MGX5181 International Business Strategy

MGX5181 International Business Strategy Week 10 Strategy Formulation Entry Modes: Mergers and Acquisitions Greenfield Management Contracts Project Management

Objectives • By the end of this session, students should be able to: • Recognise the difference between a merger, acquisition and takeover • Demonstrate an understanding of the benefits and problems with undertaking M&As • Identify strategies that will enhance the chance of M&A success and options available when they fail. • Assess when management contracts are most appropriate for international operations • Recognise the benefits and challenges of running international projects

Definitions • Merger • Is a strategy through which two firms willingly agree to integrate their operations on a relatively co-equal basis • Why – because they believe they have the resources and capabilities that together may create a stronger competitive advantage • Both previous entities disappear into the new organisation. Shares are commuted into new shares and usually revalued to account for new market value. • In practice the two partners are usually of comparable size .

Definitions • Acquisition • Is a strategy through which one firm buys a controlling, or 100% interest in another firm • Why – intent of using a core competence more effectively by making the acquired firm a subsidiary business within its portfolio. • Usually involves the joining of unequal partners. The large firm subsumes the smaller one into its structure (Stonehouse et al 2001) • Can be agreed or hostile • Agreed is where target company accept the price offer for shareholding • Hostile acquisition (also called hostile take-over) is where the shares are acquired from the shareholders at a price that the target company directors do not recommend.

Global Value • 2013 was the third static year for deal value, down 3.2% at US$ 2,215.1bn (Mergermarket, Jan 2014) • Compared to US$ 2,288.8bn in 2012. 2013 has been the slowest year since 2010 (US$ 2,089.6bn) • Total value of cross-border deals through 2013 was down 11.5% with deals valued at US$ 774.4bn compared to 2012’s cross-border deals valued at US$ 875.2bn • Europe continued to take the majority share of all cross-border deals with US$ 338.6bn worth of transactions (43.7% share) compared to deals valued at US$ 359.4bn in 2012 (41.1% share).

In Australia • In Australia alone, merger and acquisition activity for 2013 was valued at $101 billion (up 16% over 2012); • peak year was 2011 worth nearly $155 billion but big drop in 2012 with nervousness over Europe economy (Dealogic Jan 2014) • An Australian study (KPMG, 2003) found that for the first time shareholder value was increased as a result of mergers and acquisitions more frequently than it was reduced. • It was established that 34% of the deals enhanced shareholder value, 32% reduced value and 34% had no effect • Research shows over 50% of M&As reduce shareholder value (KPMG, 2003).

Reasons for acquisitions 1.Increased market power • Main aim is to increase size and scope • Gain efficiencies • Horizontal acquisitions • Taking over of a firm in the same industry eg competitors • Research shows these work if businesses have similar characteristics ie corporate cultures • Vertical acquisitions • Taking over of a supplier or distributor • Aim is to control the value chain eg Fosters buying hotel outlets • Can lead to customer alienation eg PepsiCo selling only their products in owned restaurants • Related acquisitions • Taking over a firm in a related industry • Example: Carnival Corp cruise lines attempt to take over time-share business Fairfield Communities.

Reasons for acquisitions 2.Overcoming entry barriers • Barriers to market entry might include economies of scale requirements and differentiated products (different to own) • The higher the barrier to entry the more likely a take over. • Cross-border acquisitions • Provides more control that alliances 3.Cost of new product development • Taking over existing products rather than own R&D. • Almost 88% of innovations fail to achieve adequate returns • 60% of innovations are successfully imitated within 4 years after patent is obtained

Reasons for acquisitions 4.Increased speed to market • Provide a quick route to new products and new markets e.g process via internal development is too slow • i.e an e-commerce business 5.Lower risk compared to developing new products (R&D) • Buying known quantity rather than needing to develop your own. • e.g BTR and Nylex 6.Increased diversification • Provides product diversification in unfamiliar markets • Diversification strategies can be related or unrelated • Wesfarmers purchase of Kleenheat Gas, Western Collieries and Bunnings.

