Importance of Strategy

With the increase in the pressure of external threats, companies have to make clear strategies and implement them effectively so as to survive. There have been companies like Martin Burn, Jessops, etc that have completely become extinct and some companies which were not existing before they became the market leaders like Reliance, Infosys, etc. The basic factor responsible for differentiation has not been governmental policies, infrastructure or labour relations but the type of strategic thinking that different companies have shown in conducting the business

1. Strategy provides various benefits to its users:
2. Strategy helps an organization to take decisions on long range forecasts
3. It allows the firm to deal with a new trend and meet competition in an effective manner
4. With the help of strategy, the management becomes flexible to meet unanticipated changes
5. Efficient strategy formulation and implementation result into financial benefits to the organization in the form of increased profits
6. Strategy provides focus in terms of organizational objectives and thus provides clarity of direction  for achieving the objectives
7. Organizational effectiveness is ensured with effective implementation of the strategy
8. Strategy contributes towards organizational effectiveness by providing satisfaction to the personnel
9. It gets managers into the habit of thinking and thus makes them, proactive and more conscious of their environment
10. It provides motivation to employees as it paves the way for them to shape their work in the context of shared corporate goals and ultimately they work for the achievement of these goals
11. Strategy formulation and implementation gives an opportunity to the management to involve different levels of management in the process
12. It improves corporate communication, coordination and allocation of resources
13. With all the benefits listed above, it is quite clear that strategy forms an integral part of an organization and is the means to achieve the end in an efficient and effective manner.

Financial Statement Analysis

Financial Statement analysis helps figuring out strengths and weaknesses of a firm. This is done by matching the income statements to balance sheets.

The three most common statements used for analysis are

a) Cash Flow Statements- A compilation of the cash receipts and disbursements of a company.

b) Profit and Loss account- indicates how a company’s revenue is converted to net income

c) Balance Sheet- A compilation of assets and liabilities of the company and tells the value of the company

Types of analysis

1) Trend analysis

Trend analysis- comparing values over the years. It gives a sort of a trend certain values follow. For e.g an investor would want to know the future growth prospects of the company and he would forecast that value based on the past revenues, EBITDA, net income etc. Therefore such an analysis can give a growth estimation. Also it can be used to observe sudden improvement or decline in the performance the company in a particular year, the reasons for which can be found out

2) Ratio Analysis (comparables analysis)

Ratio Analysis is generally of use to the investors and acquirers. It helps investors compare two different stock based on certain ratios. The most common ratios are P/E, EV/ EBITDA(Enterprise Value/ EBITDA). Each ratio has a different utility. For example P/E ratio may be useful in determining whether a stock is undervalued or overvalued by comparing it to the industry standards. Lower the value of P/E more chances of the stock being undervalued if the fundamentals and growth prospects of the company are good.  EV/EBITDA is a multiple that might be used by the acquirers to value a company.

Similarly other ratios such as Current Ratio and also information like operating cycle and debt to equity ratio can help banks decide whether to see how leveraged the firm and also to see if short terms loans be given to them etc.

Thus these statements have multiple utility and can be used by Shareholders, Investors, Acquirers, Banks and even the internal management.

To the internal Management these statements give an account of where the company is standing. Cash flows help the company understand how much cash is it actually generating which is the ultimate aim of a company. The profit and loss statement helps companies decide how profitable their operations and what the major areas of expenditure. It also helps analyzing the operations in part. It is possible to know exactly where the major issue is incase of losses. It could be a lower gross margin, higher administrative expenditure etc.

Disadvantages of Financial Statement Analysis

If the financial statements are not prepared properly they may actually end up misleading the user leading to poor decision making

Financial statements may not be useful for planning at times since they are based on the historical data and the conditions that prevailed then may not be applicable now

Financial Statements only provide a quantitative aspects about a business’s position, therefore, a complete financial statement analysis may lead to ignorance of qualitative factors affecting the business..

Financial statement analysis is highly subjective and may vary from person to person. One may consider a growth of 10% as high but other may consider it low. Therefore, conclusions may vary from person to person. 

Patent Laws- Socially Cost Justified?

