questions are included in the quiz 3.Doc for 2 pages essay. others are some resources to help writing. thanks againMBA 870:
7th Class Session
September 30th, 2014
Which Way to Grow
Two Broad Way:
1. Internal organic growth
2. External partnering (i.e. M&A or SA)
Firm’s Value Proposition
3. Cultural DNA
Growth will naturally flow?
Which Way to Grow
Three is the magic number
1. Price-value leaders: expand to adjacent markets (e.g.
Walmart and the grocery business)
2. Relational-value players: expand scope by broadening the
definition of a solution (e.g. IBM with integrated solutions)
3. Performance-value leaders: expand through continuous
innovation (e.g. R&D shops like Merck…)
Long-term winners sustain their growth by edging out from
their core, with natural extensions of their resources, or
by reaching out with those resources into new markets
Which Way Should You Grow
By: Day. G.S. Harvard Business Review July/August 2004
Your growth strategy should be determined by your value proposition. That may seem
obvious. But precious few companies know themselves well enough to do it
Most companies believe they have a choice when it comes to growth strategies. Some look at firms
like General Electric or Cisco and think acquisition is the way to go. Others think they should start
competing on low price and high volume, as Wal-Mart and Dell have done. Still others think that
jump-starting innovation will let them grab the brass ring. But too often the growth strategy du jour
fails because most companies select an inappropriate, and ultimately unprofitable, path.
The acquisition battlefield, for example, is littered with the bodies of dead growth strategies.
Remember Merck-Medco? In 1993, Merck thought it might skim some cream from the managed
care business. To that end, the giant pharmaceutical firm bought Medco, which was in the business
of authorizing and supplying drugs for patients of managed care companies. Since Merck owned
Medco, Medco would steer more prescriptions toward its parent-or so the theory went. But when
federal regulators insisted that such practices would compromise patient health, Merck was forced
in 2002 to divest Medco.
Now, a highly regulated company in the innovation business like Merck should already have
understood that meddling in managed care – whose business is price control- would create an
untenable conflict. But it was not just a conflict of interest; it was also a conflict of value
proposition. The strategy appropriate for a performance-value leader like Merck or Meditronic is
not right for a price-value leader like Wal-Mart, Dell, or Medco, or a relational-value leader like
IBM Global Services.
To craft a winning growth strategy, you must first firmly identify your company’s value
proposition-including its capabilities, assets, and cultural DNA. What is your company really good
at? Do you best compete on price, on integrated solutions, or on innovation? Based on your true
value proposition, you should select the strategy that imbues this proposition with meaning and
direction. Growth will naturally follow.
Price-value leaders like Dell and Wal-Mart grow best by extending their low-cost value proposition
to adjacent markets. The European no-frills airline EasyJet, for example, has successfully expanded
into car rentals and internet cafés and is considering launching EasyCruise.com, EasyBus.co.uk, and
EasyDorm.com. The common denominator? A combination of convenience and low cost that
appeals to small-business people, backpackers, and other price sensitive tourists. The firm varies
prices according to demand and sells only through the Web.
Relational-value players are companies like Fidelity Investments, IBM, and GE Aircraft Engines
that create value for customers by offering integrated solutions. They don’t just bundle products and
services but customize them to such a degree that they act as production partners in many cases,
absorbing some of their customers’ risk. The best growth path for relational-value leaders is to keep
expanding their scope by broadening the definition of a solution. The pivotal question they need to
ask is: “Which of the functions that our customers perform could we do better?”
Performance-value leaders grow best through continuous innovation-think of Genentech, Intel, and
Nokia. These companies exploit emerging and converging technologies; they also shape and build
new markets. They do this by deploying a decentralized, team-oriented organization that values
discovery and experimentation. Merck, a performance-value leader, may have failed to grow by
merging with Medco. But by drawing on its strengths in R&D, Merck has garnered a huge success
with the drug Fosamax, both defining a new prevention market for osteoporosis and extending the
product life cycle by introducing a once-a-week, rather than a daily, formulation.
Clearly, the resource requirements for each of these three growth paths are very different. Choose
the wrong growth path, and all you may have to show for it is higher costs. But focusing on your
value proposition can raise the odds of choosing wisely. Consider the options open to a major
brewer whose growth had stalled. Its operations and logistics group believed the road to growth lay
in streamlining and standardizing new product development by employing a small staff that used
stringent screening criteria to find brand concepts with broad appeal. A second group, within sales
and marketing, pushed for an approach that would respond quickly to changing customer demands.
This group felt the firm should develop and distribute new brands of beer tailored to local markets,
which would require a more flexible, decentralized organization. Still another faction wanted to
search for big new concepts such as ice beer or dry beer. That would have required a different
product development process, additional dedicated resources, and the heavy involvement of senior
After much soul-searching, management concluded that since the company was a price-value
leader, streamlining was the way to growth. The other paths would be distractions that would dilute
its resources. Though niche markets held a few attractive growth options, these could not be
pursued within the core business.
In essence, long-term winners sustain their growth by edging out from their core, with natural
extensions of their resources, or by reaching out with those resources into new markets. Price
players should look for growth segments within the markets they already serve. Relational players
can look for latent customer needs that they can solve well. Performance players will want to
embrace technological discontinuities. To achieve superior profitability, you need to beat your
competition in at least one of these value arenas and equal them in the other two. But remember, the
value systems are utterly different. If you try to conquer too much, you can find yourself in trouble.
What is a firm’s core?
With the globalization of production
as well as markets, you need to evaluate
your international strategy. Here’s a
framework to help you think through your
options. by Pankaj Ghemawat
The Central Challenge of Global Strategy
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YEL MAG CYAN BLACK
HEN IT COMES TO GLOBAL STRATEGY, most business leaders and academics make two assumptions: first, that the central challenge is to strike
the right balance between economies of scale
and responsiveness to local conditions, and second, that
the more emphasis companies place on scale economies in
their worldwide operations, the more global their strategies
These assumptions are problematic. The main goal of any
global strategy must be to manage the large differences that
arise at borders, whether those borders are defined geographically or otherwise. (Strategies of standardization and
those of local responsiveness are both conceivably valid responses to that challenge – both, in other words, are global
strategies.) Moreover, assuming that the principal tension
in global strategy is between scale economies and local responsiveness encourages companies to ignore another functional response to the challenge of cross-border integration:
arbitrage. Some companies are finding large opportunities
for value creation in exploiting, rather than simply adjusting
to or overcoming, the differences they encounter at the borders of their various markets. As a result, we increasingly see
value chains spanning multiple countries. IBM’s CEO, Sam
Palmisano, noted in a recent Foreign Affairs article that an estimated 60,000 manufacturing plants were built by foreign
firms in China alone between 2000 and 2003. And trade in
IT-enabled services – with India accounting for more than
half of IT and business-process offshoring in 2005 – is finally
starting to have a measurable effect on international trade
in services overall.
In this article, I present a new framework for approaching global integration that gets around the problems outlined above. I call it the AAA Triangle. The three A’s stand
for the three distinct types of global strategy. Adaptation
seeks to boost revenues and market share by maximizing a
firm’s local relevance. One extreme example is simply creating local units in each national market that do a pretty good
job of carrying out all the steps in the supply chain; many
companies use this strategy as they start expanding beyond
their home markets. Aggregation attempts to deliver economies of scale by creating regional or sometimes global operations; it involves standardizing the product or service offering and grouping together the development and production
processes. Arbitrage is the exploitation of differences between national or regional markets, often by locating separate parts of the supply chain in different places – for instance, call centers in India, factories in China, and retail
shops in Western Europe.
Because most border-crossing enterprises will draw from
all three A’s to some extent, the framework can be used to develop a summary scorecard indicating how well the company
is globalizing. However, because of the significant tensions
within and among the approaches, it’s not enough to tick off
Pankaj Ghemawat is the Anselmo Rubiralta Professor of Global Strategy at IESE Business School in Barcelona, Spain, and the Jaime and
Josefina Chua Tiampo Professor of Business Administration at Harvard Business School in Boston. He is the author of “Regional Strategies for Global Leadership” (HBR December 2005) and the forthcoming book Redefining Global Strategy: Crossing Borders in a World
Where Differences Still Matter, which will be published in September
2007 by Harvard Business School Press. For a supplemental list of
publications on globalization and strategy, go to www.hbr.org and
click on the link to this article.
