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Chapter 5
Implementation: Search through Closing—Phases 3 to 10
Answers to End of Chapter Discussion Questions
5.1 Identify at least three criteria that might be used to select a manufacturing firm as a potential acquisition candidate.
A financial services firm? A high technology firm?
5.2 Identify alternative ways to make ‘‘first contact’’ with a potential acquisition target. Why is
confidentiality important? Under what circumstances might a potential acquirer make its intentions public?
5.3 What are the differences between total consideration, total purchase price/enterprise value, and net purchase price?
How are these different concepts used?
5.4 What is the purpose of the buyer and seller performing due diligence?
5.5 Why is pre-closing integration planning important?
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5.6 In a rush to complete its purchase of health software producer HBO, McKesson did not perform adequate due
diligence but rather relied on representations and warranties in the agreement of sale and purchase. Within six
months following closing, McKesson announced that it would have to reduce revenue by $327 million and net
income by $191.5 million for the past 3 fiscal years to correct for accounting irregularities. The company’s
stock fell by 48 percent. Assume HBO’s financial statements had been declared to be in accordance with GAAP,
would McKesson have been justified in believing that HBO’s revenue and profit figures were 100 percent
accurate?
5.7 Find a transaction currently in the news. Speculate as to what criteria the buyer may have employed to identify
the target company as an attractive takeover candidate. Be specific.
5.8 In mid-2008, Fresenius, a German manufacturer of dialysis equipment, acquired APP Pharmaceuticals for $4.6
billion. The deal includes an earn-out, under which Fresenius will pay as much as $970 million, if APP reaches
certain future financial targets. What is the purpose of the earn-out? How does it affect the buyer and seller?
5.9 Material adverse change clauses (MACs) are a means for the parties to the contract to determine who will bear the
risk of adverse events that occur between the signing of an agreement and the closing. MACs are frequently not
stated in dollar terms. How might MACs affect the negotiating strategies of the parties to the agreement during the
period between signing and closing?
5.10 Despite disturbing discoveries during due diligence, Mattel acquired The Learning Company (TLC), a leading
developer of software for toys, in a stock-for-stock transaction valued at $3.5 billion on May 13, 1999. Mattel had
determined that TLC’s receivables were overstated, a $50 million licensing deal had been prematurely put on the
balance sheet, and that TLC’s brands were becoming outdated. TLC also had substantially exaggerated the amount
of money put into research and development for new software products. Nevertheless, driven by the appeal of
rapidly becoming a big player in the children’s software market, Mattel closed on the transaction aware that TLC’s
cash flows were overstated. After restructuring charges associated with the acquisition, Mattel’s consolidated 1999
net loss was $82.4 million on sales of $5.5 billion. Mattel’s stock fell by more than 35 percent during 1999 to end
the year at about $14 per share. What could Mattel have done to better protect its interests? Be specific.
Solutions to End of Chapter Case Study Questions
Intel Buys Mobileye in a Bet on Self-Driving Car Technology
Discussion Questions:
1. What key factors are driving Intel's board and management to attempt to transform the firm? Be specific.
2. Characterize Intel's business strategy as a cost leadership, differentiation, focus, or some combination. Justify your
answer.
3. A corporate vision can be described narrowly or broadly. Describe Intel’s vision. How useful do you find this vision
statement in providing guidance for future investment decisions? (Hint: Discuss the advantages and disadvantages of a
broad versus narrow corporate vision statement.)
4. Speculate as to whether you think Intel will be able to earn financial returns demanded by their shareholders on its
acquisition of Mobileye. Discuss what you believe are the factors likely to boost returns and those likely to reduce
returns.
Examination Questions and Answers
1. The first step in establishing a search plan for potential acquisition or merger targets is to identify the primary
screening or selection criteria. True or False
2. The number of selection criteria should be as extensive as possible to ensure that all factors relevant to the firm’s
decision-making process are considered. True or False
3. Only acquiring firms perform due diligence. True or False
4. Banks are commonly used to provide bridge or temporary financing to pay all or a portion of the purchase price
and meet possible working capital requirements until permanent financing can be found. True or False
5. The targeted industry and the maximum size of the potential transaction are often the most important selection
criteria used in the search process. True or False
6. Advertising in the business or trade press is generally a very efficient way to locate attractive acquisition target
candidates. True or False
7. An excessively long list of screening criteria used to develop a list of potential acquisition targets can severely
limit the number of potential candidates. True or False
8. The appropriate approach for initiating contact with a target firm is essentially the same for large or small, public
or private companies. True or False
9. In contacting large, publicly traded firms, it is usually preferable to make initial contact through an intermediary
and at the highest level of the company possible. True or False
10. Rumors of impending acquisition can have a substantial deleterious impact on the target firm. True or False
11. So-called permanent financing for an acquisition usually consists of long-term unsecured debt. True or False
12. Confidentiality agreements are usually signed before any information is exchanged to protect the buyer and the
seller from loss of competitive information. True or False
13. Confidentiality agreements often cover both the buyer and the seller, since both are likely to be exchanging
confidential information, although for different reasons. True or False
14. Confidentiality agreements usually also cover publicly available information on the potential acquirer and target
firms. True or False
15. A letter of intent formally stipulates the reason for the agreement, major terms and conditions, the responsibilities
of both parties while the agreement is in force, a reasonable expiration date, and how all fees associated with the
transaction will be paid. True or False
16. The signing of a letter of intent usually precludes the target firm from suing the potential acquiring company if the
acquirer eventually withdraws its initial offer. True or False
17. “No shop” provisions are seldom found in letters of intent. True or False
18. The letter of intent often specifies the type of information to be exchanged as well as the scope and duration of the
potential buyer’s due diligence. True or False
19. Letters of intent are usually legally binding on the potential buyer but rarely on the target firm. True or False
20. The actual price paid for a target firm is unaffected by the buyer’s due diligence. True or False
21. Total consideration refers to what is to be paid for the target firm and usually only consists of cash or stock,
exclusively. True or False
22. The total purchase price paid by the buyer should also reflect the assumption of liabilities stated on the target’s
balance sheet, but it should exclude all off balance sheet liabilities. True or False
23. Discretionary assets are undervalued or redundant assets not required to run the acquired business and which can
be used by the buyer to recover a portion of the purchase price. True or False
24. The actual purchase price paid for a target firm is determined doing the negotiation process and is often quite
different from the initial offer price stipulated in a letter of intent. True or False
25. Buyers routinely perform due diligence on sellers, but sellers rarely perform due diligence on buying firms. True
or False
26. Due diligence is the process of validating assumptions underlying the initial valuation of the target firm as well as
the uncovering of factors that had not previously been considered that could enhance or detract from the value of
the target firm. True or False
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27. It is usually in the best interests of the seller to allow the buyer unrestricted access to all seller employees and
records doing due diligence in order to create an atmosphere of cooperation and goodwill. True or False
28. Buyers should not be concerned about performing an exhaustive due diligence since in doing so they could
degrade the value of the target firm because of the disruptive nature of a rigorous due diligence. The buyer can be
assured that all significant risks can be handled through the standard representations and warranties commonly
found in agreements of purchase and sale. True or False
29. Bridge financing refers to the temporary financing obtained by the buyer to pay all or a portion of the purchase
price until so-called permanent financing can be arranged. True or False
30. Seller financing represents a very important source of financing for buyers. True or False
31. Elaborate multimedia presentations made to potential lenders in an effort to “shop” for the best financing are often
referred to as the “road show.” True or False
32. The buyer’s ability to obtain adequate financing is a closing condition common to most agreements of purchase
and sale. True or False
33. Closing is a phase of the acquisition process that usually occurs shortly after the target has been fully integrated
into the acquiring firm. True or False
34. Shrewd sellers often negotiate a break-up clause in an agreement of purchase and sale requiring the buyer to pay
the seller an amount at least equal to the seller’s cost associated with the transaction. True or False
