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21
Question: When does a business put itself up for sale? Answer: When it is unable to adapt to changing competitive conditions. That
is exactly what the second largest US supermarket chain, Safeway, did in early 2014. Beset by slowing industry-wide sales and a
daunting array of emerging rivals, the firm sought to improve its competitive position by combining with another supermarket
chain. Supermarket chain competitors include “big-box” retailers such as Walmart and Target, warehouse stores such as Costco,
specialty chains, drug stores, and discount “dollar” stores. These new and often more aggressive competitors have eroded US
supermarket and grocery store sales in recent years. Such sales grew a meager 0.4% to $531.4 billion in 2013, before declining by
1% in 2014 according to IBISWorld Inc.
Safeway’s decision is the continuation of a longer term trend in the industry toward consolidation which has accelerated in
recent years. Kroger Co., the largest US supermarket chain, snapped up regional chain Harris Teeter in 2013. Also in 2013, an
investor group led by private equity partnership Cerberus Capital Management acquired from SuperValu the remaining
Albertsons’s stores it did not already own as well as Acme Markets, Jewel-Osco, Shaw’s and Star Markets brands. Most of
Albertsons’s operations had been acquired by Cerberus, CVS Pharmacy, and SuperValu Stores in 2006.
Despite efforts to streamline operations by divesting some of its smaller less profitable units including its Canadian operations
and Dominick’s stores in Chicago, Safeway was unable to materially improve its profitability. The outlook for the firm appeared
grim. With modest excess cash flow and borrowing capacity, the firm’s strategic options were limited. Achieving more rapid
growth by substantially updating its stores and by expanding regionally seemed out of the question. Following a review of its
remaining options including more aggressively downsizing its operations, the firm’s board concluded that selling the firm to a
strategic buyer would make the most sense. The most attractive strategic buyer would be one with “deep pockets,” a willingness to
invest in the firm, and whose existing operations were sufficiently similar to offer the prospect of substantial synergies.
With this in mind, Safeway agreed to be acquired by Cerberus Capital Management in a deal valued at $9.4 billion, assuming
fully diluted shares outstanding of 235 million (i.e., common shares plus all securities that can be converted into common shares).
Safeway shareholders received $40 per share, consisting of $32.50 per share in cash, stock valued at $3.95 per share in Safeway’s
gift card unit Blackhawk Network Holdings, and $3.55 contingent on the sale of certain assets. The offer price represented a 17%
premium over Safeway’s stock price on February 18, 2014, the day before Safeway announced that it was in discussions with an
undisclosed bidder. The deal also included a go shop provision allowing Safeway to look for potential bidders for up to 21 days
and a sizeable breakup fee payable to Cerberus if Safeway chose another bid. The fee escalated from $150 million for bids that
surfaced within the 21 day period to $250 million for bids submitted after that date.
Kroger expressed interest in buying Safeway early in 2014. However, the substantial increase in industry concentration
resulting from combining Kroger and Safeway made this option unlikely to be acceptable to the regulators. Furthermore, Kroger
was busy integrating its acquisition of the Harris Teeter supermarket chain. Without any serious alternative buyers, the transaction
closed in late 2014. Despite the combination of Albertsons and Safeway, Kroger will remain the industry leader with 2,640
supermarkets, 735 convenience stores, 320 jewelry stores, and 38 food processing plants and annual revenue of almost $100
million.
The deal brings Safeway and Albertsons under the same corporate ownership; and, as such, it offers opportunities for cost
savings from shared overhead and better utilization of distribution centers and manufacturing facilities. Bob Miller, the current
CEO of Albertsons was named the Executive Chairman of the combined businesses, with Robert Edwards, Safeway’s then
president and CEO, becoming the President and CEO of the combined firms. The deal creates a network of 2,400 stores in 24
states and the District of Columbia employing more than 250,000 people. The combined firms also operate 27 distribution
facilities and 20 manufacturing plants. While the two chains have stores across the country, the deal creates a dominant West Coast
combination and significantly improves their East Coast coverage.
The motivation for the deal is to cut costs and to become more responsive to customer demands by refurbishing some stores and
by expanding the combined firms’ product offering. The deal was the largest leveraged buyout in 2014, reflecting the availability
of cheap financing. The deal was financed using $7.6 billion in new borrowing. Sensitive to the negative press associated with a
previous buyout of Safeway 20 years earlier, Cerberus was quick to note that there were no planned layoffs.
HP Implements a Transformational Strategy, Again and Again
_______________________________________________________________________________________________________
22
Key Points
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.9
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.
Discussion Questions
1. Discuss the advantages and disadvantages of fully integrating business units within a parent firm? Be specific.
2. 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.
3. Discuss the strategic advantages and disadvantages of diversified versus relatively focused firms? Be specific.
24
4. To what do you attribute the inconsistent and incoherent strategic flip-flops at Hewlett-Packard during the last decade? Be
specific.
Years in the Making: Kinder Morgan Opportunistically Buys El Paso Corp. for $20.7 Billion
______________________________________________________________________________________________________
Key Points
Companies often hold informal merger talks for protracted periods until conditions emerge that are satisfactory to both parties.
Capital requirements and regulatory hurdles often make buying another firm more attractive than attempting to build the other
firm’s capabilities independently.
