Exam 4: Planning: Developing Business and Acquisition Plans: Phases 1 and 2 of the Acquisition Process

What are the advantages and disadvantages of using an acquisition to implement a business strategy as compared to a joint venture?

What is the core competence underlying Honda Corporation product offering?

eBay Struggles to Reinvigorate Growth Founded in September 1995, eBay views itself as the world’s online market place for the sale of goods and services to a diverse community of individuals and small businesses. Currently, eBay has sites in 24 different countries, and it offers a wide variety of tools, features, and services enabling members to buy and sell on its sites. The firm’s primary business is Markeplaces consisting of eBay, Shopping.com, and classified websites. In 2006, this business accounted for 90 percent of eBay’s sales and profits. Historically, acquisitions made by eBay have always been related to e-commerce. For example, concern about slowing growth in its core U.S. market caused eBay to acquire online payments provider, PayPal, in 2002. The firm achieved significant synergy between eBay and PayPal by facilitating payments between buyers and sellers. In late 2005, eBay announced that it had acquired Skype International SA, a firm whose software enabled PC users to make calls over the internet, for $2.6 billion. Skype had revenue of $60 million in 2005, a tiny fraction of eBay’s $4.4 billion in 2005 sales, and it was unprofitable. Skype’s existing businesses include services that give people the ability to call landline phones for about 3 cents a minute, voicemail, and providing a traditional phone number for Skype accounts. Skype is facing new competition from Google, Yahoo!, and many startups. eBay expects Skype to facilitate trade on their sites by increasing the ability of buyers and sellers to negotiate. In addition to paying eBay listing and completed-auction fees, sellers also could pay eBay a fee for getting an internet call, or lead, via Skype. eBay will also use Skype to facilitate entering new markets, such as new cars, travel, real estate, and personal and business services. Skype software gives eBay an advantage in China, Eastern Europe and Brazil, where online trust is not well-established and where haggling may be more a part of the culture. The acquisition of a telephony company represented a marked departure for eBay, which had previously acquired companies directly related to e-commerce. eBay is venturing into new territory without any overt request from or support of its buyers and sellers. Historically, buyers and sellers guided eBay into new markets through their activities, such as embracing PayPal years before eBay acquired it, or by requesting new features. In the past when eBAy has gone off on its own, such as collaborating with Christy’s for live auctions, it has been unsuccessful. Only time will tell how well this acquisition will work. -What are some of the key assumptions implicit in eBay's decision to make this acquisition?

An analysis of markets should involve current and potential customers, as well as current and potential competitors, but it should exclude suppliers.

Market profiling entails collecting sufficient data to accurately assess and characterize a firm's competitive environment within its chosen markets.

