Testfragen

(Barney/Hesterly, Strategic Management and Competitive Advantage)

Strategic Management in General

The strategic management process is a sequential set of analyses and choices that can
increase the likelihood that a firm will choose a good strategy that generates competitive
advantages.
Answer: TRUE

The second step in the strategic management process is the definition of a firm's mission.
Answer: FALSE

A firm's mission defines both what it wants to be in the long run and what it wants to avoid in
the meantime.
Answer: TRUE

Mission statements often contain so many common elements that even if a firm's mission
statement does not influence behavior throughout an organization, it is likely to have a
significant impact on a firm's actions.
Answer: FALSE

Mission statements that are very inwardly focused and are defined only with reference to the
personal values and priorities of its founders and top managers can hurt a firm's
performance.
Answer: TRUE

Green Frog is an environmentally friendly firm in the cosmetics industry that has decided to
undertake a strategic planning project. It wants to ensure that it performs the process
correctly and so intends to start the process with the first step of the strategic planning
process, which is
A) crafting a mission statement.
B) setting objectives.
C) measuring performance.
D) defining its business level strategy.
Answer: A

Define the term "mission" and discuss how a firm's mission can both positively and
negatively impact a firm's performance.
Answer:
A firm's mission is its long-term purpose and it defines both what a firm aspires to be
in the long run and what it wants to avoid in the meantime. If a mission statement does
not influence firm behavior, it is unlikely to have an impact on a firm's actions.
However, visionary firms, or firms whose mission is central to all they do, tend to earn
substantially higher returns than average over the long run even though their mission
statements suggest that profit maximization is not their primary reason for existence.
However, missions that are inwardly focused and defined only with reference to the
personal values and priorities of their founders or top managers, independent of
whether or not those values and priorities are consistent with the economic realities
facing a firm, are not likely to be a source of competitive advantage.

Visionary firms earn substantially higher returns than average firms because they
acknowledge that profit maximizing is their primary reason for existence.
Answer: FALSE

Objectives are the specific measurable targets a firm can use to evaluate the extent to which
it is realizing its mission.
Answer: TRUE

Write objectives for each of the following mission statements.

a. We will be a leader in pharmaceutical innovation
b. Customer satisfaction is our primary goal
c. We promise on time delivery
d. Product quality is our first priority.
Answers:
a. At least 25% of our sales in the next five years will be generated from new products.
b. Ensure that customer complaints are less than 1% of all units sold.
c. At least 98% of all deliveries each quarter will be consistent with the terms
negotiated with our customers.
d. Ensure that Six Sigma is implemented across all manufacturing lines within two
years.

Corporate level strategies are actions firms take to gain competitive advantages in a single
market or industry.
Answer: FALSE

Business level strategies are actions firms take to gain competitive advantages by operating
in multiple markets or industries simultaneously.
Answer: FALSE

Green Frog is an environmentally friendly firm in the cosmetics industry. If Green Frog were
considering expanding beyond the cosmetics industry into pharmaceuticals in order to gain
competitive advantages by operating in multiple markets and industries, this would be an
example of which type of strategy?
A) Business level strategy
B) Functional level strategy
C) Marketing strategy
D) Corporate level strategy
Answer: D

Differentiate between business level and corporate level strategies and give examples of
each.
Answer:
Business level strategies are actions firms take to gain competitive advantages in a
single market or industry. The two most common business level strategies are cost
leadership, such as Wal-Mart, and product differentiation, such as Macy's. Corporate
level strategies are actions firms take to gain competitive advantages in multiple
markets or industries simultaneously. Common corporate level strategies include
vertical integration strategies, diversification strategies, strategic alliances strategies
and merger and acquisition strategies.

A sustained competitive advantage is virtually permanent.

Answer: FALSE

What are objectives, what role do they play in the strategic management process and what
differentiates high quality objectives from low quality objectives?
Answer:
Objectives are specific measurable 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, are difficult to measure or are difficult to track over time.

Define strategy implementation and discuss three specific organizational policies and
practices that are particularly important in implementing a strategy.
Answer:
Strategy implementation occurs when a firm adopts organizational policies and
practices that are consistent with its strategy. Three specific organizational policies
and practices are particularly important in implementing a strategy: a firm's formal
organizational structure, its formal and informal management control systems, and
employee compensation policies.

There is little empirical evidence that having a formal, written mission statement improves a
firm’s performance. Yet many firms spend a great deal of time and money developing
mission statements. Why?
Answer:
Firms invest in developing mission statements in the hope that the mission statement
will serve to motivate and unite people around a common goal. Ideally the mission
statement serves to inform people within the organization about what they can and
should do to further the interests of the organization. The mission statement also
communicates a message to people outside the organization. Firms rationally invest
in efforts to develop mission statements because of the potential benefits of this
favorable communication.
Will a firm that has a sustained competitive disadvantage necessarily go out of business?
How about a firm with below average accounting performance over a long period of time?
How about a firm with below normal economic performance over a long period of time?
Answers:
a) No, a firm could have a sustained competitive disadvantage and remain in
business. Remember that a sustained competitive disadvantage simply means the
firm is generating less value than competitors. Many firms continue to operate even
though they do so at a competitive disadvantage in some areas because they usually
have some advantage in another area. If the firm had no competitive advantages at all,
in time the firm would likely begin to earn below normal economic returns and may go
out of business as explained in answer (c) below.

b) No, a firm could have below average accounting performance and remain in
business. As long as the returns to the owners of the firms are satisfactory, the firm
will remain in business, even if those returns are less than the industry average.

c) Yes, a firm that earns a below average economic return over a long period of time
will eventually go out of business. The reason for this is that the firm is earning less
than its cost of capital. In time, the firm would be unable to attract capital and would
be forced to go out of business.

Resources and Capabilities

Capabilities are a subset of a firm's resources and are defined as tangible and intangible
assets that enable a firm to take full advantage of other resources it controls.
Answer: TRUE

Resources in the resource based view are defined as the tangible and intangible assets that
a firm controls, which it can use to conceive of and implement its strategies.
Answer: TRUE

Financial resources include only the profits a firm has made earlier in its history and that it
has reinvested in itself.
Answer: FALSE

Organizational resources include the training, experience, judgment, intelligence,

relationships and insight of individual managers and workers in a firm, while human
resources are an attribute of collections of individuals.
Answer: FALSE

One of the key assumptions of the RBV is resource homogeneity.