______________________________________________________________________________________________________
Using a combination of advanced horizontal drilling techniques and hydraulic fracturing, or “fracking” (i.e., shooting water and
chemicals deep underground to blast open gas-bearing rocks), U.S. natural gas production has surged in recent years. As a result,
proven gas reserves have soared such that the Federal Energy Information Administration estimates that the overall supplies of
natural gas would last more than 100 years at current consumption rates. But surging supplies have pushed natural gas prices to $4
per million BTUs down from a peak of $13 in July 2008. Despite the depressed prices, energy companies around the globe have
rushed to enter the business of producing shale gas. With energy prices depressed, independent players are struggling to find
financing for their projects, prompting larger competitors to engage in buyouts. Exxon acquired XTO Energy in 2009, and
Chesapeake Energy sold a partial stake in its shale gas reserves to Chinese companies for billions of dollars. In 2011 alone, oil and
gas firms announced $172 billion worth of acquisitions in the continental United States, accounting for about two-thirds of the
$261 billion spent on oil and gas acquisitions worldwide.
The increase in energy supplies has strained current pipeline capacity in the United States. Today more than 50 pipeline
companies transport oil and gas through networks that do not necessarily transport the fuel where it is needed from where it is
being produced. For example, pipeline construction in the Marcellus shale field in Pennsylvania has not kept pace with drilling
activity there, limiting the amount of gas that can be sent to the northeast. In the Bakken field in North Dakota, producers are
shipping much of their new oil production by train to west coast refineries, and excess gas is being burned off. In the meantime,
new oil and gas fields are being developed in Ohio, Kansas, Oklahoma, Texas, and Colorado. According to the Interstate Natural
Gas Association of America Foundation, a trade group, pipeline companies are expected to have to build 36,000 miles of large-
diameter, high-pressure natural gas pipelines by 2035 to meet market demands, at a cost of $178 billion.
Responding to these developments, on October 17, 2011, Kinder Morgan (Kinder) agreed to buy the El Paso Corporation (El
Paso) for $21.1 billion in cash and stock. Including the assumption of debt owed by El Paso and an affiliated business, El Paso
Pipeline Partners, the takeover is valued at about $38 billion. This represents the largest energy deal since Exxon Mobil bought
XTO Energy in late 2009.
Kinder Morgan’s stock had been declining throughout 2011, and the firm was looking for a way to jumpstart earnings growth.
The acquisition offers Kinder both the scale and the geographic disposition of pipelines necessary to support the burgeoning
supply of shale gas and oil supplies. The acquisition makes Kinder the largest independent transporter of gasoline, diesel, and other
petroleum products in the United States. It will also be the largest independent owner and operator of petroleum storage terminals
and the largest transporter of carbon dioxide in the United States. The combined firms will operate the only oil sands pipeline to
the west coast. To attempt to replicate the El Paso pipeline network would have been time consuming, required large amounts of
capital, and faced huge regulatory hurdles.
Kinder will own or operate about 67,000 miles of the more than 500,000 miles of oil and gas pipelines stretching across the
United States.10 Kinder’s pipelines in the Rocky Mountains, the Midwest, and Texas will be woven together with El Paso’s
expansive network that spreads east from the Gulf Coat to New England and to the west through New Mexico, Arizona, Nevada,
and California. In buying El Paso, Kinder creates a unified network of interstate pipelines. By increasing its dependence on
utilities, Kinder will reduce its exposure to the more volatile industry end user market. The acquisition also offers significant cost-
cutting opportunities resulting from reconfiguring existing pipeline networks.
Kinder paid 14 times El Paso’s last 12 months’ earnings before interest, taxes, depreciation, and amortization of $2.67 billion.
Investors applauded the deal by boosting Kinder’s stock by 4.8% to $28.19 on the announcement date. El Paso shares climbed
25% to $24.81. For each share of El Paso, Kinder paid $14.65 in cash, .4187 of a Kinder share, and .640 of a warrant entitling the
bearer to buy more Kinder shares at a predetermined price. The purchase price at closing valued the deal at $26.87 per El Paso
share and constituted a 47% premium to El Paso 20-day average price prior to the announcement. Kinder’s debt will increase to
$14.5 billion from $3.2 billion after the acquisition. To help pay for the deal, Kinder is seeking a buyer for El Paso’s exploration
business. The combined firms will be called Kinder Morgan. Richard D. Kinder, the founder of Kinder Morgan, will be the
chairman and CEO.
The proposed takeover was not approved by regulators until May 2, 2012, on the condition that Kinder Morgan agree to sell
three U.S. natural gas pipelines. The deal represents the culmination of years of discussion between Kinder Morgan and El Paso.
Kinder, which went private in 2006 in a transaction valued at $22 billion, reemerged in an IPO in February 2011, raising nearly
$2.9 billion. The IPO made the deal possible. While Kinder had for years held talks with El Paso’s management about a merger, it
needed the “currency” of a publicly traded stock to complete such a deal. El Paso shareholders wanted to be able to participate in
any future appreciation of the Kinder Morgan shares. Whether the combination of these two firms makes sense depends on the
magnitude and timing of the expected resurgence in natural gas prices and the acceptability of shale gas and “fracking” to the
regulators.
Discussion Questions
1. Who are Kinder Morgan’s customers and what are their needs?
2. What factors external to Kinder Morgan and El Paso seemed to drive the transaction? Be specific.
3. What factors internal to Kinder Morgan and El Paso seemed to be driving the transaction? Be specific.
4. How would the combined firms be able to better satisfy these needs than the competition?
26
From a Social Media Darling
to an Afterthought—The Demise of Myspace
_____________________________________________________________________________________
Key Points
It is critical to understand a firm’s competitive edge and what it takes to sustain it.