Pepsi Buys Quaker Oats in a Highly Publicized Food Fight On June 26, 2000, Phillip Morris, which owned Kraft Foods, announced its planned $15.9 billion purchase of Nabisco, ranked seventh in the United States in terms of sales at that time. By combining Nabisco with its Kraft operations, ranked number one in the United States, Phillip Morris created an industry behemoth. Not to be outdone, Unilever, the jointly owned British–Dutch giant, which ranked fourth in sales, purchased Bestfoods in a $20.3 billion deal. Midsized companies such as Campbell’s could no longer compete with the likes of Nestle, which ranked number three; Proctor & Gamble, which ranked number two; or Phillip Morris. Consequently, these midsized firms started looking for partners. Other companies were cutting back. The U.K.’s Diageo, one of Europe’s largest food and beverage companies, announced the restructuring of its Pillsbury unit by cutting 750 jobs—10% of its workforce. PepsiCo, ranked sixth in U.S. sales, spun off in 1997 its Pizza Hut, KFC, and Taco Bell restaurant holdings. Also, eighth-ranked General Mills spun off its Red Lobster, Olive Garden, and other brand-name stores in 1995. In 2001, Coca-Cola announced a reduction of 6000 in its worldwide workforce. As one of the smaller firms in the industry, Quaker Oats faced a serious problem: it was too small to acquire other firms in the industry. As a result, they were unable to realize the cost reductions through economies of scale in production and purchasing that their competitors enjoyed. Moreover, they did not have the wherewithal to introduce rapidly new products and to compete for supermarket shelf space. Consequently, their revenue and profit growth prospects appeared to be limited. Despite its modest position in the mature and slow-growing food and cereal business, Quaker Oats had a dominant position in the sports drink marketplace. As the owner of Gatorade, it controlled 85% of the U.S. market for sports drinks. However, its penetration abroad was minimal. Gatorade was the company’s cash cow. Gatorade’s sales in 1999 totaled $1.83 billion, about 40% of Quaker’s total revenue. Cash flow generated from this product line was being used to fund its food and cereal operations. Gatorade’s management recognized that it was too small to buy other food companies and therefore could not realize the benefits of consolidation. After a review of its options, Quaker’s board decided that the sale of the company would be the best way to maximize shareholder value. This alternative presented a serious challenge for management. Most of Quaker’s value was in its Gatorade product line. It quickly found that most firms wanted to buy only this product line and leave the food and cereal businesses behind. Quaker’s management reasoned that it would be in the best interests of its shareholders if it sold the total company rather than to split it into pieces. That way they could extract the greatest value and then let the buyer decide what to do with the non-Gatorade businesses. In addition, if the business remained intact, management would not have to find some way to make up for the loss of Gatorade’s substantial cash flow. Therefore, Quaker announced that it was for sale for $15 billion. Potential suitors viewed the price as very steep for a firm whose businesses, with the exception of Gatorade, had very weak competitive positions. Pepsi was the first to make a formal bid for the firm, quickly followed by Coca-Cola and Danone. By November 21, 2000, Coca-Cola and PepsiCo were battling to acquire Quaker. Their interest stemmed from the slowing sales of carbonated beverages. They could not help noticing the explosive growth in sports drinks. Not only would either benefit from the addition of this rapidly growing product, but they also could prevent the other from improving its position in the sports drink market. Both Coke and PepsiCo could boost Gatorade sales by putting the sports drink in vending machines across the country and selling it through their worldwide distribution network. PepsiCo’s $14.3 billion fixed exchange stock bid consisting of 2.3 shares of its stock for each Quaker share in early November was the first formal bid Quaker received. However, Robert Morrison, Quaker’s CEO, dismissed the offer as inadequate. Quaker wanted to wait, since it was expecting to get a higher bid from Coke. At that time, Coke seemed to be in a better financial position than PepsiCo to pay a higher purchase price. Investors were expressing concerns about rumors that Coke would pay more than $15 billion for Quaker and seemed to be relieved that PepsiCo’s offer had been rejected. Coke’s share price was falling and PepsiCo’s was rising as the drama unfolded. In the days that followed, talks between Coke and Quaker broke off, with Coke’s board unwilling to support a $15.75 billion offer price. After failing to strike deals with the world’s two largest soft drink makers, Quaker turned to Danone, the manufacturer of Evian water and Dannon yogurt. Much smaller than Coca-Cola or PepsiCo, Danone was hoping to hype growth in its healthy nutrition and beverage business. Gatorade would complement Danone’s bottled-water brands. Moreover, Quaker’s cereals would fit into Danone’s increasing focus on breakfast cereals. However, few investors believed that the diminutive firm could finance a purchase of Quaker. Danone proposed using its stock to pay for the acquisition, but the firm noted that the purchase would sharply reduce earnings per share through 2003. Danone backed out of the talks only 24 hours after expressing interest, when its stock got pummeled on the news. Nearly 1 month after breaking off talks to acquire Quaker Oats because of disagreements over price, PepsiCo once again approached Quaker’s management. Its second proposal was the same as its first. PepsiCo was now in a much stronger position this time, especially because Quaker had run out of suitors. Under the terms of the agreement, Quaker Oats would be liable for a $420 million breakup fee if the deal was terminated, either because its shareholders didn’t approve the deal or the company entered into a definitive merger agreement with an alternative bidder. Quaker also granted PepsiCo an option to purchase 19.9% of Quaker’s stock, exercisable only if Quaker is sold to another bidder. Such a tactic sometimes is used in conjunction with a breakup fee to discourage other suitors from making a bid for the target firm. With the purchase of Quaker Oats, PepsiCo became the leader of the sports drink market by gaining the market’s dominant share. With more than four-fifths of the market, PepsiCo dwarfs Coke’s 11% market penetration. This leadership position is widely viewed as giving PepsiCo, whose share of the U.S. carbonated soft drink market is 31.4% as compared with Coke’s 44.1%, a psychological boost in its quest to accumulate a portfolio of leading brands. -What factors drove consolidation within the food manufacturing industry? Name other industries that are currently undergoing consolidation?

The experience curve is most important in analyzing industries with low fixed costs.

All of the following questions are relevant for conducting a self-assessment or internal analysis of the firm except for

Planning in advance of a merger or an acquisition necessarily slows down decision making.

A cost leadership strategy can be highly destructive to the firm with the largest market share if pursued concurrently by a number of firms with very different market shares.

Market segmentation involves identifying customers with common characteristics and needs.

