Analysis of Bank of America Corporation

By Justin DeMerchant, Prashant Pradhan, Mika Sakamoto, Jake Saunders, & Tony von Richter
 

Executive Summary
 

The Bank of America Corporation (BAC) has had a long history of success in the banking and finance industries, however the financial crisis of 2008 created significant problems for the company. The economic meltdown caused by the subprime mortgage crisis led to huge losses for BAC. The further deregulation of the financial industry allowed management to invest in default credit swaps as well as complicated mathematical derivative models to value risk, which led to the company issuing ill-advised loans, which could subsequently not be repaid. The company's personal banking services were also affected as increasing levels of unemployment resulted in lower amounts of money being deposited with the bank.

The financial industry also caused the company problems in the recent past. The large amount of loan defaults resulted in significant losses for the company. The lack of liquidity in the economy due to the global credit crunch restricted the lending opportunities for the company. As credit became available the public withdrew money from the market causing a downward spiral in the financial industry.

Even though BAC was not as exposed to the subprime mortgage crisis compared to other financial institutions the financial meltdown still gravely affected the company. Credit default swaps resulted in write-downs of $5.28 billion in the first quarter of 2008. The company did not have the liquidity to cover short-term liabilities necessitating the injection of government funding. The acquisition of Merrill-Lynch added to the hardship already plaguing BAC, and was mired in controversy because of questionable actions by BAC executives.

The company is still presented with opportunities although it has suffered difficulties in the recent past. If the company can pay back taxpayer funding, develop a contingency plan for the increasing regulation of the credit card industry, institute better transparency and auditing policies for the company, and make other changes it can thrive for years to come.
 

1a - Corporate Development and Strategy & 4a - What Happened in 2008 & 2009? (Justin DeMerchant)

The Bank of America has a history filled with mergers and acquisitions. Its first ancestor was the Massachusetts Bank that opened on July 5, 1784 , but its main chain of history began with the founding of the Bank of Italy in San Francisco in 1904. In 1927 the Bank of Italy merged with the Liberty Bank of America creating the Bank of Italy National Trust & Savings Association. The Liberty Bank then merged with the Bank of America Los Angeles becoming the largest banking institution in the United States called the Bank of America. At this point Bank of America was the largest bank in the country.

Throughout the 1950s banking regulation had a large impact of the Bank of America. First it was forced to separate from its parent company, the Transamerica Corporation, by the Clayton Antitrust Act . In 1956 the Bank Holding Company Act  prohibited BACs interstate banking, forcing the divestment of banks outside of California into a separate company called First Interstate Bancorp.

In 1958 technology allowed BAC to develop a credit card called BankAmericard (later to become known as Visa) . They mailed 60,000 cards out to clients unsolicited.

Later, in 1967, following amendments to the Bank Holding Company Act which again allowed interstate banking, BankAmerica Corporation (BA) was created to hold BAC and its subsidiaries. With the lift of the interstate banking ban, BAC begin an aggressive strategy of buying its way into attractive domestic markets on its way to becoming a nationwide bank.

President Jimmy Carter's Depository Institutions Deregulation and Monetary Control Act of 1980 was sold to the pubic as a benefit for consumers, but was really a gift to the banking sector . Mandatory reserve requirements were lowered and high 'caps' were placed on rates that could be charged on residential mortgages among other things. Further deregulation came with the election of Ronald Regan and the Garn-St. Garmain Depository Institutions Act.

In 1988 the Basel Accord was established that made it easy for marketable securities to be sold, essentially freeing up banks from having to back their mortgage obligations with real cash . A year later Wendy Gramm was appointed as chairperson to the U.S. Commodities Futures Trading Commission  and successfully exempted swaps and derivates from federal regulation in 1989.

BA acquired Seafirst Corporation in 1983, and Security Pacific and Valley Bank in 1992. In 1994 BA purchased Continental Illinois National Bank and Trust Co. from the federal government, again becoming the largest banking company in America before falling to number two in 1997 and three in 1998.

In 1999 proponents of deregulation won their ultimate victory with the enactment of the Gramm-Leach-Bliley Financial Services Modernization Act , which essentially did away with the Glass-Steagall Act of 1933  that separated risky investment banks from commercial banks and the Bank Holding Company Act of 1956 . This essentially opened the door for subprime lending of which Senator Phil Gramm famously said "I look at subprime lending and I see the American Dream in action." While these practices promised huge returns, BAC stayed largely out of the subprime mortgage market  but they were still exposed to much of the risk through their ownership of collateralized debt obligations.

The NationsBank Corporation bought BA in September 1998 for $64.8 billion , although it was structured more like a merger. They operated under the name Bank of America Corporation, and operated under the charter granted to the Bank of Italy back in 1927 . The newly formed BAC was forced to divest 13 branches in New Mexico because banking regulation dictates that that cannot have more than a 25% deposit share in any one state.

In the 21st century BAC continued with its acquisitions. BAC bought FleetBoston Financial in 2004 which was the nations 7th largest bank. This was somewhat of a reversal of Ken Lewis' position that BAC was going to focus on growing organically from the inside. With the purchase BAC effectively bought its way into New England where it had previously had only a small presence .

This point seems to mark a change in BAC's acquisition strategy. They focus less on horizontal growth through acquiring banks that offer similar services in geographic locations that they only had a small presence in to focusing on vertical growth into services peripheral to consumer banking. This seems to be out of necessity for a few reasons. First they are at this point of bona fide national bank with a strong presence in most of the country. Secondly at this point they are approaching state and federal caps limiting how much of a market one bank can control.

Their next target was MBNA, a credit card giant with over 40 million US accounts , which was bought on June 30, 2005. The combination of the two companies created a large deal of savings, estimated at $850 million and made them one of the world's largest credit card issuers. This also helped BOA raise revenues in the card services division by almost $11 billon from 2005 to 2006 following the full integration.

The United States Trust Company (UST) was acquired from Charles Schwab on November 20, 2006 . This acquisition was a strategic decision by BAC in an effort to gain a strong presence in the high-end 'private' banking sector where UST was the third largest bank behind J.P. Morgan and Citibank .

A large stake in Countrywide Finance (CF) was bought on August 23, 2007  with the purchase of $2 billion in preferred shares yielding 7.25% annually. Along with this purchase came the right to match any other offer to buy CF in the future and it was speculated BAC would likely exercise this right at some point .

LaSalle Bank was purchased on September 14, 2007 from ABN AMRO, a Dutch bank, which increased BAC presence in central USA, particularly Boston . There were concerns that this would push BAC over the 10% federally imposed cap on all domestic deposits, but this has not been an issue aside from precluding BAC from buying any more banks in 2008, possibly longer .

On January 11, 2008 BAC announced their plan to purchase the rest of CF  (on top of the $2 billion in preferred shares they acquired in 2007), which was completed on July 1, 2008 for $2.5 billion . CF has since been rebranded as Bank of America Home Loans.

President George W. Bush signed the Economic Stimulus Act of 2008 into force on February 13, 2008  following testimony by Federal Reserve Chairman Ben Bernanke that the United States would fall into a recession unless they took action . The legislation aimed to decrease the tax burden for low and middle-income families, to stimulate small business investment, and to raise the limits on mortgages that were eligible for government purchase.

On July 30, 2008 the Housing and Economic Recovery Act of 2008 was signed into effect . The act was aimed at restoring confidence in the mortgage sector (namely Fannie Mae and Freddie Mac) by extending federal guarantees worth $300 billion over 30 year subprime mortgages . The bill also established the Federal Housing Finance Agency, which took effective control of Fannie Mae and Freddie Mac on September 7, 2008 .