Answer: FALSE
The assumption of resource immobility holds that it may be very costly for firms without
certain resources and capabilities to develop or acquire them.
Answer: TRUE

A firm's plant and equipment, its geographic location and its access to raw materials are all
examples of physical resources.
Answer: TRUE

The value of a firm's resources and capabilities will generally manifest itself in either higher
revenues or lower costs or both once a firm starts using these resources and capabilities to
exploit opportunities or neutralize threats.
Answer: TRUE

A resource can be a source of competitive advantage even if the resource is controlled by

numerous firms.
Answer: FALSE

Most firms have a resource base that is composed primarily of valuable but common
resources and capabilities, some of which are essential if a firm is to gain competitive parity.
Answer: TRUE

In general, as long as the number of firms that possess a particular valuable resource or
capability is less than the number of firms needed to generate perfect competition dynamics
in an industry, that resource can be considered rare and a potential source of competitive
advantage.
Answer: TRUE

In general, imitation can occur in one of two ways: direct duplication or substitution.
Answer: TRUE

The interpersonal relations among managers in a firm, a firm's culture, and a firm's reputation
among suppliers and customers can all act to make a firm's resources and capabilities
socially complex.
Answer: TRUE

If a resource or capability is valuable and rare but not costly to imitate, exploiting this
resource will generate a sustainable competitive advantage for a firm.
Answer: FALSE
A firm's marketing skills and teamwork as well as its cooperation among managers are
examples of
A) financial resources.
B) human resources.
C) physical resources.
D) capabilities.
Answer: D

The training, experience, judgment, intelligence, relationships and insight of individual

managers and workers in a firm are examples of
A) physical resources.
B) human resources.
C) organizational resources.
D) financial resources.
Answer: B

A firm's formal reporting structure, its formal and informal planning and its controlling and
coordinating systems are examples of which type of resources?
A) Financial resources
B) Physical resources
C) Human resources
D) Organizational resources
Answer: D

The VRIO assumption that some of the resource and capability differences among firms may
be long lasting is known as
A) resource mobility.
B) resource homogeneity.
C) resource immobility.
D) resource heterogeneity.
Answer: C

Firms that possess and exploit costly-to-imitate, rare and valuable resources in choosing and
implementing their strategies may enjoy a period of
A) temporary competitive advantage.
B) competitive disadvantage.
C) competitive parity.
D) sustained competitive advantage.
Answer: D

If a firm's resources and capabilities are costly to imitate because imitating firms may not
understand the relationship between the resources and capabilities controlled by a firm and
that firm's competitive advantage, this competitive advantage is said to be protected from
imitation by
A) path dependence.
B) casual ambiguity.
C) unique historical conditions.
D) social complexity.
Answer: B

Resources and capabilities, such as relations among managers and a firm's culture, that may
be costly to imitate because they are beyond the ability of firms to systematically manage
and influence are referred to as
A) socially complex.
B) casually ambiguous.
C) path dependent.
D) the result of unique historical conditions.
Answer: A

If a resource or capability is valuable and rare but not costly to imitate, exploiting this
resource will generate a(n)
A) sustained competitive advantage.
B) perfectly competitive environment.
C) temporary competitive advantage.
D) environment characterized by competitive parity.
Answer: C

LaserTech is a manufacturer of industrial lasers and has developed a new, patented

technology that allows its customers to manufacture their products more precisely with a
higher level of consistency and at a lower cost than they could previously. LaserTech's
executives believe that no rivals have a similar technology and that it would be very difficult
for rivals to copy this technology since the benefits of the new technology can only be
realized within LaserTech's system, which includes processes that are protected by trade
secrets, making it difficult for rivals to understand the relationship between the company's
new technology and its competitive advantage.

LaserTech's new technology appears to be

A) valuable and rare but not costly to imitate.
B) valuable and either rare or costly to imitate.
C) valuable but neither rare nor costly to imitate.
D) valuable, rare and costly to imitate.
Answer: D

LaserTech's new technology is an example of

A) financial resources.
B) physical resources.
C) human resources.
D) organizational resources.
Answer: B
The inability of rivals to develop or acquire technology similar to that of LaserTech is an
illustration of
A) resource immobility.
B) resource heterogeneity.
C) causal ambiguity.
D) path dependence.
Answer: A

Describe the difference between resources and capabilities.

Answer: Resources in the RBV are defined as the tangible and intangible assets that a
firm controls that it can use to conceive of and implement its strategies. Examples of
resources might include a firm's factories (a tangible asset), its products (a tangible
asset), its reputation among customers (an intangible asset), and teamwork among its
managers (an intangible asset).

Capabilities are a subset of a firm's resources and are defined as tangible and
intangible assets that enable a firm to take full advantage of other resources it
controls. That is, capabilities do not enable a firm to conceive of and implement its
strategies by themselves but enable a firm to use other resources to conceive of and
implement such strategies. Examples of capabilities might include a firm's marketing
skills and teamwork and cooperation among its managers.

Identify the four broad categories that a firm's resources and capabilities can be classified
into.
Answer:
A firm's resources and capabilities can be classified into four broad categories:
financial resources, physical resources, individual resources, and organizational
resources.

Financial resources include all the money, from whatever source, that a firm uses to
conceive of and implement strategies.

Physical resources include all the physical technology used in a firm. This includes a
firm's plant and equipment, its geographic location, and its access to raw materials.
Human resources include the training, experience, judgment, intelligence,
relationships, and insight of individual managers and workers in a firm.
Organizational resources are an attribute of collections of individuals.

Identify and describe the two fundamental assumptions about the resources and capabilities
that firms may control that the RBV rests on.
Answer:
The two fundamental assumptions that the RBV rests on are resource heterogeneity
and resource immobility.

Resource heterogeneity implies that for a given business activity, some firms may be
more skilled in accomplishing this activity than other firms.

Resource immobility implies that it may be very costly for firms without certain
resources and capabilities to develop or acquire them.
Identify the four questions represented in the VRIO framework that one must ask about a
resource or capability to determine its competitive potential.
Answer: The four questions are:
The Question of Value Does a resource enable a firm to exploit an external
opportunity or neutralize an external threat?

The Question of Rarity How many competing firms already possess particular
valuable resources and capabilities?
The Question of Imitability Do firms without a resource or capability face a cost
disadvantage in obtaining or developing it compared to firms that already possess it?

The Question of Organization Is a firm organized to exploit the full competitive

potential of its resources and capabilities?

Identify two forms of imitation and describe four sources of costly imitation.
Answer:
In general, imitation occurs in one of two ways: direct duplication or substitution.
Imitating firms can attempt to directly duplicate the resources possessed by the firm
with a competitive advantage. Imitating firms can also attempt to substitute other
resources for a costly-to-imitate resource possessed by a firm with a competitive
advantage. The four sources of costly imitation include:

• Unique Historical Conditions. It may be the case that a firm was able to acquire or
develop its resources and capabilities in a low-cost manner because of its unique
historical conditions. The ability of firms to acquire, develop, and use resources
often depends upon their place in time and space.