60 Harvard Business Review
the boxes corresponding to all three. Strategic choice requires some degree of prioritization – and the framework
can help with that as well.
Understanding the AAA Triangle
Underlying the AAA Triangle is the premise that companies
growing their businesses outside the home market must
choose one or more of three basic strategic options: adaptation, aggregation, and arbitrage. These types of strategy differ in a number of important ways, as summarized in the
exhibit “What Are Your Globalization Options?”
The three A’s are associated with different organizational types. If a company is emphasizing adaptation, it probably has a country-centered organization. If aggregation is
the primary objective, cross-border groupings of various
sorts – global business units or product divisions, regional
structures, global accounts, and so on – make sense. An emphasis on arbitrage is often best pursued by a vertical, or
functional, organization that pays explicit attention to the
balancing of supply and demand within and across organizational boundaries. Clearly, not all three modes of organizing can take precedence in one organization at the same
time. And although some approaches to corporate organization (such as the matrix) can combine elements of more
than one pure mode, they carry costs in terms of managerial
Most companies will emphasize different A’s at different
points in their evolution as global enterprises, and some
will run through all three. IBM is a case in point. (This characterization of IBM and those of the firms that follow are informed by interviews with the CEOs and other executives.)
For most of its history, IBM pursued an adaptation strategy,
serving overseas markets by setting up a mini-IBM in each
target country. Every one of these companies performed a
largely complete set of activities (apart from R&D and resource allocation) and adapted to local differences as necessary. In the 1980s and 1990s, dissatisfaction with the extent to
which country-by-country adaptation curtailed opportunities to gain international scale economies led to the overlay
of a regional structure on the mini-IBMs. IBM aggregated
the countries into regions in order to improve coordination
and thus generate more scale economies at the regional and
global levels. More recently, however, IBM has also begun to
exploit differences across countries. The most visible signs of
this new emphasis on arbitrage (not a term the company’s
leadership uses) are IBM’s efforts to exploit wage differentials by increasing the number of employees in India from
9,000 in 2004 to 43,000 by mid-2006 and by planning for
massive additional growth. Most of these employees are in
IBM Global Services, the part of the company that is growing fastest but has the lowest margins – which they are supposed to help improve, presumably by reducing costs rather
than raising prices.
What Are Your Globalization Options?
Why should we
globalize at all?
To achieve local relevance through
national focus while exploiting
some economies of scale
To achieve scale and scope
economies through international
To achieve absolute economies through international
Where should we locate
Mainly in foreign countries that are similar to the home base, to limit
the effects of cultural, administrative, geographic, and economic distance
In a more diverse set of
countries, to exploit some
elements of distance
By country, with emphasis on
By business, region, or customer,
By function, with emphasis
How should we connect
achieving local presence within
with emphasis on horizontal
relationships for cross-border
economies of scale
on vertical relationships,
even across organizational
What types of extremes
should we watch for?
Excessive variety or complexity
Excessive standardization, with
emphasis on scale
Whom should we
watch out for internally?
Entrenched country chiefs
All-powerful unit, regional, or
Heads of key functions
How should we
Address issues of concern, but
proceed with discretion, given
the emphasis on cultivating local
Avoid the appearance of homogenization or hegemonism (especially
for U.S. companies); be sensitive
to any backlash
Address the exploitation or
displacement of suppliers,
channels, or intermediaries,
which are potentially most
prone to political disruption
Regions and other country groupings
Product or business
What strategic levers
do we have?
Procter & Gamble started out like IBM, with mini-P&Gs
that tried to fit into local markets, but it has evolved differently. The company’s global business units now sell through
market development organizations that are aggregated up to
the regional level. CEO A.G. Lafley explains that while P&G
remains willing to adapt to important markets, it ultimately
Administrative (taxes, regulations, security)
Geographic (distance, climate
Economic (differences in
prices, resources, knowledge)
aims to beat competitors – country-centered multinationals
as well as local companies – through aggregation. He also
makes it clear that arbitrage is important to P&G (mostly
through outsourcing) but takes a backseat to both adaptation and aggregation: “If it touches the customer, we don’t
outsource it.” One obvious reason is that the scope for labor
Harvard Business Review 61
YEL MAG CYAN BLACK
When managers first hear about the broad strategies (adaptation, aggregation, and arbitrage) that make up
the AAA Triangle framework for globalization, their most common response by far is “Let’s do all three.” But it’s
not that simple. A close look at the three strategies reveals the differences – and tensions – among them.
Business leaders must figure out which elements will meet their companies’ needs and prioritize accordingly.
arbitrage in the fast-moving consumer goods industry may
be increasing but is still much less substantial overall than in,
say, IT services. As these examples show, industries vary in terms
of the headroom they offer for each of the three A strategies.
Even within the same industry, firms can differ sharply in
their global strategic profiles. For a paired example that takes
us beyond behemoths from advanced countries, consider
two of the leading IT services companies that develop software in India: Tata Consultancy Services, or TCS, and Cognizant Technology Solutions. TCS, the largest such firm,
started exporting software services from India more than 30
years ago and has long stressed arbitrage. Over the past four
years, though, I have closely watched and even been involved
in its development of a network delivery model to aggregate
within and across regions. Cognizant, the fourth largest, also
started out with arbitrage and still considers that to be its
main strategy but has begun to invest more heavily in adaptation to achieve local presence in the U.S. market in particular. (Although the company is headquartered in the United
States, most of its software development centers and employees are in India.)
The AAA Triangle allows managers to see which of the
three strategies – or which combination – is likely to afford
the most leverage for their companies or in their industries
overall. Expense items from businesses’ income statements
provide rough-and-ready proxies for the importance of each
of the three A’s. Companies that do a lot of advertising will
need to adapt to the local market. Those that do a lot of
R&D may want to aggregate to improve economies of scale,
since many R&D outlays are fixed costs. For firms whose operations are labor intensive, arbitrage will be of particular
concern because labor costs vary greatly from country to
country. By calculating these three types of expenses as percentages of sales, a company can get a picture of how intensely it is pursuing each course. Those that score in the top
decile of companies along any of the three dimensions – advertising intensity, R&D intensity, or labor intensity – should
be on alert. (See the exhibit “The AAA Triangle” for more detail on the framework.)
How do the companies I’ve already mentioned look when
their expenditures are mapped on the AAA Triangle? At Procter & Gamble, businesses tend to cluster in the top quartile
for advertising intensity, indicating the appropriateness of
an adaptation strategy. TCS, Cognizant, and IBM Global Services are distinguished by their labor intensity, indicating arbitrage potential. But IBM Systems ranks significantly higher
in R&D intensity than in labor intensity and, by implication,
has greater potential for aggregation than for arbitrage.
The AAA Triangle
The AAA Triangle serves as a kind of strategy map for managers. The percentage of
sales spent on advertising indicates how
important adaptation is likely to be for the
company; the percentage spent on R&D is
a proxy for the importance of aggregation;
and the percentage spent on labor helps
gauge the importance of arbitrage. Managers should pay attention to any scores above
the median because, most likely, those are
areas that merit strategic focus. Scores
above the 90th percentile may be perilous
Median and top-decile scores are based on U.S. manufacturing data from Compustat’s Global Vantage database and the U.S. Census Bureau. Since the ratios
of advertising and R&D to sales rarely exceed 10%, those are given a maximum value of 10% in the chart.
62 Harvard Business Review
Although many companies will (and should) follow a strategy that involves the focused pursuit of just one of the
three A’s, some leading-edge companies – IBM, P&G, TCS,
and Cognizant among them – are attempting to perform
two A’s particularly well. Success in “AA strategies” takes two
forms. In some cases, a company wins because it actually
beats competitors along both dimensions at once. More commonly, however, a company wins because it manages the
tensions between two A’s better than its competitors do.
The pursuit of AA strategies requires considerable organizational and material innovation. Companies must do more
than just allocate resources and monitor national operations
from headquarters. They need to deploy a broad array of integrative devices, ranging from the hard (for instance, structures and systems) to the soft (for instance, style and socialization). Let’s look at some examples.