Sustaining a competitive advantage in a fast-moving market requires ongoing investment and nimble and creative decision
making.
In the end, Myspace appears to have had neither.
______________________________________________________________________________
A pioneer in social networking, Myspace started in 2003 and reached its peak in popularity in December 2008. According to
ComScore, Myspace attracted 75.9 million monthly unique visitors in the United States that month. It was more than just a social
network; it was viewed by many as a portal where people discovered new friends and music and movies. Its annual revenue in
2009 was reportedly more than $470 million.
Myspace captured the imagination of media star, Rupert Murdoch, founder and CEO of media conglomerate News Corp. News
Corp seemed to view the firm as the cornerstone of its social networking strategy, in which it would sell content to users of social
networking sites. To catapult News Corp into the world of social networking, Murdock acquired Myspace and its parent firm,
Intermix, in 2007 for an estimated $580 million. But News Corp’s timing could not have been worse. Between mid-2009 and mid-
2011, Myspace was losing more than 1 million visitors monthly, with unique visitors in May 2011 about one-half of their previous
December 2008 peak. Advertising revenue swooned to $184 million in 2011, about 40% of its 2009 level.11
In the wake of Myspace’s deteriorating financial performance, News Corp initiated a search for a buyer in early 2011. The
initial asking price was $100 million. Despite a flurry of interest in social media businesses such as LinkedIn and Groupon, there
was little interest in buying Myspace. In an act of desperation, News Corp sold Myspace to Specific Media, an advertising firm,
for only $35 million in mid-2011 as the value of the MySpace brand plummeted.
What happened to cause Myspace to fall from grace so rapidly? A range of missteps befuddled Myspace, including a flawed
business strategy, mismanagement, and underinvestment. Myspace may also have been a victim of fast-moving technology, fickle
popular culture, and the hubris that comes with rapid early success. What appeared to be an unimaginative strategy and
underinvestment left the social media field wide open for new entrants, such as Facebook. Myspace may also have suffered from
waning interest from News Corp’s top management. As consumer interest in Myspace declined, News Corp turned its attention to
its acquisition of the Wall Street Journal. Culture clash also may have been a problem when News Corp, a large, highly structured
media firm, tried to absorb the brassy startup. With a big company, there are more meetings, more reporting relationships, more
routine, and more monitoring by senior management of the parent firm. Myspace managers’ attention was often diverted in an
effort to create synergy with other News Corp businesses.
In the new era of social media, the rapid rise and fall of Myspace illustrates the ever-decreasing life cycle of such businesses.
When News Corp bought Myspace, it was a thriving online social networking business. Facebook was still contained primarily on
college campuses. However, it was not long before Facebook, with its smooth interface and broader offering of online services, far
outpaced Myspace in terms of monthly visitors. Myspace, like so many other Internet startups, had its “fifteen minutes of fame.”
Adobe’s Acquisition of Omniture: Field of Dreams Marketing?
On September 14, 2009, Adobe announced its acquisition of Omniture for $1.8 billion in cash or $21.50 per share. Adobe CEO
Shantanu Narayen announced that the firm was pushing into new business at a time when customers were scaling back on
11 Gillette, Bloomberg BusinessWeek, July 3, 2011, pp. 54–57.
27
purchases of the company’s design software. Omniture would give Adobe a steady source of revenue and may mean investors
would focus less on Adobe’s ability to migrate its customers to product upgrades such as Adobe Creative Suite.
Adobe’s business strategy is to develop a new line of software that was compatible with Microsoft applications. As the world’s
largest developer of design software, Adobe licenses such software as Flash, Acrobat, Photoshop, and Creative Suite to website
developers. Revenues grow as a result of increased market penetration and inducing current customers to upgrade to newer
versions of the design software.
In recent years, a business model has emerged in which customers can “rent” software applications for a specific time period by
directly accessing the vendors’ servers online or downloading the software to the customer’s site. Moreover, software users have
shown a tendency to buy from vendors with multiple product offerings to achieve better product compatibility.
Omniture makes software designed to track the performance of websites and online advertising campaigns. Specifically, its
Web analytic software allows its customers to measure the effectiveness of Adobe’s content creation software. Advertising
agencies and media companies use Omniture’s software to analyze how consumers use websites. It competes with Google and
other smaller participants. Omniture charges customers fees based on monthly website traffic, so sales are somewhat less sensitive
than Adobe’s. When the economy slows, Adobe has to rely on squeezing more revenue from existing customers. Omniture
benefits from the takeover by gaining access to Adobe customers in different geographic areas and more capital for future product
development. With annual revenues of more than $3 billion, Adobe is almost ten times the size of Omniture.
Immediately following the announcement, Adobe’s stock fell 5.6 percent to $33.62, after having gained about 67 percent since
the beginning of 2009. In contrast, Omniture shares jumped 25 percent to $21.63, slightly above the offer price of $21.50 per
share. While Omniture’s share price move reflected the significant premium of the offer price over the firm’s preannouncement
share price, the extent to which investors punished Adobe reflected widespread unease with the transaction.
Investors seem to be questioning the price paid for Omniture, whether the acquisition would actually accelerate and sustain
revenue growth, the impact on the future cyclicality of the combined businesses, the ability to effectively integrate the two firms,
and the potential profitability of future revenue growth. Each of these factors is considered next.
