Methods of Development: Internal vs. External PDF

**METHODS OF DEVELOPMENT** **INTERNAL VERSUS EXTERNAL DEVELOPMENT:** **INTERNAL DEVELOPMENT** ("organic or natural growth")**:** when a firm invests in its own structure, increasing its size through the building of new facilities, hiring staff, purchasing machinery. It involves investing in new pr...

**METHODS OF DEVELOPMENT** **INTERNAL VERSUS EXTERNAL DEVELOPMENT:** **INTERNAL DEVELOPMENT** ("organic or natural growth")**:** when a firm invests in its own structure, increasing its size through the building of new facilities, hiring staff, purchasing machinery. It involves investing in new production factors that improve its output capacity. A firm deploys its core competences and focuses them on the expansion of its current businesses or on the implementation of other new ones when the investments are made in the industry it has been operating in hitherto or in a completely new one. **EXTERNAL DEVELOPMENT:** when one firm purchases, invests in, associates with or controls other firms or the assets of those firms that are already operating. The firm increases its size by incorporating into its total net worth the output capacity corresponding to the firm or assets integrated. \*It may involve expanding the current business or entering new ones. This development is materialized by placing already existing production capacities at the firm´s disposal it doesn´t imply an increase in real investment or new growth in aggregate production, but a set of production assets changes ownership or is shared. \*Internal development implies growth for the firm itself and for the economic system (new output capacity is generated). The external approach means the firm grows, but not the economic system (the resulting output capacity is the same as each individual firm had beforehand). **JUSTIFYING EXTERNAL DEVELOPMENT:** REASONS OF ECONOMIC EFFICIENCY: - **Reduction in operating costs** through the achievement of economies of scale which generate synergies between the firms that come together. \*If those firms are complementary, each one may take advantage of the other´s efficiencies. - **Reduction in transaction costs:** the firms joining forces have commercial dealings with each other because the transactions are internalized (M&A) or because a lasting bond of trust is forged between the partners that avoids opportunistic behavior in alliances. - **Exploiting any surplus funds available,** which exceed the financial requirements of its current business, when faced with the opportunity for a good investment through the acquisition of another firm. STRATEGIC REASONS: - **Gaining new resources and capabilities** belonging to the other firm, when there´s reciprocity or complementarity among resources. \*When the capabilities are based on tacit knowledge or are complex, the only way of acquiring them is by merging with the firm owning them. - **Best way of overcoming an entry barrier into an industry or country**, as it may be very difficult for a firm to internally obtain the necessary skills or resources for competing in that industry or country, and adapt to the specific conditions of the new competitive environment. - **Reduction in the level of competition in the industry** when the firms that merge are direct competitors (horizontal mergers) increase in the market power of the resulting firm. \*It may help to influence or control the industry´s future evolution. - **Advantages of vertical integration** when the mergers involve firms operating in different stages of the production cycle bearing on economic performance and on market positioning. - **Becoming a top-tier international competitor,** or achieving the right size to compete, requires a firm to have a suitable size that can be achieved more quickly through external development processes. OTHER REASONS: - **Fulfilment of top managers´ own interests:** they can more readily accomplish their utility function that is related to a higher remuneration, greater power, lower corporate risk, social recognition (the overriding objective is not value creation for shareholders) [empire building] - **A response to prevailing trends in the industry**, or to pressure from investment banks or the government. This strategy is adopted due to the imitation effect regarding similar actions pursued by other firms in the industry or in response to the expectations created by pressure groups. \*[Reasons in the case of M&A:] - **The replacement of the management team** in the target firm when it´s seen to be significantly underperforming in terms of its rents earning potential - **The right to tax breaks** when there´s a government policy for favoring merger processes between firms in order to achieve a bigger company size to improve competitiveness. \*[Reasons in the case of alliances:] - **Alternative to M&A**, seeking to gain advantages while hedging their risks by keeping their management teams separate. - **Reduction in the risks and uncertainty** associated with major investments **ADVANTAGES AND PITFALLS OF EXTERNAL DEVELOPMENT:** - **Faster** than its internal counterpart it immediately incorporates the output capacity of the firm integrated without having to wait upon the maturing period for