Adaptation and aggregation. As I noted above, Procter &
Gamble started out with an adaptation strategy. Halting attempts at aggregation across Europe, in particular, led to
a drawn-out, function-by-function installation of a matrix
structure throughout the 1980s, but the matrix proved unwieldy. So in 1999, the new CEO, Durk Jager, announced the
reorganization mentioned earlier, whereby global business
units (GBUs) retained ultimate profit responsibility but
were complemented by geographic market development
organizations (MDOs) that actually ran the sales force
(shared across GBUs) and went to market.
The result? All hell broke loose in multiple areas, including at the key GBU/MDO interfaces. Jager departed after less
than a year. Under his successor, Lafley, P&G has enjoyed
much more success, with an approach that strikes more of
a balance between adaptation and aggregation and allows
room for differences across general business units and markets. Thus, its pharmaceuticals division, with distinct distribution channels, has been left out of the MDO structure; in
emerging markets, where market development challenges
loom large, profit responsibility continues to be vested with
country managers. Also important are the company’s decision grids, which are devised after months of negotiation.
These define protocols for how different decisions are to be
made, and by whom – the general business units or the
market development organizations – while still generally reserving responsibility for profits (and the right to make decisions not covered by the grids) for the GBUs. Common IT systems help with integration as well. This structure is animated
by an elaborate cycle of reviews at multiple levels.
Such structures and systems are supplemented with other,
softer tools, which promote mutual understanding and collaboration. Thus, the GBUs’ regional headquarters are often
collocated with the headquarters of regional MDOs. Promotion to the director level or beyond generally requires experience on both the GBU and the MDO sides of the house.
The implied crisscrossing of career paths reinforces the
message that people within the two realms are equal citizens. As another safeguard against the MDOs’ feeling marginalized by a lack of profit responsibility, P&G created a
structure – initially anchored by the vice chairman of global
operations, Robert McDonald–to focus on their perspectives
Aggregation and arbitrage. In contrast to Procter & Gamble, TCS is targeting a balance between aggregation and arbitrage. To obtain the benefits of aggregation without losing
its traditional arbitrage-based competitive advantage, it has
placed great emphasis on its global network delivery model,
which aims to build a coherent delivery structure that consists of three kinds of software development centers:
• The global centers serve large customers and have
breadth and depth of skill, very high scales, and mature coding and quality control processes. These centers are located
in India, but some are under development in China, where
TCS was the first Indian software firm to set up shop.
• The regional centers (such as those in Uruguay, Brazil,
and Hungary) have medium scales, select capabilities, and an
emphasis on addressing language and cultural challenges.
These centers offer some arbitrage economies, although not
yet as sizable as those created by the global centers in India.
• The nearshore centers (such as those in Boston and
Phoenix) have small scales and focus on building customer
comfort through proximity.
In addition to helping improve TCS’s economics in a number of ways, a coherent global delivery structure also seems
to hold potential for significant international revenue gains.
For example, in September 2005, TCS announced the signing
of a five-year, multinational contract with the Dutch bank
ABN AMRO that’s expected to generate more than €200 million. IBM won a much bigger deal from ABN AMRO, but
TCS’s deal did represent the largest such contract ever for an
Indian software firm and is regarded by the company’s management as a breakthrough in its attempts to compete with
IBM Global Services and Accenture. According to CEO S. Ramadorai, TCS managed to beat out its Indian competitors,
including one that was already established at ABN AMRO,
largely because it was the only Indian vendor positioned to
deploy several hundred professionals to meet the application development and maintenance needs of ABN AMRO’s
Arbitrage and adaptation. Cognizant has taken another
approach and emphasized arbitrage and adaptation by investing heavily in a local presence in its key market, the
United States, to the point where it can pass itself off as either Indian or U.S.-based, depending on the occasion.
Cognizant began life in 1994 as a captive of Dun & Bradstreet, with a more balanced distribution of power than
purely Indian firms have. When Cognizant spun off from
D&B a couple of years later, founder Kumar Mahadeva dealt
with customers in the United States, while Lakshmi Narayanan
Harvard Business Review 63
YEL MAG CYAN BLACK
From A to AA
Even within the same industry, firms can differ sharply
in their global strategic profiles.
(then COO, now vice chairman) oversaw delivery out of
India. The company soon set up a two-in-a-box structure, in
which there were always two global leads for each project –
one in India and one in the United States – who were held
jointly accountable and were compensated in the same way.
Francisco D’Souza, Cognizant’s CEO, recalls that it took two
years to implement this structure and even longer to change
mind-sets – at a time when there were fewer than 600 employees (compared with more than 24,000 now). As the exhibit “Cognizant’s AA Strategy”shows, two-in-a-box is just one
element, albeit an important one, of a broad, cross-functional
effort to get past what management sees as the key integration challenge in global offshoring: poor coordination between delivery and marketing that leads to “tossing stuff
over the wall.”
Not all of the innovations that enable AA strategies are
structural. At the heart of IBM’s recent arbitrage initiatives
(which have been added to the company’s aggregation strategy) is a sophisticated matching algorithm that can dynamically optimize people’s assignments across all of IBM’s locations – a critical capability because of the speed with which
“hot” and “cold” skills can change. Krisha Nathan, the director of IBM’s Zurich Research Lab, describes some of the reasons why such a people delivery model involves much more
rocket science than, for example, a parts delivery model.
First, a person’s services usually can’t be stored. Second, a person’s functionality can’t be summarized in the same standardized way as a part’s, with a serial number and a description of technical characteristics. Third, in allocating people
to teams, attention must be paid to personality and chemistry, which can make the team either more or less than the
sum of its parts; not so with machines. Fourth, for that reason and others (employee development, for instance), assignment durations and sequencing are additionally constrained.
Nathan describes the resultant assignment patterns as “75%
global and 25% local.” While this may be more aspirational
than actual, it is clear that to the extent such matching devices are being used more effectively for arbitrage, they represent a massive power shift in a company that has hitherto
The Elusive Trifecta
There are serious constraints on the ability of any one organization to use all three A’s simultaneously with great effectiveness. First, the complexity of doing so collides with limited managerial bandwidth. Second, many people think an
organization should have only one culture, and that can get
in the way of hitting multiple strategic targets. Third, capable
competitors can force a company to choose which dimension
it is going to try to beat them on. Finally, external relationships may have a focusing effect as well. For instance, several
private-label manufacturers whose businesses were built
around arbitrage have run into trouble because of their efforts to aggregate as well as arbitrage by building up their
own brands in their customers’ markets.
To even contemplate a AAA strategy, a company must be
operating in an environment in which the tensions among
Cognizant’s AA Strategy
Cognizant is experimenting with changes in staffing, delivery, and marketing in its pursuit of a strategy
that emphasizes both adaptation and arbitrage.
Relatively stringent recruiting process
More MBAs and consultants
• More non-Indians
• Training programs in India
Two global leads – one in the U.S., one
in India – for each project
• All proposals done jointly (between
India and the U.S.)
• More proximity to customers
• On-site kickoff teams
• Intensive travel, use of technology
64 Harvard Business Review
Joint Indian – U.S. positioning
Use of U.S. nationals in key marketing positions
• Very senior relationship managers
• Focus on selling to a small number
of large customers
on providing services as well as equipment – for example,
by training radiologists and providing consulting advice on
post-image processing. Such customer intimacy obviously
has to be tailored by country. And recently, GEH has cautiously engaged in some “in China, for China” manufacture
of stripped-down, cheaper equipment aimed at increasing
GEH has managed to use the three A’s to the extent that
it has partly by separating the three and, paradoxically, by
downplaying the pursuit of one of them: adaptation. This is
one example of how companies can get around the problem
of limited managerial bandwidth. Others range from outsourcing to the use of more market or marketlike mechanisms, such as internal markets. GEH’s success has also depended on competitors’ weaknesses. In addition to facing
a variety of size-related and other structural disadvantages
relative to GEH, SMS and particularly PMS have been slow
in some respects –for instance, in shifting production to lowcost countries. For all these reasons, the temptation to treat
the GEH example as an open invitation for everyone to pursue all three A’s should be stubbornly resisted.