The economic welfare attributed to the patent regime has been a topic of constant debate amongst academics, economists, lawyers etc. The primary criticism against according property rights in inventions concern the socials costs imposed and the proportionality of these costs with benefits.  Though there are methods that the patent regime undertakes such as limited term to reduce the social cost imposed, arguments against the characteristics of patenting in relation to social justifications still stand strong. To estimate the social value of patents, relative quality of patents are looked at since patent applications are required to cite prior patents of which applicants are aware and hence, the number and character of citations to a given patent are used and a patent is considered more valuable if cited in more areas of technology. This however, does not reveal any information about whether the invention would still have been made without the prospect of patenting.

Patent renewal rates provide an insight into the value accorded to patents by the industry members themselves. Patents have to renewed by the patentee during the term for continual enjoyment and the low depreciation rates in spite of the high renewal fees is evidence of the value accorded to the protection conferred by these patents. The objective behind these renewals can be deemed to be the need of the firms to cover their fixed costs. This raises the question that to what extent is patent protection the only method of ensuring that copying does not occur? Sometimes, even without a patent regime, the cost of imitating in industrial innovations is extremely high due to the learning curve that must be overcome. Though, in practicality, cost imitation is likely to be much less than the cost of innovation as seen in the drug industry whereby research and development is 30% of the total cost of a new drug. Therefore, without a patent regime innovations will be discouraged as no firm will want to take the initiative for R&D for fear of cheap imitators.

The acceptance of patents as a social beneficially tool is also dubious when considering the difficulty of inventing around patents. High transaction costs are imposed on firms who want to innovate around patents as licenses will need to be obtained for all of them. This will hamper further innovation for fear that whilst experimenting, innovators might infringe upon patent rights. However, this does not ultimately hamper the society as inventors will be forced to negotiate and thereby will employ the best technologies possible after reconciling the original with the improved innovation. In the United States, the Hatch-Waxman Act of 1984 allows drug manufacturers to begin the FDA testing of drug before patent on brand name expires thereby interpreting an ‘experimental use’ doctrine of patent law. This is not applicable for scientists in patented research tools thereby continuing to present the problem of inventing around the patent and high transaction costs. Patent laws have found ways to combat these problems through the imposition of doctrines such as the ‘reverse doctrine of equivalents’ which purports that if the contribution made by the improvement greatly exceeds contribution by original patent, the improver is allowed to practice his invention without infringing the original.

The effect of patents on the social sphere can also be analysed looking at the research conducted by universities. The incentive of income through patent licensing has induced universities to substitute the basic research conducted for applied research. This may result into a net social loss as the focus from basic research would have shifted. On the other hand, universities can use applied research to undertake research into fields that are socially beneficial whereas companies would undertake applied research only to the extent that it would benefit them.

On the whole, though patent accords monopoly over a certain innovation to the patentee, this innovation occurred due to the investment of the inventor in terms of R&D, time, effort, labour etc. If this investment is not rewarded is sufficient ways, ultimately innovations will be discouraged. The social gain through patent protection is ultimately higher than the cost imposed by a patent regime. 

Levels of Strategy

It is believed that strategic decision making is the responsibility of top management. However, it is considered useful to distinguish between the levels of operation of the strategy.

Strategy operates at different levels vis-à-vis

·                     Corporate level

·                     Business level

·                     Functional level

There are basically two categories of companies – one, which have different businesses organized as different directions or product groups known as profit centres or strategic business units (SBUs) and other, which consists of companies which are single product companies. Eg. Reliance Industries and Ashok Leyland Limited.

The SBU concept was introduced by General Electric Company (GEC) of USA to manage product business. The fundamental concept in the SBU is the identification of dicrete independent product/market segments served by the organization. Because of the different environments served by each product, a SBU is created for each independent product/segment. Each and every SBU is different from another SBU due to the distinct business areas (DBAs) it is serving.

Each SBU has a clearly defined product/market segment and strategy. It develops its strategy according  to its own capabilities and needs with overall organizations capabilities and needs. Each SBU allocates resources according to its individual requirements for the achievement of organizational objectives. As against the multi product organizations, the single product organizations have single strategic  business unit. In these organizations, corporate level strategy serves the whole business. The strategy is implanted at the next lower level by functional strategies. In multiple product company, a strategy is formulated for each SBU (known as business level strategy) and such strategies lie between corporate and functional level  strategies.