the in-house investments made for internal development - **It facilitates the processes of unrelated diversification or internationalization**: merging with a firm that is already operating in the target industry or country eases the entry, reduces the growth risk and permits the acquisition of new resources and capabilities for operating in that competitive environment. - **It may lead to a better choice of the right moment in which to enter an industry or a country** a firm may also begin to compete from the very moment at which the operation is undertaken - **Easier to enter mature industries**, as no change is made to the industry´s overall size. \*Highly recommended in emerging or growth industries. In this type of industry (competition very intense) it´s more difficult to corner greater market shares through internal development. !!Drawbacks which may often lead to a performance that is worse than expected. **TYPES OF EXTERNAL DEVELOPMENT:** ACCORDING TO THE METHOD OR PROCEDURE FOLLOWED: - **[Firm merger:]** integration of 2 or more firms at least one of the original ones disappears - **[Firm acquisition:]** operation in which packets of shares are traded between 2 firms, with each one retaining their own legal personality - **[Cooperation or strategic alliances between firms:]** links and relations are established between the firms through specific legal or political arrangements, without the loss of legal personality by any one of the parties, which maintain their legal and operational independence. DEPENDING ON THE TYPE OF RELATIONSHIP BETWEEN THE FIRMS: - **[Horizontal:]** firms compete with each other and belong to the same industry - **[Vertical:]** firms are at different stages of the full cycle of the exploitation of a product - **[Complementary:]** firms have no vertical relationships and nor are they direct competitors **TYPES OF MERGERS AND ACQUISITIONS:** **TYPES OF MERGERS:** When 2 or more firms join forces, with at least one party losing its legal personality. a. **PURE MERGER:** 2 or more firms (similar size) agree to join forces, incorporating a new company to which they contribute all their resources winding up of the original firms. (A + B C) b. **MERGER BY TAKEOVER/ACQUISITION:** one of the firms involved (the one taken over) disappears, with its equity being transferred to the acquiring company. The acquiring company (A) continues to exist, but its equity now includes the assets corresponding to the firm taken over (B), which is legally wound up. (A + B A´) c. **MERGER WITH A PARTIAL ASSETS TRANSFER:** one firm (A) contributes only part of its net worth (a) along with the other firm it´s merging with (B) to form a new company (C) that is created within the merger agreement itself, or to another pre-existing company (B) which increases in size (B´). \*The firm providing the assets (A) must not be wound up. \***Firm deconcentration methods**: absence of growth in the original company and actual reduction in its size. These operations involve: - [Break up] or [split-up processes:] when it allocates its net worth to several new or pre-existing companies and then winds up. (A B + C) - [Spin-off] or [demerger:] part of the net worth of an existing company is broken down into one or more parts to form sundry firms that are legally independent, although most or all their stock is held by the original or parent firm. (A (a) a + A) These operations are mostly restructuring processes involving firms through the twin approaches of restructuring a business or a portfolio of businesses. Sometimes, they involve the restructuring of a group of firms and may be accompanied by other concentration operations. **TYPES OF ACQUISITIONS:** Investing in or taking over companies a firm uses different procedures to acquire part of another firm´s shareholder capital, with the aim being to control it either partially or in full. Both the acquiring and the acquired firms continue to exist. \*The acquisition of, or investment in, firms give rise to different levels or degrees of control according to the amount of shareholder capital acquired in the operation (absolute, majority or minority) and depending on the way in which the rest of the stock is distributed among shareholders (large packets of shares in the hands of a very small number of individuals or large number of shareholders with small individual stakes). A firm may be acquired in a traditional manner when its owners agree to the terms and sign a sales contract. When such an agreement is not possible (difficulty of identifying the owners of its widely distributed capital or lack of collaboration on the part of the target firm´s management team), the purchasing firm may resort to a **Public Takeover Bid (TOB):** a firm makes an offer to buy all or part of the shareholder capital of another listed firm according to certain specific terms (price, percentage of shareholder capital to be bought, timing). \*If a public takeover succeeds, the purchasing company has to offer the shareholders of the target firm more than its market value an additional cost for the purchaser that will have to be offset in the future through the value creation project arising from the operation. **MANAGING MERGERS AND ACQUISITIONS:** \*A highly significant number of M&A sometimes don´t record the expected value for shareholders, or firms on their own would have registered higher levels of performance and value. This may be due to the appearance of different factors that condition the success of the M&A: - **Design of the operation:** 1. Establishment of [due diligence] search for and locate the target firm for the operation, identify its characteristics and determine the value, risks and variables with a bearing on its future. 