BAC then announced its plan to purchase Merrill Lynch & Co., Inc. (ML) on September 15, 2008 . On the same day Lehman Brothers (LB) filed for Chapter 11 bankruptcy protection. It was widely speculated that BAC had intended to purchase either ML or LB , and with other financial institutions backing off of LB it was apparent that no one was going to save them.

The Emergency Economic Stabilization Act of 2008 was enacted on October 3, 2008 . It was created to authorize the United States Treasury Department to spend up to $700 billion to bail out the financial sector by buying up mortgage backed securities and making capital injections into banks . When the law was enacted it established the Troubled Asset Relief Program (TARP), which is the subject of section 4b of this study .

The deal to buy ML closed on January 1, 2009, after gaining the support of both companies' shareholders,  and is thought to have saved ML from bankruptcy . On January 16 massive fourth quarter losses by ML in the amount of $15.31 billion were reported . The deal was controversial after it came to light that federal officials pressured BAC CEO Kenneth Lewis into the deal , and that BAC tried to back out of the deal once the full extent of the losses were known.

Shortly after his inauguration on January 20, 2009 President Barack Obama signed the American Recovery and Reinvestment Act of 2009 into effect on February 17, 2009 . The $787 billion act invested in many social areas such as tax cuts to low-income earners, unemployment benefits, health care, and infrastructure .

The Securities and Exchange Commission came to a $33 million settlement with BAC on August 3, 2009 because they failed to disclose an agreement to pay out $5.8 billion in bonuses to employees of ML. Federal judge Jed Rakoff subsequently rejected this agreement on August 5, 2009 . The trial is set to begin on February 1, 2010.
 

1b - Mission / Vision (Justin DeMerchant)

BAC does not have a clear accessible mission statement. Its website is riddled with statements one would expect about providing value to all stakeholders  and corporate responsibility, but there fails to be a unifying message. Looking further into press releases and financial statements you can begin to get a picture about the vision the company has for itself.

In 2004 Chad Gifford, then Chairman of BOA gave the most clear articulation of what exactly the BOA is when he said:

Our goal is to provide our shareholders consistent, attractive earnings growth and high levels of profitability. On our own, I believe we would have continued to gain strength and momentum, and that the progress we're making with all our customer groups, from consumers and small businesses to middle-market and large corporate clients, would have driven significant improvements in both top- and bottom-line growth. With the addition of the former Fleet franchise, I believe our future prospects are brighter still.

2a - Nature of the Business and its Significance

Undoubtedly one of the major portions of the American economy is the services offered by the banking industry. In large part the stability of the American economy is tied up in the success of the banking industry otherwise the American government would not have provided funding to certain firms to help ensure that they continued to operate during the financial crisis. The three main components of the banking and financial industry are mortgage banking, investment banking, and personal banking.

Mortgage Banking

With about 7,000 firms and annual revenue between 50 and 75 billion the mortgage industry is a significant player in the American economy. Some of the major competitors to BAC are Citigroup and Wells Fargo, who, along with the other top 50 firms in the industry, account for 70 percent of mortgage revenue.

Obviously the biggest function of the mortgage industry is to provide funding for people to purchase homes. For the most part this is done on a fixed interest rate basis, usually spread over 30 years. Recently subprime mortgages became popular offering funding to people who wouldn’t have qualified for traditional mortgages. As we now know this ended up helping cause the financial crisis in the United States that began in September 2008.

Investment Banking

The investment banking industry falls between the mortgage and personal banking industry with $100 billion in annual revenue. It is also the most heavily concentrated of the three industries with the 50 largest firms accounting for 90 percent of the industry’s revenue.

Main activity of the industry is to supply capital to businesses so they can fund their operations or expand via mergers and acquisitions. The success of these firms is dependent on their ability to successfully determine which companies will be able to pay back this capital. In terms of revenue within the industry 50 percent comes from trading activities, 35 percent from asset management, and 15 percent from merger and acquisition fees and public offerings.

Personal Banking

The personal banking industry is without question one of the largest in the American economy with around $630 billion in revenue annually. This revenue is split over 7,100 commercial banks, 1,200 savings banks, and 8,000 credit unions. Revenue is split with 81 percent coming from commercial banks, 13 percent coming from savings banks, and the remaining 6 percent coming from credit unions. Similar to the mortgage industry the 50 largest firms account for 60 percent of the industry’s revenue.

Like any other operation banking industry relies upon efficient operations. Of course the industry is quite capital intensive which only makes sense given the nature of the business; it is also quite automated due to the high amount of data that is generated on a daily basis. One of the most important aspects of the business is risk management as one of the industry’s main products is giving out money through loans. Banks need to successfully evaluate who will be able to pay back the money they are loaned (as well as the interest that is charged along with it).

BAC is involved in the three areas of the banking and financial industry, however the company separates and structures its operations differently than described above. For the recent past until 2009 BAC divided operations into three areas: Global Consumer and Small Business Banking (GCSBB), Global Corporate and Investment Banking (GCIB), and Global Wealth and Investment Management (GWIM).

Global Consumer and Small Business Banking includes deposits and student lending ($20,649 million in revenue in 2008), card services ($28,433 million in revenue in 2008), mortgage, home equity, and insurance services ($9,262 million in revenue in 2008). In 2008 this section of the business accounted for 79 percent of BAC's total revenues.

Global Corporate and Investment Banking includes business lending ($7,823 million in revenue in 2008), capital markets and advisory services (a loss of $3,018 million in 2008), treasury services ($7,784 million in revenue in 2008), and asset and liability management ($851 million in revenue in 2008). In 2008 this section of the company accounted for 18 percent of BAC's total revenues.

Global Wealth and Investment Management includes U.S. Trust, Bank of America Private Wealth Management ($2,650 million in revenue in 2008), Columbia Management ($391 million in revenue in 2008), Premier Banking and Investments ($3,201 million in revenue in 2008), and asset and liability management ($1,543 million in revenue in 2008). In 2008 this section of the company accounted for 11 percent of BAC's total revenues.

In terms of net income, the GCSBB division posted net income of $4,234 million which accounted for 106 percent of the company's total. The GCIB division posted a net loss of $14 million, which was one percent of the company's total net income. GWIM division posted revenues of $1,416 million, 35 percent of the company's total in 2008. Interestingly enough, the a major portion of the company's losses, $1,628 million or 40% of the total, came from areas of the company outside of the three main divisions. These other areas consisted of merger and restructuring costs, the liquidation of certain businesses, equity investments, and activities associated with the residential mortgage portfolio.

Tangible and Intangible resources

Each company in the industry will have their own specific competencies the industry generally has similar types of tangible and intangible resources.

Tangible resources would be the capital available to the company, either through their own reserves or the deposits and funds available to them from their clients. Capital investments such as offices, branch locations, automated teller machines, etc. would also be considered tangible resources.

Other than the capital available to the company the intangible resources in the banking and finance industry are arguably of more importance. These intangible resources can be broken down into two main areas: relationships and competencies.

Relationships can include the direct relationship with consumers, whether they are individual consumers or businesses, and the... A firm's reputation can also be considered a relationship-based intangible asset. For BAC this could include being known as a top personal and commercial banking firm, and also their status as an innovator in the industry.

In terms of competencies generally they can be categorized as knowledge or capabilities. Knowledge refers to the information that a firm possesses in various segments of the industry (personal banking, small business banking, card services, etc.). Capabilities refer to a firm's ability to utilize the knowledge it possesses to participate in a particular market segment. An example for BAC would be its wealth management business. In acquiring Merrill Lynch, BAC is now able to utilize its knowledge of the wealth management industry (as well as the knowledge gained by acquiring Merrill Lynch), as it now possesses Merrill Lynch's capabilities in the wealth management sector.
 