The three levels are explained as follows 

Corporate level strategy 

At the corporate level, strategies are formulated according to organization wise policies. These are value oriented, conceptual and less concrete than decisions at the other two levels. These are characterized by greater risk, cost and profit potential as well as flexibility. Mostly, corporate level strategies are futuristic, innovative and pervasive in nature. They occupy the highest level of strategic decision making and cover the actions dealing with the objectives of the organization. Such decision aremade by top management of the firm. The examples of such strategies includeacquisition strategies, diversification, structural redesigning, etc. The board of directors and chief executive officer are the primary groups involved in this level of strategy making.  In small and family owned businesses, the entrepreneur is both the general manager and the chief strategic manager

Business Level Strategy 

The strategies formulated by each SBU to make best use of its resources given the environment it faces, come under the gamut of business level strategies. At such a level, strategy is a comprehensive plan providing objectives for SBUs, allocation of resources among functional areas and coordination between them for achievement of corporate level objectives. These strategies operate within the overall organizational strategies i.e within the broad constraints and policies and long term objectives set by the corporate strategy. The SBU managers are involved in this level of strategy. The strategies are related with a unit within the organization. The SBU operates within the defined scope of operations by the corporate level strategy and is limited by the assignment of resources by the corporate level. However, corporate strategy is not the sum total of business strategies of the organization. Business strategy relates with the“how” and the corporate strategy relates with the “what”. Business strategy defines the choice of product or service and market of individual business within the firm. The corporate strategy has impact on business strategy.

Functional  level Strategy

This strategy relates to single functional operation and the activities involved therein. This level is at the operating end of the organization. The decisions at this level within the organization are described as tactical. The strategies are concerned with how different functions of the enterprise like marketing, finance, manufacturing, etc contribute to the strategy of other levels. Functional strategy deals with a relatively restricted plan providing objectives for specific function, allocation of resources among different operations within the functional area and coordination between them for achievement of SBU and corporate level objectives

Sometimes a fourth level of strategy also exists. This level is known as the operating level. It comes below the functional level strategy and involves actions relating to various sub functions of the major function. For example, the functional  level strategy of marketing function is divided into operating levels such as marketing research, sales promotion, etc

The three levels of strategies have different characterstics as shown below –

Dimensions	Levels
	Corporate	Business	Functional
Impact	Significant	Major	Insignificant
Risk Involved	High	Medium	Low
Profit potential	High	Medium	Low
Time Horizon	Long	Medium	Low
Flexibility	High	Medium	Low
Adaptability	Insignificant	Medium	Significant

Military tactics in Business

Military tactics have formed an integral part in business ever since. Since many a time business is compared to war many military tactics are also used in business.

These tactics are generally used in a competitive environment where one company needs to capture the other companies market. These tactics may be defensive or aggressive depending on whether one is defending market share or capturing it.

The different types of aggressive tactics are


Frontal Attack- Frontal Attack is a direct head on attack to your competitor where you attack your competitor in the market where he is strong. This is generally between companies of equal strength. It is an attack directly on the opponent’s strength and is, therefore, not the sharpest form of attack. Companies should consider such an attack if they have the resources of that can be committed to such an attack for a long time and have no other option available


Flank Attack- Flank attack is the form of attack where a company engages the competitor in an area where the opponent is weak. The target area is not one where the opponent is initially engaged but it is merely to distract the opponent. The idea is to split the competitor’s resources and distract him so that an attack can be launched at the main area later on.


Guerilla Attack- It aims at weakening the opponent by launching small attacks in different areas. The idea is to destabilize the opponent while remaining mobile.


Encirclement Attack- Encirclement attack is the form of the attack where you surround your competitor and then down him from the centre. The company must be able to block the opponent in whatever direction he turns thereby diluting his ability to retaliate in strength.

The different types of defensive tactics are


Position Defense- This is the form of defense where the company holds its position in the area where it is strong. This generally demobilizes the defender who may then become a sitting duck for the competitor.


Mobile Defense- This is the form of defense where a company creates more than one base and therefore the competitor does not know where to attack. In the meanwhile the company can collect its resources to launch a final attack to save its position. Such sort of a defense can be obtained by diversification of businesses.