Besides, the jury is still out on GEH. Adapting to the exceptional requirements of potentially large but low-income markets such as China and India while trying to integrate globally is likely to be an ongoing tension for the company.
What’s more, GEH isn’t clearly ahead on all performance dimensions: SMS has focused more on core imaging, where it
is seen as the technological leader.
Developing a AAA Strategy
Let’s now consider how a company might use the AAA Triangle to put together a globally competitive strategy. The example I’ll use here will be PMS, the smallest of the big three
At a corporate level, Philips had long followed a highly decentralized strategy that concentrated significant power in
the hands of country managers and emphasized adaptation.
Under pressure from more aggregation-oriented Japanese
competitors in areas such as consumer electronics, efforts
began in the 1970s to transfer more power to and aggregate
more around global product divisions. These were blocked
by country chiefs until 1996, when the new CEO abolished
the geographic leg of the geography-product matrix. It is
sometimes suggested that Philips’s traditional focus on adaptation has persisted and remains a source of competitive advantage. While that’s true about the parent company, it isn’t
the case for PMS. Any adaptation advantage for PMS is limited by SMS’s technological edge and GEH’s service-quality
edge. These can be seen as global attributes of the two competitors’ offerings, but they also create customer lock-in at
the local level.
More generally, any adaptation advantage at PMS is more
than offset by its aggregation disadvantages. PMS’s absolute
Harvard Business Review 65
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adaptation, aggregation, and arbitrage are weak or can be
overridden by large scale economies or structural advantages, or in which competitors are otherwise constrained.
Consider GE Healthcare (GEH). The diagnostic-imaging
industry has been growing rapidly and has concentrated
globally in the hands of three large firms, which together
command an estimated 75% of revenues in the business
worldwide: GEH, with 30%; Siemens Medical Solutions
(SMS), with 25%; and Philips Medical Systems (PMS), with
20%.1 This high degree of concentration is probably related to
the fact that the industry ranks in the 90th percentile in
terms of R&D intensity. R&D expenditures are greater than
10% of sales for the “big three” competitors and even higher
for smaller rivals, many of whom face profit squeezes. All of
this suggests that the aggregation-related challenge of building global scale has proven particularly important in the industry in recent years.
GEH, the largest of the three firms, has also consistently
been the most profitable. This reflects its success at aggregation, as indicated by the following:
Economies of scale. GEH has higher total R&D spending than SMS or PMS, greater total sales, and a larger
service force (constituting half of GEH’s total employee
head count) – but its R&D-to-sales ratio is lower, its other
expense ratios are comparable, and it has fewer major production sites.
Acquisition capabilities. Through experience, GEH has become more efficient at acquiring. It made nearly 100 acquisitions under Jeffrey Immelt (before he became GE’s CEO);
since then, it has continued to do a lot of acquiring, including the $9.5 billion Amersham deal in 2004, which moved
the company beyond metal boxes and into medicine.
Economies of scope. The company strives, through Amersham, to integrate its biochemistry skills with its traditional
base of physics and engineering skills; it finances equipment
purchases through GE Capital.
GEH has even more clearly outpaced its competitors
through arbitrage. Under Immelt, but especially more recently, it has moved to become a global product company
by migrating rapidly to low-cost production bases. Moves
have been facilitated by a “pitcher-catcher” concept originally developed elsewhere in GE: A “pitching team”at the existing site works closely with a “catching team” at the new
site until the latter’s performance is at least as strong as the
former’s. By 2005, GEH was reportedly more than halfway
to its goals of purchasing 50% of its materials directly from
low-cost countries and locating 60% of its manufacturing in
In terms of adaptation, GEH has invested heavily in countryfocused marketing organizations, coupling such investments relatively loosely with the integrated developmentand-manufacturing back end, with objectives that one
executive characterizes as being “more German than the
Germans.” It also boosts customer appeal with its emphasis
R&D expenditures are one-third lower than those of GEH
and one-quarter lower than those of SMS, and PMS is a
much larger part of a much smaller corporation than its rivals are. (Philips’s total acquisition war chest at the corporate
level was recently reported to be not much larger than the
amount that GEH put down for the Amersham acquisition
alone.) In addition, PMS was stitched together out of six separate companies in a series of acquisitions made over three
years to improve the original and aging X-ray technology.
It is somewhat surprising that this attempt has worked as
well as it has in a corporation without much acquisition experience to fall back on – but there have also clearly been
negative aftereffects. Most dramatically, PMS paid more than
€700 million in 2004 related to past acquisition attempts –
one consummated, another considered–nearly wiping out its
reported earnings for that year, although profitability did
recover nicely in 2005.
PMS’s preoccupation (until recently) with connecting its
disparate parts is also somewhat to blame for the company’s
lack of progress on the arbitrage front. PMS has trailed not
only its rivals but also other Philips divisions in moving manufacturing to low-cost areas, particularly China. Although
Philips claims to be the largest Western multinational in
China, PMS did not start a manufacturing joint venture
there until September 2004, with the first output for the Chinese market becoming available in 2005 and the first supplies for export in 2006. Overall, PMS’s sourcing levels from
low-cost countries in 2005 were comparable to levels GEH
achieved back in 2001, and they lagged SMS’s as well.
Insights on positioning relative to the three A’s can be
pulled together into a single map, as shown in the exhibit
“AAA Competitive Map for Diagnostic Imaging.” Assessments along these lines, while always approximate, call attention to where competitors are actually located in strategy
space; they also help companies visualize trade-offs across
different A’s. Βoth factors are important in thinking through
where and where not to focus the organization’s efforts.
How might this representation be used to articulate an action agenda for PMS? The two most obvious strategy alternatives for PMS are AA strategies: adaptation-aggregation
Adaptation-aggregation comes closest to the strategy currently in place. However, it is unlikely to solve the aggregationrelated challenges facing PMS, so it had better offer some
meaningful extras in terms of local responsiveness. PMS
could also give up on the idea of creating a competitive advantage and simply be content with achieving average industry
profitability, which is high: The big three diagnostic-imaging
companies (which also account for another profitable global
triopoly, in light bulbs) are described as “gentlemanly”in setting prices. Either way, imitation of bigger rivals’ large-scale
moves into entirely new areas seems likely to magnify, rather
than minimize, this source of disadvantage. PMS does appear
to be exercising some discipline in this regard, preferring to
66 Harvard Business Review
engage in joint ventures and other relatively small-scale
moves rather than any Amersham-sized acquisitions.
The adaptation-arbitrage alternative would aim not just at
producing in low-cost locations but also at radically reengineering and simplifying the product to slash costs for large
emerging markets in China, India, and so forth. However, this
option does not fit with Philips’s heritage, which is not one
of competing through low costs. And PMS has less room to
follow a strategy of this sort because of GEH’s “in China, for
China” product, which is supposed to cut costs by 50%. PMS,
in contrast, is talking of cost reductions of 20% for its first line
of Chinese offerings.
If PMS found neither of these alternatives appealing–and
frankly, neither seems likely to lead to a competitive advantage for the company – it could try to change the game entirely. Although PMS seems stuck with structural disadvantages in core diagnostic imaging compared with GEH and
SMS, it could look for related fields in which its adaptation
AAA Competitive Map for
Philips Medical Systems, the smallest of the big three diagnosticimaging firms, historically emphasized adaptation but has recently placed some focus on aggregation. Siemens Medical
Solutions emphasizes aggregation and uses some arbitrage.
The most successful of the three, GE Healthcare, beats each of
its rivals on two out of the three A’s.
Philips Medical Systems
Siemens Medical Solutions
Not all the integration that is required to add value across borders
needs to occur within a single organization.
The danger in discussions about integration is that they can
float off into the realm of the ethereal. That’s why I went into
specifics about the integration challenges facing PMS – and
it’s why it seems like a good idea to wrap this article up by
recapitulating the general points outlined.
Focus on one or two of the A’s. While it is possible to make
progress on all three A’s – especially for a firm that is coming
from behind – companies (or, often more to the point, businesses or divisions) usually have to focus on one or at most
two A’s in trying to build competitive advantage. Can your organization agree on what they are? It may have to shift its
focus across the A’s as the company’s needs change. IBM is
just one example of a general shift toward arbitrage. But the
examples of IBM, P&G, and, in particular, PMS illustrate
how long such shifts can take – and the importance, therefore, of looking ahead when deciding what to focus on.