2b - Barriers to Entry and Exit (by Tony von Richter)

There are significant barriers to entry in the banking and financial sector. Primarily these barriers are based on government regulation, capital requirements, and switching costs to the consumer.
In terms of government regulations of most significance is the Basel II accord, which is the second of the Basel Accords issued by the Basel Committee on Banking Supervision. The Basel II accord is outlined in more detail above in section 1-d, however it is mostly concerned with setting minimal capital requirements for banks.

Obviously the capital required for operating a company in the banking and financial industry is quite significant. Obviously not every firm would be as large as BAC nor would they require as much capital, however the nature of the industry requires large amounts of capital be available. Each company operates differently however a large portion of a company’s assets are loaned out at any one time which makes operating a company extremely difficult without significantly high assets.
 

2c - Customer Groups (by Mika Sakamoto)

It seems that BAC frames two segments as its customers, personal banking and corporate banking. In addition, BAC covers two different language groups: English speakers and Spanish speakers.

Personal Banking

There are four types of personal banking services: regular personal banking, life-stage based services, monetary status based services, and the specific services for the certain occupations.

Regular Personal Banking Service

The first service group is the regular personal banking service, which includes checking, savings, and credit card. These services are provided by BAC. For the credit card service, the Bank of America has a partnership with VISA and American Express.

Life-Stage Based Services

The second service group is designed based on the life-stage of its customers. There is a mortgage plan for a customer for buying a house, and a loan plan for purchasing a vehicle. If a customer has a child and wants to prepare for his/her education, the Bank of America provides an education saving plan. For those who want to start considering their retirements, it offers several retirement plans, such as reverse mortgage, 401Kplan, Annuities, Individual Retirement Arrangement (IRA). Most of the products in this group are offered by BAC, except for investment products and insurance.

The investment products, IRA and 401K plan for example, are offered by the Bank of America Investment Services, Inc. The Bank of America Investment Services, Inc. is a subsidiary of BAC, which assumes investment and premier banking  responsibilities (as of December 7, 2009, it seems that products of Banc of America Investment Services are offered by Merrill Lynch).

A couple of types of insurance are offered by several agencies depending on the customers’ needs, such as life insurance, auto insurance, and home insurance. Life insurance is provided by three agents. For simplified term life insurance, Great-West Life & Annuity Insurance Company offers it to non-New York state residents, and First Great-West & Annuity Insurance Company provides it to the residents of the New York state. Term life insurance is offered by AMPAC Insurance Marketing, Inc. , and Auto Insurance is available at GEICO. If a customer needs to buy home insurance, s/he can contract with the Bank of America and the Banc of America Insurance Service, Inc.

As a subsidiary of the Bank of America, the Bank of America Insurance Service, Inc. belongs to the non-banking industry. AMPAC Insurance Marketing, Inc. and the Bank of America tied up their partnership. In August 2007, Warren Buffet, who is the owner of the parent company of GEICO (Berkshire Hathaway), bought approximately 5% of the Bank of America’s shares.

From the above-mentioned points, it is observed that the Bank of America creates strong relationships with those companies through partnership, underwriting preferred shares, or letting others to be its shareholders.

In addition, in the insurance area, it is observed that BAC offers Auto insurance through GEICO, but not by its own subsidiary. Since GEICO is the third largest insurer for the US autos, it implies that the Bank of America uses GEICO’s brand name for a fulfillment of its product line-up.

Monetary-Status Based Services

The third group of services is based on monetary status. One example is the wealth management. Although investment and gift fund services are provided by subsidiaries of the Bank of America, such as the Banc of America Investment Services, Inc. and Columbia Management Group , the wealth management advisory is mainly implemented by U. S. Trust, which is another subsidiary of the Bank of America. This division of roles shows that the Bank of America aims each subsidiary to focus on one role in the Bank of America corporation group. Other than the wealth management, the Bank of America offers the refinance program for its customers who have a hardship to repay their mortgages.

Specific Services for the Certain Occupations

The final group of personal services are distinctive services by the occupations. BAC offers specific account services for students and military officers.

Corporate Banking

There are two segments of corporate banking, such as small businesses and large corporations/institutions.

For small business, BAC offers almost all of the services, such as merchant card processing, online payroll, invoicing, tax services, and lending money. For this segment, BAC has a partnership with VISA and MasterCard, but not with American Express, in terms of corporate card service.

For large corporations and institutions, BAC offers similar corporate card services as the small business obtains. However, the services for this segment are divided by Merrill Lynch and other subsidiaries that depend on the clients’ industry. For example, Merrill Lynch solely provides its services to accounting firms, law firms, and Security Alarm industries. The Bank of America Public Capital Corp offers services to the non-profit organizations. Although the Banc of America Securities LLC. provides its services to some industries solely, such as sport and natural resources, it also deliver some services instead of Merrill Lynch with other industries.

This division of roles between three subsidiaries implies that BAC focuses on shaping its business by the resource-based perspective in terms of corporate banking service.

Examining the customer groups through Porter’s five forces model there are high levels of initial buyer power as there are many different firms offering similar services to all clients. This power does shift once the buyer has made an initial decision as the cost of switching to another firm, both monetary and non-monetary, can be significant.
 

2d - Mapping of Relevant Strategic Groups (by Tony von Richter)

Citigroup

Citigroup offers services similar to Bank of America and competes with them in all of their business segments. The company recently restructured their operations into two major operating groups: Citicorp and Citi Holdings. Citicorp focuses on banking services for business and consumers. Citi Holdings focuses on mortgages, asset management, and the assets covered under the company’s loss-sharing agreement with the US government. In 2008 Citi posted losses of 27.7 billion.

JP Morgan Chase

JP Morgan Chase offers products in the same segments as Bank of America, however the company is focused more towards the investment, card services, and retail banking sectors as they account for 72% of the company’s revenues. In 2008 the company reported a profit of $6.5 billion. The company expanded on both the retail and investment sides of the financial industry with its acquisitions of Bear Sterns and Washington Mutual.

Wells Fargo

Operating in 39 states Wells Fargo earned a $2.7 billion profit in 2008 and managed to increase revenues by 6 per cent. The company completed a takeover of Wachovia on Dec. 31, 2008. Primarily focused on retail banking (what the company refers to as ‘Community Banking’ resulted in 32 per cent of the company’s earnings (not including Wachovia’s earnings). The next biggest portions of the company’s business are the specialized lending (student loans, credit cards, etc.) and home mortgage segments each earning 19% of the firm’s revenue.
 

3a - Generic Strategic Orientation (Jake Saunders)

BAC is currently pursuing a broad differentiation strategy, as they are currently a full-service provider in the financial services. At the heart of BAC’s strategy is the ambition to become the number one, largest bank within its domestic market; it pursues this goal through making both key acquisitions to expand its market and organic growth within its segments.

The company has made several key acquisitions within the past five years while following a market development approach to growing their operations. Acquisitions of MBNA in 2005, a credit card giant, allowed the company to become a leading credit card issuer as they penetrated this relatively new market; this division now consists of Bank of America’s Card Services. In 2008, Countrywide Financial was acquired for approximately 4.1 billion and this allowed the company to buy a substantial market share of the home mortgage industry, where BAC previously had little presence; Countrywide Financial has since become Bank of America Home Loans. Finally, Merrill Lynch’s acquisition was finalized in early 2009 as this was BAC’s shift to strengthen their investment banking and wealth management divisions, which had previously been downsizing prior to the acquisition. Merrill Lynch allowed the company to officially become the largest brokerage in the world with more than 20,000 advisors and 2.5 trillion in client assets.