Adobe paid 18 times projected 2010 earnings before interest, taxes, depreciation, and amortization, a proxy for operating cash
flow. Considering that other Web acquisitions were taking place at much lower multiples, investors reasoned that Adobe had little
margin for error. If all went according to plan, the firm would earn an appropriate return on its investment. However, the
likelihood of any plan being executed flawlessly is problematic.
Adobe anticipates that the acquisition will expand its addressable market and growth potential. Adobe anticipates significant
cross-selling opportunities in which Omniture products can be sold to Adobe customers. With its much larger customer base, this
could represent a substantial new outlet for Omniture products. The presumption is that by combining the two firms, Adobe will be
able to deliver more value to its customers. Adobe plans to merge its programs that create content for websites with Omniture’s
technology. For designers, developers, and online marketers, Adobe believes that integrated development software will streamline
the creation and delivery of relevant content and applications.
The size of the market for such software is difficult to gauge. Not all of Adobe’s customers will require the additional
functionality that would be offered. Google Analytic Services, offered free of charge, has put significant pressure on Omniture’s
earnings. However, firms with large advertising budgets are less likely to rely on the viability of free analytic services.
Adobe also is attempting to diversify into less cyclical businesses. However, both Adobe and Omniture are impacted by
fluctuations in the volume of retail spending. Less retail spending implies fewer new websites and upgrades to existing websites,
which directly impacts Adobe’s design software business, and less advertising and retail activity on electronic commerce sites
negatively impacts Omniture’s revenues. Omniture receives fees based on the volume of activity on a customer’s site.
Integrating the Omniture measurement capabilities into Adobe software design products and cross-selling Omniture products
into the Adobe customer base require excellent coordination and cooperation between Adobe and Omniture managers and
employees. Achieving such cooperation often is a major undertaking, especially when the Omniture shareholders, many of whom
were employees, were paid in cash. The use of Adobe stock would have given them additional impetus to achieve these synergies
in order to boost the value of their shares.
Achieving cooperation may be slowed by the lack of organizational integration of Omniture into Adobe. Omniture will become
a new business unit within Adobe, with Omniture’s CEO, Josh James, joining Adobe as a senior vice president of the new business
unit. He will report to Narayen. This arrangement may have been made to preserve Omniture’s corporate culture.
28
Adobe is betting that the potential increase in revenues will grow profits of the combined firms despite Omniture’s lower
margins. Whether the acquisition will contribute to overall profit growth depends on which products contribute to future revenue
growth. The lower margins associated with Omniture’s products would slow overall profit growth if the future growth in revenue
came largely from Omniture’s Web analytic products.
Discussion Questions:
1. Who are Adobe’s and Omniture’s customers and what are their needs?
2. What factors external to Adobe and Omniture seem to be driving the transaction? Be specific.
3. What factors internal to Adobe and Omniture seem to be driving the transaction? Be specific.
4. How would the combined firms be able to better satisfy these needs than the competition?
5. Do you believe the transaction can be justified based on your understanding of the strengths and weaknesses of the two
firms and perceived opportunities and threats to the two firms in the marketplace? Be specific.
CenturyTel Buys Qwest Communications to Cut Costs and Buy Time
as the Landline Market Shrinks
Key Points:
• Market segmentation can be used to identify “underserved” segments which may sustain firms whose competitive
position in larger markets is weak.
• A firm’s competitive relative is best viewed in comparison to those firms competing in its served market rather than with
industry leading firms.
____________________________________________________________________________________________
In what could best be described as a defensive acquisition, CenturyTel, the fifth largest local phone company in the United States,
acquired Qwest Communications, the country’s third largest, in mid-2010 in a stock swap valued at $10.6 billion. While both firms
29
are dwarfed in size by AT&T and Verizon, these second-tier telecommunications firms will control a larger share of the shrinking
landline market.
The combined firms will have about 17 million phone lines serving customers in 37 states. This compares to AT&T and
Verizon with about 46 and 32 million landline customers, respectively. The deal would enable the firms to reduce expenses in the
wake of the annual 10 percent decline in landline usage as people switch from landlines to wireless and cable connections.
Expected annual cost savings total $575 million; additional revenue could come from upgrading Qwest’s landlines to handle DSL
Internet.
In 2010, about one-fourth of U.S. homes used only cell phones, and cable behemoth Comcast, with 7.6 million residential and
business phone subscribers, ranked as the nation’s fourth largest landline provider. CenturyTel has no intention of moving into the
wireless and cable markets, which are maturing rapidly and are highly competitive.
While neither Qwest nor CenturyTel owns wireless networks and therefore cannot offset the decline in landline customers as
AT&T and Verizon are attempting to do, the combined firms are expected to thrive in rural areas where they have extensive
coverage. In such geographic areas, broadband cable Internet access and fiber-optics data transmission line coverage are is limited.
The lack of fast cable and fiber-optics transmission makes voice over Internet protocol (VOIP)—Internet phone service offered by
cable companies and independent firms such as Vonage—unavailable. Consequently, customers are forced to use landlines if they
want a home phone. Furthermore, customers in these areas must use landlines to gain access to the Internet through dial-up access
or through a digital subscriber line (DSL).