Counter attack- Attack is sometimes considered the best form of attack and counter attack is generally used by companies which means attacking the area where the attacker is strong thereby making him withdraw to protect his own base. Another variation of counter attack is the pre-emptive attack where the company attacks in anticipation of an attack thereby saving its position.


Flanking Defense- In flanking defense a company generally occupies a position that could be of importance to the competitor in the future. This would provide the company with a vantage point and may prevent the competitor from attacking in the first place.


Withdrawl- Sometimes it is best to withdraw from the battlefield if the opponent is way too strong based on your resources. However, withdrawl is generally not a preferred option by business mainly due to emotional attachment, a feeling of loss, exit barriers in the industry etc.

Diversification, Over diversification and Re-focusing

Ansoff Matrix - A video

Strategy Vs Tactics

Strategies are on one end of the organizational decisions spectrum while tactics lie on the other end.
Carl Von Calusewitz, a Prussian army general and military scientist defines military strategy as making use of battles in the furtherance of the war and the tactics as "the use of armed forces in battle". A few points of distinction between the two are:


1) Strategy determines the major plans to be undertaken while tactics is the means by which previously determined plans are executed.


2) The basic goal of strategy according to military science is to break the will of the army, deprive the enemy of the means to fight, occupy his territory, destroy or obtain control of his resources or make him surrender. The goal of tactics is to achieve success in a given action and this forms one part of a group related to military action.


3) Tactics decisions can be delegated to all the levels of an organization while strategic decisions cannot be delegated too low in the organization. The authority is not delegated below the levels than those which possess the perspective required for taking decisions effectively.


4) Strategy is formulated in both a continuous as well as irregular manner. The decisions are taken on the basis of opportunities, new ideas etc. Tactics is determined on  a periodic basis by various organizations. A fixed time table may be made for the following tactics.


5) Strategy has a long term perspective and occasionally it may have a short term duration. This the time horizon in terms of strategy is flexible but in case of tactics its is short run and definite.


6) The decisions taken as  part of strategy formulation and implementation have a high element of uncertainty and are under the conditions of partial ignorance. In contrast tactical decisions are more certain as they work upon the framework set by the strategy. So the evaluation of strategy is difficult than the evaluation of tactics.


7) Since an attempt is made in strategy to relate the organization with its environment, the requirement of information is more than that required in tactics. Tactics use information available internally in the organization.


8) The formulation of strategy is affected considerable by the personal values of the person involved in the process but the same is no the case in tactics implementation.

PAC Model

PAC model is a term we coined to explain the necessary characteristics to have to run a good business


P- Perseverance 


Success comes to those who perseveres over a long period of time even in the face of staggering adversities.

The key is to set your business goals, determine the strategies that will help you reach that goal and pursue that goal with everything you've got .

Steve Jobs , started Apple when he was 20 years old

Within a decade the company blossomed into a $2 billion empire. 

At age 30, Jobs was fired from the company he created

Jobs went on to found NeXT, a software company, and Pixar, the company that produces animated movies such as Finding Nemo

At the 2000 Macworld Expo, Jobs was renamed Apple’s CEO (iCEO)

A- Adapt

Change is inevitable; you must adapt fast enough to survive in the highly competitive business environment.

To be a successful entrepreneur, you must have the ability to recognize, and then leap, on new opportunities in the midst of misfortunes.

Bill Lederer, founder of Art.com, has shown the ability to transform a tragedy into an opportunity

When his father developed cancer, he quit his successful Wall Street career in 1997 to return to his family's framing and art supplies business

He then expanded his business to the Internet, where it became the online poster and print shop Art.com

In 1999, Art.com was bought by Getty Images, the giant stock photo and film footage company, for $84 million in cash and $200 million worth of stocks

C- Core Competency

When you are thinking of expanding your markets and/or your products,it is best to begin in fairly 
familiar territory.

If you will move to an area where you have inadequate knowledge and you have insufficient resources to cover your expansion, you run the risk of failure.

Avoid spreading yourself too thinly, particularly during the start-up phase.