These acquisitions allowed BAC to expand their market and grow into new segments where they did not competitively participate and where their presence was weak. In the case of Merrill Lynch and Countrywide, both of these companies were near bankruptcy and BAC likely saw this as an opportunity to acquire huge market share in both industries at a significant discount, due to the influence the financial crisis had had on both firm’s market value.

The acquisition of Merrill Lynch came at a significant cost to BAC as the extent of the 2008 losses reported by Merrill Lynch nearly destroyed the deal; CEO Ken Lewis suggested before congress that once he had expressed his interest in backing out of the deal, he was pressured into completing the acquisition of Merrill Lynch or faced losing his job and BAC’s relationship would be damaged with regulators, forcing the deal to go through to the anger of many shareholders. Merrill Lynch reported a fourth quarter loss of $21.5 billion, which was eventually absorbed by BAC once the acquisition was concluded on January 1st, 2009. From such losses, and among other contributing factors occurring before this acquisition, this left BAC in a liquidity crisis and desperate for added capital strength. Although the company was actively purchasing companies in 2008 and on into 2009 suggesting that they were in a superior financial position, they were making decisions internally to raise their capital strength as they were struggling and highly volatile.

During 2008, in order to cut costs and preserve capital, the company cut their dividend to a penny, which had increased each year since 1977; other cost cutting initiatives to reduce preventable spending included no bonuses or incentive compensation for the year to members of the banks executive management. To raise capital for the company, they issued $10 billion worth of common stock in the secondary market in order to increase liquidity.  On top of all of this, the company received $20 billion from TARP funds in 2009 to supposedly aid in closing the deal with Merrill Lynch, on top of the $25 billion that had already been received from TARP. The company described this as necessary for the bank to maintain their capital strength and stability throughout the crisis. The company seems to be doing all that is possible to maintain the highest levels of capital achievable within the company through these though times.

When the characteristics of their operating strategy are dissected, BAC is making numerous movements in response to the financial crisis towards realizing their goal of becoming the largest bank within their domestic market. To begin, in their 2008 annual statements, they have realized that they cannot so heavily depend on complex mathematical models for assessing risk, as the company’s CEO expresses taking more of a “commonsense” approach and understanding of economic fundamentals is necessary. These new assessments of risk factors, such as credit worthiness, portfolio structure, and the like, includes the use of new tools and approaches to managing risk more effectively, and will likely be necessary to ensure stability going forward. BAC has expressed their disinterest in future excessive use of derivatives and complex unregulated financial instruments, which in part played a role in causing the financial crisis; simple, transparent financial products to meet customers’ current needs shall be one of the main focuses of the company going forward.

BAC has built their business on the basis of “diversity creates strength”. The business believes that the more growth opportunities that they can pursue in coordination to each other, the more likely they will be in a position to achieve their goals. The company feels that if they are able to diversity their businesses, revenue streams, risks, ideas, perspectives, and people, this will allow them to become the leading provider of financial services in the United States. Through this diversification strategy of their operations, primarily being accomplished through their acquisition strategy, it allows them to become a full service provider of financial services, providing a high degree of convenience and increased simplicity for the consumer.

Another important aspect of BAC’s operational strategy consists of their public relations efforts and charitable generosity initiatives. BAC’s created an environmental initiative that encompasses $20 billion in charitable donations over 10 years to address global climate change. This initiative includes creating environmental opportunities and is part of a larger organizational commitment to supporting a healthy economy in the United States, creating access to greater economic and social opportunities for people and business across the country as the company feels that the long-term sustainability of the company is based on the health and wellbeing of American communities. The Neighborhood Excellence Initiative is a grant program the banks signature philanthropic program while it rewards community -based organizations, local heroes and student leaders who work to improve their communities. The program focuses on areas such as: education, community development/ neighborhood preservation, arts and culture, and health and human services. The majority of their charitable contributions are based on the theme of developing “healthy communities”, as the bank feels that this principle will aid in the banks prosperity into the future.
 

3b - Competitive Advantages and Disadvantages (by Prashant Pradhan)

Two central questions underlie the competitive position. The first is the attractiveness of industries for long-term profitability and the factors that determine it. The second central question in competitive position is the determinants of relative competitive position with in an industry. Neither point mentioned above is sufficient by itself to establish a competitive advantage. Both industry attractiveness and competitive position can be shaped by a firm by choosing a competitive strategy both challenging and exciting. One of the factors on which competitive advantage is dependent is industry attractiveness, however this is partly a reflection of factors over which a firm has little influence. However, choice of sound competitive strategy has considerable power to make an industry more or less attractive. At the same time a firm can clearly improve or erode its position within an industry through its choice of strategy. Competitive strategy not only responds to the environment but also attempts to shape that environment in a firm's favour.

The firm’s competitive advantage arises from the industry that the firm operates in. In any industry, whether it is domestic or international or produces a product or a service, the rules of competition are embodied in five competitive forces: the bargaining power of buyers, the bargaining power of suppliers, the entry of new competitors, the threat of substitutes and the rivalry among existing competitors. The collective strength of these five competitive forces determines the ability of the firms in an industry to earn on average rates of return on investment in excess of cost of capital. If the five competitive forces and their structural determinants were solely a function of intrinsic industry characteristics, then competitive strategy would rest heavily on picking the right industry and understanding the five forces better than competitors. But while these are surely important tasks for any firm and are the essence of competitive strategy in some industries, a firm is usually not a prisoner of its industry's structure. Firms, through their strategies can influence the five forces. If a firm can shape structure, it can fundamentally change an industry's attractiveness for better or for worse. Many successful competitors have shifted the rules of competition in this way. As such, while analyzing the competitive advantage of BAC, it will have to be looked at from the prospective of how attractive the industry is as well. In terms of new entrants, doing business in the banking and finance sector entails huge capital investments as well as compliance with number of rules and regulation both in state and federal level. As such an average person can't come along and start up a bank. However different banks within a banking industry are categorized based on the different capital structure and the area of coverage. These banks have the ability to enter into a sector that they were not currently catering to by increasing the level of capital or fulfilling some regulatory requirement. As such, potential threats arise from existing banks that are not catering to that segment. For example an insurance company can start offering mortgage and loan services or a regional bank can expand and be a national bank thereby competing with the existing national banks.

Power of Suppliers

Banks are involved in a service industry, as such the question of raw material supplier does not arise. The ability of a bank to service its customer is entirely dependent on its people. Therefore power of supplier can be looked at from the perspective of its employees. As such there is threat of employees being lured away by its competitors. At the same time due to the recent sub-prime mortgage crisis the issue of compensation has become a very sensitive issue. As such there is the ever-looming threat that good employees may be lured away by competitors by providing better incentives. Another supplier to banks are the suppliers of capital. If the bank is stable and under normal circumstances, the suppliers of capital might not pose a big threat, however under uncertain circumstances like the recent sub-prime mortgage crisis, which exposes the vulnerability of the bank, the suppliers of the capital may try to get out of the market.

Power of Buyers

The customers of a bank have the option to choose from so many different banks which means that the power of buyer is relatively high. However one factor that prevents investors from switching from one bank to another is relatively high switching cost. If a person has a mortgage, car loan, credit card, line of credit etc. with one particular bank, it can be extremely hard for that person to switch to another bank given the inconvenience of switching the products from one bank to another. Banks try to lure in customers by reducing the cost of changing banks but are not very successful. On the other hand, large corporate clients have strong bargaining power. Financial institutions offer competitive interest rates, exchange rates and better service to maintain corporate clients.