Reasons for acquisitions 7. Reshaping the firm’s competitive scope (strategic reasons) • May want to reduce dependence on a single market or product range. 8. The competitive situation • Market may be static and only chance enter a market is via buying existing capacity. 9. Human asset networks • Access to key people or known quantity. 10. New opportunities identified • Leaders move between different businesses and see opportunities • May take over business CEO previously worked for.

Reasons for acquisitions 11. Deregulation of industry • Rationalisation often occurs when regulations allow. • Fragmentation in such industries as telecommunication and public utilities like power and water with companies offering multi-utility options eg gas/electricity etc. 12. Low share value/ P/Eattractiveness • Buying under valued companies • Can lead to asset stripping. 13. Buying cost efficiency • Established company may be well down experience curve and have achieved efficiencies difficult to match by internal development. • Necessary innovation and organisational learning would be too slow

Reasons for acquisitions 14. Meet stakeholder expectations • Shareholders may expect to see continuous growth • Danger is parent can destroy value if poor fit • Some stakeholders are only speculative and push for short-term gain rather than long-term value. 15. Reputation enhancement • Reputation can be enhanced if the acquisition is with a business of some repute in a key market or with a key stakeholder group.

Problems with acquisitions • Integration difficulties • Difficult to meld different corporate cultures • Integration most important step in acquisition • Positive link between speed of integration and success. • Need to deal with unpopular issues first and be honest with people on likely results of integration on them • Inadequate evaluation of target • Needs to cover more than finance • Need to look at cultures, tax consequences, workforce attributes • Failure of proper due diligence is likely to be paying a premium eg AMP purchase of GIO

Problems with acquisitions • Large or extraordinary debt • Debt can be positive or negative • Too much debt reduces spending on key resources eg people and R&D • Debt may discipline managers but may not • Principle and interest can send the company into bankruptcy. • Inability to achieve synergy • Must identify if increasing value together or more valuable apart • Need to look at transaction costs required to achieve planned outcomes • Public relations problems • Taking over local icon can have negative consequences • Void in executive leadership and strategic communications • Goal of acquisition or merger unclear

Problems with acquisitions • Too much diversification • Over-diversified firms have declining results • Resources get stretched • Lack of clarity of direction • Tend to under perform against the market • Managers overly focused on acquisitions • Can divert attention from other important matters • Managers may fail to objectively assess the value of outcomes and spend too much time in the wrong areas. Eg Mazda and Ford (3 Presidents in Japan in 3 years) • Too large • When a firm gets too large, bureaucratic controls may diminish flexibility and performance

Attributes of successful acquisitions • Success is more likely if: • Acquired firm has assets or resources that are complementary to the acquiring firm’s core business • Acquisition is friendly • Acquiring firm selects target firms and conducts negotiations carefully and deliberately • Acquiring firm has financial slack (cash or favourable debt position) • Merged firm maintains low to moderate debt position • Has experience with change and is flexible and adaptable • Sustained and consistent emphasis on R&D and innovation

Reasons for Mergers Many are similar to acquisitions. • Active investing • Acquiring a company and running it more efficiently and profitably as a stand alone • Growing scale • Gaining scale in specific elements of a business and using these elements to become more competitive overall. • Building adjacencies • Expand the business in new locations, new products and higher growth markets or new customers • Closely related to company’s existing business • Broadening scope • Of products or technologies

Reasons for Mergers • Redefining business • Enhancing capabilities and resources rather than remain stale • Redefining industry • Change boundaries of competition • Reputation enhancement • Merger partner has some repute in key markets or with key stakeholders such as suppliers or customers.

M&A Failures Reasons for failure similar between M&As. • Main issues: • Lack of research • Not understanding the internal and external environmental features of the target company – hence expectations too high. • Poor strategic rationale or poor understanding of the strategic levers • Ego rather than value adding • Cultural incompatibility • Within and between the parties

M&A Failures • Inadequate integration planning and execution • Less than 10% of integration planning addresses cultural issues (Segil, 2000) • Loss of key personnel • Target company losses the people necessary for long-term success • Overpayment and or overestimate of value (Gadiesh et al 2001) • Assumption that target company’s market will continue indefinitely (markets fall as well as rise) • Change in legislation • Government in a target country makes it impossible to proceed.