Make sure the new elements of a strategy are a good fit
organizationally. While this isn’t a fixed rule, if your strategy
does embody nontrivially new elements, you should pay
particular attention to how well they work with other things
the organization is doing. IBM has grown its staff in India
much faster than other international competitors (such as
Accenture) that have begun to emphasize India-based arbitrage. But quickly molding this workforce into an efficient
organization with high delivery standards and a sense of
connection to the parent company is a critical challenge:
Failure in this regard might even be fatal to the arbitrage
Employ multiple integration mechanisms. Pursuit of more
than one of the A’s requires creativity and breadth in thinking about integration mechanisms. Given the stakes, these
factors can’t be left to chance. In addition to IBM’s algorithm
for matching people to opportunities, the company has demonstrated creativity in devising “deal hubs” to aggregate
across its hardware, software, and services businesses. It has
also reconsidered its previous assumption that global functional headquarters should be centralized (recently, IBM relocated its procurement office from Somers, New York, to
Shenzhen, China). Of course, such creativity must be reinforced by organizational structures, systems, incentives, and
norms conducive to integration, as at P&G. Also essential to
making such integration work is an adequate supply of leaders and succession candidates of the right stripe.
Think about externalizing integration. Not all the integration that is required to add value across borders needs to
occur within a single organization. IBM and other firms illustrate that some externalization is a key part of most ambitious global strategies. It takes a diversity of forms: joint ventures in advanced semiconductor research, development, and
manufacturing; links to and support of Linux and other efforts at open innovation; (some) outsourcing of hardware to
contract manufacturers and services to business partners;
IBM’s relationship with Lenovo in personal computers; customer relationships governed by memoranda of understanding rather than detailed contracts. Reflecting this increased
Harvard Business Review 67
YEL MAG CYAN BLACK
profile might have more advantages and fewer disadvantages. In terms of the AAA Triangle, this would be best
thought of as a lateral shift to a new area of business, where
the organization would have more of a competitive advantage. PMS does seem to be attempting something along
these lines – albeit slowly – with its recent emphasis on medical devices for people to use at home. As former Philips CFO
Jan Hommen puts it, the company has an advantage here
over both Siemens and GE: “With our consumer electronics
and domestic appliances businesses, we have gained a lot of
experience and knowledge.” The flip side, though, is that
PMS starts competing with large companies such as Johnson
& Johnson. PMS’s first product of this sort – launched in the
United States and retailing for around $1,500 – is a home-use
defibrillator. Note also that the resources emphasized in this
strategy –that is, brand and distribution –operate at the local
(national) level. So the new strategy can be seen as focusing
on adaptation in a new market.
What do these strategic considerations imply for integration at PMS? The company needs to continue streamlining
operations and speed up attempts at arbitrage, possibly considering tools such as the pitcher-catcher concept. It needs to
think about geographic variation, probably at the regional
level, given the variation in industry attractiveness as well as
PMS’s average market share across regions. Finally, it needs
to enable its at-home devices business to tap Philips’s consumer electronics division for resources and capabilities. This
last item is especially important because, in light of its track
record thus far, PMS will have to make some early wins if it
is to generate any excitement around a relaunch.
For most of the past 25 years, the rhetoric of globalization
has been concentrated on markets. Only recently has the
spotlight turned to production, as firms have become aware
of the arbitrage opportunities available through offshoring.
This phenomenon appears to have outpaced strategic thinking about it. Many academic writings remain focused on the
globalization (or nonglobalization) of markets. And only a
tiny fraction of the many companies that engage in offshoring
appear to think about it strategically: Only 1% of the respondents to a recent survey conducted by Arie Lewin at Duke
University say that their company has a corporatewide strategy in this regard. The AAA framework provides a basis for
considering global strategies that encompasses all three effective responses to the large differences that arise at national
borders. Clearer thinking about the full range of strategy options should broaden the perceived opportunities, sharpen
strategic choices, and enhance global performance.
1. Figures are for 2005. Otherwise, the account is largely based on Tarun Khanna
and Elizabeth A. Raabe, “General Electric Healthcare, 2006” (HBS case no. 9-706478); D. Quinn Mills and Julian Kurz, “Siemens Medical Solutions: Strategic Turnaround” (HBS case no. 9-703-494); and Pankaj Ghemawat, “Philips Medical Systems in 2005” (HBS case no. 9-706-488).
To order, see page 145.
“Leave some room in the jacket. Sometimes in court the hairs on my back stand up.”
68 Harvard Business Review
range of possibilities, reported levels of international joint
ventures are running only one-quarter as high as they were
in the mid-1990s, even though more companies are externalizing operations. Externalization offers advantages not just
for outsourcing noncore services but also for obtaining ideas
from the outside for core areas: for instance, Procter & Gamble’s connect-and-develop program, IBM’s innovation jams,
and TCS’s investments in involving customers in quality
measurement and improvement.
Know when not to integrate. Some integration is always a
good idea, but that is not to say that more integration is always better. First of all, very tightly coupled systems are not
particularly flexible. Second, domain selection – in other
words, knowing what not to do as well as what to do – is usually considered an essential part of strategy. Third, even when
many diverse activities are housed within one organization,
keeping them apart may be a better overall approach than
forcing them together in, say, the bear hug of a matrix structure. As Lafley explains, the reason P&G is able to pursue arbitrage up to a point as well as adaptation and aggregation is
that the company has deliberately separated these functions
into three kinds of subunits (global business units, market development organizations, and global business shared services) and imposed a structure that minimizes points of contact and, thereby, friction.
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June 21st, 2014 From The Economist
Weblink – http://www.economist.com/news/briefing/21604559-20-amazon-bulking-up-it-notyetslowing-down-relentlesscom
At 20 Amazon is bulking up. It is not-yet-slowing down
HIGH-TECH creation myths are expected to start with a garage. Amazon, impatient with
ordinary from the outset, began with a road trip. In the summer of 1994 Jeff Bezos quit his job
on Wall Street, flew to Fort Worth, Texas, with his wife MacKenzie and hired a car. While
MacKenzie drove them towards the Pacific Northwest, Jeff sketched out a plan to set up a
catalogue retailing business that would exploit the infant internet. The garage came later, in a
suburb of Seattle, where he set up an office furnished with desks made from wooden doors.
About a year later, Amazon sold its first book.
The world saw a website selling books and assumed that Amazon was, and always would be,
an online bookshop. Mr Bezos, though, had bigger plans. Books were a good way into online
retailing: once people learned to buy books online they would buy more and more other stuff,
too. The website would be able to capture much more data about what they looked at and thus
might want than any normal shop; if they reviewed things, that would enrich the experience
for other shoppers. He saw a virtuous circle whereby low prices pulled in customers and
merchants, which boosted volumes, which led to ever lower prices–a “flywheel” that would
generate growth for as long as the company put the interests of the customers first. Early on,
Mr Bezos registered “relentless.com” as a possible name; if it was a little lacking in touchyfeeliness, it captured the ambition nicely.
A phone to shop with
The latest manifestation of that ambition was unveiled in Seattle on June 18th: Amazon’s first
phone. The Fire Phone is designed to stand out in a market crowded with sleek devices in
various ways, such as with a sort-of-3D screen, but none is more telling than its Firefly button.
This uses cloud computing to provide the user with information about more or less anything
the phone sees or hears, be it a song, a television show, a bottle of wine or a child’s toy-including how to buy it from Amazon. If it works as promised, it will turn the whole world into a
The Fire Phone takes pride of place in an expanding family of devices with which Amazon has
both anticipated and responded to shifts in the way consumers read, shop and divert
themselves. Offering iPad-like tablets, e-readers and a television set-top box for streaming
videos has brought the company into more direct competition than ever before with Apple and
Google, which also offer suites of hardware, digital content and services. Amazon’s hope is that
its signature selling points–features and quality that belie their relatively low pricing–will
attract consumers to its devices just as they have to its online shops. Then they will end up
shopping for other stuff, too.