HP Implements a Transformational Strategy, Again and Again Failure to develop and implement a coherent business strategy often results in firms reacting to rather than anticipating changes in the marketplace. Firms reacting to changing events often adopt strategies that imitate their competitors. These “me too” strategies rarely provide any sustainable competitive advantage. _______________________________________________________________________________________________________ Transformational, when applied to a firm’s business strategy, is a term often overused. Nevertheless, Hewlett-Packard (HP), with its share price at a six-year low and substantially underperforming such peers as Apple, IBM, and Dell, announced what was billed as a major strategic redirection for the firm on August 18, 2011. The firm was looking for a way to jumpstart its stock. Since Leo Apotheker took over as CEO in November 2010, HP had lost 44% of its market value through August 2011. A transformational announcement appeared to be in order. HP, the world’s largest technology company by revenue, announced that, after an extensive review of its business portfolio, it had reached an agreement to buy British software maker Autonomy for $11.7 billion. The firm also put a for-sale sign on its personal computer business, with options ranging from divestiture to a spinoff to simply retaining the business. HP said the future of the PC unit, which accounted for more than $40 billion in annual revenue and about $2 billion in operating profit, would be decided over the next 12 months. Apotheker had put this business in jeopardy after he had announced that the WebOS-based TouchPad tablet would be discontinued due to poor sales. The announcement was transformational in that it would move the company away from the consumer electronics market. Under the terms of the deal, HP will pay 25.50 British pounds, or $42.11, in cash for Autonomy. The price represented a 64% premium. With annual revenue of about $1 billion (only 1% of HP’s 2010 revenue), the purchase price represents a multiple of more than 10 times Autonomy’s annual revenues. HP’s then-CEO, Leo Apotheker, indicated that the acquisition would help change HP into a business software giant, along the lines of IBM or Oracle, shedding more of the company’s ties to lower-margin consumer products. Autonomy, which makes software that searches and keeps track of corporate and government data, would expedite this change. HP said that the acquisition of Autonomy will complement its existing enterprise offerings and give it valuable intellectual property. Investors greeted the announcement by trashing HP stock, driving the share price down 20% in a single day, wiping out $16 billion in market value. While some investors may be sympathetic to moving away from the commodity-like PC business, others were deeply dismayed by the potentially “value-destroying” acquisition of Autonomy, the clumsy handling of the announcement of the wide range of options for the PC business, and HP’s disappointing earnings performance. By creating uncertainty among potential customers about the long-term outlook for the business, HP may have succeeded in scaring off potential customers. With this announcement, HP once again appeared to be lagging well behind its major competitors in implementing a coherent business strategy. It agreed to buy Compaq in 2001 in what turned out to be widely viewed as a failed performance. In contrast, IBM transformed itself by selling its PC business to China’s Lenovo in late 2004 and establishing its dominance in the enterprise IT business. HP appears to be trying to replicate IBM’s strategy. Heralded at the time as transformational, the 1997 $25 billion Compaq deal turned out to be hotly contested, marred by stiff opposition from shareholders and a bitter proxy contest led by the son of an HP cofounder. While the deal was eventually passed by shareholder vote, it is still considered controversial, because it increased the firm’s presence in the PC industry at a time when the growth rate was slowing and margins were declining, reflecting declining selling prices. HP planned to move into the lucrative cellphone and tablet computer markets with the its 2010 purchase of Palm, in which it outbid three other companies to acquire the firm for $1.2 billion, ultimately paying a 23% premium. However, sales of webOS phones and the TouchPad have been disappointing, and the firm decided to discontinue making devices based on webOS, a smartphone operating system it had acquired when it bought Palm in late 2010. In contrast to the mixed results of the Compaq and Palm acquisitions, HP’s purchase of Electronic Data Systems (EDS) for $13.9 billion in 2008 substantially boosted the firm’s software services business. IBM’s successful exit from the PC business early in 2004 and its ability to derive the bulk of its revenue from the more lucrative services business has been widely acclaimed by investors. Prospects seemed good for this HP acquisition. However, in an admission of the firm’s failure to realize EDS’s potential, HP in mid-2012 wrote off $8 billion of what it had paid for EDS. HP has purchased 102 companies since 1989, but with the exceptions of its Compaq and its $1.3 billion purchase of VeriFone, it has not paid more than $500 million in any single deal. These deals were all completed under different management teams. Carly Fiorina was responsible for the Compaq deal, while Mark Hurd pushed for the acquisitions of EDS, Palm, and 3Par. Highly respected for his operational performance, Hurd was terminated in early 2010 on sexual harassment charges. Under pressure from investors to jettison its current CEO, HP announced on September 22, 2011, that former eBay CEO, Meg Whitman, would replace Leo Apotheker as Chief Executive Officer. In yet another strategic flip-flop, HP announced on October 27, 2011, that it would retain the PC business. The firm’s internal analysis indicated that separating the PC business would have cost $1.5 billion in one-time expenses and another $1 billion in increased expenses annually. Citing the deep integration of the PC group in HP’s supply chain and procurement efforts, Whitman proclaimed the firm to be stronger with the PC business. In mid-December 2011, HP announced that it would also reverse its earlier decision to discontinue supporting webOS and stated that it would make webOS available for free under an open-source license for anyone to use. The firm will continue to make enhancements to the webOS system and to build devices dependent on it. By moving to an open-source environment, HP hopes others will adopt the operating system, make improvements, and develop mobile devices using webOS to establish an installed user base. HP could then make additional webOS devices and applications that could be sold to this user base. This strategy is similar to Google’s when it made its Android mobile software available for cellphones under an open-source license. HP’s share price plunged 11% on November 25, 2012, to $11.73 following its announcement that it had uncovered “accounting irregularities” associated with its earlier acquisition of Autonomy. The revelation required the firm to write down its investment in Autonomy by $8.8 billion, about three-fourths of the purchase price. The charge contributed to a quarterly loss of $6.9 billion for HP. Confidence in both the firm’s management and board plummeted, further tarnishing the once-vaunted HP brand. -Discuss the impact of HP's strategic reversals over the last decade on its various constituencies such as customers, employees, stockholders, and suppliers. Be specific.