Demerger • When expectations are not met you may need to consider a demerger. Benefits • Increased earnings per share therefore increased share price • Focus on core activities • Increase control via own shareholding and key people • Removes mistrust and cynicism of leadership, loss of key people • Reduce debt and free up resources

Successful M&A’s • According to Sirower (1997) successful integration occurs when seven success factors are observed: • Find a suitable target partner • Problematic. May need to wait years. Often need to compromise. • Evaluate target’s competitive position • Evaluate profitability, market share, product portfolio, competitiveness, key success factors and core competencies (can you identify and evaluate them? Do you have access?) • Fully evaluate target’s management and culture for compatibility the initiator • Evaluate management styles and cultures – never identical but can they work together? Can you find out in advance?

Successful M&A’s • Investigate the compatibility of the two companies’ structures • Integration works best when the two structures in question are comparably decentralised and have similar “height and width” • Ensure that key resources (including human resources) can be locked in after the integration • Key resources that help build core competencies must be locked in including people, locations, processes, patents, brands, sources of finance. • Ensure the price paid is realistic • Valuing goodwill is a challenge • Plan the post-merger process carefully • Review likely resistance to change, problem of focus on personal security rather than organisational goals, culture shock, and resentment of management

Australian Study on M&As • This study explored three key areas of merger and acquisition (M&A) strategy. These were: the link between corporate vision and M&A strategy; the importance of the due diligence process; and the impact of experience in completing successful M&As. • The study found • That there was a clear alignment between corporate and M&A strategic objectives but that each organisation had a different emphasis on individual criterion. • Due diligence was critical to success; its particular value was removing managerial ego and justifying the business case. • There was mixed evidence on the value of experience, with improved results from using a flexible framework of assessment. • McDonald, Coulthard and De Lange (2005)

Greenfield (New) Operations • Reasons for setting up new operations: • Product requires detailed adaptation for local customers • Product technology provides competitive edge and may be compromised by transfer into an existing firm. • The production process technology is the special strength of the firm and equivalent firms are not available or the advantage is not easily transferred to existing firms.

ACQUISITION VS GREENFIELD • The advantages of acquisition are: • Rapidity: building from scratch takes time. • Personnel: if hiring foreign personnel is difficult, acquisition solves the problem (however may cause problems if some personnel not needed) • Distribution channels already exist. • Customers, market share • Lead-time and pay-back period should be shorter

MANAGEMENT CONTRACTS • Definition: • An arrangement under which operational control of an enterprise (or one phase of an enterprise) which would otherwise be exercised by the board of directors or managers elected or appointed by its owners is vested by contract in a separate enterprise which performs the necessary managerial functions in return for a fee. (Pugh,1961)

Two cases of Management Contracts Management Contract Case 1: Salaries, fringe benefits Manager (s) Management Contractor Management Contractee Management Fee Management Contract Case 2: Management Fee Management Contractor Management Contractee Salaries, fringe benefits Ownership Resources Manager (s) Target contract venture

Equity Investment Project Delivery Management Contract Licensing Management Contract Plus Operation 9 9 9

Foreign Government action Commercial and political risk Link with other penetration modes Creation of other market opportunities Import security Training future competitors Training problems Personnel demands Relationship development need Differences with host government partner Control Why management contracts? Against For

MANAGEMENT PLUS CONTRACT • Contract often tied to other forms of operation eg. licensing, equity, project operation. • May link to project delivery to ensure production is satisfactory - guaranteeing quality and quantity of output, or tied to profitability.

MANAGEMENT PLUS CONTRACT (cont.) • Link to licensing usually relates to transfer of technology to operate the organisation. • Equity participation is usually small to gain commitment by the contractor, and may involve useful financial contribution.

RETURNS • May be fixed for the term of the contract or variable eg as a percentage of output. The drawback of the fixed fee is that it is subject to the effects of inflation. • Many contracts include an incentive fee set as a percentage of profit or a bonus fee if profits exceed a predetermined level. • Additional services may be provided for a fee (eg training, marketing, technical services).

CONTRACT DURATION • Terms vary and are subject to negotiation. • UK research found 3-5 years normal • Swedish research 5-10 years. • Renewal of contract is common.