• Causal Ambiguity. A second reason why a firm's resources and capabilities may be
costly to imitate is that imitating firms may not understand the relationship between
the resources and capabilities controlled by a firm and that firm's competitive
advantage.

• Social Complexity. A third reason that a firm's resources and capabilities may be
costly to imitate is that they may be socially complex phenomena, beyond the ability
of firms to systematically manage and influence.

• The existence of patents.

Which approach to strategy formulation is more likely to generate economic profits: (a)
evaluating external opportunities and threats and then developing resources and capabilities
to exploit these opportunities and neutralize these threats or (b) evaluating internal resources
and capabilities and then searching for industries where they can be exploited? Why?
Answer:
(b) is more likely to generate economic profits because the firm in answer (a) would
have to acquire resources. These resources would have to be acquired in a market
where other firms would very likely know the value of the resources. Prices would be
bid up to the point where economic profits would probably not be possible. The firm
in answer (b) already has the resources and capabilities and they would not capitalize
the value of the resources and capabilities in the process of acquiring them.
Which firm will have a higher level of economic performance: (a) a firm with valuable, rare,
and costly-to-imitate resources and capabilities operating in a very attractive industry or (b) a
firm with valuable, rare, and costly-to-imitate resources and capabilities operating in a very
unattractive industry? Assume both these firms are appropriately organized. Explain your
answer.
Answer:

The firm in answer (a) will have higher performance because overall profits will be
higher in the attractive industry. There will be less pressure from each of the five
forces explained in Porter’s Five Forces Model. However, this is not to say that a firm
in an unattractive industry cannot earn high economic performance. In fact, some
firms do earn very attractive returns in industries that would be considered
unattractive because they have resources and capabilities that set them apart from
competitors. Wal-Mart is a good example.

Your former college roommate calls you and asks to borrow $10,000 so the he can open a
pizza restaurant in his hometown. He acknowledges that there is a high degree of rivalry in
this market, that the cost of entry is low, and that there are numerous substitutes for pizza,
but he believes that his pizza restaurant will have some sustained competitive advantages.
For example, he is going to have sawdust on his floor, a variety of imported beers, and a
late-night delivery service. Will you lend him the money? Why or why not?
Answer:
No, you would not want to lend your friend the money. The claimed sources of
competitive advantage do not meet the VRIO criteria. The sawdust might not even be
valuable and the imported beers and late-night delivery are not rare. There should be
no expectation that the new pizza restaurant would earn any better than a normal
return. In fact, unless your friend is at least as good as the other restaurants, below
normal returns would be expected.

Vertical Integration

A firm engages in backward vertical integration when it incorporates more stages of the value
chain within its boundaries and those stages bring it closer to gaining access to raw
materials.
Answer: TRUE

If Wal-Mart were to purchase a factory to make socks and it planned to sell these socks in its
stores, this would be an example of forward vertical integration.
Answer: FALSE

Firms should not vertically integrate into business activities where they do not possess the
resources necessary to gain competitive advantages.
Answer: TRUE

A firm's vertical integration strategy is rare when few competing firms are able to create value
by vertically integrating in the same way.
Answer: TRUE

Outsourcing can help firms reduce costs and focus their efforts on those business functions
that are central to their competitive advantage.
Answer: TRUE

If a firm has capabilities that are valuable and rare, then vertically integrating into businesses
that exploit these capabilities can enable the firm to gain at least a temporary competitive
advantage.
Answer: TRUE

A firm may be able to gain an advantage from vertically integrating when it resolves some
uncertainty it faces sooner than its competition.
Answer: TRUE

From a CEO's perspective, coordinating functional specialists to implement a vertical

integration strategy rarely involves conflict resolution.
Answer: FALSE

When Apple, Inc. opened retail stores to sell its computers and iPods, this was an example
of
A) forward vertical integration.
B) backward vertical integration.
C) forward horizontal integration.
D) backward horizontal integration.
Answer: A

If Dell computers were to open its own factory to manufacture the LCD televisions it sells at
its online store, this would be an example of
A) forward vertical integration.
B) product differentiation.
C) forward horizontal integration.
D) backward vertical integration.
Answer: D

Digipics is an assembler of digital cameras. As an assembler, Digipics' operations are limited

to purchasing all of the components necessary to assemble the cameras and then selling
these cameras to wholesalers who, in turn, sell them through online stores and in retail
electronics stores.

If Digipics were to begin manufacturing lenses for the cameras they assembled, this would
be an example of
A) backward vertical integration.
B) a strategic alliance.
C) forward vertical integration.
D) opportunism.
Answer: A

If Digipics were to begin selling the cameras it assembled directly to customers through a
website operated by the company, this would be an example of
A) backward vertical integration.
B) a strategic alliance.
C) forward vertical integration.
D) opportunism.
Answer: C

If Digipics were to agree to spend a significant amount of money to establish a new assembly
line for a large client, PicPro, that has unique needs that would make this assembly line
largely useless for any other customer, the funds Digipics spent in establishing this line
would be an example of
A) forward vertical integration.
B) backward vertical integration.
C) a transaction-specific investment.
D) opportunism.
Answer: C

TerraLoc competes in the market for global positioning devices and services. The company
manufactures its own GPS units, which are smaller than those of any other competitor and
include a proprietary battery that lasts 200% longer than any other competitor's battery and
that TerraLoc manufacturers on-site. TerraLoc also has developed proprietary software that
is much faster and more precise than that of any competitor. When developing the
proprietary battery, TerraLoc decided to manufacturer the battery in-house to reduce the
possibility that the company it outsourced the battery manufacturing to might reverse
engineer the battery and sell a similar product to competitors. This possibility was especially
troubling given that the company expected a significant increase in demand due to the
improved battery life. Additionally, TerraLoc sells its products and services through its own
direct sales force to ensure that its representatives highlight the longer battery life of
TerraLoc's units.