Discussion Questions
1. How would you describe CenturyTel’s business strategy? Be specific.
2. Describe the key factors both external and internal to the firm that you believe are driving this strategy.
3. Why might the acquisition of Qwest be described as defensive?
Oracle Continues Its Efforts to Consolidate the Software Industry
Oracle CEO Larry Ellison continued his effort to implement his software industry strategy when he announced the acquisition of
Siebel Systems Inc. for $5.85 billion in stock and cash on September 13, 2005. The global software industry includes hundreds of
firms. During the first nine months of 2005, Oracle had closed seven acquisitions, including its recently completed $10.6 billion
hostile takeover of PeopleSoft. In each case, Oracle realized substantial cost savings by terminating duplicate employees and
related overhead expenses. The Siebel acquisition accelerates the drive by Oracle to overtake SAP as the world's largest maker of
business applications software, which automates a wide range of administrative tasks. The consolidation strategy seeks to add the
existing business of a competitor, while broadening the customer base for Oracle's existing product offering.
Siebel, founded by Ellison's one-time protégé turned bitter rival, Tom Siebel, gained prominence in Silicon Valley in the late
1990s as a leader in customer relationship management (CRM) software. CRM software helps firms track sales, customer service,
and marketing functions. Siebel's dominance of this market has since eroded amidst complaints that the software was complicated
and expensive to install. Moreover, Siebel ignored customer requests to deliver the software via the Internet. Also, aggressive
rivals, like SAP and online upstart Salesforce.com have cut into Siebel's business in recent years with simpler offerings. Siebel's
annual revenue had plunged from about $2.1 billion in 2001 to $1.3 billion in 2004.
In the past, Mr. Ellison attempted to hasten Siebel's demise, declaring in 2003 that Siebel would vanish and putting pressure on
the smaller company by revealing he had held takeover talks with the firm's CEO, Thomas Siebel. Ellison's public announcement
of these talks heightened the personal enmity between the two CEOs, making Siebel an unwilling seller.
Oracle's intensifying focus on business applications software largely reflects the slowing growth of its database product line,
which accounts for more than three fourths of the company's sales.
Siebel's technology and deep customer relationships give Oracle a competitive software bundle that includes a database,
middleware (i.e., software that helps a variety of applications work together as if they were a single system), and high-quality
customer relationship management software. The acquisition also deprives Oracle competitors, such as IBM, of customers for their
services business.
Customers, who once bought the so-called best-of-breed products, now seek a single supplier to provide programs that work
well together. Oracle pledged to deliver an integrated suite of applications by 2007. What brought Oracle and Siebel together in the
past was a shift in market dynamics. The customer and the partner community is communicating quite clearly that they are looking
for an integrated set of products.
Germany's SAP, Oracle's major competitor in the business applications software market, played down the impact of the merger,
saying they had no reason to react and described any deals SAP is likely to make as "targeted, fill-in acquisitions." For IBM, the
Siebel deal raised concerns about the computer giant's partners falling under the control of a competitor. IBM and Oracle compete
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fiercely in the database software market. Siebel has worked closely with IBM, as did PeopleSoft and J.D. Edwards, which had
been purchased by PeopleSoft shortly before its acquisition by Oracle. Retek, another major partner of IBM, had also been recently
acquired by Oracle. IBM had declared its strategy to be a key partner to thousands of software vendors and that it would continue
to provide customers with IBM hardware, middleware, and other applications.
Discussion Questions:
1. How would you characterize the Oracle business strategy (i.e., cost leadership, differentiation, niche, or some
combination of all three)? Explain your answer.
2. What other benefits for Oracle, and for the remaining competitors such as SAP, do you see from further industry
consolidation? Be specific.
3. Conduct an external and internal analysis of Oracle. Briefly describe those factors that influenced the development
of Oracle’s business strategy. Be specific.
4. In what way do you think the Oracle strategy was targeting key competitors? Be specific.
HP Redirects Its Mobile Device Business Strategy with the Acquisition of Palm
With global PC market growth slowing, Hewlett-Packard (HP), number one in PC sales worldwide, sought to redirect its business
strategy for mobile devices. Historically, the firm has relied on such partners as Microsoft to provide the operating systems for its
mobile phones and tablet computer products. However, the strategy seems to have contributed to the firm’s declining smartphone
sales by limiting its ability to differentiate its products and by delaying new mobile product introductions.
HP has been selling a smartphone version of its iPaq handheld device since 2007, although few consumers even knew HP made
such devices, since its products were aimed at business people. Sales of iPaq products fell to $172 million in 2009 from $531
million in 2007 and to less than $100 million (excluding sales of Palm products) in 2010.
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With smartphone sales expected to exceed laptop sales in 2012, according to industry consultant IDC, HP felt compelled to
move aggressively into the market for handheld mobile devices. The major challenge facing HP is to overcome the substantial lead
that Apple, Google, and Research-In-Motion (RIM) have in the smartphone market.
To implement the new business strategy, HP acquired Palm in mid-2010 in a deal valued at $1.4 billion (including warrants and
convertible preferred stock). HP acquired Palm at a time when its smartphone sales were sliding, with Palm’s share of the U.S.
market dropping below 5 percent in 2010. Palm was slow to recognize the importance of applications (apps) designed specifically
for smartphones in driving sales. Palm has several hundred apps, while the number for Apple’s iPhone and Google’s Android are
in the tens of thousands.