Topps was known in the industry as one of the top two producers of baseball cards

Also successful  in selling the formula and base materials for the chewing gum that went into the packs of cards

Decided to expand and begin competing with larger confectioners, such as Wrigley’s and Beech Nut

This proved disastrous and new products, such as chocolate flavored gum failed, the company neared bankruptcy

In 1984, the firm was bought by the leveraged buy out firm of Forstmann Little & Co

Porter 5 Forces in the Indian Telecom Industry

Let us look at the various factors influencing the telecom industry in India. Telecom Industry in India has shown an amazing growth and has grown at a CAGR of 20% over the past 5 years. The growth in the telecom industry has recently been driven by the enormous growth in the Value Added Services which has grown at a CAGR of 51% over the past 5 years.

Let us apply the porters 5 forces on the Indian Telecom Industry

1) Bargaining Power of Supplier -With a large number of equipment providers the bargaining power of suppliers is low in the fixed asset sector. However when we talk about the HR supply, their power remains high. This is due to the fact that the number of engineers and managers well versed with the technology remain low. After 3G, 4G is set to come to the Indian market and the number of people exposed to this technology is even fewer.

2) Bargaining Power of Buyers - With a uniform service provided by the telecom companies and the entry of a large no. of players in the market the power of the buyers has gone up. The increase has also been driven by mobile number portability which allows the users to switch between service providers without incurring much of a cost.

3) Threat of New Entrants - Telecom requires a huge amount of capital. Therefore, the threat goes up when the capital markets are going good since it is much easier to arrange for capital. Since the industry requires ownership of licenses the entry barriers remain high. Also even though players may enter the market, the number of good spectrums is low so all in all the threat of new entrants remains low.

4) Threat of substitutes - Internet Telephony is the biggest threat to the telecom industry. With its advent many people has shifted to it thereby affecting the telecom industry. The cable and satellite operators have lines that are reaching directly to homes. Another threat to the telecom industry is the fact that railway companies have started laying telephone cables next to their railway track and thus many substitutes to this industry seem to be emerging.

5) Competitive Rivalry -Cut throat competition in this industry has made the prices of the services the lowest in the world. It has also adversely affected the industry with average revenue per user declining to Rs. 176 from Rs. 191. The rivalry continues to remain high due to high exit barriers and the difficulty in liquidating the specialized assets owned by these companies.

Strategic CSR and its implementation

Currently the global public’s expectation that business will operate in society’s best
interests has rapidly increased to an all-time high, while the public’s perception that
business is operating in society’s best interests has rapidly declined to an all-time low.
Several key factors have caused corporate social responsibility (CSR) to explode and
finally make its way into mainstream business thinking in recent years:
• The rise of technology giving citizens immediate access to transparent information
and news
• The NGO sector’s increasing sophistication in targeting corporate malfeasance
• Workers demanding that their employers contribute to bettering the world
• Pockets of consumer pressure
• Generation Y proving to be the most cause-focused generation in decades
While CSR is not meant to be presented as the panacea to all that ails the world or
global business, it is increasingly being viewed as a viable component of overall business
strategy, along with marketing, branding, research and development, innovation, talent
management, and operations.
I view CSR from the lens of corporate strategy, and encourage firms to use CSR as part
of their portfolio of overall business strategies designed to create both top - and bottom-line growth. My definition of strategic corporate social responsibility is: a business
strategy that is integrated with core business objectives and core competencies to create
business value and positive social/environmental value, and is embedded in day-to-day
business culture and operations. To be effective, CSR must be aligned with two things:
• Core business objectives of the firm
• Core competencies of the firm


If CSR is to be treated as a part of an effective corporate strategy, then
its definition should in fact be unique to each firm based upon that
company’s specific objectives, risks, opportunities, and competencies.

Putting CSR into practice


1) Senior leadership must make an authentic, firm, and public
commitment to CSR.

2) The firm should clearly define the specific business objectives
it seeks with CSR strategy.

3) CSR strategy must be aligned with the firm’s core competencies. This requires focus and discipline.

4) CSR should be fully integrated into the governance of the company and into
existing management systems.

5) Companies should view CSR as both a risk mitigation strategy and an opportunity-seeking strategy.

6) Companies should develop clear performance metrics to measure the impact
of their CSR strategies.