35. The purchase price for a target firm may be fixed at the time of closing, subject to future adjustment, or be
contingent on future performance. True or False
36. Brokers or finders should never be used in the search process. True or False.
37. More and more firms are identifying potential target companies on their own without the use of investment
bankers. True or False
38. Fees charged by investment bankers are never negotiable. True or False
39. Debt-to-equity ratios may be used to measure a firm’s degree of leverage and are frequently used as a search
40. Even though time is critical, it is always critical to build a relationship with the CEO of the target firm before
approaching her with an acquisition proposal. True or False
41. There is no substitute for performing a complete due diligence on the target firm. True or False
42. Confidentiality agreements are rarely required when target and acquiring firms exchange information. True or
False
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43. The financing plan may be affected by the discovery during due diligence of assets that can be sold to pay off debt
accumulated to finance the transaction. True or False
44. There is no need for the seller to perform due diligence on its own operations to ensure that its representations and
warranties in the definitive agreement are accurate. True or False
45. The closing often involves getting all the necessary third-party consents and regulatory and shareholder approvals.
True or False
46. The purchase price may be fixed at the time of closing, subject to future adjustment, or it may be contingent on
future performance of the target business. True or False
47. Earnouts are generally very poor ways to create trust and often represent major impediments to the integration
process. True or False
48. Loan covenants are promises made by the borrower that certain acts will be performed and others will be avoided.
True or False
49. Buyers generally want to complete due diligence on the seller as quickly as possible. True or False
50. A data room is a method commonly used by sellers to limit buyer due diligence. True or False
51. Total consideration is a legal term referring to the composition of what is paid for the target company and can
consist of cash, stock, debt or some combination of all three.
1. Each of the following is true about the acquisition search process except for
a. A candidate search should start with identifying the primary selection criteria.
b. The number of selection criteria should be as lengthy as possible.
c. At a minimum, the primary criteria should include the industry and desired size of transaction.
d. The size of the transaction may be defined in terms of the maximum purchase price the acquirer is willing
to pay.
e. A search strategy entails the use of electronic databases, trade publications, and querying the acquirer’s
law, banking, and accounting firms for qualified candidates.
2. The screening process represents a refinement of the search process and commonly utilizes which of the following
as selection criteria
a. Market share, product line, and profitability
b. Product line, profitability, and growth rate
c. Profitability, leverage, and growth rate
d. Degree of leverage, market share, and growth rate
e. All of the above
3. Initial contact should be made through an intermediary as high up in the organization for which of the following
firms
a. Companies with annual revenue of less than $25 million
b. Medium sized companies between $25 and $100 million in annual revenue
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c. Large, publicly traded firms
d. Small, privately owned firms
e. Small, privately owned competitors
4. All of the following statements are true about letters of intent except for
a. Are always legally binding
b. Spells out the initial areas of agreement between the buyer and seller
c. Defines the responsibilities and rights of the buyer and seller while the letter of intent is in force
d. Includes an expiration date
e. Includes a “no shop” provision
5. All of the following are true about a confidentiality agreement except for
a. Often applies to both the buyer and the seller
b. Stipulates the type of seller information available to the buyer and how the information can be used
c. Limits the use of information about the seller that is publicly available
d. Includes a termination date
e. Limits the ability of either party to disclose publicly the nature of discussion between the buyer and seller
6. The actual price paid by the buyer for the target firm is determined when
a. The initial offer is made
b. As a result of the negotiation process
c. When the letter of intent is signed
d. Following the completion of due diligence
e. Once a financing plan has been approved
7. In a merger, the acquiring firm assumes all liabilities of the target firm. Assumed liabilities include all but which
of the following?
a. Current liabilities
b. Long-term debt
c. Warranty claims
d. Fully depreciated operating equipment
e. Off-balance sheet liabilities
8. The negotiation process consists of all of the following concurrent activities except for
a. Refining valuation
b. Deal structuring
c. Integration planning
d. Due Diligence
e. Developing the financing plan
9. All of the following are true of buyer due diligence except for
a. Due diligence is the process of validating assumptions underlying valuation.
b. Can be replaced by appropriate representations and warranties in the agreement of purchase and sale.
c. Primary objectives are to identify and to confirm sources and destroyers of value
d. Consists of operational, financial, and legal reviews.
e. Endeavors to identify the “fatal flaw” that could destroy the deal
10. Which of the following are commonly used sources of financing for M&A transactions?
a. Asset based lending
b. Cash flow based lending
c. Seller financing
d. A and B only
e. All of the above
11. Which of the following is generally not true of a financing contingency?
a. It is a condition of closing in the agreement of purchase and sale
b. Trigger the payment of break-up fees if not satisfied.
c. Protects both the lender and seller
d. Primarily protects the buyer
e. Primarily protects the seller
12. Which of the following is generally not true of integration planning?
a. Is of secondary importance in the acquisition process.
b. Is crucial to the ultimate success of the merger or acquisition
c. Represents an opportunity to earn trust among all parties to the transaction
d. Involves developing effective communication strategies for employees, customers, and suppliers.
e. Is often neglected in the heat of negotiation.