Availability of Substitutes 

Even though over 130 banks have failed in the past year , there are still many substitutes in the banking industry. Although banks offer different services but since the services offered by the banks are standardized in nature, the customer has the option to choose from a wide array of options. At the same time, these days non-banking financial services are offering similar services like that offered by bank which increases the number of substitutes. For example when one goes to buy a car, the companies are offering 0% financing.

Competitive Rivalry 

The banking industry is highly competitive. As mentioned above the number of substitutes in the banking industry is high and at the same time the services offered by different banks are very standardized as such they try to differentiate by offering lower financing, preferred rates and investment services.

Having analyzed the competitive attractiveness of the banking industry, the competitive advantages from the perspective of BAC are outlined below.

Size

BAC is one of the largest banks in the world and in the USA. It is the nation’s largest consumer bank. Its geographic reach is coast-to-coast, covering over 32 states. They currently have a customer base of over 53 million and over 18,254 ATM machines.

Economies of Scope

Given the size of BAC, economies of scope automatically arises as by having so many branches BAC can offer different services to its customers as such resulting in the economies of scope.

Too Big to Fail

As mentioned earlier, BAC is one of the biggest Bank in America and it has a very wide coverage the failure of which could have a catastrophic impact on the financial systems of America. Therefore they are considered as "too big to fail" by the United States Government. As such this can be one competitive advantage of BAC because if they are considered too big to fail, the Government will ensure its continuity. 

Brand Value

BAC has a rich history of over 78 years of operation. Given its wide coverage in America as well as its presence in different parts of the world, BAC has an established brand value. Even though BAC had to resort to TARP funds to maintain a sound capital, despite severe difficulty in the financial market as a result of credit squeeze, BAC was able to generate profit though at a reduced level at the end of fiscal year 2008.

In terms of competitive disadvantage, the size of BAC can also be a competitive disadvantage because given the size of BAC it is difficult for BAC adapt to changing situations quick at the same time it is difficult for BAC to tailor to local needs. Another competitive disadvantage of BAC is the existence of TARP funds in its capital structure. During the recent sub-prime mortgage crisis, BAC had resorted to TARP funds to maintain its capital level which was provided under some strict conditions that BAC are required to comply with. For example some conditions were required to be fulfilled before paying bonus to its executives. As such, having TARP funds in its capital structure limits the flexibility with which the Bank of America can operate. This can have an adverse impact because important people can leave BAC and join other organizations. The Bank of America will also have to work on improving its current financial position. In 2008, BAC earned $4.01 billion, down from $14.98 billion in 2007. Revenue (on a fully taxable-equivalent basis) rose 8 percent to $73.98 billion from $68.58 billion in 2007, from organic growth and the addition of U.S. Trust, LaSalle and Countrywide. Return on average common shareholders’ equity fell to 1.80 percent from 11.08 percent. Provision expense rose $18.44 billion to $26.83 billion, and nonperforming assets and net charge-off ratios rose to 1.96 percent and 1.79 percent, respectively.

 

3c - Strategic Weaknesses at the Business and Functional Levels (by Prashant Pradhan)

Effective January 1, 2009 with the acquisition of Merrill Lynch BAC changed the basis of presentation from three segments to six segments- deposits, global card services, home loans and insurance, global banking, global markets and Global Wealth and Investment Management with the remaining operations recorded as all other. The former Global Consumer and Small Business Banking now is reflected in three separate business segments: Deposits, Global Card Services and Home Loans and Insurance. In order to better coordinate consumer payment business BAC consolidated all consumer and small business card products into Global Card Services; therefore debit card has moved from deposits to card services. The former Global Corporate and Investment Banking now is divided into Global Banking and Global Markets. As such while analyzing the strategic weaknesses at the business and functional level it has been looked at from the six segments or area of business of BAC.

Deposits

Deposits includes the consumer deposit activities, which consist of a comprehensive range of products provided to consumers and small businesses. At the same time deposits also includes student lending results and the effect of asset liability management activities. In the USA, BAC caters to approximately 53 million consumer and small business relationships through a franchise that stretches through 32 states and the District of Columbia utilizing network of 6,008 banking centers, 18,254 domestic branded ATMs, and telephone and Internet channels. BAC’s deposit products include traditional savings accounts, money market savings accounts, certificate of deposits and non-interest and interest-bearing checking accounts. Deposit products provide a relatively stable source of funding and liquidity. They earn net interest spread revenues from investing this liquidity in earning assets through extending lending facility to client and asset liability management activities. The revenue is allocated to the deposit products using funds transfer pricing process which takes into account the interest rates and maturity characteristics of the deposits. Deposits also generate fees such as account service fees, non-sufficient fund fees, overdraft charges and ATM fees.

During the third quarter of 2009, BAC announced changes to its overdraft fee policies intended to help customers limit overdraft fees. These changes will negatively impact net revenue beginning in the fourth quarter of 2009. In addition, in the fourth quarter of 2009, the Federal Reserve is expected to issue the final Electronic Funds Transfer Act (i.e., Regulation E), which could

Position Statement

Tenova SpA is a strong company in a troubled industry. The metals and mining industry is faced with a declining demand for their products, which is in turn reducing their need for new equipment. Tenova has the resources to weather the short-term reduction in demand with large cash reserves and a solid backlog of orders. For this reason the current market crisis may present Tenova with an opportunity for acquisition of companies in both the steel and mining equipment industries at discount prices.

I recommend is that Tenova acquire one or more companies in the mining equipment industry that occupy adjacent segments to Pyromet and Takraf. In the near future the mining industry is capable of weathering the current economic storm better than the steel industry. This will provide more opportunities than the steel industry, which is expected to be stagnant for the next five years.

An Evolving Strategy

Tenova has significantly grown in the current decade. This is not only due to the booming mining industry but also their increased understanding of the business and its environment; allowing them to deliver value to customers and shareholders.

In the industry there are two major types of competition: the full-liner companies offer customers systems that can follow the complete stream of steel production, while niche companies help customers with expertise in one area of production. Tenova has pursued a focused differentiation strategy with multiple products by offering advanced and customized systems in several niches that the are involved in.

Since the commencement of the 2003 expansion strategy, the growth of Tenova has been rapid; focusing on expansion of their technological expertise through acquiring of firms to improve existing technologies. Generally with these acquisitions Tenova has worked to preserve the company itself, while absorbing its knowledge and technology. This has proven to be a successful strategy for the company, allowing them to achieve their desire to be a technological (and sales) leader in their niche markets.

Regardless, it is important that the company not rely on acquisitions as the only way to grow technologically. Improving their own technology may be more cost efficient than simply buying companies that have good ideas.

It is also critical for management to effectively control any organizational structure complications. With an ever-growing number of business units, project management and fostering information sharing between units will become increasingly important yet difficult. As things become more and more complicated is may be necessary to further divide the company along additional function lines.

The Current Economic Crisis

Commodity Demand

The global economic slowdown has led to falling demand and prices for raw materials and commodities. From 2002 to 2007 steel production has grown approximately ten percent per annum, reaching approximately 1,350 million tons per year in 2007 and 2008. In 2009 it is expected that that number will fall by almost 15% to 1,150 tons per year in 2009 before it begins its recovery.

Equipment Demand

Steel manufacturers have managed the increased demand for steel by creating of additional capacity to produce. Over the past five years they have increased capacity by approximately ten percent per annum, mirroring demand for steel and maintaining production levels between 91% and 95% of capacity. In 2009 it is expected that the world's steel manufacturers will hit the ceiling for production capacity at just under 1,600 million tons per year, but production levels will be far lower at 74% of capacity. This lack of utilization of capacity is forecasted to lead to growth in capacity expansion being halted until 2013.