Google's view- On Motorola acquisition

Googles view on its recent acquisition of the Handset company Motorola:


"Since its launch in November 2007, Android has not only dramatically increased consumer choice but also improved the entire mobile experience for users. Today, more than 150 million Android devices have been activated worldwide—with over 550,000 devices now lit up every day—through a network of about 39 manufacturers and 231 carriers in 123 countries. Given Android’s phenomenal success, we are always looking for new ways to supercharge the Android ecosystem. That is why I am so excited today to announce that we have agreed to acquire Motorola.

Motorola has a history of over 80 years of innovation in communications technology and products, and in the development of intellectual property, which have helped drive the remarkable revolution in mobile computing we are all enjoying today. Its many industry milestones include the introduction of the world’s first portable cell phone nearly 30 years ago, and the StarTAC—the smallest and lightest phone on earth at time of launch. In 2007, Motorola was a founding member of the Open Handset Alliance that worked to make Android the first truly open and comprehensive platform for mobile devices. I have loved my Motorola phones from the StarTAC era up to the current DROIDs.

In 2008, Motorola bet big on Android as the sole operating system across all of its smartphone devices. It was a smart bet and we’re thrilled at the success they’ve achieved so far. We believe that their mobile business is on an upward trajectory and poised for explosive growth.

Motorola is also a market leader in the home devices and video solutions business. With the transition to Internet Protocol, we are excited to work together with Motorola and the industry to support our partners and cooperate with them to accelerate innovation in this space.

Motorola’s total commitment to Android in mobile devices is one of many reasons that there is a natural fit between our two companies. Together, we will create amazing user experiences that supercharge the entire Android ecosystem for the benefit of consumers, partners and developers everywhere.

This acquisition will not change our commitment to run Android as an open platform. Motorola will remain a licensee of Android and Android will remain open. We will run Motorola as a separate business. Many hardware partners have contributed to Android’s success and we look forward to continuing to work with all of them to deliver outstanding user experiences.

We recently explained how companies including Microsoft and Apple are banding together in anti-competitive patent attacks on Android. The U.S. Department of Justice had to intervene in the results of one recent patent auction to “protect competition and innovation in the open source software community” and it is currently looking into the results of the Nortel auction. Our acquisition of Motorola will increase competition by strengthening Google’s patent portfolio, which will enable us to better protect Android from anti-competitive threats from Microsoft, Apple and other companies.

The combination of Google and Motorola will not only supercharge Android, but will also enhance competition and offer consumers accelerating innovation, greater choice, and wonderful user experiences. I am confident that these great experiences will create huge value for shareholders."

Posted by Larry Page, CEO, Google

Understanding Behavior

This post would be slightly different from the topics generally covered in this blog. Here I talk about profiling. 
Criminal profiling is the act of developing a psychological profile of an offender based on the state of the crime scene. Profiling is most often done by a forensic psychologist -- someone who has studied the criminal mind. This profile can then be used by police departments to assist in apprehending the criminal.
Criminal Profiling essentially aims at getting into the mind of the criminal by looking at his actions. These actions help us identify whether the criminal is a kid or an adult, rich or poor, trained or untrained, all from simply the way things are at the crime scene. 
While criminal profiling is a limited field, what is relevant in business is profiling. Very commonly used in negotiations, profiling is the technique of creating a psychological sketch of the person you are dealing with. Such a profile helps us in determining the possible reactions the person might have to any of your propositions which would then enable us to be prepared in advance to counter any argument the other person may have.
It also helps us in identifying what the other person wants.Very often we come across people who would involve a salesperson for a long time to take him to a stage where he would just want to close the deal to get something out of the time spent. As a result the sales person often ends up giving a better deal to the customer. If only, the salesperson could get into the mind of the customer first he would know exactly how to counter each step. Knowing what your counter party wants is the first step at being a good negotiator, second being the ability to hide what you want.
Negotiation is about deception. It about making the other feel that you do not want what you actually want so that the other person under values it. 
Try this at a shop. Suppose you want a product A. Try giving a hint to the shopkeeper that you actually want the product B. You will notice how the shopkeeper would skip his focus to product B and start overselling it. During this process the shopkeeper actually ignores the product A. Once the shopkeeper has been engaged for some one, act disappointed and go for product A. The shopkeeper would be in no position to oversell this product since he had already oversold the product B. All this would end up in you getting a better deal. Obviously all this would depend on whether the shopkeeper is able to read you or not.
So it all comes down to the ability to read the other person whenever negotiating. Therefore even though criminal profiling may a very technical field, profiling ability in general is a useful tool to have whenever on a negotiating table.