13. All of the following are true of closing except for
a. Consists of obtaining all necessary shareholder, regulatory, and third party consents
b. Requires significant upfront planning
c. Is rarely subject to last minute disagreements
d. Involves the final review and signing of such documents as the agreement of purchase and sale, loan
agreements (if borrowing is involved), security agreements, etc.
e. Fulfillment of the so-called closing conditions
14. Which of the following do not represent typical closing documents in an asset purchase?
a. Letter of intent
b. Listing of any liabilities to be assumed by the buyer
c. Loan and security agreements if the transaction is to be financed with debt
d. Complete descriptions of all patents, facilities, and investments
e. Listing of assets to be acquired
15. Which of the following is not typically true of post-closing evaluation of an acquisition?
a. It is important not to change the performance benchmarks against which the acquisition is measured
b. It is critical to ask the tough questions
c. It is an opportunity to learn from mistakes
d. It is commonly done
e. It is frequently avoided by acquiring firms because of the potential for embarrassment.
16. Which of the following is true about integration planning? Without integration planning, integration is not likely to
a. Provide anticipated synergies
b. Proceed without significant disruption to the target business’ operations
c. Proceed without significant disruption to the acquirer’s operations
d. Be completed without experiencing substantial customer attrition
e. All of the above
17. Which of the following statements are true about due diligence?
a. The seller should perform due diligence on its own operations.
b. The seller should perform due diligence on the buyer.
c. The seller should perform due diligence on the lender used by the buyer to finance the transaction.
d. A & B
e. A, B, & C
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18. Which of the following is not true of the financing plan?
a. It is rarely affected by the discovery during due diligence of target assets not required to operate the
business.
b. It may include both stock and debt.
c. It may include a combination of stock, debt, and cash.
d. It serves as a reality check on the buyer.
e. None of the above.
19. Refining the target valuation based on new information uncovered during due diligence is most likely to affect
which of the following
a. Total consideration
b. The search process
c. The business plan
d. The acquisition plan
e. The target’s business plan
20. The negotiation process consists of all of the following except for
a. Refining valuation
b. Due diligence
c. Closing
d. Developing a financing plan
e. Deal structuring
21. Closing is included in which of the following activities?
a. Development of a business plan
b. Development of an acquisition plan
c. The search process
d. The negotiation process
e. None of the above
22. Integration planning is included in which of the following activities?
a. Development of a business plan
b. The search process
c. Development of a financing plan
d. Post-closing integration
e. None of the above
23. The development of search criteria is included in which of the following activities?
a. Development of a business plan
b. Development of the acquisition plan
c. Post-closing integration
d. Post-closing evaluation of the acquisition process
e. None of the above
24. The financing plan is included in which phase of the acquisition process?
a. The development of the business plan
11
b. The negotiation phase
c. The integration planning phase
d. The development of the acquisition plan
e. None of the above
25. Which of the following is not true of the acquisition process?
a. It always follows a predictable sequence of steps.
b. It sometimes deviates from the sequence outlined in this chapter.
c. It involves a negotiation phase
d. It involves the development of a business plan
e. None of the above
Case Study Short Essay Examination Questions
END OF CHAPTER CASE STUDY: MICHAEL DELL COMPLETES THE BIGGEST DEAL IN TECH
HISTORY IN BUYING STORAGE MAKER EMC
Case Study Objectives: To Illustrate
• Challenges of strategically realigning a firm
• What it takes to achieve a “competitive edge”
The importance of getting out in front of rather than simply reacting to market changes
_______________________________________________________________________With the PC market maturing,
Michael Dell continued his effort to shift the firm more toward software and services. In doing so, he closed the biggest
deal in tech history in 2016 in acquiring data storage provider EMC in a deal valued at more than $63 billion. Dell
reasoned that the takeover would enable Dell Inc. to achieve a “competitive edge” over others battling it out in the software
and services marketplace. A competitive advantage involves a strategy allowing a firm to gain sales, increase profit
margins, or both over its primary competitors by better satisfying customer needs than its competitors. A competitive
advantage can result from the pursuit of cost leadership, differentiation, focus or in rare cases some combination of these
strategies. The extent to which it can be sustained often reflects the ability of a firm to build barriers that insulate it from
the actions of its competitors.
The size of the deal was possible largely because Dell Inc. was a private company and ownership was heavily
concentrated. As such, Dell Inc. was able to make decisions without interference from public shareholders that might have
occurred due to the potential reduction in near term earnings per share. The firm was able to finance the deal as a result of a
substantial reduction in the amount of debt incurred when Dell Inc. was taken private and through the use of tracking stock
as a form of payment. The latter reduced the amount Dell Inc. had to borrow to pay for the transaction. Finally, the time
was right. Unwilling to break-up the company, EMC’s senior management and board had run out of options and were
experiencing considerable pressure from activist shareholders to improve performance.
The takeover of EMC represented another bold move by Michael Dell to reposition the firm bearing his name for the
21st century. What follows is a discussion of Dell’s efforts to transform the company from one concentrating on personal
computers to a firm offering customers an array of integrated solutions to problems whose resolution was critical to the
performance of their businesses, the methods used, and the challenges remaining to achieve this transformation.
Dell Computer was founded by Michael Dell in his college dormitory room in 1987. One year later, he took the
company public at 23 years of age. He was 29 when his firm hit 1 billion dollars in revenue and 31 when it achieved $5
billion. By 2001, the company became the global leader in PCs. Over the next 3 years, the firm sustained continued growth
by diversifying into servers, storage, printers, mobile phones, and MP3 players. In 2004, Dell stepped down from the day-
to-day operations as CEO, appointing Kevin Rollins to that position, but he retained his role as Chairman of the board.