In booming economy of 2007 the steel industry invested $95 billion in capital expenditures, of which 75% was expansion of capacity and 25% was maintenance of current capacity. During this period Tenova's order intake value was approximately $2.2 billion, or 2.3% of all capital expenditures. In 2010 it is expected than capital expenditures will fall to $33 billion, with 39% going to expansion and 61% to maintenance. If Tenova maintains their current 2.3% share of capital expenditures it will result in an order intake of $0.759 billion, down by over 65% from 2007.

Company Position

Despite the inevitability that equipment demand will fall sharply for the next five years, Tenova is in a fairly strong position. Due to the current backlog of orders the company will be working for the next eighteen months, through what appears to be the worst of the economic crisis. The company has also built a large cash reserve of $409 million that give it the means to weather tough economic times, or take advantage of opportunities that may present themselves. Finallym Tenova's international presence gives them the ability to focus on markets that have not been as hard hit by the current economic conditions like India which may still be open to the possibility of growing their steel production capacity especially if they can do it at lower prices.

Tenova also believes that its multi-niche strategy creates an advantage over its competition, delaying its exposure to the crisis. This assumption is far from realistic. If a company benefits as a result of a prosperous economy, then it follows that it will be weaker during a dismal economy. While they have made changes that have benefited the company, some of their success should be attributed to the economy.

An Opportunity for Growth

It is expected that it will take until 2012 for steel's global demand to reach a level sufficient for steel production companies to justify investing in major capital expenditures. In the meantime, it is prudent for Tenova to invest their excess capital in related viable industries that will create long-term value for shareholders.

Short Term Return on Investment

When choosing an acquisition target, Tenova should find a company in an industry that will offer returns in the short term and long term. The steel industry is suffering, and is projected to continue suffering, an issue of overcapacity for the next several years. The mining industry however, does not generally suffer the same overcapacity problem. So when the economy recovers, mining companies will quickly be interested in expanding their production capacity again.

The mining industry's advantage in this respect is evidenced when we compare the compound annual grow rates (CAGR) that are expected through 2015 within the two industries. While the steel industry's CAGR is expected to retract by 3% per year, the mining industry is expecting growth of 14% per year. At these growth rates capital expenditures will be back to its 2008 levels of expenditures in the mining industry by 2015, while they will only be at 50% in the steel industry.

Diversification

Shifting a company into multiple business segments can very successful at reducing risk, because a downturn in one industry will not mean a complete erosion of cash flows in all business groups. Moreover, diversification is generally only successful when it extends a business into product lines where there are commonalities in buyers, channels, suppliers, or strong technological connections. Also, it is most likely to succeed when it extends into industries where the firm already competes.
The firm's past ventures into the mining industry have been relatively successful to date leading one to have confidence that further diversification into the sector can create additional value. This is not surprising, since their customers are similar and deal with each other. There are also strong technological similarities between the two industries, because when it comes down to it equipment manufacturing is equipment manufacturing.

Cost vs. Value of Acquisition

Things in the steel market will be difficult industry wide for several years. Consequently there may be apparent bargains, however that perceived value is eliminated when hardships are expected to continue. The right time to expand into more areas in the steel industry is when it is about to pick up again, and there is not any major growth forecasted through 2014. Buying a company now, and having it sit idle or at a low level of production will add to the real cost of an acquisition and is a less effective use of cash then leaving it in the bank earning interest.

The mining industry on the other hand is forecasting strong growth after 2010. This gives Tenova a year or two to select an acquisition target, and then iron out the details when the market conditions are ideal for acquiring mining equipment companies at the best value.

Complication and Experience

The mining industry is more complex than the steel industry. For that reason it is important that management take things slow and gradually work their way into the industry. The best way to accomplish this is to enter into segments, which Tenova has existing competencies, namely those that are adjacent to Pyromet and Takraf. In this way they can best leverage their experience and knowledge of this complicated industry.

Action Plan

Short Term

To ensure that Tenova's steel equipment division keeps working during the economic downturn and until steel companies start expanding capacity, they should continue to renegotiate contracts extending delivery time. Although this may reduce short-term profitability of the projects it will ensure that Tenova has work for its important employees, and will foster positive relationships with clients.

The many business units within Tenova's steel division will also need to improve efficency. They should expect less work coming in the upcoming years and may want to consider reducing their workforces. While the slowdown in orders may not be ideal, there can be some long-term benefits from developing a leaner more productive workforce.

Tenova should put a great deal of effort into selecting the right acquisition target within the mining industry. They should evaluate their options in the same way as they have with their acquisitions in the steel industry, looking for a company with a lot of technological know-how, with good people that can also provide knowledge and skills.

With the planned acquisitions, and possibility of continuing growth in the mining equipment industry, Tenova will need to consider restructuring its business organization. Right now the structure works well because, although they are into the mining equipment industry, they still have a larger stake in the steel equipment industry. As they become more balanced, the need to separate into two distinct divisions will become more apparent. Some functions should still be managed as one organization wide unit, some should be shifted down to the two business (steel and mining) area units, and some should remain with the local business units and offices.

Long Term

Continuing to acquire companies, both in mining and steel equipment, long-term is a good idea for Tenova. Being able to be a one-stop shop for clients, delivering a fully integrated system will allow them to derive maximum return per project. Consolidating their business in the steel industry and expanding product offerings are logical steps, and were it not for the projected state of the industry through to 2015 it would be the clear choice. As competencies in the mining equipment industry are developed, Tenova should also take advantage of opportunities to expand into other product lines.

Tenova needs to develop a system for information sharing between groups to deal with the large number of autonomous business units. The first step towards encouraging cooperation between units is bringing high-level managers and researchers from their various divisions for research and development conferences, as opposed to the current model, where information and technology is pushed down from upper management.

Position Statement

The Brown-Forman Corporation (BFC) has realized the necessity of segmentation between some of their brands of wine, however they have poorly executed any implementation of this realization. By dividing functions that could achieve strong synergies they have increased costs and caused duplication of effort. By not dividing their brands into proper segments they have not derived the greatest benefit from the flexibility that division of their brands can provide.

My recommendation is that BFC fold the wines currently being managed by Brown-Foreman's Wine Estates (WE) division back into the main Wine Division (WD). With all brands back under the same umbrella BFC can centralize tasks that are standard across all brands, and further decentralize tasks that can be best managed brand to brand. BFC needs to try to achieve the benefits of both a large streamlined company, while still getting the benefits of a smaller company. Breaking the company up the way it currently is hurts the company by causing duplication of effort and expense, and leads to underutilization of the expertise of top-level management.

Duplication of Effort and Expense

Running two separate entities requires that many tasks be done twice that result in higher costs. This is clearly illustrated in case exhibit 12, where WD and WE are already unnecessarily duplicating the functions of at least three departments (sales, finance, and pr/marketing).  Combining these functions could save money and allow the best managers within the two groups to be placed at the head of their divisions.

Sales Underoptimization

Off premises sales make up 78% of total sales volume in the wine industry, and has been the major focus of BFC's efforts. WD has built strong sales relationships with distributors through their Fetzer brand, which has benefited their other brands greatly. There is also a strong on-premises sales competency in WE that they acquired with the purchase of Sonor-Cutrer giving BFC a good opportunity to get the rest of their wines into restaurants, opening an additional 22% of the wine market. The combination of the competencies of the two sales units would give BFC a large amount of market influence and power.