TerraLoc's development of the new battery technology is likely to

A) reduce the rarity of TerraLoc's vertical integration strategy since competitors can purchase
batteries from other sources.
B) increase the rarity of TerraLoc's vertical integration strategy since TerraLoc has reduced
uncertainties related to increased battery life in its products.
C) increase the imitability of TerraLoc's vertical integration strategy since competitors can
purchase traditional batteries from other sources.
D) decrease the imitability of TerraLoc's vertical integration strategy since it increases
competitors' flexibility.
Answer: B
If TerraLoc wanted to expand into selling its GPS units through company-owned retail stores,
this would be an example of ________
A) forward vertical integration.
B) backward vertical integration.
C) opportunism.
D) a joint venture.
Answer: A

Define vertical integration and differentiate between forward vertical integration and
backward vertical integration.
Answer:
Vertical integration is a corporate strategy. A firm's level of vertical integration is
simply the number of steps in this value chain that a firm accomplishes within its
boundaries. More vertically integrated firms accomplish more stages of the value
chain within their boundaries than less vertically integrated firms. Less vertically
integrated firms accomplish fewer stages of the value chain within their boundaries
than more vertically integrated firms. A firm engages in backward vertical integration
when it incorporates more stages of the value chain within its boundaries and those
stages bring a firm closer to the beginning of the value chain, i.e., closer to gaining
access to raw materials. A firm engages in forward vertical integration when it
incorporates more stages of the value chain within its boundaries and those stages
bring a firm closer to the end of the value chain, i.e., closer to interacting directly with
final customers.

Identify the three fundamental explanations of how vertical integration can create value and
discuss how value is created under each.
Answer:
There are three explanations of how firms can create value through vertical
integration:
• Opportunism-Based Explanation: Reducing opportunistic threats from a firm's
buyers and suppliers due to any transaction specific investments it may have made.
• Capabilities-Based Explanation: By enabling a firm to exploit its valuable, rare, and
costly-to-imitate resources and capabilities.
• Flexibility-Based Explanation: When the decision-making environment is uncertain,
firms create value by engaging in vertical integration. Under high uncertainty vertical
integration can commit a firm to a costly-to-reverse course of action and the
flexibility of a non-vertically integrated may be preferred.

Corporate Diversification

A firm implements a corporate diversification strategy when it operates in multiple industries

or markets simultaneously.
Answer: TRUE

A firm has implemented a strategy of limited corporate diversification when all or most of its
business activities fall within a single industry and geographic market.
Answer: TRUE

If all the businesses in which a firm operates share a significant number of inputs, production
technologies, distribution channels, similar customers, and so forth, this corporate
diversification strategy is called related-constrained diversification.
Answer: TRUE

If the different businesses that a single firm pursues are linked on only a couple of
dimensions, or if different sets of businesses are linked along very different dimensions, that
corporate diversification strategy is called related-linked diversification.
Answer: TRUE

Economies of scope exist in a firm when the value of the products or services it sells
increase as a function of the number of businesses in which the firm operates.
Answer: TRUE

Operational economies of scope include shared activities and risk reduction.

Answer: FALSE

Shared activities can increase the revenues in diversified firms' businesses, and failure to
exploit shared activities across businesses can lead to out-of-control costs.
Answer: TRUE

Core competencies are complex sets of resources and capabilities that link different
businesses in a diversified firm through managerial and technical know-how, experience, and
wisdom.
Answer: TRUE

For an internal capital market to create value for a diversified firm, it must offer some
efficiency advantages over an external capital market.
Answer: TRUE

Shared activities and risk reduction are usually difficult-to-duplicate bases for corporate
diversification, but tax advantages and employee compensation are usually relatively easy to
duplicate.
Answer: FALSE

Exploiting market power is an example of a costly-to-duplicate economies of scope.

Answer: TRUE

In order for corporate diversification to be economically valuable

A) there must be some valuable economy of scope among the multiple businesses in which
a firm is operating and it must be more costly for managers in a firm to realize these
economies of scope than for outside equity holders on their own.
B) there must not be any valuable economy of scope among the multiple businesses in
which a firm is operating and it must be less costly for managers in a firm to realize these
economies of scope than for outside equity holders on their own.
C) there must be some valuable economy of scope among the multiple businesses in which
a firm is operating and it must be less costly for managers in a firm to realize these
economies of scope than for outside equity holders on their own.
D) there must not be any valuable economy of scope among the multiple businesses in
which a firm is operating and it must be more costly for managers in a firm to realize these
economies of scope than for outside equity holders on their own.
Answer: C

If a diversified firm had three businesses and these companies shared a common marketing
and service operation, as well as common technology and development, this would be an
example of which type of economy of scope?
A) Core competencies
B) Shared activities
C) Risk reduction
D) Multipoint competition
Answer: B

A firm that diversifies by exploiting its resources and capability advantages in its original
business will have ________ costs than (as) firms that begin a new business without these
resource and capability advantages, or ________ revenues than (as) firms lacking these
advantages.
A) higher; lower
B) the same; higher
C) lower; the same
D) lower; higher
Answer: D

Which of the following economies of scope do not have the potential for generating positive
returns for a firm's equity holders since the economies of scope can be realized by outside
equity holders at a low cost by investing in a diversified portfolio of stock?
A) Shared activities
B) Diversification to maximize the size of a firm
C) Internal capital allocation
D) Exploiting market power
Answer: B
Substitutes for exploiting economies of scope in diversification include
A) growing and developing independent businesses within a diversified firm and vertical
integration.
B) vertical integration and strategic alliances.
C) growing and developing independent businesses within a diversified firm and strategic
alliances.
D) strategic alliances and multipoint competition.
Answer: C

One simple way to think about relatedness is to look at the products or services a firm
manufactures. The more similar these products or services are, the more related is the firm’s
diversification strategy. However, will firms that exploit core competencies in their
diversification strategies always produce products or services that are similar to each other?
Why or why not?
Answer:
The Honda example can be used to see how core competencies are related to
products. Honda has a core competency in making high performance engines. They
have tremendous skills in engine design that encompasses a variety of related skills.
Honda has used its engine design core competency to diversify into automobiles
(from their original business of motorcycles), lawn movers, snow throwers, and off
road vehicles. While they all have the engine as the common part, they serve different
markets. The key is not to look for similar products but products that will benefit from
a core competency.

A firm implementing a diversification strategy has just acquired what it claims is a

strategically related target firm but announces that it is not going to change this recently
acquired firm in any way. Will this type of diversifying acquisition enable the firm to realize
any valuable economies of scope that could not be duplicated by outside investors on their
own? Why or why not?

It is unlikely that this type of diversifying acquisition will help the firm exploit
economies of scope that outside investors cannot do on their own. To exploit
economies of scope, the newly acquired firm must be linked to the existing
businesses in the acquiring firm’s portfolio. The chapter looked at a number of ways
to obtain economies of scope –operational economies, financial economies, etc.
Unless the newly acquired firm is connected to the rest of the organization (which
would require making changes to it), the firm would not be able to realize economies
of scope in a way that equity holders can do on their own.