The success was not to last as the firm failed to anticipate the massive shift of the desktop PC, its primary revenue
source, to the notebook PC. By 2006, Dell had lost its number one spot in the PC market. In 2007, Michael Dell assumed
control of the firm again and moved quickly to expand its software, networking, security, and services offerings. The firm’s
long-term business strategy was to shift its focus from its end-user computing business (EUC), which includes PC,
mobility, and third-party software, to its enterprise solutions and services business (ESS), which provides higher margin
enterprise-wide solutions and services to businesses. The firm spent $13 billion to acquire 20 firms including spending $3.9
billion for information technology (IT) services provider Perot Systems.
12
The transformation to become a more ESS-driven business proved to be more challenging than first believed. Other tech
firms had a commanding lead in the software and services business including HP, IBM, Cisco, and Oracle. As a global IT
company with significant dependence on the PC market, the Company continued to be highly vulnerable to the fundamental
long-term changes in this market.
What the firm was trying to do would require years and in the near term the firm’s earnings would suffer. Shareholders
were unlikely to accept a protracted period of depressed earnings. Michael Dell was at a cross-road: To remain public or to
take the company private by buying out its public shareholders. He opted for the latter strategy.
The events of 2013 surrounding the conversion of Dell Inc. from a public to a private company proved turbulent, pitting
billionaire entrepreneur Michael Dell against billionaire activist investor Carl Icahn. Sensing an opportunity to save the
multibillion dollar tech firm he had created in the late 1980s, Michael Dell initiated an audacious move to buy out public
investors. The objective was to change the firm from one dependent on PCs to one focused on software and services. To be
successful, he felt he needed to gain unfettered control over the firm.
The strategy required layering bone-crushing debt on the already foundering firm. Midway through Michael Dell’s
effort to privatize the firm, well known corporate raider Carl Icahn entered the fray using social media such as Twitter and
TV interviews to vilify Michael Dell’s leadership and personal ethics. Both Dell and Icahn were smart, aggressive, and
accustomed to winning. The subsequent effort to take the firm private became one the nastiest tech takeovers in recent
history. The stage was set for a battle of the billionaire titans.
From start to finish, the deal took more than one year to complete. On October 31, 2013, Dell Inc., one of the world’s
leading PC manufacturers, ended its 25 year history as a public firm. Dell paid $13.88 per share, which represented a 36%
premium over Dell’s share price 90 days prior to the merger announcement date, and which valued the Company at $24.9
billion.1 The deal included Michael Dell’s 16% ownership stake, valued at more than $3 billion, and another $750 million
of his cash along with $21.2 billion from Silver Lake Partners, a consortium of lenders, and excess cash on Dell Inc.’s
balance sheet. The transaction boosted Michael Dell’s ownership stake in the firm to 75%, with Silver Lake holding the
remaining equity.
In 2015, the new Dell Corporation has more than 160,000 channel distribution partners (i.e., parties selling Dell
products), with about $20 billion of the firm’s $65 billion in annual revenue coming from these partners. This compares to
zero in 2008. The firm has also doubled the number of sales specialists with technical training to 8,000 from 2009. The firm
is experiencing increasing success in encouraging existing customers to buy more expensive products and services. About
90% of its customers that buy PCs also buy other products and services.
With 110,000 employees worldwide, the firm’s current objectives are cash flow and growth: cash flow to pay off the
firm’s debt and growth to increase the firm’s value when it is again taken public. Incremental cash flow is expected to come
from increased sales and slashing costs, with a target of $2 billion in annual cost savings. As a private firm, it will have
fewer regulatory hurdles and disclosures than a public firm, allowing for a speedier execution of its business strategy of
growing its enterprise solutions business.
The challenges the “New Dell” faces are daunting. Michael Dell must transform the firm from one dominated by PCs to
software and services and to generate sufficient cash to pay off the $20 billion in debt. Dell’s market share in software and
services is about 1%, but these are the only categories making money. Dell is battling traditional rivals in software and
services such as Hewlett-Packard and IBM and must now combat new entrants such as Amazon and Rackspace which are
expanding in the cloud-based storage and services business.
The firm’s fortunes improved markedly in 2015. According to tech-industry analytical firm IDC, Dell’s global PC
shipments increased by about 10% over the prior year. In the United States, Dell’s shipments increased by almost 20%
bringing its total share of the US PC market to 26%. This compares to market leader Hewlett-Packard’s share of about
28%. The improvement in the firm’s PC sales may provide sufficient cash to finance Dell’s changing product focus. Dell’s
operating performance appears to be holding up as its share of the global PC market has held steady in recent years at about
14%.
While taking the firm private appears to have improved the firm’s financial performance, Michael Dell believed that
more change was necessary to achieve his strategic vision. Dell saw EMC as an opportunity to accelerate movement toward
1 Some shareholders argued they had been shortchanged and initiated a law suit to have their stock appraised. In late 2016,
a Delaware court concluded that Michael Dell and Silver Lake Partners had paid shareholders at least 20% less than its then
fair market value. However, only those having voted against the deal will receive compensation under Delaware law.
13
realizing this vision. Dell believed that acquiring EMC would enable the firm to combine its server businesses with EMC’s
storage and virtualization businesses to offer a broader range of products to challenge Cisco Systems, IBM and HP in the
areas of cloud computing, mobility and cyber security. In striking its deal for storage provider EMC, Dell and its financial
partner, private equity firm Silver Lake, are betting that this huge acquisition will help Dell, one of the best-known names
in the industry, move increasingly into the fastest growing areas of the information technology industry. Both Michael Dell
and his private equity partner Silver Lake had shown an ability to consolidate industries.
Understanding how the EMC transaction unfolded requires an appreciation of the personalities of the CEOs of the firms
involved. Billionaire Michael Dell had a passion for preserving and growing the business bearing his name, and the 68 year
old EMC CEO Joseph Tucci sought to protect his legacy. He had been considering retiring since 2009 but postponed it
several times amid his firm’s slumping stock performance, pressure from activist investors, and a changing environment for
computer storage. In agreeing to the deal, Mr. Tucci had an opportunity to establish a positive legacy and generate almost
$27 million more in compensation than he would have received had he willingly retired. His employment contract provided
for his receiving the additional compensation if he were ousted due to a change in control of the firm. He built EMC into
what it is. EMC had become his identity, and he didn’t want to see it dismembered.