A Good Read- Synergy Trap by Mark L Sirower

Two of the great economic phenomena of the end of the twentieth century are the bull market in stocks and the great national and international consolidation that has taken place in a wide variety of industries. While the
collapse of communism, computer technology, and the Fed’s easy money policy have been major contributors, the massive mergers and acquisitions movement has played a very direct role in both the bull market and this process of consolidation and economic development. Indeed, in each of the last several years, we have set new records for the largest single merger, the total number of mergers per year, and the total value of mergers.
Enter Mark Sirower, who asks the simple question, are mergers efficient? Do they really create synergy? And, ultimately, do they reward the shareholders of companies who make acquisitions through mergers? His surprising answer is, no. Mergers are not good for shareholders or, presumably, for the economy. This corporate self-exploitation starts with the hefty stock-price premiums that companies pay to buy or merge with their “target” company. The author finds that this premium causes a loss to the acquirer’s stockholders because the benefits of mergers, often labeled “synergy” are greatly overestimated. In addition, many mergers result in unforeseen difficulties that actually result in even worse stock performance.  While The Synergy Trap is a work in “management science,” the author is not unfamiliar with economics. He writes knowingly about “economic rents,” the competitive-market hypothesis, the winner’s curse, and he uses competitive market forces as one of his prime arguments as to why many mergers don’t work (because mergers alert competitors to changing competitive conditions and they do not sit still while the two firms merge). This, however, does not a good theory make and he provides little in the way of explaining why mergers fail to improve the
lot of stockholders. Ultimately, the author is led to an explanation of mergers based on economic
irrationality. Company executives make “value-destroying acquisitions” as a form of gambling that has their own self-aggrandizement as its goal—“from a policy perspective . . . managers make these decisions because they can.” He concludes that there are no mutual gains from exchange. The big capitalist is making irrational
bets with the money of little stockholders and destroying billions of dollars of shareholder value in the process.
Why do big corporations pay so much more than you or I do for the stock of their target company? Simple, buying stock increases the demand and price of a stock. The typical small purchase has no perceptible impact on the price of a stock, but large block trades often have a noticeable positive or negative effect on the stock price. A merger is just a stock purchase on a much larger scale and, therefore, has a much more noticeable effect on price.
The key question that the author fails to ask here is, why is the company willing to pay top dollar on every share when it could buy so many shares at much lower prices on the stock market, and thus preserve a great deal of its own shareholder’s value? Regulation causes this anomoly because it prevents companies from
acquiring large blocks of stock in companies, without registering their intentions with the government and alerting the market to their intentions. The government protects these “target firms” from “hostile takeovers.”
If mergers are so beneficial, why does the acquirer’s stock price fall when mergers are announced? Mergers, like divestitures, put the market for a stock in disequilibrium. A merger can increase the supply if the target is purchased with the company’s stock, or diminish the company’s credit rating if purchased with debt or
cash. Mergers can also affect demand if current shareholders find that the new merged company is no longer appropriate for their portfolios. A decrease in stock price for acquisition firms is, therefore, not irrational nor completely unexpected.
But why do most mergers destroy shareholder value? Here lies both the great problem and the great contribution of the book. The vast majority of mergers and acquisitions enhance shareholder wealth of both companies, but Mr. Sirower only looks at the 168 largest mergers of the 1980s. Other research has also shown that the larger the merger, the worse the stock price performance.
The largest companies are precisely the ones that are allowed the fewest opportunities to enhance shareholder value and are also the companies that come under the greatest antitrust scrutiny by government. If a large firm tries to grow too large, it can be accused of unfair trade practices, dumping, of trying to monopolize
an industry. Large companies are also more likely to be prevented from expanding their business through vertical and horizontal integration because it might violate antitrust law. Likewise large companies are also more restricted from forming the most efficient mergers possible because such mergers might create too much
market power or industry concentration. While the author does not recognize these constraints on the companies in his sample, he claims that it would be cheaper for shareholders to simply buy shares of
the target firm themselves, rather than through their company at such a big premium. This suggestion fails to recognize that such individual purchases would also increase the price, but more importantly, it neglects the fact that if the company were to distribute cash, shareholders would then immediately lose
between one-quarter and two-fifths of their dividends to taxes. The high premiums paid to acquire new companies compares favorably to paying these taxes and paying taxes is much worse for society.
Mr. Sirower has done a great service in pointing out the anomaly concerning large-company mergers. While his own interpretation and policy conclusions are far off base, he has provided good evidence for the Austrian theory that antitrust policy is harmful to the competitive process and standard of living in society.