Despite the fact that almost a quarter of wine sales happen on-premises none of BFC's top five wines, making up over 86% of it's portfolio, are effectively leveraging this market. Currently wine sales account for just less than 40% of BFC's $2.18 billion annual sales, or around $872 million. Even a 5% increase of on-premises sales would increase revenues $9.6 million.

Marketing Overlap

The major concern with marketing arises from the issue that if all wines in the BFC portfolio are marketed in the same way then the brands will begin to look more and more alike and this will lead to cannibalization of their own brands. While this is a valid concern, each brand marketing their own wines separately gives rise to the same issue (See Exhibit 2). What will add the most value to the corporation as a whole is a sophisticated and targeted marketing plan that will allow the various brands to cover the spectrum of the market, minimizing overlap.

Spreading out the brands to cover a broader spectrum of the market will prevent market cannibalization, which is important when 1% of the total market is worth $150 million. Putting that another way if WE introduced a brand that took away even 1% of Fetzer's sales it would cost the company as a whole  $3.14 million in sales. With the stakes so high it is easy to see why there is a preference to take market share away from competitors as opposed to their own brands.

Management has made an assumption that the only way (or at least the best way) to preserve separate brand identity and value perception is through the complete segregation of brands into essentially separate companies. Implicit in this is the assumption that the value created would be greater than any additional costs that would be incurred. I have to disagree with this assumption. An active and aware marketing department that will have a holistic view of the company and its brands can effectively segregate brands and maintain their value, delivering maximum return to BFC while minimizing costs.

Management Deficiencies

Combining the forces of WD and WE will allow the top specialized managers within BFC to steer the departments. As it currently is there are few high-level specialized managers at WE, and rather Steven Dorfman is the sole clear head of the organization effectively having control of things like finance, which he holds no special knowledge of.

A company as large as BFC needs the best mangers to make it successful. Spreading its talent over two groups is an underutilization of company resources. When BFC brings WD and WE back together they need to carefully evaluate who is the best and brightest of their current managers, who is an up-and-comer and should be groomed to lead the company in the future, and who is expendable and should have their position eliminated.

Economy of Scale

There is a clear economy of scale that can be created by BFC if it merges WD and WE through increased market power both with their suppliers (of glass, grapes, etc.) and buyers. They can also reap further efficiencies through access to larger financing options. This economy of scale opportunity can be taken even further by continued acquisitions of other vineyards and wineries. BFC should even consider (with its larger size) acquiring some companies that give it value added services like a wine bottle manufacturer.

This advantage that can be gained is apparent from the consolidation trend in the market with larger firms buying smaller companies and growing the company portfolio. BFC thinking it was a good idea to buck that trend and effectively divest a piece of its core business to itself is illogical, when the advantages it sought were attainable by far less drastic means.

Protecting Brands

As important as it is to save the company money and better utilize resources by centralizing some activities, it is equally important that the identity and unique characteristics of each brand be preserved. For this reason there are some activities that should be (or should continue to be) decentralized. For example even if a brand is pursuing a focused low-cost strategy (which is a corporate level marketing decision) then it is important the winery still produce a product of comparable quality to other products in the same segment, just at a better price. Both the quality of the wine, and how efficiently it is produced, are essentially up to the individual wineries.

In an industry like this there are very small switching costs for buyers (some information gathering and risk) so it is important to deliver a product as good as, or better than, what a consumer would expect for a particular price segment. After a consumer has developed a palate for a particular brand of wine their brand loyalty may increase and thus their propensity to switch will go down. As consumers continue to trade up from just wines to premium brands it is a good opportunity to capture them with a superior lower end product, with a goal of turning them into loyal customers.

Investment In Non-Value-Adding Activities

BFC needs to make a decision. Are they a sprits and wine company, or are they a consumer durables company? The two make very little sense together. There is no apparent synergy between the two units, and more value could be added to BFC by divesting their consumer durables segments and putting that money towards related industries.

Many companies make the assumption that diversifying an organization means engaging in business unrelated to the core industry, and BFC seems to have the same understanding. It is up to shareholders to diversify in the market where they see fit by owning multiple companies in different segments, while individual organizations should only 'diversify' when they can use one of their competencies to add value to that line of business. Usually this is best done through vertical integration, or horizontal integration into related industries (like wine and liquor). 

With $116 million in cash and cash equivalents sitting on the balance sheet, and the potential revenues from divesting consumer durables BFC should be able to make a move if any good acquisition deals arise. They could alternatively use the additional cash to pay down some of their current and long-term liabilities and thus reduce their debt load and interest expense.

Action Plan

BFC needs to take advantage of advantage of synergies that will be created by combining their two wine groups as outlined above. Since the groups have only been segregated for a short time, the sooner this combination can happen the better.

Short Term Divestitures and Acquisitions

The first thing BFC needs to start on is divesting their consumer durables division. This process could take a fair bit of time to find a suitable buyer at a fair price and overcome legal hurdles. The cash that will be raised through offloading the durables division will come in handy for acquisitions down the road. The board may be resistant to this idea at first as BFC has never before divested a division it had previously acquired, but this could be shown as a good way to raise capital for future expansion as opposed to selling off a piece of the company.

As cash becomes available from the sale of the consumer durables divisions it should be used to take advantage of any acquisition opportunities that become available. These opportunities should be actively sought, and care should be taken to consider which takeover candidates make the most sense in fitting into the overall marketing plan.

Short Term Restructuring

WD and WE should be combined as soon as possible, but there are a few key steps that must take place first.

The combined management team must be selected, and if any corporate reorganization is going to happen now is the time. I have proposed in exhibit 1 that some restructuring take place, most notably the reinstatement and promotion of the "Vice President of Winery Operations" position to senior management who will be tasked with supervising the day to day operations of the separate wineries and vineyards. I have suggested Steven Dorfman fill this position because of his previous experience in the area. It is important that this not be seen as a demotion back to his old job so a new title may be in order.

Also important in this combination is the centralization of tasks that can best be done as one large wine conglomerate, and the decentralization of activities that are best done at the grass roots level. This division needs to be clear to avoid any confusion as to what tasks each group is responsible for. Each of the brands will need a manager appointed specifically to run their day-to-day operations.
Once this structure is in place then the two groups should be brought in under the same umbrella. This will essentially be a paper change, but will involve eliminating some activities and positions to centralize staff in the corporate financing, sales, and marketing departments. The best and the brightest within the current organization should be kept and supplemented by hiring outside the company where needed, and any unneeded staff should be released.

Since these changes are essentially paper changes costs should be minimal. Layoffs from combining groups will result in an initial outlay of severance costs, but even in the short term should be more than recovered by decreased salary expense. There may be some lost productivity while the groups are being restructured, but if top management moves quickly these losses will be minimized.

Once merged the new WD should take full advantage of the advanced tracking system acquired with Sonoma-Cutrer. It should be implemented across all BFC's brands and used to drive sales into existing accounts, and help with expansion into new accounts. There will likely be a large fixed cost to get the system up and running for all the brands, but if managed properly this system could develop into a large competitive advantage within the organization.

Long Term

The main focus of the new BFC Wine Group conglomerate will be to slowly shift its brands so that the portfolio covers the spectrum of the market. This will take more work for some brands that will need to make larger changes to their image than others, but in the end it will make the entire portfolio stronger. There will likely be some overlap (especially with continued acquisition and expansion of brands) but that can be beneficial so long as the overlap does not lead to the brands cannibalizing each other directly and may actually lead to increased shelf space and some illusion of choice for the consumer.

Once the new combined sales group is in place they will have sufficient expertise to set their sights on expanding distribution of their brands. Their focus will be to push existing brands further, both internationally and into on-premises and off-premises sales markets. Getting brands into more markets will lessen the risk that falling demand in one area will eliminate demand for the brand entirely.