Activist hedge fund manager Paul Singer of Elliott Management was among EMC’s largest investors and had been
pushing the board and management to break up the firm. Investors had shown their dismay with the firm’s performance by
pushing down EMC’s share price by over 15% during the three years prior to the announced takeover by Dell. Founded in
Boston Massachusetts 40 years ago, EMC has struggled over the past decade as the cost of data storage has plummeted.
Subsequent acquisitions have failed to reverse the firm’s operating outlook. The bulk of the firm’s value is concentrated in
its 81% ownership stake in VMware, a popular maker of virtualization software that emulates different operating systems.
As a collection of largely unrelated businesses ranging from data storage to networking to content management, the value
of EMC’s shares suffered from a conglomerate discount.
But Mr. Tucci balked at the idea of spinning off VMware. Instead, he sought to be acquired by Hewlett-Packard,
although these talks reportedly ended in late 2014 after more than a year of discussions. The failure of these discussions
provided an opportunity for Michael Dell to contact Mr. Tucci.
Dell agreed to pay the equivalent of $33.15 per share for all of EMC’s outstanding shares. The offer consisted of $24.05
in cash and tracking stock valued at $9.10. The tracking stock mirrors the value of the roughly 20 percent of VMware’s
outstanding shares already trading on the New York Stock Exchange. In theory, the tracking stock should fluctuate with the
value of VMware’s publicly traded shares as investors have the option of holding either the tracking shares or the VMware
common shares traded publicly. The purchase price represents an approximate 27% premium over EMC’s trading price just
prior to the announcement of the deal.2
In the past, tracking stocks have often performed poorly, particularly when they were linked to the performance of
non-public companies. Why? Governance issues can be greater for firms with highly concentrated ownership and more
opaque financial reporting. Tracking stocks tend to underperform the overall stock market in the years immediately
following their issue. This has been especially true of private firms not subject to the discipline of public investors.
Moreover, tracking shares usually have inferior voting rights – or none at all, and holders often do not receive dividends.
While the EMC offer represented a 27% premium to the EMC trading price immediately prior to the announcement of
the deal, most of the premium comes from the problematic valuation of the tracking stock. Dell valued the deal at $33.15
per EMC share but investors questioned the valuation as EMC’s share value rose to only $28.07 at the end of trading on the
announcement date. Shares of VMware dropped by 10 percent, reflecting concern about the loss of key employees and the
uncertainty associated with future decisions made by the Dell board. EMC shareholders also fretted that the issuance of
tracking shares (shares that trade like VMware shares) would increase the supply of VMware shares and depress the price.
Nevertheless, EMC shareholders approved the deal since the outlook for EMC as an independent entity was dire, with the
firm’s core enterprise business faltering and the promising cloud-software unit too small to have much of an impact.
VMware’s server virtualization business was doing better resulting in EMC’s investment in VMware accounting for almost
2 Tracking shares are not actual common stock of VMware; rather, they are issued by Dell. A company issuing tracking
stock still owns all the assets associated with the business being tracked, but some of its risks and benefits are sold to
investors interested in the "pure play" of the tracking stock. Holders of tracking stock are considered to hold equity in the
parent firm (Dell) and not the specific entity represented by the tracking stock (VMware). Determined during the
negotiation process, EMC shareholders at closing received tracking stock representing 0.111 shares of VMWare for each
EMC share they owned.
one-half of the consolidated company’s market capitalization. In other words, the Dell deal simply seemed to EMC
shareholders as better than no deal at all.
The new firm (including EMC) has more than $50 billion in debt on its consolidated balance sheet. Interest paid on the
debt amounts to $2.5 billion annually. That is $2.5 billion less to spend on R&D and other critical activities, thereby
potentially limiting new product development and improving customer service. In addition, integrating EMC and Dell,
which combined have more than $75 billion in revenue and nearly 200,000 employees, is a massive undertaking and an
enormous distraction for employees and their management team as two very different cultures come together and a new
business strategy is implemented. Moreover, bringing two business portfolios together will require a significant amount of
pruning overlapping and unprofitable products, which will be disruptive to their business and create confusion for their
customers. Customers simply will not know if the products they are buying today from either company will be supported in
a year or two. Finally, since many of these products are sold through distributors, this merger is going to cause chaos in the
distribution channels as they bring together two different distributor programs and marketing approaches.
Large acquisitions often are used to rapidly change corporate direction and are referred to as transformative to appear as
bold and imaginative moves. However, history shows that many large acquisitions fail to live up to their expectations either
because of a flawed strategy, overpayment, inadequate integration or simply bad postmerger execution. Time will tell
whether Michael Dell’s “bold” changes represented true strategic thinking or simply a series of desperate moves.
Discussion Questions
3. Discuss the pros and cons of taking a company private. Is a private firm better positioned than a public company to
make acquisitions? Be specific.
4. What are the key trends external to Dell Inc. that you believe are driving Michael Dell’s effort to transform the firm?
Be specific.
5. Speculate as to the strengths and weaknesses of the new firm (i.e., the combined Dell Inc. and EMC). Consider the
various stakeholder groups in your answer. Be specific.
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6. Characterize Dell Inc.’s business strategy as a cost leadership, differentiation, focus, or some combination. Justify your
answer.
7. In what sense was Dell’s takeover strategic and in what way was it opportunistic? Be specific.
Struggling Johnson Controls and Tyco Merge to Create More Focused Global Business
KEY POINTS
Having a clear business strategy makes target selection easier
Approaching the target firm at the appropriate time with a compelling vision for the combined firms increases the
probability of reaching a deal
Friendly acquisitions often offer the greatest potential for synergy and shareholder wealth creation by promoting
cooperation
Continuing a long term trend, many companies have been narrowing their product and market focus in an effort to make
their businesses easier to manage and for investors to understand. The shares of more focused firms often tend to trade at a
higher price-to-earnings multiple than those that are highly diversified. Tyco International Plc (Tyco) and Johnson Controls
Inc. are recent examples of firms attempting to boost their share prices in this manner. Both firms were pursuing business
strategies that involved attempting to achieve greater focus while leveraging their resources.