A collection of markets is said to comprise an industry.

Which of the following phases of the acquisition process contains a "feedback" loop?

In your judgment, which of the acquisition plan management preferences discussed in this chapter is the most important and why?

Which of the following are components of an acquisition plan?

Which of the following are components of a business strategy?

Consolidation in the Global Pharmaceutical Industry: The Glaxo Wellcome and SmithKline Beecham Example By the mid-1980s, demands from both business and government were forcing pharmaceutical companies to change the way they did business. Increased government intervention, lower selling prices, increased competition from generic drugs, and growing pressure for discounting from managed care organizations such as health maintenance and preferred provider organizations began to squeeze drug company profit margins. The number of contact points between the sales force and the customer shrank dramatically as more drugs were being purchased through managed care organizations and pharmacy benefit managers. Drugs commonly were sold in large volumes and often at heavily discounted levels. The demand for generic drugs also was declining. The use of formularies, drug lists from which managed care doctors are required to prescribe, gave doctors less choice and made them less responsive to direct calls from the sales force. The situation was compounded further by the ongoing consolidation in the hospital industry. Hospitals began centralizing purchasing and using stricter formularies, allowing physicians virtually no leeway to prescribe unlisted drugs. The growing use of formularies resulted in buyers needing fewer drugs and sharply reduced the need for similar drugs. The industry’s first major wave of consolidations took place in the late 1980s, with such mergers as SmithKline and Beecham and Bristol Myers and Squibb. This wave of consolidation was driven by increased scale and scope economies largely realized through the combination of sales and marketing staffs. Horizontal consolidation represented a considerable value creation opportunity for those companies able to realize cost synergies. In analyzing the total costs of pharmaceutical companies, William Pursche (1996) argued that the potential savings from mergers could range from 15–25% of total R&D spending, 5–20% of total manufacturing costs, 15–50% of marketing and sales expenses, and 20–50% of overhead costs. Continued consolidation seemed likely, enabling further cuts in sales and marketing expenses. Formulary-driven purchasing and declining overall drug margins spurred pharmaceutical companies to take action to increase the return on their R&D investments. Because development costs are not significantly lower for generic drugs, it became increasingly difficult to generate positive financial returns from marginal products. Duplicate overhead offered another opportunity for cost savings through consolidation, because combining companies could eliminate redundant personnel in such support areas as quality assurance, manufacturing management, information services, legal services, accounting, and human resources. The second merger wave began in the late 1990s. The sheer magnitude and pace of activity is striking. Of the top-20 companies in terms of global pharmaceutical sales in 1998, one-half either have merged or announced plans to do so. More are expected as drug patents expire for a number of companies during the next several years and the cost of discovering and commercializing new drugs continues to escalate. On January 17, 2000, British pharmaceutical giants Glaxo Wellcome PLC and SmithKline Beecham PLC agreed to merge to form what was at the time the world’s largest drug company. The merger was valued at $76 billion. The resulting company was called Glaxo SmithKline and had annual revenue of $25 billion and a market value of $184 billion. The combined companies also would have a total R&D budget of $4 billion and a global sales force of 40,000. Total employees would number 105,000 worldwide. Although stressed as a merger of equals, Glaxo shareholders would own about 59% of the shares of the two companies. The combined companies would have a market share of 7.5% of the global pharmaceutical market. The companies projected annual pretax cost savings of about $1.76 billion after 3 years. The cost savings would come primarily from job cuts among middle management and administration over the next 3 years -What are the alternatives to merger available to the major pharmaceutical companies? What are the advantages and disadvantages of each alternative?

An acquisition is one of many options available for implementing a firm's business plan.

A differentiation strategy is one in which customers believe that various competitors have significantly different cost structures.