less than the costs of entry.

Question 36

Porters Five: Threats from Buyers Influence

Answer 36

Buyers purchase a firm’s products or services and powerful buyers act to decrease a firm’s revenues (Powerful suppliers act to increase a firm’s costs).

Indicators of the threat of buyers’ influence in an industry:
(1) Number of buyers is small
(2) Products sold to buyers are undifferentiated and standard
(3) Products sold to buyers are a significant percentage of a buyer’s final costs
(4) Buyers threaten Backward Vertical Integration

Question 37

General Environment: Technological Change

Answer 37

has had significant impacts on the ways firms do business and on the products and services they sell (e.g. digital information, biotechnology, etc.).

Technological change creates both opportunities (as firms begin to explore how to use technology to create new products/services) and threats (as technological change forces firms to rethink their technological strategies).

Question 38

General Environment: Specific International Events

Answer 38

include civil wars, political coups, terrorism, wars between countries, famines, and country or regional economic recessions. → All of these can have an enormous impact on the ability of a firm’s strategies to generate competitive advantages.

Question 39

General Environment: Legal and Political Conditions

Answer 39

refer to the laws and legal system’s impact on business, together with the general nature of the relationship between government and business.

Question 40

General Environment: Economic Climate

Answer 40

The economic climate is the overall health of the economic systems within which a firm operates.

The health of the economy varies over time in a distinct pattern.

Business cycle: prosperity followed by recession (depression - a severe recession that lasts for several years), followed by prosperity.

Although government policy can have a significant impact on the frequency and the size of economic downturns, these policies are unlikely to be able prevent these downturns altogether.

Question 41

General Environment: Demographic Trends

Answer 41

the distribution of individuals in a society in terms of age, sex, marital status, income, ethnicity, and other personal attributes that may determine buying patterns. → Help a firm determine whether its products/services will appeal to customers and how many potential customers for these products/services it might have

Question 42

General Environment: Cultural Trends

Answer 42

Culture is the values, beliefs, and norms that guide behavior in a society, defining what is “right or wrong”, “acceptable or unacceptable”, and “fashionable or unfashionable” in a society.

Failure to understand changes in culture, or differences between cultures, can have a very large impact on the ability of a firm to gain a competitive advantage

Question 43

Define value chain

Answer 43

the set of business activities in which a firm engages to develop, produce, and market its products or services

Question 44

Define the types of competitive advantage

Answer 44

Sustained competitive advantages – Competitive advantages that last a long time.

Temporary competitive advantages – Competitive advantages that lasts for a very short period of time.

Competitive parity – When a firm creates the same economic value as its rivals.

Competitive disadvantages (Temporary or Sustained) – When a firm creates less economic value than its rivals.

Question 45

Define the two levels of strategies

Answer 45

(A) Business-level strategies: Actions firms take to gain competitive advantages in a single market or industry (e.g. Cost leadership, Product differentiation).

(B) Corporate-level strategies: Actions firms take to gain competitive advantages in multiple markets or industries simultaneously (e.g. Vertical integration, Diversification, Strategic alliance, Merger & Acquisition, Global strategies).

Question 46

Define the letters in SWOT analysis

Answer 46

Strengths
Weaknesses
Opportunities
Threats

Question 47

Define strategic choice

Answer 47

Strategic Choice: A firm is ready to choose its theory of how to gain competitive advantage

Question 48

Define product differentiation as a barrier to entry

Answer 48

Incumbent firms possess brand identification and customer loyalty that potential new competitors do not.

2. New competitors not only have to absorb the standard costs associated with overcoming starting production in a new industry; they also have to absorb the costs associated with overcoming incumbent firms’ differentiation advantages (i.e. brand identification and customer loyalty).

If the cost of overcoming these advantages is greater than the potential return from entering an industry, entry will not occur, even if incumbent firms are earning positive profits.

Question 49

Define product differentiation

Answer 49

firms attempt to gain a competitive advantage by increasing the perceived value of their products or services relative to the perceived value of other firms’ products or services. → The firm will be able to charge a higher price than it would otherwise, generating competitive advantages

Question 50

Define internal analysis

Answer 50

An internal analysis helps a firm identify its organizational strengths and weaknesses. → It also helps a firm understand which of its resources and capabilities are likely to be sources of competitive advantages (strengths). → It also helps firms identify those areas of its organization that require improvement and change (weaknesses).