Tyco, at one time a high flying conglomerate, had been restructuring its operations for years to become a global
company offering security systems and fire suppression equipment. With annual sales of $10 billion in 2015, Tyco is a
shadow of its conglomerate days in the 1990s. The firm has been downsizing for years by selling or spinning off such
business as electronic components and surgical equipment to become the world’s largest “pure-play” fire protection and
security systems’ company. Similarly, Johnson Controls, maker of systems to optimize energy use in buildings and car
batteries and seat components, with annual sales of $37 billion, seeking to reinvigorate earnings growth and to narrow its
product offering, announced in 2015 that it would spin off Adient. Adient is its slow growing automotive business, which at
one time accounted for as much as two thirds of Johnson Controls’ annual revenue.
Despite these efforts, the share prices of both firms had underperformed the overall stock market in recent years making
it clear to their boards of directors that more had to be done. On January 25, 2016, Johnson Controls announced that it had
reached an agreement to merge with Tyco in a deal valued at about $15 billion. The new firm will have $32 billion in
annual revenue and earnings before interest, taxes, depreciation and amortization (EBITDA) of $4.5 billion before
synergies (but including the planned spinoff of Adient) on a proforma basis.3
3 Proforma basis refers to the illustration of how the two companies’ financial statements would look hypothetically if
combined.
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Tyco’s CEO, George Oliver, initially contacted Mr. Alex Molinaroli, CEO of Johnson Controls, about structuring a
smaller deal involving the Johnson Control’s systems controls business. By October, discussions between the two firms had
escalated to a merger involving the two firms. The two CEO’s believe that together the firms could leverage their combined
resources. How? By offering packages of products and services consisting of fire, security, heating and air conditioning,
power solutions and energy storage controls and systems to serve various end-markets including large institutions,
commercial buildings, retail, industrial, small business and residential.
The expected benefits of the transaction included additional revenue growth by selling complementary products to each
firm’s customer groups, $500 million in annual pretax cost savings, and $150 million in annual tax savings resulting from
moving the combined firm’s headquarters from the U.S. to Ireland in what is known as a corporate inversion.4 The $500
million in operating synergies are to be achieved by increasing efficiencies, eliminating redundancies, integrating the global
branch networks, and realizing the economies of scale associated with an over $20 billion buildings’ business.
Upon completion of the merger, the new firm will be renamed Johnson Controls Plc, with the firm’s legal domicile and
global headquarters in Cork, Ireland. Operational headquarters are in Milwaukee, Wisconsin where Johnson Controls had
its headquarters. Both Johnson Controls and Tyco shareholders will receive shares of Adient (Johnson Controls automotive
business) following its spinoff in 2017.
When Patience Pays—Signet Jewelers Buys Zales
Case Study Objectives:
Having a clear business strategy makes target selection easier
Approaching the target firm at the appropriate time with a compelling vision for the combined firms increases the
probability of reaching a deal
Friendly acquisitions often offer the greatest potential for synergy and shareholder wealth creation by promoting
cooperation.
Signet Jewelers, a specialty retailer, announced it had signed a definitive agreement to acquire all of the outstanding shares
of its smaller competitor, Zales Corporation, for $21 per share in cash in early 2014. The deal is valued at $690 million and
$1.4 billion including assumed debt. The purchase price represents a substantial 41% premium to Zales’s closing price the
preceding day. The size of the premium reflects Signet’s anticipated synergy with Zales.
Dallas, Texas-based Zales Corporation operates more than 1,000 retail stores and kiosks in the United States, Canada,
and Puerto Rico. Its brands also include Gordon’s Jewelers and Piercing Pagoda. Its 2013 revenue totaled $1.9 billion. Hit
hard during the 2008–2009 recession, Zales’s profitability plummeted, with the struggling firm recording a series of annual
losses. The 90-year-old firm is in the process of completing its successful multiyear turnaround effort to restore
profitability. Having delivered 12 consecutive quarters of revenue growth, the firm recorded a $10 million profit in 2013.
Signet, headquartered in Bermuda, operates more than 1,400 stores under the Kay Jewelers and Jared the Galleria of
Jewelry brand names in the United States. It also operates about 500 stores in the United Kingdom under the brands H.
Samuel and Ernest Jones. Signet’s CEO, Mike Barnes, said that the Zale deal fits perfectly with his firm’s strategy of
expanding its domestic and international brand portfolio by making opportunistic acquisitions.
The deal substantially improves Signet’s geographic coverage throughout the United States and gives it access to
additional well-known brands. The addition of Zale also gives Signet its first presence in Canada, where Zales operates 199
stores under the Peoples brand. The deal also gives Signet access to several popular jewelry brands as well as those that
have been exclusively sold by Zales, including Vera Wang Love and Celebration Diamonds.
The combined firms have annual sales of $6.2 billion. Signet intends to operate Zales under its current CEO, Theo
Killion, who was responsible for the Zale’s turnaround. The merger is expected to increase earnings per share during its
first full year of operation resulting from the elimination of duplicative overhead and the potential for combining retail
4This deal is the 12th inversion undertaken by U.S. firms since the U.S. Department of the Treasury attempted to curb such
deals through new regulations in September 2014. Johnson Controls and Tyco structured their deal to reap maximum tax
benefits. With Johnson Controls investors owning less than 60% of the combined company, the firms’ side-stepped
regulations that might have made the deal less attractive. See Chapter 12 for more detail on inversions.
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outlets. Cost savings from combining the two firms are expected to total $100 million annually. Following closing, Signet
will retain the Zale brand name.
Signet had been watching Zales’s successful turnaround with great interest for several years. Impressed with its
management and how its geographic coverage and brand offering would complement Signet’s geographic foot print and
brand offering, Signet approached Zales in late 2013 with a proposal to combine the firms. The proposal included a well-
thought out business strategy for growing the combined firms and for retaining key Zale managers.
Signet’s patience paid off. Recognizing the immediate synergy created by combining the former competitors, investors
applauded the deal sending Zale’s share price up 40%, while Signet’s rose by 9% on the news. Reflecting the effects of the
firm’s successful turnaround, Zales Corporation’s share price has been up 208% compared to Signet’s 25% improvement in
2013 over 2012.
Google’s Foray into “Device Makers” in its Search for the Next Big Thing
Case Study Objectives: To illustrate
• The challenge of translating vision into strategy
• The challenge of moving beyond a firm’s legacy business.
As one of the most successful firms on the planet measured by most any metric, Google represents a firm at a cross roads.