A particular firm is owned by members of a single family. Most of the wealth of this family is
derived from the operations of this firm, and the family does not want to “go public” with the
firm by selling its equity position to outside investors. Will this firm pursue a highly related
diversification strategy or a somewhat less related diversification strategy? Why?
Answer:
The economic logic of a diversification strategy rests on the assumption that certain
economies of scope can be obtained more efficiently by a firm owing a number of
businesses than by equity holders acting on their own. The family firm will pursue a
strategy of highly related diversification if the firm as a whole can get certain
economies of scope that family members acting on their own cannot. However, family
members may also want to minimize their risks because the majority of their portfolio
is invested in this firm. If a strategy of highly related diversification positions the firm
in certain product-market areas where the risks are high, the firm may decide on a
somewhat less related diversification strategy.

Under what conditions will a related diversification strategy not be a source of competitive
advantage for a firm?
Answer:
The key to value creation in a related diversification strategy is to exploit economies
of scope more efficiently than what is possible by equity holders acting on their own.
The related diversified firm succeeds because it has a competitive advantage based
on scope economies. If the related diversified firm does not exploit economies of
scope then it will not have a competitive advantage. It is possible that the relatedness
is based on relatively loose links among the businesses such that there is no great
possibility of economies of scope.

Consider the following list of strategies. In your view, which of these strategies are examples
of potential economies of scope underlying a corporate diversification strategy? For those
strategies that are an economy of scope, which economy of scope are the? For those
strategies that are not an economy of scope, why aren’t they?

The Coca-Cola Corp. replaces its old diet cola drink (Tab) with a new diet cola drink called
Diet Coke.

Apple Computer introduces an I-Pod MD3 Player with a larger memory.

PepsiCo distributes Lay’s Potato Chips to the same stores where it sells Pepsi.

K-Mart extends its licensing arrangement with Martha Stewart for four years.

Wal-Mart uses the same distribution system to supply its Wal-Mart stores, its Wal-Mart Super
Centers (Wal-Mart stores with grocery stores in them), and its Sam’s Club.

Head Ski Company introduces a line of tennis rackets.

General Electric borrows money from BankAmerica at 3% interest and then makes capital
available to its jet engine subsidiary at 8% interest.

McDonald’s acquires Boston Market and Chipotle (two restaurants where many customers
sit at the restaurant to eat their meals).

A venture capital firm invests in a firm in the bio-technology industry and a firm in the
entertainment industry.

Another venture capital firm invests in two firms in the bio-technology industry.

Answers:
Coca-Cola & Diet Coke – Operational economies of scope

Apple Computer & I-Pod MD3 – Operational economies of scope

PepsiCo & Lays Potato Chips distribution – Operational economies of scope

K-Mart & Martha Stewart – Financial economies of scope

Wal-Mart distribution – Operational economies of scope & Multi-point competition

Head Ski Company – Operational economies of scope

GE & BankAmerica – Financial economies of scope (internal capital allocation)

McDonalds acquires Boston Market – Anticompetitive economies of scope

Venture capital investment in biotech – financial economies of scope

Venture capital investment in two biotech firms – Financial economies of scope &
anticompetitive economies of scope.

Strategic Alliances
In a nonequity alliance, firms create a legally independent firm in which they invest and from
which they share any profits that are created.
Answer: FALSE

In an equity alliance, cooperating firms supplement contracts with equity holdings an alliance
partners.
Answer: TRUE

When a firm cannot realize the cost savings from economies of scale all by itself, it may join
in a strategic alliance with other firms so that together both firms will have sufficient volume
to be able to gain the cost advantages of economies of scale.
Answer: TRUE

In general, due to the intangible nature of knowledge, firms are not able to use alliances to
learn from their competitors.
Answer: FALSE

Tacit collusion exists when firms coordinate their pricing decisions not by directly
communicating with each other but by exchanging signals with other firms about their intent
to cooperate.
Answer: TRUE

Alliances to facilitate entry into new industries are only valuable when the skills needed in
these industries are complex and difficult to learn.
Answer: FALSE
In new and uncertain environments it is not unusual for firms to develop numerous strategic
alliances.
Answer: TRUE

Moral hazard occurs when partners in an alliance possess high-quality resources and
capabilities of significant value in an alliance but fail to make those resources and capabilities
available to alliance partners.
Answer: TRUE

In an alliance a holdup occurs when a firm that has not made significant transaction-specific
investments demands returns from an alliance that are higher than what the partners agreed
to when they created the alliance.
Answer: TRUE

The rarity of strategic alliances depends solely on the number of competing firms that have
already implemented an alliance.
Answer: FALSE

In general, firms will prefer to go it alone rather than enter into a strategic alliance when the
level of transaction-specific investment required to complete an exchange is low.
Answer: TRUE

Capabilities theory suggests that an alliance will be preferred over going it alone when an
exchange partner possesses valuable, rare, and costly-to-imitate resources and capabilities.
Answer: TRUE

An alliance will be preferred to an acquisition when there are legal constraints on

acquisitions.
Answer: TRUE

The primary purpose of organizing a strategic alliance is to enable 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.
Answer: TRUE

In general, contracts are sufficient to resolve all the problems associated with cheating in an
alliance.
Answer: FALSE
Sometimes the value of cheating in a joint venture is sufficiently large that a firm cheats even
though doing so hurts the joint venture and forecloses future opportunities.
Answer: TRUE

In comparison to strategic alliances, joint ventures increase the threat of cheating by

partners.
Answer: FALSE

When the probability of cheating in a cooperative relationship is lowest, a joint venture is

usually the preferred form of cooperation.
Answer: FALSE

A ________ is a form of nonequity alliance that exists when one firm allows another to use
its brand name to sell its products.
A) supply agreement
B) distribution agreement
C) licensing agreement
D) joint venture
Answer: C

In a ________, cooperating firms create a legally independent firm in which they invest and
from which they share any profits that are created.
A) licensing agreement
B) supply agreement
C) distribution agreement
D) joint venture
Answer: D

Strategic alliances are particularly valuable in facilitating market entry and exit when the
value of market entry or exit is
A) high.
B) low.
C) moderate.
D) uncertain.
Answer: D