Question 51

Define government policy as a barrier to entry

Answer 51

Governments may decide to increase the cost of entry into an industry and
this occurs most frequently when a firm operates as a government-
regulated monopoly.

The government conclude that it is in a better position to ensure that specific
products or services are made available to population at reasonable prices
than competitive market forces.

Question 52

Define external analysis

Answer 52

An external analysis helps a firm identifies the critical threats and opportunities in its environment. → It also examines how competition in this environment is likely to evolve and what implications that evolution has for the threats and opportunities a firm is facing.

Question 53

Define economies of scale

Answer 53

exist in an industry when a firm’s costs fall as a function of its volume of production (optimal level of production).

Diseconomies of scale exist when a firm’s costs rise as a function of its volume of production.

Potential new competitors have other options besides (1) entering at the efficient scale and losing money or (2) entering at an inefficient scale and losing money.

Question 54

Porters Five: Threats from Existing Competitors

Answer 54

Direct competition threatens firms by reducing their economic profits (e.g. frequent price cutting, frequent introduction of new products, intense advertising campaigns, rapid competitive actions and reactions

Attributes of an industry that increase the threat of direct competition:
(1) Large number of competing firms that are roughly the same size
(2) Slow industry growth:
(3) Lack of product differentiation
(4) Production capacity added in a large increments

Question 55

Define cost advantages independent of scale as a barrier to entry

Answer 55

1. When incumbent firms have Proprietary (secret or patented) Technology that reduces their costs below the costs of potential entrants
2. When incumbent firms have Managerial Know-How
3. Favorable Access to Raw Materials
4. Learning-Curve Cost Advantages

Question 56

Define competitive advantage

Answer 56

A firm has a competitive advantage when it is able to create more economic value than rival firms. → Economic value is the difference between the ‘perceived’ benefits gained by a customer that purchases a firm’s products or services and the full economic cost of these products or services.

The size of a firm’s competitive advantage is the difference between the economic value a firm is able to create and the economic value its rivals are able to create.

Question 57

Define a mission

Answer 57

A firm’s long-term purpose, defining both what a firm aspires to be in the long run and what it wants to avoid in the meantime. → A broad statement of a firm’s purpose and values.

Question 58

Bases of Product Differentiation

Answer 58

1. Focusing on the Attributes of a Firm’s Products or Services
   Product Features:
   a. The most obvious way that firms can try to differentiate their products is altering the features of the products they sell (e.g. automobile industry)
   b. Product Complexity: A special case of altering a product’s features to create product differentiation
   c. Timing of Product Introduction: Introducing a product at the right time can help create product differentiation.
   d. Location: The physical location of a firm can also be a source of product differentiation.
2. Focusing on Relationship between a Firm and its Customers
   a. Product Customization: Products can be differentiated by the extent to which they are customized for particular customer applications.
   b. Consumer Marketing: Through advertising and other consumer marketing efforts, firms attempt to alter the perceptions of current and potential customers, whether or not specific attributes of a firm’s products or services are actually altered
   c. Reputation (the most important relationship between a firm and its customers): A firm’s reputation is really no more than a socially complex relationship between a firm and its customers. → Once developed, a firm’s reputation can last a long time, even if the basis for that reputation no longer exist
3. Focusing on Links within and between Firms:
   a. Linkages between Functions: A firm can attempt to differentiate its products through linking different functions or linking different products within a single firm.
   b. Links with Other Firms: Differentiation can be based on explicit linkages between one firm’s products and the products or services of other firms
   c. Product Mix: One of the outcomes of 1 and 2 can be changes in the mix of products a firm brings to the market. → The mix of products/services can be a source of product differentiation when (1) those products/services are technologically linked or (2) a single set of customers purchases several of a firm’s products/services
   d. Distribution Channels
   e. Service and Support

Question 59

Define “level of vertical integration”

Answer 59

the number of steps in the value chain that a firm accomplishes within its boundaries

Question 60

Define opportunism

Answer 60

a firm engages in vertical integration to reduce the threat of opportunism – Opportunism exists when a firm is unfairly exploited in exchange

a party to an exchange
(1) discovers it has received a lower level of quality product than it expected;
(2) receives a service late (or early) not at a particular point in time; and (3) is demanded a higher price than what was agreed

Firms should only bring market exchanges within their boundaries when the cost of vertical integration is less than the cost of opportunism

Question 61

When should a firm vertically integrate?