There is a lot of other stuff for them to buy. According to Internet Retailer, a magazine,
Amazon now carries 230m items for sale in America–some 30 times the number sold by
Walmart, the world’s biggest retailer, which has its own fast-growing online business–and
there is no sign of let-up. Amazon’s total revenues were $74.5 billion last year, but when one
takes into account the merchandise that other companies sell through its “marketplace” service
the sales volume is nearly double that. Though by far the biggest online retailer in America, it
is still growing faster than the 17% pace of e-commerce as a whole (see chart 2 on page after
next). It is the top online seller in Europe and Japan, too, and has designs on China’s vast
market. Last year Amazon was the world’s ninth-biggest retailer ranked by sales; by 2018 it
will be number two, predicts Kantar Retail, a research group.
On top of its online-retail success, Amazon has produced two other transformative businesses.
The Kindle e-reader pioneered the shift from paper books to electronic ones, creating a market
that now accounts for more than a tenth of spending on books in America and which Amazon
dominates. Less visible but just as transformative is Amazon’s invention in 2006 of cloudcomputing as a pay-as-you-go service, now a $9 billion market. That venture, called Amazon
Web Services (AWS), has slashed the technology costs of starting an enterprise or running an
And Amazon enjoys an advantage most would-be competitors must envy: remarkably patient
shareholders. The company made a net profit of just $274m last year, a minuscule sum in
relation to its revenues and its $154-billion value on the stockmarket. Even after a recent
slump (see timeline on next page) its shares still cost more than 500 times last year’s
earnings, 34 times the multiple for Walmart. Its core retail business is thought to do little
better than break-even; most of its profits come from the independent vendors who sell
through Amazon’s marketplace. Matthew Yglesias, a blogger, memorably described Amazon as
a “charitable organisation being run by elements of the investment community for the benefit
The company’s ascent has left a trail of enemies and skeptics, including competitors crushed-or forced to sell out to Amazon–by its ruthless pricing practices. It has been attacked for
driving workers at warehouses too hard and of avoiding tax in America, Britain, France and
Germany. The French culture minister has accused it of “destroying bookshops”. To Stephen
Colbert, a comedian whose publisher, Hachette, is warring with Amazon over pricing, Mr Bezos
is “Lord Bezomort”.
Amazon is sometimes a bully, but it does not yet threaten competition the way that its Seattle
neighbor Microsoft did when it enjoyed a near-monopoly of operating systems for PCs. For
every shop it obliterates another finds itself selling to places it never imagined it could. Ward
Gahan, who runs BiddyMurphy.com out of an Irish gift shop in South Haven, Michigan, marvels
that through Amazon he is shipping tweed caps to Sao Paulo. And Amazon’s success means
that competitors are keenly plotting ways to best the company. “We wouldn’t be here if it
wasn’t for Amazon,” says Tom Allason, founder of Shutl, which uses local courier networks to
deliver packages from retailers even faster than Amazon can. It was bought by eBay, an
Amazon rival, late last year.
Get your kicks on PHX 6
Among the things that Amazon relies on to keep ahead of such competitors are Mr Bezos and
the culture he has created. Though like many billionaires he has developed outside interests-he has a firm building a spaceship and owns a newspaper, the Washington Post–he still
dominates the company, and has made invention, long-term thinking and viewing the world
through the customer’s eyes its catechism. An almost perverse pleasure in low margins
inspires ventures no one else would think of, like AWS. The building names on the Seattle
campus drive the message home: “Day 1 North” reminds employees not to be complacent, but
always to act as if just starting out; “Wainwright” is named after the first person to buy a book
through the site. The bulldozer is an obsessive curator of its own traditions.
Mr Bezos is a notoriously testy boss, but also an inspiring one for the right sort of person. “He
challenged me to create something like no one else challenged me,” says Vikas Gupta, who
built Amazon’s payments software and now runs a startup. But the strengths the culture may
offer are accompanied by a touchy, tight-lipped side that makes Amazon difficult to understand
or to love. Amazonians will not tell visitors to its campus exactly where Mr Bezos works. They
chatter freely about the consumer benefits of the firm’s devices and services but say as little as
possible about the commercial logic behind them. The attitude is “everything we don’t talk
about is a competitive edge,” says Mr Gupta.
Another huge Amazon advantage is a global network of 96 “fulfillment centres”, warehouses
both vast and clever that shuffle shipments from thousands of suppliers to millions of
customers. PHX 6, one of four such centres in Phoenix, Arizona, is a conveyor-belted Grand
Canyon with a roof. With 11 hectares of floor space it could easily hold 20 American-football
fields. A slogan over the door reads, a bit creepily, “Work hard. Have fun. Make history.”
Inside, “stowers” scurry about with yellow containers placing items seemingly at random on
shelves–board games abut power tools–and recording their location with pistol-like scanners.
“Pickers” wield pistols that guide them on the shortest path through the jumble, measure their
progress and log in the items they pluck from the shelves. Amazon’s plan to deploy thousands
of robots in its fulfillment centres will shorten the pickers’ journey (and perhaps, in the long
run, their careers). Through algorithmic alchemy, orders are packed into right-sized boxes,
stamped with address labels and hauled away by couriers from UPS, FedEx and others.
Not all the stuff in PHX 6 is Amazon’s. “Fulfillment by Amazon” (FBA) allows independent
merchants not just to sell their wares on Amazon’s website but also to ship them through
Amazon’s supply chain. This helps the distribution centres pay their way. It also binds the
merchants more closely to Amazon. Sellers tracked by Mercent, an e-commerce software
company, use FBA for 16% of their sales, up from 8% in 2012.
Amazon’s original idea was to have few warehouses and to put them far away from population
centres, thus avoiding the need to collect sales tax in the states with the most business. Now it
is positioning infrastructure like siege equipment near big cities, speeding delivery and cutting
its costs. In North America Amazon can offer same-day delivery to 23% of the population, says
Marc Wulfraat of MWPVL International, a supply-chain consultancy. By 2015 it will be 28%.
Spending on fulfillment centres in Europe and Asia as well as America tripled between 2010
and 2013, says Colin Sebastian of Baird, an investment bank. In Britain and parts of America
Amazon has been experimenting with making last-mile deliveries itself, a practice that may
expand along with its logistic network.
Following the Prime directive
The company sees ample opportunity for putting this infrastructure to work. Digital natives are
entering their prime shopping years. When Walmart, with a poorer clientele, sells almost three
times as much to its average American customer every year as Amazon does to its, there is
plenty of room for Amazon to grow further.
One way to narrow the gap is to sell more “consumables”, such as toiletries and food. These
account for nearly half of spending by internet-connected American households, but are
thought to be a much smaller share of Amazon’s sales. Sanford C. Bernstein, a research firm,
thinks its potential American market for non-perishables is $150 billion.
Then there is Prime, the flypaper on Amazon’s flywheel. Some 25m subscribers pay an annual
flat fee ($99 in America, [pounds sterling]79 in Britain) to belong to this souped-up loyalty
programme, which offers shipping at no extra cost as well as increasing amounts of digital
content. Scot Wingo of ChannelAdvisor, a company that helps online sellers, reckons that
people with Prime spend around four times what others do and account for half of all spending
Many Amazon activities that look tangential to shopping have been designed to make Prime
even stickier. In April it paid HBO, a television company, an estimated $200m-250m for a
package of shows which Prime members can stream at no extra cost. On June 12th it added
more than a million songs. Amazon produces programming of its own for the Prime audience,
including several kids’ shows (mothers are good customers). If they own Kindle e-readers or
tablets members can “borrow” a book a month. A slow reader need never pay for one.
And Amazon is very keen that they should own such devices. The shift from desktop to mobile
shopping is a “big second wind to the whole of e-commerce,” says Sebastian Gunningham, the
head of Amazon’s marketplace, and its devices are intended to catch as much as possible of
From the original Kindle, on which you could buy e-books, it moved to the Kindle Fire tablet,
on which you could buy anything, and now the Fire Phone. As with every phone and tablet, the
user can download apps from all sorts of other people, though those of Amazon’s rivals look
under-represented. The gadgets do pretty much anything that phones or tablets from Apple or
Samsung do, and have nifty wrinkles–such as a direct video link to technical support, on the
Fire and the Fire Phone–which others lack. They are also pretty cheap–Amazon does not
propose to turn a profit on them. It does, though, integrate them thoroughly into its other
services, making them little wardrobes that open out into the Narnia of everything it has to
offer. The Fire Phone comes with a year’s free Prime membership, encouraging people to
become accustomed to Amazon’s streaming–and its free deliveries.