2. [Set the price] of the operation value the price of the 2 firms involved (mergers) or value the price of the target firm, unless the purchase is partially or fully covered with shares of the purchasing firm (acquisitions) \*The greatest difficulty for setting the price lies in valuing the intangibles that don´t appear on the balance sheet and which are related to the firm´s ability to generate income in the future. \*The purchaser tends to pay the "control premium" or an extra amount in order to gain control over the target firm. 3. [Method of financing] cash, exchange of shares, issue of bonds or other financial agreement. \*Acquisitions **Leveraged buyout (LBO):** financing a significant part of a firm´s sales price through borrowing. This debt is secured by the purchaser´s equity or borrowing capacity, and by the assets of the firm purchased and its future cash flows. \***Management Buyout (MBO):** when the purchasing party is the target firm´s management team. - **Organizational and cultural integration:** problems arising from the integration of the human and organizational systems that may be forthcoming due to: - The attempt made by the firms joining forces to maintain their culture, values, identity, symbols - The differences in the structural design of firms joining forces regarding hierarchical levels, reporting habits between levels, the size of administrative teams, organizational routines and bureaucratic procedures - The differences in factors of a psychological nature in aspects such as personal power needs, ethical suppositions, management and leadership styles, degree of worker participation - Differences in the systems of employee compensation, incentives and social welfare benefits for personnel in the original firms - The danger of a mass exodus of those individuals who (still being of great value) leave the organization because they don´t feel morally engaged or they feel let down by the integration process. [\*Organizational fit process:] organize the degree of compatibility existing between the organizational and socio-cultural systems of the original firms, evaluating the following: - **Structural features:** job descriptions, grouping of organizational units, size of units, chain of command - **Administrative processes and systems:** standardization of processes, communication systems, planning of activities and performance monitoring - **Human resources:** systems of recruitment, training, motivation, promotion, participation, remuneration - **Organizational culture:** values, beliefs, habits, rituals, symbols, standards of behavior - **Operations integration:** integration of the production systems of the firms joining forces and the potential generation of synergies. The possible duplication of all nature of assets requires: - Dealing with the additional cost involved in restructuring the resulting firm due to the integration of operating systems - Relocation of activities - The withdrawal from duplicated premises or activities - Reduction in staff \*[Redundancies] due to the severance costs incurred and the conflict this may involve. - **Competition or anti-trust laws:** M&A (mainly between direct competitors) are subject to the legislation all the advanced economies have enacted to preserve free market competition. **STRATEGIC ALLIANCES: COOPERATION BETWEEN FIRMS** **CONCEPT AND CHARACTERISTICS:** An agreement between 2 or more separate firms that by joining or sharing their resources and/or capabilities (although not merging) introduce a certain degree of interrelation with a view to reinforcing their competitive advantages. - **There´s no dominance of one firm over another among those entering into cooperation:** as their voluntary involvement means that no one firm is subordinated to another - **Coordination of future actions:** with a view to the coordinated and joint undertaking of certain activities, accepting certain commitments - **Loss of a certain amount of organizational independence:** arising from the agreement secured and the commitments assumed, maintaining its autonomy in all its other operations. - **Blurring of the organization´s boundaries:** difficult to clearly define the activities, people or assets that are part of one firm and which ones are outside it and pertain to the partner. - **Interdependence:** partners depend on each other to successfully observe the agreement, because if not they would have sought to achieve their objectives by themselves. - **Achieving a goal:** it would have been difficult to attain, or done so under worse conditions, without the agreement The purpose of the cooperation is to strike a greater balance between performance and flexibility in order to gain advantages and avoid the risks inherent to M&A