Answer 61

1. When there is an imminent threat of opportunism or an instance of it
2. Firms should vertically integrate into those business activities where they possess valuable, rare, and costly-to-imitate resources and capabilities

Question 62

What are the values of vertical integration?

Answer 62

1. reduce the threat of opportunism
2. firm capabilities
3. flexibility

Question 63

Define flexibility

Answer 63

how costly it is for a firm to alter its strategic and organizational decisions (Flexibility is high when the cost of changing strategic choices is low, vise versa).

vertically integrating is less flexible than not vertically integrating.
→ Once a firm has vertically integrated, it has committed its organizational structure, its management controls, and its compensation policies to a particular vertically integrated way of doing business

Question 64

Define Corporate Diversification

Answer 64

A firm implements a corporate diversification strategy when it operates in multiple industries (product diversification strategy) simultaneously or markets (geographic market diversification strategy) simultaneously

When a firm implements both types of diversification simultaneously, it is implementing product-market diversification strategy

When firms vertically integrate backward or forward, they may also be implementing a diversification strategy

Question 65

What are the three types of corporate diversification?

Answer 65

1. Limited
2. Related
3. Unrelated

Question 66

What is Corporate Limited Diversification? What are the two types?

Answer 66

When all or most of a firm’s business activities fall within a single industry and geographic market

(a) Single-business firms (firms with greater than 95% of their total sales in a single-product market – engaging in only one business); and

(b) Dominant-business firms (firms with between 70 and 95% of their total sales in a single-product market – pursuing two businesses but the smaller business is tightly linked to the dominant business). → Donato’s Pizza (pizza vs. non-pizza
food products).

Question 67

What is related corporate diversification? What are the two types?

Answer 67

When less than 70% of a firm’s revenue comes from a single-product market and these multiple lines of business are linked.

(a) Related-Constrained:
When all the businesses in which a firm operates share a “significant” number of inputs, production technologies, distribution channels, similar customers, and so forth. ← Managers pursue business opportunities in new markets or industries only if those markets or industries share numerous resource and capability requirements with the business the firm is currently pursuing. PepsiCo’s businesses focus on providing snack-type products (food or beverage), attempting to use a single, firm-wide capability to gain competitive advantages in each of its businesses (its ability to develop and exploit well-known brand names).

(b) Related-Linked:
When the different businesses that a single firm pursues are linked on “only a couple of dimensions” (businesses with relatively few links) or when different sets of businesses are linked along very different dimensions (businesses with different kinds of links). Although much of the Disney empire still builds on characters developed in its animated motion pictures, it also owns and operates businesses that are less directly linked to these characters (including several hotels and resorts that have little or nothing to do with Disney characters and a television network [ABC] that broadcasts non-Disney-product content). But, most of Disney’s businesses are in the entertainment industry

Question 68

What is unrelated corporate diversification?

Answer 68

When less than 70% of a firm’s revenues is generated in a single-product market and when a firm’s businesses share few, if any, common attributes, then, that firm is pursuing a strategy of unrelated diversification

It is possible for firms to pursue numerous different businesses and for there to be no linkages among them.

Examples: GE and Samsung

Question 69

Define economies of scope

Answer 69

Economies of scope exists in a firm when the value of the products or services it sells increases as a function of the number of the businesses in which that firm operates

“scope” refers to the range of businesses in which a diversified firm operates. → For this reason, only diversified firms can, by definition, exploit economies of scope

are valuable to the extent that they increase a firm’s revenues or decrease its costs

Question 70

Define strategic alliance

Answer 70

when two or more independent organizations cooperate in the development, manufacture, or sale of products or services

Question 71

Why do firms use licensing?

Answer 71

when a firm wishes to participate in foreign market but is prohibited from doing so (such as wholly owned subsidiary) by barriers to investment.

Question 72

What are the types of strategic alliances?

Answer 72

1. Non-equity alliance
   Cooperating firms agree to work together to develop, manufacture, or sell products or services, but they do not take equity positions in each other or form an independent organizational unit to manage their cooperative efforts
2. Equity alliance
   Cooperating firms supplement contracts with equity holdings in alliance partners.
3. Joint Venture
   Cooperating firms create a legally independent firm in which they invest and from which they share any profits that are created

Question 73

What are the benefits of strategic alliances?