As long as the cost of ________ to enter a new industry is less than the cost of ________,
an alliance can be a valuable strategic opportunity.
A) vertically integrating; learning new skills and capabilities
B) learning new skills and capabilities; using an alliance
C) using an alliance; learning new skills and capabilities
D) learning new skills and capabilities; vertically integrating
Answer: C
The rarity of strategic alliances
A) depends solely on the number of competing firms that have already implemented an
alliance.
B) depends solely on whether or not the benefits that firms obtain from their alliances are not
common across firms in the industry.
C) depends not only on the number of competing firms that have already implemented an
alliance but also on whether or not the benefits that firms obtain from their alliances are
not common across competing firms in the industry.
D) depends solely on the number of substitutes available for alliances.
Answer: C

One of the reasons why the benefits that accrue from a particular strategic alliance may be
rare is that
A) relatively few firms may have the complementary resources and abilities needed to form
an alliance.
B) there is a relatively large number of alliance partners available.
C) relatively many firms may have the complementary resources and abilities needed to form
an alliance
D) there may be a relatively low amount of transaction-specific assets to enter into similar
alliances.
Answer: A

When the probability of cheating in a cooperative relationship is greatest, a(n) ________ is

the preferred form of cooperation.
A) equity agreement
B) licensing agreement
C) joint venture
D) distribution agreement
Answer: C

eBay, the online auction company, has an impressive portfolio of cooperative agreements.
This portfolio includes an agreement with the U.S. Postal Service to facilitate the shipping of
goods purchased through eBay auctions, an agreement to allow MBNA to use eBay's name
on a credit card, and an agreement in an online auction company in Korea that is
supplemented with an investment by eBay in the Korean partner. In addition, at one time
eBay had formed an independent firm, called eBay Australia and New Zealand, with an
Australian company known as ecorp.

eBay's agreement with the U.S. Postal Service is most accurately classified as a(n)
A) joint venture.
B) equity agreement.
C) licensing agreement.
D) nonequity agreement.
Answer: D

eBay's agreement with MBNA is most accurately characterized as a(n)

A) supply agreement.
B) licensing agreement.
C) equity alliance.
D) joint venture.
Answer: B

eBay's agreement with the Korean online auction company is best characterized as a(n)
A) licensing agreement.
B) joint venture.
C) equity alliance.
D) distribution agreement.
Answer: C

eBay's former agreement with ecorp is best characterized as a(n)

A) joint venture.
B) equity alliance.
C) licensing agreement.
D) nonequity alliance.
Answer: A

Define a strategic alliance and identify and differentiate between three broad categories of
strategic alliances.
Answer:
A strategic alliance exists whenever two or more independent organizations cooperate
in the development, manufacture, or sale of products or services. The three broad
categories of alliances include nonequity alliances, joint ventures and equity alliances.
In a nonequity 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. Rather, these cooperative relations are managed through the use of various
forms of contracts. In an equity alliance, cooperating firms supplement contracts with
equity holdings in alliance partners. In a joint venture, cooperating firms create a
legally independent firm in which they invest and from which they share any profits
that are created.

Identify and discuss the three ways alliances can create economic value by helping firms
improve the performance of their current operations.
Answer:
One way that firms can use strategic alliances to improve their current operations is to
use alliances to realize economies of scale. To realize economies of scale, firms have
to have a large volume of production, or at least a volume of production large enough
so that the cost advantages associated with scale can be realized. When a firm cannot
realize the cost savings from economies of scale all by itself, it may join in a strategic
alliance with other firms. Jointly, these firms may have sufficient volume to be able to
gain the cost advantages of economies of scale.

Firms can also use alliances to improve their current operations by learning from their
competitors. Different firms in an industry may have different resources and
capabilities and these resources can give some firms competitive advantages over
other firms. Firms that are at a competitive disadvantage may want to form alliances
with the firms that have an advantage in order to learn about their resources and
capabilities.
Finally, firms can use alliances to improve their current operations through sharing
costs and risks. This is especially valuable when the future state of the environment or
the growth rate of the industry is uncertain.

Identify the conditions under which a strategic alliance can be rare and discuss the role that
complementary resources can play in the rarity of strategic alliances.
Answer:
The rarity of strategic alliances depends both on the number of competing firms that
have already implemented an alliance and whether or not the benefits that firms obtain
from their alliances are not common across firms competing in an industry. One of the
reasons why the benefits that accrue from a particular strategic alliance may be rare is
that relatively few firms may have the complementary resources and abilities needed
to form an alliance. This is particularly likely when an alliance is formed to enter into a
new market and especially a new foreign market. In many less developed economies,
only one local firm or a very few local firms may exist with the local knowledge,
contacts, and distribution network needed to facilitate entry into that market.
Moreover, sometimes the government acts to limit the number of these local firms.
Although several firms may seek entry into this market, only a very small number will
be able to form a strategic alliance with the local entity and therefore the benefits that
accrue to the allied firms will likely be rare.

Discuss when strategic alliances may be costly to directly duplicate.

Answer:
To the extent that a strategic alliance goes well beyond simple legal contracts and is
characterized by socially complex phenomena such as a trusting relationship between
alliance partners, friendship, and even (perhaps) a willingness to suspend narrow self-
interest for the longer-term good of the relationship, it will be costly for other firms to
directly duplicate. Additionally, to the extent that the organizational and relationship-
building skills required for successful alliance building are rare among a set of
competing firms and costly to develop, strategic alliances will be costly to duplicate
and firms that are able to exploit these abilities by creating alliances may gain
competitive advantages.

One reason why firms might want to pursue a strategic alliance strategy is to exploit
economies of scale. Exploiting economies of scale should reduce a firm’s costs. Does this
mean that a firm pursuing an alliance strategy to exploit economies of scale is actually
pursuing a cost leadership strategy? Why or why not?
Answer:
Not necessarily. While the objective of a cost leader is to lower its cost structure
through economies of scale, a firm pursuing a strategy of differentiation may also be
interested in economies of scale. If there is a certain activity (say distribution) which
is less important to the differentiator in terms of its competitive advantage, it would
seek to minimize its distribution costs. In other words, for such a company
distribution is necessary but not a source of competitive advantage. Utilizing
economies of scale (through an alliance) helps minimize the cost of this activity.

Consider the joint venture between General Motors and Toyota. GM has been interested in
learning how to profitably manufacture high-quality small cars from its alliance with Toyota.
Toyota has been interested in gaining access to GM’s U.S. distribution network and in
reducing the political liability associated with local content laws. Which of these firms do you
think is more likely to accomplish its objectives, and why? What implications, if any, does
your answer have for a “learning race” in this alliance?
Answer:
Toyota is more likely to achieve its objectives simply because what it is trying to learn
is easier than what GM is trying to learn. Accessing GM’s U.S. network and adhering
to local content laws are far more easy to learn than complex manufacturing
processes. GM has the bigger challenge because Toyota’s manufacturing expertise (in
small cars) may consist of various tangible and intangible factors, some of which may
take tremendous amounts of time to absorb. Also, since both companies are
competitors, they are engaged in a “learning race.” Each, in a way, is motivated to
slow the other down. Which aspect is easier to slow down – manufacturing
techniques or distribution structure? Arguably, it is manufacturing techniques
because Toyota can “choose” to keep hidden certain nuances of its production
technology. Distribution is more visible and therefore may be harder to slow down.