because they keep management teams separate reducing the problems of cultural, organizational and operational integration. This means a more reversible commitment that enables each partner to focus on their specialist areas. Cooperation curtails uncertainty and the risks of business activity through the sharing of resources and capabilities among partners while saving time in the achievement of strategic objectives. PITFALLS OF COOPERATION: - **It may undermine a firm´s competitive positioning** when the alliances are between direct competitors, as it may dilute the sources of competitive advantages because resources, technology and knowledge are shared with partners. \*Cooperation may come as a "Trojan horse" that allows a partner to exploit another´s skills, or open the door to local markets for non-domestic competitors in the case of international alliances - **Loss of independence** in decision-making, as it´s restricted by the terms of the agreement and by the control wielded over it by the other partners - **No delegation of power** to those supervising the cooperation to enable them to make the right decisions as a result of the displacement of power and influence within organizations or between them and the governing bodies in the alliance - **It incurs costs in time and money** regarding the negotiation and surveillance of the agreement, and **some organizational complexity**, as it requires seamless coordination between the partners - **Diverging interests** among partners, as they might be pursuing different goals, which hinder the implementation of a joint strategy - **Lack of trust and commitment** among partners. When there´s a mistrust or a partner is not offered the best a firm can give, the agreement tends to become less effective. \*More commonly when the alliances are direct competitors **TYPES OF AGREEMENTS:** - Based on the number of partners (2 or more) - Based on the number of activities involved (focused or complex) - Type of relationship between the partners (horizontal or vertical) - Type of strategic goals to be achieved BASED ON THE NATURE OR FORM OF THE AGREEMENT BETWEEN THE PARTNERS: a. **CONTRACTUAL AGREEMENTS:** contracts between firms that don´t involve the exchange of shares or an investment in the capital of an existing firms or a new one. \*Not all agreements necessarily involve some form of alliance, as a certain degree of continuity in the cooperation is required in order to differentiate them from ordinary contracts or market relations as a way of operating in the market. \*The simplest form involves long-term contracts through which the partners agree to undertake certain joint operations. - [Franchise:] contract in which one firm (franchiser) grants another (franchisee) the right to retail certain products or services within a specific geographical area and under certain conditions in exchange for a direct or indirect financial consideration. - [Licence:] contract where a firm (licenser) grants another (licensee) the right to use its industrial property rights (patents, trademarks, designs, copyrights, know-how and technical information) in return for a consideration. - [Subcontracting:] a firm (contractor or principal) commissions another (subcontractor or agent) to undertake certain production activities or render certain services (with pre-arranged instructions) with the principal firm retaining all financial liability. - [Consortium:] contract where a long-term relationship is formally arranged between the partners and an umbrella organization (the consortium) in which they are all integrated. \**Temporary Business Associations* (legal form used for consortia) b. **SHAREHOLDER AGREEMENTS:** acquisition of shares in a firm by at least one of the participating partners. AIMS: - Incorporate a new firm joint venture - Reinforce the interaction between firms that enter into an association through a share swap or exchange - Support the project of another firm in which there´s an interest through minority shareholdings - [Joint-venture:] agreement where 2 or more independent firms (parent or dominant companies) create a new partnership through which to pursue a common activity. - [Share swap or exchange:] parties buy or subscribe part of each other´s shareholder capital. The allied firms don´t relinquish any control over their respective businesses. - [Minority shareholding:] only one firm takes the minority stake in the capital of another one, with the aim of continuity and the intention of being an active party in support of the affiliate´s business project in which it is interested. c. **INTER-ORGANIZATIONAL NETWORKS:** organizational form that lies between the market and the firm, combining cooperation and competition. Networks bring firms together to provide mutual support in different activities, and may involve the simultaneous use of specific agreements. - Plurality of cooperation agreements between firms - Multiplicity of partners - Complexity of relationships \*Complementarity of activities that enables the participants to perform efficiently, as each organization specializes in those activities in the value chain in which they have a distinctive competence and which are vital to their competitive advantage (each partner has