HP is hoping to leverage Palm’s smartphone operating system (webOS) to become a leading competitor in the rapidly growing
smartphone market, a market that had been largely pioneered by Palm. HP hopes that webOS will provides an ideal common
“platform” to link the firm’s mobile devices and create a unique experience for the user of multiple HP mobile devices. The intent
is to create an environment where users can get a common look and feel and a common set of services irrespective of the handset
they choose.
HP also acquired 452 patents and another 406 applications on file. Palm offers one key potential competitive advantage in that
its operating system can run several tasks at once, just as a PC does; however, other smartphones are expected to have this
capability in the near future.
By buying Palm, HP signals a “go it alone” strategy in smartphones and tablet computers at the expense of Microsoft. HP is
also hoping that by having a proprietary system, they will be able to differentiate their mobile products in a way that Apple and
Google have in introducing their proprietary operating systems and distinguishing “look and feel.”
Through its sales of computer servers, software, and storage systems, HP has significant connections with telecommunications
carriers like Verizon that could help promote devices based on Palm’s technology. Also, because of its broad offering of PCs,
printers, and other consumer electronics products, HP has leverage over electronics retailers for shelf space.
Discussion Questions
1. To what extent could the acquisition of Palm by HP be viewed as a “make versus buy decision” by HP?
2. How would you characterize the HP strategy for mobility products (cost leadership, differentiation, focus, or a hybrid) and why?
BofA Acquires Countrywide Financial Corporation
On July 1, 2008, Bank of America Corp (BofA) announced that it had completed its acquisition of mortgage lender Countrywide
Financial Corp (Countrywide) for $4 billion, a 70 percent discount from the firm’s book value at the end of 2007. Countrywide
originates, purchases, and securitizes residential and commercial loans; provides loan closing services, such as appraisals and flood
determinations; and performs other residential real estate–related services. This marked another major (but risky) acquisition by
Bank of America's chief executive Kenneth Lewis in recent years. BofA's long-term intent has been to become the nation's largest
consumer bank, while achieving double-digit earnings growth. The acquisition would help the firm realize that vision and create
the second largest U.S. bank. In 2003, BofA paid $48 billion for FleetBoston Financial, which gave it the most branches,
customers, and checking deposits of any U.S. bank. In 2005, BofA became the largest credit card issuer when it bought MBNA for
$35 billion.
The purchase of the troubled mortgage lender averted the threat of a collapse of a major financial institution because of the U.S.
2007–2008 subprime loan crisis. U.S. regulators were quick to approve the takeover because of the potentially negative
implications for U.S. capital markets of a major bank failure. Countrywide had lost $1.2 billion in the third quarter of 2007.
Countrywide's exposure to the subprime loan market (i.e., residential loans made to borrowers with poor or nonexistent credit
histories) had driven its shares down by almost 80 percent from year-earlier levels. The bank was widely viewed as teetering on
the brink of bankruptcy as it lost access to the short-term debt markets, its traditional source of borrowing.
Bank of America deployed 60 analysts to Countrywide's headquarters in Calabasas, California. After four weeks of analyzing
Countrywide's legal and financial challenges and modeling how its loan portfolio was likely to perform, BofA offered an all-stock
deal valued at $4 billion. The deal valued Countrywide at $7.16 per share, a 7.6 discount to its closing price the day before the
announcement. BofA issued 0.18 shares of its stock for each Countrywide share. The deal could have been renegotiated if
Countrywide experienced a material change that adversely affected the business between the signing of the agreement of purchase
and sale and the closing of the deal. BofA made its initial investment of $2 billion in Countrywide in August 2007, purchasing
preferred shares convertible to a 16 percent stake in the company. By the time of the announced acquisition in early January 2008,
Countrywide had a $1.3 billon paper loss on the investment.
The acquisition provided an opportunity to buy a market leader at a distressed price. The risks related to the amount of potential
loan losses, the length of the U.S. housing slump, and potential lingering liabilities associated with Countrywide’s questionable
business practices. The purchase made BofA the nation's largest mortgage lender and servicer, consistent with the firm's business
strategy, which is to help consumers meet all their financial needs. BofA has been one of the relatively few major banks to be
successful in increasing revenue and profit following acquisitions by "cross-selling" its products to the acquired bank's customers.
Countrywide's extensive retail distribution network enhances BofA's network of more than 6,100 banking centers throughout the
United States. BofA had anticipated almost $700 million in after-tax cost savings in combining the two firms. Almost two-thirds of
these savings had been realized by the end of 2010. In mid-2010, BofA agreed to pay $108 million to settle federal charges that
Countrywide had incorrectly collected fees from 200,000 borrowers who had been facing foreclosure.
Discussion Questions:
1. How did the acquisition of Countrywide fit BofA’s business strategy? Be specific. What were the key assumptions
implicit the BofA’s business strategy? How did the existence of BofA’s mission and business strategy help the firm
move quickly in acquiring Countrywide?
2. How would you classify the BofA business strategy (cost leadership, differentiation, focus or some combination)?
Explain your answer.
3. Describe what the likely objectives of the BofA acquisition plan might have been. Be specific. What are the key
assumptions implicit in BofA’s acquisition plan? What are some of the key risks associated with integrating the
Countrywide? In addition to the purchase price, how would you determine BofA’s potential resource commitment in
making this acquisition?
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4. What capabilities did the acquisition of FleetBoston Financial and MBNA provide BofA? How did the Countrywide
acquisition complement previous acquisitions?