Some have argued that alliances can be used to help firms evaluate the economic potential
of entering into a new industry or market. Under what conditions will a firm seeking to
evaluate these opportunities need to invest in an alliance to accomplish this evaluation?
Why couldn’t such a firm simply hire some smart managers, consultants, and industry
experts to evaluate the economic potential of entering into a new industry? What, if anything,
about an alliance makes this a better way to evaluate entry opportunities than alternatives?
Answer:
Strategic alliances are attractive from a learning perspective. By entering into a
strategic alliance for, say, international market entry, the firm is evaluating the
attractiveness of the new market and learning how to succeed in that new market.
This learning opportunity is absent when the firm hires consultants to do the
evaluation. The second major advantage of strategic alliances in this context is that
alliances are options that allow a firm to pursue future opportunities. The real options
approach considers what are called “embedded” options – options embedded in
certain options. An alliance agreement that allows the firm to buy out its partner is an
example of a real option. This way, the firm can evaluate the market potential and if it
is a very attractive market, the firm then has the option to buy out the partner. These
avenues are not open when consultants are used.

Mergers & Acquisitions

While mergers typically begin as a transaction between equals, that is, between firms of
equal size and profitability, they often evolve after a merger such that one firm is more
dominant in the management of the merged firm than the other.
Answer: TRUE

In all acquisitions bidding, firms will be willing to pay a price for a target up to the value that
the firm adds to the bidder once it is acquired.
Answer: TRUE
If there is any hope that mergers and acquisitions will be a source of superior performance
for bidding firms, it must be because of some sort of strategic relatedness between bidding
and target firms.
Answer: TRUE

In a product extension merger, a firm acquires complementary products through merger and
acquisition activities.
Answer: TRUE

To be economically valuable, links between bidding and target firms must meet the same
criteria as diversification strategies.
Answer: TRUE

If bidding and target firms are strategically related, then the economic value of these two
firms combined is greater than their economic value as separate entities.
Answer: TRUE

Firms should pursue merger and acquisition strategies only to obtain valuable economies of
scope that outside investors find too costly to create on their own.
Answer: TRUE

The existence of strategic relatedness between bidding and target firms is sufficient for the
equity holders of bidding firms to earn economic profits from their acquisition strategies.
Answer: FALSE

Perhaps the most significant challenge in integrating bidding and target firms has to do with
cultural differences.
Answer: TRUE

Operational, functional, strategic, and cultural differences between bidding and target firms
can all be compounded by the merger and acquisition process especially if that process
was unfriendly.
Answer: TRUE

Unfriendly takeovers can generate anger and animosity among the target firm management
that is directed toward the management of the bidding firm.
Answer: TRUE
When one firm acquires a(n) ________ of another firm, it has acquired enough of that firm's
assets so that the acquiring firm is able to make all the management and strategic decisions
in the target firm.
A) market stake
B) equity share
C) controlling share
D) equity stake
Answer: C

The difference between the current market price of a target firm's shares and the price a
potential acquirer offers to pay for those shares is known as an
A) acquisition premium.
B) acquisition discount.
C) acquisition margin.
D) acquisition price.
Answer: A

When Sears and Kmart, two retail firms of relatively equal size in the United States, agreed
to combine their assets, this was an example of a(n)
A) joint venture.
B) acquisition.
C) merger.
D) equity agreement.
Answer: C

In an unrelated acquisition, if 5 firms are interested in acquiring a firm and each of the
bidding firms had a current market value of $30,000 while the current market value of the
target firm is $20,000, this acquisition is likely to generate economic profits of ________ for
the acquiring firm.
A) $10,000
B) $20,000
C) $50,000
D) $0.00
Answer: D

If an electronics manufacturer were to acquire a chain of retail electronic stores to sell its
products, this would be an example of a ________ merger.
A) vertical
B) horizontal
C) market extension
D) product extension
Answer: A

If eBay were to acquire a smaller online auction company, this would be an example of a
________ merger.
A) conglomerate
B) vertical
C) market extension
D) horizontal
Answer: D

When eBay acquired Baaze.com, an Indian auction firm, in order to enter the Indian online
auction market, this was an example of a ________ merger.
A) product extension
B) market extension
C) conglomerate
D) vertical
Answer: B

In a related acquisition, if there is one target firm and ten bidding firms, and the value of each
of the bidding firms as a stand-alone entity is $50,000 and the value of the target firm as a
stand-alone entity is $30,000, the market value of the combined entity will be
A) $0.00.
B) less than $80,000.
C) $80,000.
D) more than $80,000.
Answer: D

) Managers of bidding firms continue to engage in merger or acquisition strategies even

though they usually do not generate profits for bidding firms in order to
A) ensure survival.
B) generate free cash flow.
C) reduce agency problems.
D) reduce managerial hubris.
Answer: A

Which of the following actions should bidding firm managers take to help earn superior
performance in an acquisition strategy?
A) Share information with other bidders.
B) Delay the closing of the deal.
C) Avoid winning bidding wars.
D) Operate in competitive acquisition markets.
Answer: C

To ensure that the owners of target firms appropriate whatever value is created by a merger
or acquisition, managers in these target firms should
A) create a thinly traded market for their firm.
B) seek information from bidders.
C) close the acquisition deal quickly.
D) limit the number of bidders involved in the bidding competition.
Answer: B
The most significant challenge in integrating bidding and target firms has to do with
A) accounting differences.
B) cultural differences.
C) operational differences.
D) logistic differences.
Answer: B

P&G is a leading consumer goods company in the United States that has grown its business
through a combination of international growth, alliances, acquisitions and mergers. In 2003,
P&G acquired the beauty care company Wella to acquire products that would complement its
current product. In 2004, P&G acquired AG-Hutchison Ltd to establish a stronger presence in
the Chinese consumer goods products market. In 2005, P&G acquired Gillette, another
consumer goods company, in a deal worth approximately $57 billion dollars.