Outside the realm of e-books, Amazon has yet to make a great impression in the world of
devices. Tablets from Apple and Samsung easily outsell the Kindle Fire–perhaps because,
unusually for an Amazon emporium, its app store offers a smaller selection than do the others.
“We struggle with whether hardware and streaming media will have value long-term,” says
Eric Sheridan, an analyst at UBS. But the feature-packed Fire Phone shows that Amazon is not
giving up. As Eric Best of Mercent says, “the battle for the shopper will be won on the phone”;
Amazon thinks owning a bit of that battleground matters.
Amazon’s competitors are increasingly turning all sorts of devices into windows that display the
wares of all sorts of other shops. Google sells mobile “local inventory ads” which point
shoppers to nearby stores–an online-retailing option that avoids the need for fulfillment
centres and delivery vans. It has enriched search results for shoppers with Amazon-like images
and prices. Mr Best says he has noticed a slowdown in the growth of Amazon’s marketplace
sales since Google became more active in selling stuff; Amazon claims not to see any such
Turkish delight, too
Whereas some see Google as Amazon’s biggest worry, others tout Walmart, which has ecommerce sales that are growing faster than Amazon’s. Then there is Alibaba, a Chinese ecommerce giant soon to receive an infusion of cash through a share offering. It is planning a
marketplace in America called 11 Main and is part-owner of ShopRunner, which promises twoday delivery from 100 retailers. A new wave of online-only shops like Wanelo (“Want, need,
love.”) could pose a challenge. Or perhaps the threat will come from firms like Instacart, which
lets people make deliveries in their spare time.
Mr Bezos has always insisted that Amazon will continue to be “customer-focused” rather than
“competitor-focused”. In the letter he sent to shareholders when Amazon went public in 1997-and has had republished every year since–Mr Bezos warned that because of this focus the
company would take a long-term view. If you ask Amazon officials about ventures that appear
not to be prospering, like its push into Alibaba’s Chinese home base, they echo the boss. “We
thought it would take us five years” to succeed there, says Diego Piacentini, the international
chief. “We’ve figured out it will take us 15.”
But long-termism takes investment. In its early days Amazon danced around retailers because
its lack of stores made it “capital-light”. Its empire of warehouses and data centres changes
that. Now its pitch to merchants and technologists is that it will build physical assets so that
they don’t have to. Amazon still uses less capital than traditional retailers, observes Matt
Nemer of Wells Fargo Securities. But it is no longer capital-light. The flywheel is ever heavier–
but must spin as fast.
The focus on Amazon’s meager profits, though, can exaggerate the impression that its
shareholders are simply waiting for it to start releasing all the revenue made possible by the
dominant position it has achieved. In the past five years it has produced $10 billion of free
cashflow, a less distorted measure of profitability than net income, which was just $2.9 billion
over the same period, says Mr Nemer. That is still not much for a company worth $154 billion
on the stockmarket. But investors are counting on Amazon’s growth to increase it. If you look
at Amazon’s share price in relation to its sales (including those through the marketplace) it
looks like a bargain, according to a recent note by Wolfe Research, an equity-research firm.
And investors know Amazon’s managers share their interests. Shares are the main way
Amazon pays top employees; the highest salary–Mr Piacentini’s–is $175,000. Though it may
look bent on world domination, it often passes on ventures it thinks will not pay off, like
moving into South Korea. “The cost to be a relevant e-commerce player would be too high,”
says Mr Piacentini. AWS will be “way more global” than Amazon’s retail operation.
In a television interview last year Mr Bezos admitted that Amazon “will be disrupted one day”,
though not, he hoped, during his lifetime. It is hard to imagine it happening soon. That is not
because Amazon always makes the right bets. The skeleton of an Ice Age bear displayed in
Seattle, which Mr Bezos bought on Amazon’s abortive auction website, commemorates the
failure. But the bets he has placed on customers, patience, technology and scale appear to
have paid off. And he has followed through on them relentlessly.
Mergers & Acquistitions: New Rules of Attraction
November 15th 2014 From The Economist print edition
Weblink – http://www.economist.com/news/business/21632675-latest-boom-dealmaking-appears-more-sensibleits-predecessors-valuations-are
The latest boom in dealmaking appears more sensible than its predecessors. But
valuations are creeping into the danger zone
RUCE WASSERSTEIN was probably the most famous mergers and acquisitions (M&A) banker
on Wall Street in the 1980s and 1990s. Yet “Bid ’em up Bruce”, who died in 2009, was
ambivalent about his trade. The best rainmakers were capable men, he once wrote, but
dealmaking also attracted “hustlers and swaggering mediocrities”. And whereas takeovers
made the business world more dynamic, they also led to “pain, dislocations and blunders”.
Whether dealmaking is sensible is once more an important question, because M&A are back
with a vengeance, after a lull following the financial crisis. Worldwide, $3.6 trillion of deals
have been announced this year, reckons Bloomberg, an information provider, approaching
the peak reached in 2007. In pharmaceuticals (see next story) and among media firms the
activity is frantic. Deals worth more than $10 billion are again common. America and
Britain, with their open markets for corporate control, account for a disproportionate share
of the action. So do cross-border deals, which have risen from a sixth of activity in the mid1990s to 43% today.
Long experience of booms and slumps in M&A has made investors wary. Veteran fund
managers and academics argue that deals satisfy executives’ vanity and enrich their
bankers, but destroy value for shareholders. Reflecting this worry, when a firm announces
an acquisition its shares have tended to fall, as investors fret that the premium it is paying
will exceed the benefit from the synergies it will reap. However, since 2012 acquirers’ share
prices have generally been stable or have risen, according to McKinsey, a consulting firm.
That begs an intriguing and dangerous question. Might this time be different?
On paper, M&A make sense. When two firms combine they can cut duplicated overheads,
raising their margins. By adding together their market shares they can gain pricing power
over customers and suppliers. By cross-selling each other’s product ranges in each other’s
geographic markets, merging firms can make their combined sales a lot bigger than the
sum of their individual ones.
M&A folklore, however, dwells on giant catastrophes, such as the combinations of Time
Warner and AOL in 2000 just as the dotcom bubble burst, or Royal Bank of Scotland (RBS)
and ABN AMRO in 2007, as the subprime crisis struck. Yet some of the world’s most
successful firms are the result of giant deals. Exxon became the energy industry’s top dog
thanks to its purchase in 1999 of Mobil, which had an under-appreciated collection of global
assets. AB Inbev has done $100 billion of deals over two decades to become the world’s
biggest brewer, with thirst-quenching profits.
In any case smaller, and probably less risky, deals account for most activity–ones worth
less than $5 billion have accounted for two-thirds of total deal volumes over the past
decade. Today’s huge multinationals are constantly bolting on new businesses, in
transactions that are often barely noticed. General Electric, Google and Intel have between
them bought more than 500 firms in the past five years.
Contrary to M&A’s dire reputation most deals do in fact create value, at least in the short
term: since 2000 the combined market capitalisations of buyers and target firms has
typically risen when deals are announced (see chart 1). The problem is that, all too often,
over 100% of these gains has accrued to the shareholders of the firm being bought.
Typically the acquirer overpays for the synergies on offer, exaggerates or overestimates
them in its lust to justify a deal, or botches the subsequent integration of the organisations.
M&A are cyclical and the worst deals happen at the top.
Why might the benefits of M&A be more evenly spread between targets and acquirers this
time round? One view is that investors are asserting themselves: activist funds are more
powerful than ever in America. They are keen for firms to buy back their own shares
cheaply, not buy other companies’ shares expensively. In Europe institutional shareholders,
ranging from sovereign-wealth funds to private-sector fund managers, are far more
important than in the 1990s, and act as a brake on corporate chiefs’ empire-building. “The
militancy and engagement of shareholders has risen,” says Kenneth Jacobs, the head of
Lazard, an investment bank. Thanks to tighter regulation the too-big-to-fail bulge-bracket
banks that usually finance big M&A deals may also have become more restrained.