5. What options to outright acquisition did BofA have? Why do you believe BofA chose to acquire Countrywide rather than
to pursue an alternative strategy?
Nokia’s Gamble to Dominate the Smartphone Market Falters
The ultimate success or failure of any M&A transaction to satisfy expectations often is heavily dependent on the answer to a
simple question. Was the justification for buying the target firm based on a sound business strategy? No matter how bold,
innovative, or precedent-setting a bad strategy is, it is still a bad strategy.
In a bold move that is reminiscent of the rollout of Linux, Nokia, a Finnish phone handset manufacturer, announced in mid-
2008 that it had reached an agreement to acquire Symbian, its supplier of smartphone operating system software.12 Nokia also
announced its intention to give away Symbian's software for free in response to Google’s decision in December 2008 to offer its
Android operating system at no cost to handset makers.
This switch from a model in which developers had to pay a license fee to create devices using the Symbian operating system
software to a free (open source) model was designed to supercharge the introduction of innovative handheld products that relied on
Symbian software. Any individual or firm can use and modify the Symbian code for any purpose for free. In doing so, Nokia is
hoping that a wave of new products using Symbian software would blunt the growth of Apple’s proprietary system and Google’s
open source Android system.
Nokia is seeking to establish an industry standard based on the Symbian software, using it as a platform for providing online
services to smartphone users, such as music and photo sharing. According to Forrester Research, the market for such services is
expected to reach $92 billion in 2012 (almost twice its size when Nokia acquired Symbian), with an increasing portion of these
services delivered via smartphones.
In its vision for the future, Nokia seems to be positioning itself as the premier supplier of online services to the smartphone
market. Its business strategy or model is to dominate the smartphone market with handsets that rely on the Symbian operating
12 A smartphone is one device that can take care of all of the user’s handheld computing and communication needs in a single handheld device.
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system. Nokia hopes to exploit economies of scale by spreading any fixed cost associated with online services over an expanding
customer base. Such fixed expenses could include a requirement by content service providers that Nokia pay a minimum level of
royalties in addition to royalties that vary with usage.
Similarly, the development cost incurred by service providers can be defrayed by selling into a growing customer base. The
implementation strategy involved the acquisition of the leading supplier of handset operating systems and subsequently to give
away the Symbian software free. The success or failure of this vision, business strategy, and implementation strategy depends on
whether Symbian can do a better job of recruiting other handset makers, service providers, and consumers than Nokia's
competitors.
The strategy to date seems to be unraveling. At the time of the acquisition, Symbian supplied almost 60 percent of the operating
system software for smartphones worldwide. Market researcher Ovum estimates that the firm’s global market share fell to less
than 50 percent in 2010 and predicts the figure could decline to one-third by 2015, reflecting the growing popularity of Google’s
Android software.13 Android has had excellent success in the U.S. market, leapfrogging over Apple’s 24 percent share to capture
27 percent of the smartphone market, according to the NPD Group. Research-In-Motion (RIM), the maker of the Blackberry,
remained the U.S. market share leader in 2010 at 33 percent.
Dell Computer’s Drive to Eliminate the Middleman
Historically, personal computers were sold either through a direct sales force to businesses (e.g., IBM), through company-owned
stores (e.g., Gateway), or through independent retail outlets and distributors to both businesses and consumers (e.g., CompUSA).
Retail chains and distributors constituted a large percentage of the customer base of other PC manufacturers such as Compaq and
Gateway. Consequently, most PC manufacturers were saddled with the large overhead expense associated with a direct sales force,
a chain of company-owned stores, a demanding and complex distribution chain contributing a substantial percentage of revenue, or
some combination of all three.
Michael Dell, the founder of Dell Computer, saw an opportunity to take cost out of the distribution of PCs by circumventing the
distributors and selling directly to the end user. Dell Computer introduced a dramatically new business model for selling personal
computers directly to consumers. By starting with this model when the firm was formed, Dell did not have to worry about being in
direct competition with its distribution chain.
Dell has changed the basis of competition in the PC industry not only by shifting much of its direct order business to the
internet but also by introducing made-to-order personal computers. Businesses and consumers can specify online the features and
functions of a PC and pay by credit card. Dell assembles the PC only after the order is processed and the customer’s credit card has
been validated. This has the effect of increasing customer choice and convenience as well as dramatically reducing Dell’s costs of
carrying inventory.
The Dell business model has evolved into one focused relentlessly on improving efficiency. The Dell model includes setting up
super-efficient factories, keeping parts in inventory for only a few days before they are used, and selling computers based on
common industry standards like Intel chips and Microsoft operating systems. By its nature, the Dell model requires aggressive
expansion. As growth in the PC market slowed in the late 1990s, the personal computer became a commodity. Since computers
had become so powerful, there was little need for consumers to upgrade to more powerful machines. To offset growth in its
primary market, Dell undertook a furious strategy to extend the Dell brand name into related electronics markets. The firm started
to sell “low end” servers to companies, networking gear, PDAs, portable digital music players, an online music store, flat-panel
televisions, and printers. In late 2002, the firm began to sell computers through the retail middleman Costco.
Michael Dell believes that every product should be profitable from the outset. His focus on operating profit margins has left
little for product innovation. Dell’s budget for new product R&D has averaged 1.3% of revenues in recent years, about one-fifth of
what IBM and Hewlett-Packard spend. Rather than be viewed as a product innovator, Dell is pursuing a “fast follower” strategy in
which the firm focuses on taking what is currently highly popular and making it better and cheaper than anyone else. While not a
product innovator, Dell has succeeded in process innovation. The company has more than 550 business process patents, for
everything from a method of using wireless networks in factories to a configuration of manufacturing stations that is four times as
productive as a standard assembly line.