Answer 73

1. Improving Current Operations:
   a. Firms can use strategic alliances to improve their current operations, realizing economies of scale. → When a firm cannot realize economies of scale all by itself, it may join a strategic alliance with other firms (Jointly, these firms may have volume to be able to gain the cost advantages of economies of scale).
   b. Firms can also use alliances to improve their current operations by learning from their competitors. → Firms that are at a competitive disadvantage in an industry may want to form alliances with the firms that have an advantage in order to learn about their resources and capabilities
   c. Firms can use alliances to improve their current operations through sharing costs and risks.

2.Creating a Favorable Competitive Environment:
a. First, firms can use alliances to help set technology standards in an industry, particularly in network industries.
b. Second, strategic alliances may facilitate the development of tacit collusion, that is, firms coordinate their production and pricing decisions “not” by directly communicating with each other (explicit collusion is illegal in most countries), but by exchanging signals with other firms about their intent to cooperate.

3. Facilitating Entry & Exit:
   a. when the value of market entry or exit is uncertain.
   b. can help a firm enter a new industry by avoiding the high costs of creating skills, abilities, and products required
   c. to withdraw from industries
   or industry segments in a low-cost way. → By forming an alliance with a firm that may want to purchase tangible and intangible assets
   d. Firms may use strategic alliances to manage uncertainty

Question 74

What are the benefits of joint ventures?

Answer 74

1. under conditions of uncertainty, to retain the ability to move quickly into a market or industry if valuable opportunities present themselves. ← By investing in a joint venture, a firm may gain access to the information it needs to evaluate full-scale entry into a market

2.enables partners in the alliance to gain all the benefits associated with
cooperation while minimizing the probability that cooperating firms will cheat on their cooperative agreements

Question 75

What are Acquisitions?

Answer 75

A firm engages in an acquisition when it purchases a second firm:
(a) An acquiring firm can purchase all of a target firm’s assets;

(b) a majority of those assets (greater than 51%); or

(c) a controlling share of those assets (enough assets so that the acquiring firm is able to make all the management and strategic decisions in the target firm)

Friendly acquisitions occur when the management of the target firm wants
the firm to be acquired. ↔ Unfriendly acquisitions (Some unfriendly acquisitions are also known as hostile takeovers)

Question 76

What are mergers?

Answer 76

When the assets of two similar-sized firms are combined (in many of the same ways as acquisitions, using cash or stock to purchase a percentage of another firm’s assets).

Mergers will not be unfriendly because both firms purchase some percentage of another firm’s assets

Although mergers typically begins as a transaction between equals (equal
size and profitability), they often evolve after a merger such that one firm becomes more dominant in the management of the merged firm than the other

Question 77

Why are there so many mergers and acquisitions?

Answer 77

most of the economic value created in mergers and acquisitions is appropriated by the owners of the target firms (On average, mergers and acquisitions generate only zero economic profits for bidding firms)

1. To Ensure Survival:
   Here, the purpose of a merger or acquisition is not to gain competitive advantages, but rather to gain competitive parity.
2. To survive in the consolidated industry
3. Free Cash Flow
   Merger and acquisition strategies, on average, are expected to generate at least competitive parity for bidding firms and this zero economic profit may be a more attractive investment for firms that generate free cash flow
4. Agency Problems
   Mergers and acquisitions benefit managers directly by helping diversify their human capital investments; managers can use mergers and acquisitions to quickly increase firm size, measured in either sales or assets. → If management compensation is closely linked to firm size, managers who increase firm size are able to increase
   their compensation
5. Managerial Hubris
   unrealistic beliefs held by managers in bidding firms that they can manage the assets of a target firm more efficiently than the target firm’s management. → The existence of managerial hubris suggests that the economic value of bidding firms will fall once they announce a merger or acquisition strategy
6. The Potential for Economic Profits
   The fact that bidding firms, on average, do not earn profits on merger and acquisition strategies, does not mean that all bidding firms will always fail to earn profits. → In some situations, bidding firms may be able to gain competitive advantages from merger and acquisition activities

Question 78

What is free cash flow?

Answer 78

the amount of cash a firm has to invest after all positive net
present-value investments in its ongoing businesses have been funded (when a firm’s ongoing business operations are very profitable but offer few opportunities or additional investments)