With the combination of the two above efforts a maximization of firm value from each of its brands will be achieved. The goal will be to span as much of the market (in terms of distribution) as possible with a brand, while targeting a particular value point. In this way each brand will target a particular segment of consumer and will reach the maximum amount of target consumers.

The newly forged larger divisions will also give a larger pool for the discovery of talented managers. The company needs to take advantage of this valuable resource and promote good managers from within. This will give the organization consistency in the long term. As long as divisions stay innovative and productive this should be a positive for the organization, but when groups lag behind top management and the board of directors shouldn't hesitate to hire from outside the organization.

Risks

While this change in strategy creates some temporary instability at BFC, benefits in the long term make this worthwhile. The longer the two groups are separated the harder it will be to bring them back in under the same umbrella. To get this plan accomplished board and management support will be necessary, and should be relativity unresisting so long as it is clear how the brands will be preserved as separate identities, not cheapening each other. Getting Steven Dorfman on side is essential, and will make the transition far easier.

As has been the concern throughout the past few years at BFC, there is some risk that the brands will begin to blend together degrading the image of some brands. So long as marketing is cognizant of this risk it should be minimal. If the board finds that any of the combined groups are failing to maintain the separated brands images then the board should consider looking outside the company to hire new management to bring in new ideas.

The Kao Corporation defines itself as a learning organization that uses a product division system for its international expansion. While this strategy seems to be extremely effective in its local markets of Japan and to a lesser extent South East Asia, it is an ineffective strategy to pierce the European and North American markets because of differing consumer tastes. International markets require a particular sensitivity to the local culture that cannot be learned with a ten-day stint at the company training facility, or even a two-year immersion in a foreign culture.

I propose that Kao's growth potential could be best served by executing their global strategy of 1990 to focus their research centers "to analyze local market needs and characteristics and integrate them into the product development process," and to move headquarters' business level functions to local markets in South East Asia, the US, and Europe. This is an export via sales subsidiary strategy. Great company synergies are possible internationally with resources allocation (leveraging resources), and product development and improvement (integrating activities), but concerning marketing, this strength is not as realistic.

Kao has developed its strategy over the company’s 100-year history, and while the strategy has evolved the same core elements of producing a high-quality product at an affordable price has not waivered. This seems like the most basic strategy in the world, but has failed to be implemented by company after company. Since the launch of their laundry detergent in 1940 Kao has made increasing efforts to grow into other markets, which it feels, it can apply its core competencies to.

The learning organization that Kao strives to continue to be is aided by its flat organizational structure which helps reduce redundancy and encourages information sharing. Examples of this can been seen within the organization through developments like Glycerin Ether; was developed as a joint project between three Kao labs. The systems that have been put in place to encourage communication among research departments, such as the monthly R&D conferences, have helped Kao to be an industry leader in innovation.

One of Kao's great successes, the Sofina product line, illustrates how their flat organizational structure and culture as a learning organization can be hugely successful. R&D worked together with marketing to change the perception of the local population that a high price equated high quality, and showed them instead that everyone can afford a superior product when it is fairly priced. This led to Sofina's 15.6% share in the growing cosmetics market, with their brands being at the top of every single product category with the exception of lipstick. Lots of Kao's products have had similar successes in Japan and to a lesser extent South East Asia, even when going up against internationally established competitors like Procter and Gamble, Unilever, and L'Oreal. So, why have they had such a difficult time moving into the US and European markets? Kao has been unable to sufficiently tailor their offerings to the West's differing consumer tastes.

The corporation's strategic development has been a slow evolution. This has served them well in their local markets, but has hampered them internationally. The decision to focus on expansion into highly diverse foreign markets is not a process that is easily achieved with a slow change in how the corporation thinks, but rather one that forces the corporation to drastically change their way of thinking. There should be little debate that Kao has failed to successfully expand into the international market successfully.  Only ten percent of the company's total sales are international, despite the fact that Japan had only 2.34% of the world's population in 1990 (Exhibit 1). While the opportunity for international expansion has been recognized, the company has failed to develop the core competencies necessary to gain a competitive advantage.

While the paperweight corporation works efficiently for a single market company it can be a hindrance when expanding beyond that market. To be successful internationally Kao must add a third level to its organization (Exhibit 2), delegating marketing tasks to business units specifically geared towards targeting the desired foreign markets (European, North American, and South East Asian). This strategy has effective in their most successful foreign market, South East Asia, where they have made strong inroads with several products. Long-term Kao should have its sights set on replicating the successes it has seen in Japan on the worldwide stage. It has taken Kao 25 years to have a substantial presence in South East Asia. With the experience Kao has earned in this venture, and other international projects thus far, realistically this could be a 20-year plan.

To achieve their goal Kao should continue to move business level tasks to offices in the target markets. This is not an overnight change, but a gradual process beginning with the planned shift of research centers and continuing through the other marketing functions until all business level functions have been moved to local offices, leaving the Japanese head office to focus on corporate level strategies and Japanese operations. Bartlett and Ghoshal would call this a coordinated federation internationalization strategy and in this particular case the following competitive advantages are possible by improving local responsiveness:

• Marketing departments can better conduct localized research into customer needs, wants, and expectations to aid R&D departments by giving them a greater understanding of how to tailor products to foreign markets
• Advertising techniques can be more effectively employed to show how products meet the different customer needs of the particular region

The company's head office should continue to place a strong emphasis on communication, coordination, and the sharing of information between the three business units, as no doubt there will be possible synergies, namely:

• Reaping scale advantages in procurement of any additional resource inputs needed, R&D of products, and production of those products
• Capitalizing on location advantages of the resource inputs currently owned by Kao, the research specialists that the company already has trained, and manufacturing their products in their existing facilities where labour is cheaper and they have existing facilities
• Achieving resource relocation of raw material that are owned and produced by Kao, money that they have from their current revenues, and knowledge in the many areas of expertise that they have developed
• Attaining resource replication of their communication methods, and expertise in R&D, production, and marketing

Shifting business level tasks will require a change in top-level managerial thinking. Senior management will not be as active in operational matters but focused on corporate level strategy and formal planning, which is not the current norm at Kao nor is it consistent with Japanese management culture. For this reason it may be preferable to bring in some professional managers to help with the international transition process.

As the foreign business units grow and develop, top level management should allow the units to develop individual structures, being cognizant of differing norms between Asian and Western cultures. In Europe and North America companies are more likely to be mechanistic with strong hierarchies, while Asian companies are generally more organic and clan like in form. These structures are not just the norm in these markets, but are what workers expect and are used to and may be the most effective in these markets.

Kao's major risk is financial; if one business unit fails and they continue to pour money into it could jeopardize the viability of the entire company. The level of risk taken on by this expansion will correlate closely with the speed it is rolled out at. Kao could chose to fast track corporate changes and move to an immediate shift of business level strategy responsibility to local market headquarters, but this could be excessively risky. That being said moving too slowly will allow other companies to strengthen their position in the markets that are being targeted. Kao must strike a balance by gradually increasing the responsibility of the individual business units so that once they are competent at one task they are working towards other tasks. In this way Kao can minimize risk while growing at a good pace.

Realistically this plan is one of balance between gaining the advantages of local responsiveness (an added cost) while maintaining the benefits of being part of the larger organization. Top-level management will need to refocus their attention from running the day-to-day operations of the company to shaping the overall corporate strategy. This shift will require a lot of time, money and effort, and likely at times painful decisions will need to be made, but if internationalization is what Kao wants to achieve then the changes that have been proposed are necessary.