access to the competences of others). The network is a new instrument that management uses to attain a strong competitive positioning because it allows each partner to rely on the support of all the other partners in the confrontation with dominant competitors. Networks may also help to avoid or hinder the formation of other alliances. **MANAGING STRATEGIC ALLIANCES:** **Management of strategic alliances:** sum of issues or factors that need to be considered when implementing an agreement and seeking to ensure its success: A. **THE PROCESS OF SECURING AN AGREEMENT:** activities that need to be undertaken before the alliance can effectively begin to operate, and which culminate with the subscription of the agreement between the partners involved. STAGES: 1. [The decision to choose cooperation as the most appropriate method of strategic development:] cooperation is not intrinsically beneficial, so it needs to be compared with other options. The decision is conditioned by the prior stances adopted by top management (values, beliefs, favorable or unfavorable attitude), and the satisfaction or dissatisfaction stemming from any prior experiences there might have been. 2. [The choice of partner or partners to be approached:] looking for potential partners, analyzing and assessing their strengths and weaknesses, and setting the criteria for choosing the right one: - Strategic fit depends on the interests and the complementarity of resources and capabilities across partners - Cultural fit compatibility between the partners´ modus operandi (core values of their organizational culture, ethical values, attitude to risk, way of understanding work) 3. [Characteristics and terms of the agreement:] - Content definition of the agreement´s objectives and each partner´s contributions and returns - Formal and legal aspects adopted form, protection of individual information and ways of resolving conflicts - Organization task sharing, assignment of duties and coordination mechanisms - Planning timeframe and milestones, operational plans for each partner and for the overall project, allocation of financial and human resources to the project B. **MANAGING THE AGREEMENT:** when the activities provided in the agreement start to be developed, this tends to be a critical moment for its ultimate success. - [The attitudes maintained by each partner] towards all the other partners and towards the agreement, regarding trust, commitment and flexibility. - Trust belief held by each partner that the other party will proceed with honesty and integrity and observe the commitments it has embraced. - Commitment each partner´s real involvement in the activities assigned to it and the project´s success assigning the necessary resources, dedicating time and care to the agreement´s process and making the agreed investments - Flexibility ability to adapt to the characteristics, behaviors and attitudes of all the other partners. - [The specific mechanisms for making the agreement work,] linked to the agreements´ organization and planning stages. - Clearly defined objectives and goals - Suitable allocation of resources - Support for top management - Delegation of authority and responsibility in those top managers appointed to oversee the agreement´s observance - Mechanisms for identifying the returns expected in terms of information and learning - Mechanisms for resolving conflicts and ending the alliance - Monitoring and control systems for recording and measuring the results obtained \*Many firms now have to deal with the management of one alliance, the management of a raft of alliances, or a portfolio of alliances. Certain additional tools are required for managing a broad portfolio of alliances with greater changes of success: - Designing and implementing a portfolio strategy that includes a general approach applicable to all the alliances - Supervision, coordination and monitoring of the portfolio - The implementation of a support infrastructure that facilitates the management of individual alliances and the overall portfolio. C. **THE OUTCOMES OF THE COOPERATION:** an alliance is successful when the strategic objectives for which it was formed are achieved. The problem posed is that each partner may have their own agenda and they might not all be compatible with each other. An agreement may fulfil its objectives and at the same time compromise one or more of the partners, or it may end in failure because the overall objectives have not been achieved, but it may be very beneficial to one or more of the partners. MEASURING THE RESULTS OF COOPERATION AGREEMENTS FROM A DUAL PERSPECTIVE: - [From a joint perspective on the agreement as such:] whether or not the objectives initially agreed for the alliance are achieved, or depending on the alliance´s stability the manner in which it develops over time and eventually comes to an end. - [From each partner´s perspective:] depends on how each one of them subjectively appraises their involvement in the agreement. \*It´s not easy to achieve this parity regarding the returns from cooperation, as observed by each one of the partners, especially when all the firms involved are very different in terms of size, characteristics, management procedures and their competitive strategies.