Dell’s expansion seems to be focused on its industry lead in process engineering and innovation resulting in super efficient
factories. The current strategy seems to be to move into commodity markets, with standardized technology that is widely
available. In such markets, the firm can apply its finely honed skills in discipline, speed, and efficiency. For markets that are
13 For more information, see www.guardian.co.uk/business/2010/feb/04/symbian-smartphone-software-open-source.
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becoming more commodity-like but still require some R&D, Dell takes on partners. For example, in the printer market, Dell is
applying its brand name to Lexmark printers. In storage products, Dell has paired up with EMC Corp. to sell co-branded storage
machines. As these markets become more commodity-like, Dell will take over manufacturing of these products. This is what
happened at the end of 2003 when it took over production of low-end storage production from EMC. In doing so, Dell was able to
cut production costs by 25%.
The success of Michael Dell’s business model is evident. Its share of the global PC market in 2003 topped 16%; the company
accounts for more than one-third of the hand-held device market. At the end of 2003, Dell’s price-to earnings ratio exceeded IBM,
Microsoft, Wal-Mart, and General Electric. Dell has had some setbacks. In 2001, the firm scrapped a plan to enter the mobile-
phone market; in 2002 Dell wrote off its only major acquisition, a storage-technology company purchased in 1999 for $340
million. Dell also withdrew from the high-end storage business, because it decided its technology was not ready for the market.
Discussion Questions:
1. Who are Dell’s primary customers? Current and potential competitors? Suppliers? How would you assess Dell’s
bargaining power with respect to its customers and suppliers? What are Dell’s strengths/weaknesses versus it current
competitors?
2. In your opinion, what market need(s) was Dell able to satisfy better than his competition?
3. How would you characterize Dell’s original business strategy (i.e., cost leadership, differentiation, niche, or some
combination? Give examples to illustrate your conclusions. How has Dell’s strategy evolved over time? Give examples
to illustrate your answer.
4. How would you describe Dell’s current implementation strategy (i.e., solo venture, shared growth/shared control,
merger/acquisition, or some combination)? On what core competencies is Michael Dell relying to make this strategy
work?
Consolidation in the Global Pharmaceutical Industry:
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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
Discussion Questions:
1. What was driving change in the pharmaceutical industry in the late 1990s?
2. In your judgment, what are the likely strategic business plan objectives of the major pharmaceutical companies and why
are they important?
3. What are the alternatives to merger available to the major pharmaceutical companies? What are the advantages and
disadvantages of each alternative?
4. How would you classify the typical drug company’s strategy in the 1970s and 1980s: cost leadership, differentiation,
focus, or hybrid? Explain your answer. How have their strategies changed in recent years?
5. What do you think was the major motivating factor behind the Glaxo SmithKline merger and why was it so important?
Maturing Businesses Strive to “Remake” Themselves--
UPS, Boise Cascade, and Microsoft
UPS, Boise Cascade, and Microsoft are examples of firms that are seeking to redefine their business models due to a maturing of
their core businesses. With its U.S. delivery business maturing, UPS has been feverishly trying to transform itself into a logistics
expert. By the end of 2003, logistics services supplied to its customers accounted for $2.1 billion in revenue, about 6% of the
firm’s total sales. UPS is trying to leverage decades of experience managing its own global delivery network to manage its
customer’s distribution centers and warehouses. After having acquired the OfficeMax superstore chain in 2003, Boise Cascade
announced the sale of its core paper and timber products operations in late 2004 to reduce its dependence on this highly cyclical
business. Reflecting its new emphasis on distribution, the company changed its name to OfficeMax, Inc. Microsoft, after meteoric
growth in its share price throughout the 1980s and 1990s, experienced little appreciation during the six-year period ending in 2006,
despite a sizeable special dividend and periodic share buybacks during this period. Microsoft is seeking a vision of itself that
motivates employees and excites shareholders. Steve Ballmer, Microsoft’s CEO, sees innovation as the key. However, in spite of
spending more than $4 billion annually on research and development, Microsoft seems to be more a product follower than a leader.
Discussion Questions:
1. In your opinion, what are the primary challenges for each of these firms with respect to their employees, customers,
suppliers, and shareholders? Be specific.
2. Comment on the likely success of each of this intended transformation?
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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.
Discussion Questions:
1. What factors drove consolidation within the food manufacturing industry? Name other industries that are currently
undergoing consolidation?
2. Why did food industry consolidation prompt Quaker to announce that it was for sale?
3. Why do you think Quaker wanted to sell its consolidated operations rather than to divide the company into the food/cereal
and Gatorade businesses?
4. Under what circumstances might the Quaker shareholder have benefited more if Quaker had sold itself in pieces (i.e.,
food/cereal and Gatorade) rather than in total?
5. Do you think PepsiCo may have been willing to pay such a high price for Quaker for reasons other than economics? Do
you think these reasons make sense? Explain your answer.
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.
Discussion Questions:
1. Do you believe this acquisition if related or unrelated to eBay’s business? What are the implications of your answer..
2. What are some of the key assumptions implicit in eBay’s decision to make this acquisition?