Evaluating M&A is hard because there is no archetype of success. Some acquirers grant the
firms they buy dignity and autonomy; others set up firing squads. Every industry has
triumphs and flops. Individual firms can be both brilliant and suicidal. RBS had a fine track
record before ABN. So the best bet for those in search of a sanity-check on the new M&A
boom is to gauge whether overall activity is near a peak, which is when most excesses
Cycles of history
The first test is whether a bandwagon is rolling, with corporate bosses jumping aboard
unthinkingly. In America between the 1890s and the early 1900s there was a craze for
creating monopolies, in steel, tobacco and other industries, prompting trustbusting laws to
break them up. In the 1960s conglomerates were in fashion; by the 1980s these lumbering
giants were also being dismantled, with the aid of the newly created junk-bond market. In
1999-2000, during the dotcom bubble, technology and telecoms firms accounted for 40% of
activity, only to be among the biggest to pop subsequently. In the last surge of deals, in
2003-07, several bandwagons were rolling, including a rush into emerging markets and
commodities, and a gallop into private-equity buy-outs. (These accounted for a quarter of
deals in 2007, but are down to 19% so far this year.)
So far this time there is no widespread mania. There are pockets of silliness: the
pharmaceutical industry is in a frenzy of “inversion” deals, in which American firms buy
foreign ones in order to switch their domiciles and avoid American tax rules. But inversions
account for only 9% of M&A activity so far this year.
Meanwhile, there are lots of relatively unadventurous deals, says Roger Altman, the boss of
Evercore, an investment bank. These seek to build firms’ shares of existing markets,
strengthen their product portfolios and cut costs rather than to enter completely new
industries or distant countries.
Among the biggest of these, Comcast’s $68 billion bid for Time Warner Cable will, if
regulators approve it, give the bidder control of 17 of the top 25 cable markets in America.
GSK and Novartis, two drugs firms, are swapping assets to bolster their respective
strengths in vaccines and oncology. Verizon’s $130 billion purchase of Vodafone’s share in
their American mobile venture was the largest deal in 2013-14 but hardly a leap into the
unknown: Verizon already manages the business.
In a further reflection of the restrained mood, some serial acquirers have gone into reverse,
divesting or spinning off assets, notes John Studzinski of Blackstone, a financial firm.
Dismemberments tend to be investor-friendly. Altria, a conglomerate that included Philip
Morris and Kraft Foods, was created in a flurry of deals in the 1980s and 1990s. Since 2007
it has split itself into four main parts, that are today worth $333 billion, almost double what
the combined group had been worth.
In October Hewlett-Packard said it would spin off its personal-computer business, reversing
its acquisition of Compaq in 2001 (while also offloading its printers business). BHP Billiton,
an Australian miner, has been one of the most acquisitive companies in history. But it now
wants to spin off its metals and coal businesses, largely reversing a merger that created the
firm in 2001 (though it shelved the sale of part of the metals business this week, after
failing to get a good price for it).
The trend for spin-offs may have further to go. Plenty of multinationals plunged into
emerging markets just before these countries’ economic growth rates slowed: now some of
them will be getting cold feet. And many of Asia’s biggest firms, such as Tata Sons in India,
Hutchison Whampoa in Hong Kong and Samsung in South Korea, are sprawling
conglomerates that may in time be broken up.
The present M&A boom passes the first test: there is little sign of senseless bandwagonjumping. The second sanity test is the extent of speculative financing and stretched
valuations. Here the news is less good. Admittedly, the average premium paid by an
acquirer as a percentage of the target’s share price, at 23%, is in line with the 20-year
average. But this measure tends to be a poor guide to peaks and troughs. Two other
measures are less reassuring.
First, lots of deals are being terminated or withdrawn–15% of total activity this year. For
example, Rupert Murdoch’s 21st Century Fox withdrew a $94 billion offer for Time Warner,
after Fox’s share price fell. A high failure rate is a sign of a toppy M&A market, with
speculative bids made by nervous buyers. The failure ratio was last as high in 1999 and
Second, absolute valuations are creeping up to queasy levels. On average, companies have
been bought this year at an enterprise value (roughly speaking, stockmarket value plus net
debt) equivalent to 12 times gross operating profit, higher than at the peak of the last two
booms (see chart 2). Successful deals are a union of two things: the business combination
has to work, but so does the price.
At the peak of the boom in 2000, Wasserstein highlighted seven newly-combined firms he
said exemplified an era of globalisation and technology. Since then one has been bailed out
(Citigroup), one has gone bust (WorldCom) and two have been dismembered
(DaimlerChrysler and Viacom-CBS). However sensible today’s M&A boom feels, as
valuations creep into the danger zone, humility is in order.
Case Study: Brewer Mergers – Foamy War
September 20th, 2014 From The Economist print edition
Weblink – http://www.economist.com/news/business/21571425-michael-dell-plans-buy-out-firm-he-founded-willit-work-dell-goes-private
SABMiller may be swallowed up by its main rival, AB InBev
HE world’s biggest brewer, AB InBev (ABI), is also the most frugal. There are no company
cars for senior executives. Carlos Brito, the boss, flies economy class. That is one reason
why, with 18% of global beer sales, ABI has a third of the profits.
This will matter in the wary manoeuvres now taking place among the giants of global
brewing. On September 14th Heineken, the number three by volume (see chart), said it had
rejected a takeover proposal from SABMiller, the number two. SAB seems to have been
trying to defend itself against a possible takeover by ABI, which was said to be talking to
bankers about raising [pounds sterling]75 billion ($121 billion) to buy its rival. That was
little more than a rumour, but industry-watchers suspect something big is indeed brewing,
in brewing. And the chances are that ever-thirsty ABI, maker of Budweiser and Stella Artois,
will swallow SAB.
The beer behemoth has few other ways to grow. In rich countries, consumption of beer has
stopped rising. In America, ABI’s Anheuser-Busch division is suffering growing competition
from small makers of “craft beer”. The number of American breweries has jumped from
fewer than 100 in 1983 to more than 3,000 today. ABI has its roots in Brazil, but there
drinkers are suffering from a sluggish economy and post-World Cup blues. This leaves ABI
with two options, says Andrew Holland, an analyst at Societe Generale: give its cash back to
shareholders or buy something.
SAB is a tempting target. Though based in London, its origins are in South Africa; it has
breweries and bottling plants in 15 African countries, where people still mainly guzzle
moonshine. It has stakes in 21 others through an alliance with Castel, a French drinks
company. Nearly 70% of SAB’s sales are in emerging markets, many of which are still
developing a taste for beer. Last year its sales by volume expanded by 3% (not counting
growth from acquisitions). ABI’s, in contrast, dropped 2%.
If ABI gets hold of SAB it will no doubt try to repeat tricks that have worked well since
AmBev of Brazil merged with Interbrew of Belgium a decade ago and then pushed out its
American boss: squeeze costs and use the new acquisition as a platform to spread its
brands. That was the formula after the merged group bought Anheuser-Busch, the maker of
Budweiser, in 2008. Grupo Modelo, a Mexican brewer which makes Corona and has been
part of ABI since last year, is now undergoing the same rigours.
SAB would be a more difficult undertaking. For one thing, notes Mr Holland, it is more
tightly managed than “fat and lazy” Anheuser-Busch was, so there is less scope for cutting
costs. SAB is bigger and more complex than anything else ABI has taken on. A knack for
cost-cutting may not serve it as well in fast-growing markets. Another problem is that in
some countries the two giants’ combined businesses would be too big. In America
Anheuser-Busch and SAB’s joint venture with Molson Coors, another rival, would together
have three-quarters of the beer market. In China the two would have more than a third.
These are not insurmountable problems. In America, for example, the stake in the joint
venture could be sold to Molson Coors.
Despite the obstacles, a merger of the leading two beer companies looks the likeliest of the
potential huge deals. Heineken, which is controlled by the Heineken family even though it
owns just 23% of the company’s equity, has now given notice that it does not want to be
bought (though that could change if SAB boosted its offer). Carlsberg, the smallest of the
big four, is controlled by a foundation. So the parsimonious Mr Brito may well get his hands
on SAB if he wants it enough. Teaching Africans to like Budweiser, however, may prove
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