How does it grow beyond the extraordinary success it has achieved in its legacy search business? How does it find the
“next big thing” that will drive its revenue and profits? Its actions in recent years provide an important glimpse into the
challenges associated with a firm trying to find its future beyond its legacy as the premier search engine on the globe.
Google’s website describes its mission/vision as organizing the world’s information and making it universally accessible
and useful. Central to the firm’s culture is the quality of the people they hire, “favoring ability over experience.” The firm
strives to maintain an open culture in which “everyone is a hands-on contributor and feels comfortable sharing ideas and
opinions.” Among its core beliefs are a focus on the user and the ability to do one thing “really, really well.” Google notes
its core capability is to provide users the ability to search from any location at any time vast amounts of information and to
retrieve only that which is relevant.
Google states unequivocally that it is a business that makes money by offering search technology to companies and from
the sale of advertising displayed on its website and other websites across the web. It pledges to conduct its business in a
legal and socially responsible manner to maintain the highest possible trust among its users that the information it collects
will not be used to their detriment.
At Google “great just isn’t good enough.” Through innovation, the firm aims to “take things that work well and improve
upon them in unexpected ways.” The customers for its products and services are consumers, businesses, and the Web (i.e.,
community of web designers and developers). For consumers, the company strives to make it as easy as possible to find the
information they need and to get the things the need done. For business, Google provides tools to help businesses engage in
all aspects of e-commerce from advertising to fulfillment. For the Web, Google engages in a variety of projects to make it
easier for developers and designers to contribute the improvement of the Web.
Founded in 1998, Google continues to grow at a torrid pace, largely driven by the shift of advertising and commerce
from traditional media and brick and mortar retail outlets to the Internet. This is likely to continue well into the foreseeable
future. Furthermore, the firm’s profitability continues to rank well above most other technology firms. However, reflecting
the effects of increasing infrastructure costs and efforts to diversify its core business, the firm’s operating margins have
declined for 5 consecutive years. Despite accelerated efforts in recent years to diversify its revenue base, about 95% of the
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firm’s total 2013 revenue of more than $56 billion came from advertising on its website and those of its network members
in 2013. See Table 5.3 for a trend in key financial performance indicators since 2008.
In recent years, Google has accelerated the pace of diversification by moving from a largely software business into one
offering both software and hardware. The diversification effort into hardware businesses began in earnest in 2011 with
Google’s $12.5 billion acquisition of wireless handset manufacturer Motorola Mobility. In 2013, Google acquired four
robotics companies with products ranging from robot arms and heads to walking androids. In mid-2014, it purchased Titan
Aerospace, a maker of high altitude solar powered drones, in an effort to bring internet access more cost effectively than
satellites to millions of people in largely inaccessible places. Such drones are capable of staying aloft for several years. That
same year, Facebook acquired Ascenta, a British based maker of similar types of drones.
What all these transactions have in common is that they involve the gathering and analysis of data. But is that enough to
create real and sustainable synergy? What the firm was trying to achieve with this seemingly disparate and random
acquisitions was puzzling to many observers.
In 2013, Google’s CEO, Larry Page, known for his emphasis on making audacious investment and a pragmatic
management style mused at a Google developer conference in mid-2013 about how “technology should do the hard work so
people can do the things that make them the happiest in life.” He noted that “today we are still scratching the surface of
what is possible.” Google’s role in this future seems to be to use its core skills as a technology innovator to make what
seems impossible today possible tomorrow.
Implicit in what Page is saying is that he sees a future world in which all things are connected via the Internet and that
Google can benefit by getting more people to use the Internet. In turn, Google’s stakeholders from shareholders to
employees to communities benefit as the firm’s revenues grow with increased Internet traffic. Shareholders gain by
increasing profits, employees by increased opportunities and challenges and communities from more jobs and tax revenue.
Therefore, Google’s business strategy is implicitly to seek ways to get more people to use the Internet more frequently and
in more diverse ways. But does this strategy facilitate the realization of the firm’s stated mission: organizing the world’s
information and making it universally accessible and useful?
Since so much of what Internet users do online generates revenue for the firm, consistent with its mission, Google wants
to pursue ways to make the Internet easier to use, more accessible, and faster. From its original search product, the firm has
tried to improve the quality of search results by returning only those most relevant to the search request. The objective of
the Google Chrome product was to build speed and ease of use. Through its fiber program the firm rolled out in 2013 in
Kansas City, customers can get free internet access at generally acceptable rates of speeds and for additional fees can
access increasing rates of speed reaching speeds purported to be 100 times faster than broadband. With respect to wireless
devices, Google purchased Motorola Mobility to drive the spread of its Android operating system through smartphones and
tablets displaying the Google logo. While promoting increased safety and fuel economy, Google’s self-driving cars allow
for constant internet usage during daily commutes as the vehicle’s sensors communicate with the network.
Larry Page wants the firm’s new products and services to be those that get more people to use them multiple times daily.
An important criterion for selecting new products and services has been dubbed the “toothbrush test” (analogous to
toothbrushes used at least twice daily). The firm’s search capability and Android operating system for wireless devices
satisfy this criterion. Having penetrated the software market in a big way, the firm is now pushing into the hardware market
with software embedded in such products as cars and glasses to robots and thermostats.
With its sight on enlarging its exposure in the hardware business, Google announced on January 13, 2014, that it would
pay a whopping (almost 12 times annual revenue) $3.2 billion for Nest Labs, a manufacturer of thermostats and smoke
detectors. The Nest deal takes Google into the home heating, air conditioning, and appliance business as a parts and
services supplier. Nest is in the business of energy management, with reported annual revenues of $275 million. Utilities
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pay Nest $30 to $50 monthly to manage the energy usage of Nest customers who had opted into their utility’s demand-
response programs. As part of the programs, Nest temporarily takes control of a home’s heating and cooling for a set
period. Customers are notified that their home’s temperature is about to be changed in advance. When this is done over
large neighborhoods, utility energy costs are lowered by as much as 50% by re-routing peak energy being used in empty
homes. Consistent with past practices, Nest will be operated as a wholly owned independent subsidiary of Google.