If P&G's bid for Gillette was invited by Gillette's management, this would be an example of a
A) hostile acquisition.
B) joint venture.
C) friendly acquisition.
D) merger.
Answer: C

If Gillette's total market value on the day the deal was announced was $48.30 billion, P&G's
$57 billion offer would represent a(n)
A) 18% acquisition premium.
B) 82% acquisition discount.
C) 82% acquisition premium.
D) 18% acquisition discount.
Answer: A

Since both P&G and Gillette are consumer products firms, this acquisition is best described
as a
A) vertical merger.
B) horizontal merger.
C) market extension merger.
D) conglomerate merger.
Answer: B

P&G's acquisition of Wella in 2003 is an example of a

A) market extension merger.
B) conglomerate merger.
C) vertical merger.
D) product extension merger.
Answer: D

P&G's purchase of AG-Hutchison Ltd in 2004 is an example of a

A) conglomerate merger.
B) vertical merger.
C) market extension merger.
D) conglomerate acquisition.
Answer: C

If Gillette's managers wanted to maximize the value that Gillette received from its acquisition
by P&G, they should
A) seek information from P&G about the value that P&G will receive from its acquisition of
Gillette.
B) not engage in negotiations with any bidder but P&G.
C) close the acquisition as quickly as possible.
D) stop the acquisition.
Answer: A

The most significant challenge P&G is likely to face in integrating each of the acquired
companies into P&G's operations is likely to be ________ differences between P&G and
each of the companies.
A) logistical
B) cultural
C) operational
D) distribution
Answer: B

Discuss the differences between mergers and acquisitions and differentiate between friendly
and unfriendly acquisitions.
Answer:
A firm engages in an acquisition when it purchases a second firm. An acquiring firm
can use cash it has generated from its ongoing businesses to purchase a target firm,
it can go into debt to purchase a target firm, it can use its own equity to purchase a
target firm, or it can use a mix of these mechanisms to purchase a target firm. Also, an
acquiring firm can purchase all of a target firm's assets, it can purchase a majority of
those assets (greater than 51%), or it can purchase a controlling share of those assets
(i.e., enough assets so that the acquiring firm is able to make all the management and
strategic decisions in the target firm). Acquisitions can be friendly (when the
management of the target firm wants to be acquired) or unfriendly (when the
management of the target firm does not want to be acquired). Some unfriendly
acquisitions are also known as hostile takeovers. When the assets of two similar-sized
firms are combined, this transaction is called a merger.

If there are five bidders (each of which has a current market value of $50,000) interested in a
target firm that has no strategic relatedness with any of the bidding firms and has a current
market value of $25,000, identify the economic profits that will be earned by both the bidding
firm's equity holders and the target firm's equity holders and discuss this case.
Answer:
The economic value created for both the target firm and the bidding firm will be zero.
The value for the bidding firm will be zero because the value of any one of the bidding
firms when combined with the target firm exactly equals the sum of the value of these
firms as separate entities. The price of this acquisition will quickly rise to $25,000
because any bid less than $25,000 will generate economic profits for a successful
bidder that will, in turn, generate entry into a bidding war for a target. Therefore, the
price will quickly rise to its value, and economic profits will not be created. Alternately,
the target firm's equity holders will also gain zero economic profits since the market
value of the target firm has not been increased it has only been capitalized in the
form of a cash payment from the bidder to the target. The target was worth $25,000
and that is exactly what these equity holders will receive.
Identify and discuss six rules that firms bidding on a target firm in an acquisition should follow
to increase the possibility that an acquisition strategy will earn superior performance.
Answer: In pursuing an acquisition, there are six rules that firms bidding on a target firm
should follow to increase the possibility that the target firm will earn superior performance.
Answer:

• Search for valuable and rare economies of scope. Bidding firms should seek to
acquire targets with which they enjoy valuable and rare linkages. Operationally, the
search for rare economies of scope suggests that managers in bidding firms need to
consider not only the value of a target firm when combined with their own company,
but also the value of a target firm when combined with other potential bidders. This is
important because it is the difference between the value of a particular bidding firm's
relationship with a target and the value of other bidding firms' relationships with that
target that defines the size of the potential economic profits from an acquisition.

• Keep information away from bidders. One of the keys to earning superior
performance in an acquisition strategy is to avoid multiple bidders for a single target.
One way to accomplish this is to keep information about the bidding process, and
about the sources of economies of scope between a bidder and target that underlie
this bidding process, as private as possible.

• Keep information away from targets. Unless it is illegal to do so, bidding firms must
not fully reveal the value of their economies of scope with a target firm.

• Avoid winning bidding wars. If a number of firms bid for the same target, the
probability that the firm that successfully acquires the target will gain competitive
advantages is very low. Therefore, it is to a bidding firm's advantage to avoid a
bidding war.

• Close the deal quickly. All the economic processes that make it difficult for bidding
firms to earn economic profits from acquiring a strategically related target take time to
unfold. It takes time for other bidders to become aware of the economic value
associated with acquiring a target; it takes time for the target to recruit other bidders;
information leakage becomes more of a problem over time; and so forth. A bidding
firm that begins and ends the bidding process quickly may forestall some of these
processes and thereby retain some superior performance for itself from an
acquisition.

• Operate in thinly traded acquisitions markets. A thinly traded market is a market

where there is only a small number of buyers and sellers, where information about
opportunities in this market is not widely known, and where interests besides purely
maximizing the value of a firm can be important. In the context of mergers and
acquisitions, thinly traded markets are markets where only a few (often only one) firms
are implementing acquisition strategies. These unique firms may be the only firms that
understand the full value of the acquisition opportunities in this market. Even target
firm managers may not fully understand the value of the economic opportunities in
these markets, and even if they do, they may have other interests besides maximizing
the value of their firm if it becomes the object of a takeover.

Identify and discuss the three rules that target firm managers should follow to maximize the
probability of earning economic profits from their merger and acquisition strategies.
Answer:
• Seek information from bidders. Target firms must inform themselves about the
resources and capabilities of current and potential bidders. In this way, target firms
can become fully aware of the value that they hold for bidders, and they are more
likely to be able to extract this full value in the acquisition process.

• Invite other bidders to join the bidding competition. Once a target firm is fully aware
of the nature and value of the economies of scope that exist between it and current
bidding firms, it can exploit this information by seeking other firms that may have the
same relationship with it and then informing these firms of a potential acquisition
opportunity. By inviting other firms into the bidding process, the target firm increases
the competitiveness of the market for corporate control, thereby increasing the
probability that the value by an acquisition will be fully captured by the target firm.

• Delay but do not stop the acquisition. To increase the probability of receiving more
than one bid, target firms have a strong incentive to delay an acquisition. The
objective, however, should be to delay an acquisition to create a more competitive
market for corporate control, not to stop an acquisition.