Vodafone Piramal Deal

In 22 years, Piramal grew a pharma business valued at Rs6 crore, to finally selling its main business of drug formulations to Abbott Laboratories Inc for a king’s ransom of Rs17,000 crore. Then he vowed not to sit idly with the cash.

Although a busy Piramal flagged off a Rs2,500 crore buyback of shares from shareholders who wanted to exit and also declared a miserly dividend of Rs200 crore from the spoils of the Abbott deal. He acquired 5.5% of Vodafone’s Indian operations for Rs2,900 crore.

The valuation of Piramal Healthcare, despite holding a war-chest, fell as investors were not enthused by the deal and about the lack of clarity of what Piramal plans to do with the money.

The market capitalisation of Piramal Healthcare when the Abbott deal was announced in May 2010 was Rs10,500 crore. After the 5.5% stake in Vodafone the Piramal Healthcare’s m-cap is pegged at Rs7,833 crore, a decline of 25%. During the same period Sensex rose 3.73%.

An institutional investor which used to hold a small stake in the company told DNA that they exited after the company announced plans including a possible foray into real estate and financial services.

“The stock has been derated and the company is trading at a discount to the cash on its books,” the fund manager said.
Prior to the drug formulations sale, there were nine institutional shareholders who held more than 1% in the company. This number has since dwindled to five.

The deal that would use up at least one-third of the company’s cash reserves of Rs10,000 crore. 
At about 17-20% returns annually over two years, Piramal hopes to make a killing from his latest bet — the 5.5% equity in the Indian operations of Vodafone.

“We want to park funds for mid-to-short term periods to create superior returns from our surplus funds,” said Piramal. “We are aware of the Vodafone’s ongoing tax litigation and have made this investment knowingly.”

While Piramal repeatedly mentioned the agreement with Vodafone involving an exit option after the 24-month period, he declined to disclose whether those options involved any guaranteed valuations for his investment. Compared to the $16 billion valuation at which Essar sold its 33% stake, Piramal got his 5.5% at a significant discount, as the transaction values Vodafone’s Indian operations at about $11.6 billion.

Essar has been Vodafone’s joint venture partner since 2007 till early 2011.

The valuations are suppressed primarily on account of the hyper competition and the rock-bottom tariffs in Indian telecom industry and the resulting profit squeeze faced by mobile telephony firms operating here.

However, the next six months are expected to be critical as regulations around mergers and acquisitions will likely be simplified, leading to a consolidation phase and easing of competitive pressure.

Those developments are expected to trigger a re-rating of Indian telecom sector sending the valuations northwards, which is what Piramal is likely betting on for handsome returns on his latest investment.

Given that telecom is a curious investment choice for a pharma firm, Piramal is quick to cite the sale to Abbot as proof of his credentials in creating returns for shareholders.

The wealth created through that asset sale translates to an average return of 41% for shareholders every year for 21 years.

Even as he is investing in non-pharma sectors, Piramal is committed to investing Rs7,000 crore in pharma sector over the next five years. “I don’t think pharma sector alone can absorb all the funds,” Piramal said.

“While the announcement of investing in pharma is a positive, they should have done something more focused with the bulk of the cash. They have not rewarded their shareholders. Investors were expecting a dividend but they went in for a buyback. Large institutions which also held a stake in the company did not seem to have taken an active role over the issue,” said a veteran investor who runs a stock brokerage under his own name.

In May, Piramal Healthcare said it would invest Rs225 crore for buying into group firms Indiareit Investment Management Co and Indiareit Fund Advisors Pvt Ltd.