RELATIONSHIP • The quality of the relationship will determine whether the contract is successful. • Mutual trust is more important than any contract. The position of power changes over the term of the contract. As the knowledge and skills of the client organisation build up, the knowledge on the value of the services being provided can be assessed more closely.

TERMINATION • On owner's side usually right to terminate by providing advanced notice. • Management company may want termination clause because of situations which make normal performance difficult or impossible: • Outside events eg: strikes, govt action • Events within owner's control • eg. non-payment of fees or lack of financial or other resources.

REASONS FOR MANAGEMENT CONTRACTS • Initially in developing countries particularly in situations where existing foreign owned operations were taken over to reduce foreign control over local industry. • Now used everywhere.

PROJECT OPERATIONS • Cover a broad mix of activities involved in the design and construction of different plants and facilities: such as housing, office buildings, factories, industrial plants, mining, defence and social infrastructure (power, water, roads etc).

TYPES • Partial Projects • Provides part of the package eg subcontracting but does not control the operation. • Turnkey Projects • "one party is responsible for setting up a plant and putting it into operation" (UN).

b) Turnkey Project turnkey agreement subcontractors principal contractor Buyer total delivery total responsibility control Plant Project Operations a) Partial Project A Buyer total responsibility B partial project agreement B subcontractors C A Seller C partial delivery partial suppliers Plant

Project Operations c) Turnkey Plus Project subcontractors turnkey plus agreement principal contractor Buyer turnkey delivery control turnkey plus delivery plant services and know-how inputs

Usually include: • Supply of technology and know-how, design, engineering and construction of civil works • Supply of complete plant and equipment • Commissioning of the total plant to start-up stage. • Either the turnkey can be controlled to point of being operational by installer or buyer can take full responsibility and use specialists as project managers.

Managerial Marketing Know-How Management Contracts Project Operations: Foreign Investment Package Finance International Bank Project and Continued Management Technology Licenses Equipment - plant / parts Supplier Co’s. Services Service Contract Management Contract Personnel

TURNKEY PLUS PROJECTS • Turnkey projects often combined with other forms of operation eg equity contribution, management contracts, licensing. • Many developing countries looking for the contractor to have equity in finished venture to ensure its profitability. A turnkey plus serves a number of purposes:

A. Pre-Turnkey Feasibility Study B. Turnkey Perhaps small equity interest by supplier Turnkey Project Financing Assistance start -up Training, technical services C. After-Turnkey medium - long term short term • Additional responsibilities: • running plant • continued training • marketing ouput Extended Turnkey Contract Management Contract Licensing Turnkey Plus Short: Medium: Long: - start up services - marketing services - licensing - introductory running - export start up - minority - further training - management contract - quality control established equity joint venture

Supplier Motives: • Can increase returns beyond initial project • Undertaking feasibility study can ensure winning of tender. • Adding extra services can assist in bidding for price competitive projects.

Buyer Motives: • Financial assistance reduces pressure on Foreign Exchange and ensures commitment. • Ensures operation runs efficiently after completion. • Can include training, marketing and management contracts.

Project Development:A supplier’s perspective Market Scanning Contact Network Activity Marketing Approach sometimes Consultants Feasibility Study: Tender Preparation - Project Specification Negotiations Initial tender; Short listing Alterations; Re-submission of offer (s) Bid Process Supplier Choice Project Implementation May include the provision of additional services, goods and equipment Operational Phase

Contract Components • Cost and Payment Terms: • Vary from lump sum to cost plus percentage approach. Lump sum may seem cheapest but usually includes a contingencies allowance or built down to a price rather than what is required. • Cost-plus approach can blow price out. The usual method is somewhere in-between • eg: target price and extra costs shared, incentive contracts - savings shared or payment in stages.

Funnelling to a winning contract Proposal/Tender Intrinsic Factors Extrinsic Factors Local Criteria Eligibility Screen External Criteria Formal Rigid Rules Informal Machinery Procedural Screen Technology Transfer considerations Joint ventures, localisation Linkage Screen Flexibility, trust & affinity for firm, localisation Competitive Screen Past Experience, name of firm, price Contractural influence Outside consultant linkages Influence Screen Winning Contract

MGX5181 International Business Strategy