Tony Fadell, Nest’s CEO, describes Google’s acquisition of his firm as its further penetration of the “Internet of
Things.” This is a metaphor for a world in which many different types of devices connected wirelessly use a combination of
software ad sensors to communicate with one another and their owners. Perhaps somewhat whimsically, given its largely
amorphous definition, the “Internet of Things” has been described as having a potential size of $19 trillion, larger than the
size of the US annual gross domestic product. The movement toward the “Internet of Things” is expected to accelerate in
the relatively near future. Increasingly sophisticated interconnected devices ranging from smartphones and tablets to
thermostats and smoke alarms that Nest makes to smartwatches and other wearable technologies increasingly penetrate
every aspect of our lives.
Google is not alone in pursuing this vision of the future. Samsung announced a new smart-home computing platform
that will let people control washing machines, televisions, and other devices it makes from a single app. Microsoft, the
world’s biggest maker of software, is working to transform itself into a devices, software, and services firm. The acquisition
of Nokia brings it an array of new devises that utilize a common wireless operating system.
Some argue that Google’s entry into hardware is at some level simply an imitation of Apple’s fabulously successful
strategy. That is, create your own devices to sell software and services. Apple has demonstrated that properly designed
devices win brand recognition followed by exploding sales and profit. Further, they establish an ongoing relationship
between the firm and its customers within a so-called ecosystem of interconnected software and hardware products. Once
established, the firm can sell additional products and content through these devices to its customers. The ecosystem
currently includes a variety of mobile wireless devices that run apps, TV shows, movies, music and other content today and
most likely the car, home appliances, and health services in the future.
The challenges for Google in making these hardware acquisitions are fourfold: logistical, public relations, cultural, and
competitive. The logistics associated with promotion of cooperation between the new units and existing Google operations
and the cross-fertilization of ideas could be daunting. Without these activities, it is unlikely that the firm can fully leverage
its highly impressive technology infrastructure without being stifled by a burgeoning bureaucracy that has grown to 46,000
employees. Since the new businesses are operated largely as independent entities within Google, the usual methods for
promoting the desired behaviors such as colocation and sharing of facilities are difficult making contact among current
employees and those with the new units problematic.
Entry into the “Internet of Things” also poses serious privacy concerns among regulators and activists, potentially
creating a public relations nightmare for Google. The increasing intrusion into personal lives and the accumulation of data
on personal habits and lifestyles could trigger an explosive backlash against companies attempting to enlarge their positions
in the “Internet of Things.” The backlash could take the form of customer boycotts of the firm’s products or calls for
increased government regulation.
Google’s entry into hardware is a radical departure from past practices. Google has relied on partners, including
Samsung, to promote its Android mobile operating system software and its apps ecosystem as a rival to Apple’s IPhone,
iPad, and to its IOS software. This changed in 2011 with Google’s acquisition of Motorola Mobility. Motorola gives
Google its own branded smartphone for promoting its Android system and for attracting customers to Google Play Store, a
competitor to Apple’s iTunes and App Store. Google’s new acquisitions now put them squarely in competition with its
traditional partners.
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Finally, the addition of hardware businesses creates a cultural conflict in a firm whose employees were accustomed
historically to developing and selling software services. The production and the sale of hardware will require a fundamental
change in the mindset of those employees required to work with the new hardware business if hardware is to become an
important platform for delivering software and content developed by other units within Google. For example, selling
services is significantly different from selling hardware. Services can be more readily customized to satisfy a customer’s
needs and once sold require less marketing and selling effort to maintain an ongoing relationship with the customer. In
contrast, hardware products often become commodities with few if any meaningful distinguishing features often require an
ongoing aggressive marketing and selling campaign to sustain and grow sales.
With Nest, Google puts its logo on another device. For the immediate future, Google will use Nest as a hub of products
targeted at the residential home “Internet of Things.” Because Google makes most of its money selling advertising and
collecting information about users and how they use the Internet, the penetration of the market for in-home energy products
enables the firm to collect additional information about how people use products in their personal residences. The sensors
and software in these in-home devices enable Google to tap into that data.
In early 2014, under pressure from investors and analysts, Google decided to cut its losses on its Motorola Mobility
acquisition by announcing it had reached an agreement to sell the unit to Chinese PC maker, Lenovo, for $2.91 billion.
Google retained the rights to the intellectual property that it had acquired in buying Motorola Mobility, while granting a
license to Lenovo to use certain patents to produce its handsets.5 Despite three rounds of layoffs, Motorola Mobility lost
more than $1 billion in operating income in 2013. While Motorola’s most recent offering Moto X in late 2013 has been
well received, its sales have not been sufficient to stem hemorrhaging cash flow. It had become increasingly clear that
continued investment in the unit was not likely to turnaround the business. Moreover, exiting the handset business would
assuage concerns among major handset makers that were using Android to power their phones. They had expressed concern
since Google acquired Motorola Mobility in 2011 that Google could become a competitor.
While history rarely repeats itself exactly in the same way, certain parallels may be drawn between Microsoft’s
experience with diversification and what Google is currently doing. Microsoft once having achieved dominance in the
global PC operating system market and for integrated apps such as Microsoft Office lost its way in trying to diversify into a
plethora of largely unrelated businesses. Also, it was late to the mobile device revolution and has been playing catch up for
years, most recently illustrated by its acquisition in 2014 of Nokia’s phone handset manufacturing business.
Google, which continues to dominate the global Internet search market, may be on the verge of diffusing its resources on
only loosely related investments in its seemingly haphazard search for the “next big thing.” As has been the case with
Microsoft, Google’s healthy cash flows will allow it to sustain its effort to diversity for a long period of time. Both Google
and Microsoft are likely to continue no doubt to dominate their respective markets for many years to come, with
Microsoft’s cash flows sustained by its huge installed base of users and Google’s cash flow by the continued shift of retail
trade to the Internet. However, their sustained success will ultimately depend on their ability to foresee and implement the
next great disruptive technology. As both firms continue to get ever larger and more bureaucratic, history shows that all too
often such firms lack the nimbleness to maneuver effectively in a rapidly changing technology environment.
Discussion Questions
1. A corporate vision can be described narrowly or broadly. Google’s website describes its mission/vision as organizing
the world’s information and making it universally accessible and useful. What does this mission statement tell you
about what Google believes its core competence to be and what markets needs it is targeting? How useful do you find
this mission in setting Google’s strategy? (Hint: Discuss the advantages and disadvantages of a broad versus narrow
