Fiat Auto: The Italian Giant in Trouble - Essay Example

Answer to Question No. 3 Fabbrica Italiana Automobili Torino or FIAT was established in the year 1899, in Turin, Italy under the leadership of Giovianni Agnelli. At that time the workforce was easily available and market conditions and environment were favourable and the Company soon grew to become the largest corporate business in Italy and its fame spread throughout the world. From the beginning itself, the company focused on innovations and penetration into foreign markets. The importance given to innovations resulted in diversification and process continued through decades. Diversification is the process by which firms diversify their products or operation, administrative structure or managerial process or even their location for the purpose of growth and survival (Pearce, 1993). Most of the specialized firms are highly vulnerable to changes in the environment especially when these changes are fast and unforeseen by the firm. Under such circumstances, firms tend to diversify their products and diversification has been identified as a tool to tide over such situations towards the latter half of 20th century (Whittington and Mayer, 2000). It is considered as a device to minimize risk from any one investment (Goold, et. al., 1993). In the case of FIAT, the process of diversification started at the time of inception itself and it was the result of the keen interest they had given on innovations. Under the leadership of Giovianni Agnelli, the process went on smoothly and resulted in fast growth of the company for over 4 decades. A firm takes a decision to diversify under certain circumstances. These include lesser chance to increase profit in the present business, when expecting a high increase in shareholder value by diversification, when the resources and intangible assets could be easily transferred, and when the management is strong enough to consider an extension to new business. In the case of FIAT the management was strong enough until 1960’s to venture into new businesses and they expected an increase in shareholder value through diversification. Most of these new businesses involved similar products and therefore the resources could be easily transferred and could be used in all these ventures. The technology and marketing strategies were also similar and could be shared. There are two types of diversification, related and unrelated diversification. A diversification could be called as related diversification if it involves four factors (Winter, 1987). They are: 1. When new products similar to existing products are produced through the diversification process. 2. When the diversification is leading to vertical integration of all the activities of the firm. 3. When subsidiary firms, which produce similar products, are opened outside the home country. 4. When intangible assets are shared in the production. These assets might include marketing knowledge, technology that is patented, or a managerial process which is peculiar to the firm etc. In this condition the products of the diversification would be different and would sometimes be mistaken for unrelated diversification. In the case of FIAT up to about 60 years after its inception its diversification was related diversification since the company was making similar products and the intangible assets were shared and used for production. Even in countries were they started new business the products were similar. Related diversification itself consists of different levels based on the proportion of revenue in these ventures. These are (Lopez, 2002): 1. Non-diversification: This is the level in which although the firm has diversified its products, more than 80% of the revenue comes from the original single business. 2. Low diversification: Same as above but diversification is better than above. 3. Medium diversification: This is the level in which 70 to 80% of the revenue comes from the single business. 4. High-level diversification: In this level a single business do not account for more than 70% of the revenue. 5. Unrelated diversification: This is the case where the firms have invested in areas which is not related to it in terms of products or knowledge and only financial resources are shared. If more than 20% of the assets have been diversified to a foreign country it is called geographical diversification. The diversification into foreign countries is considered to be related diversification if the products are similar. The differences in managerial or administrative process as a result of change in culture of the foreign country are not considered. In the case of FIAT, the revenue share from small and sports car segments alone was 40%. Thus the level of diversification was very high. There was also geographical diversification during this period when the company began to give more focus on its business outside Italy. Based on the changes in the market or in the firms, diversification might vary over time. The firms might reassess their procedure depending upon the market conditions as well as conditions within the company and might go for either related or unrelated diversification. So diversification strategies could undergo change at any time (Lopez, 2002). In FIAT, a change in the whole process was initiated in 1966 when Gianni Agnelli took over charge as the chairman. He initiated American style of operation by firing some of efficient and highly experienced managers. He gave great emphasis to diversification and increased the process outside Italy by using his political and social influence. The situation continued until 1990’s and by that time 60% of the market share of Italy was with FIAT. In the process of diversification, planning is highly important and the top executives are to be highly competent in the process. They should have sufficient experience to foresee environment outside organization especially the forthcoming policies of the government. As the government of Italy initiated liberalization in 1980’s and allowed foreign companies to enter Italy, companies like General Motors, Ford and Toyota entered into the soil of Italy and poised huge competition for FIAT. The technological know how of these companies were far superior than FIAT and it struggled to stand in the competition. In FIAT, the new managers appointed by Gianni failed to foresee the effect of policy of liberalization on market conditions. They should have predicted that liberalization would allow entry of other companies and increase competition in the market. They could have given more focus on research and development section so as to improve technologies and design of the cars so as to face competition in open market. Diversification would be successful only if there is a synergistic effect between the management and the organization, or between the organization and the new products. That is, the two businesses should be able to complement each other and should be able to produce more profits than when they stand alone. The management has to carefully select the portfolios that would bring profit to the organization. The selected business should go along with the management style that exists in the firm (Goold et. al., 1993). Diversification could be successful only if the management is possible to add value to it. So the success depends on management and management style. The diversification process initiated by Gianni was against all these theories. In 1980’s to 2000 the company diversified its business into initiatives such as aviation, metallurgical products, publishing, telecommunications, insurance etc, where the company was not having any expertise. At this time if they would have concentrated on FIAT AUTO, they could have improved their technology and could have produced cars of better design and consumer appeal in the best quality possible and could have emerged as the best automobile company. The resources available were invested on new business and as a result profit was reduced considerably. This in turn resulted in production of cars with quality problems and the reputation of the company was lost in most of the countries were it was known for the best quality cars. The company share in the European car market reduced to less than 10% by 2000. When the competitors were trying hard with new innovations, price cuts and improvement of technology, FIAT did not concentrate on any of these aspects. When the competitors flooded the market with new models very often, FIAT could introduce only very less models at a given period of time. Instead of wasting the precious resources on publishing, insurance etc the company could have made more models of small cars and that would have seized the market. Thus it could be seen that the process of diversification in FIAT was related one until about 1960’s. The company had good growth as all the ventures produced similar products and all the tangible as well as intangible assets could be shared. But after 1980’s as the market were opened to competition and the profit of company reduced, the inefficient management at that time opted unrelated diversification for improving the financial status of the company which resulted in the failure of the original company. Answer to Question No. 4. Merger or acquisition of those firms that would help to increase the business of the original company is a related diversification and this is a strategic approach which would result in the growth of the company. Here problems due to lack of expertise do not exist and there would be better coordination of production is such a way as to regulate supply in terms of demand and thereby making the best use of resource as well as market, in maximising profits. However, merger or acquisition of firms that lead to unrelated diversification is a strategy with financial approach and is usually made to increase shareholder value. The process would spread risk to different businesses and is done when the profit expected from the present business is megre. Companies would go for such acquisitions when the potential and resources could be put in best use in a different business compared to the present business so as to make better profits. In order to succeed in this, it is necessary to keep correct timing in acquiring and shifting of resources and, if necessary, selling also. The price of acquisition should be well planned and negotiated in such a way that there is no hidden debts and there would be value for money invested (Strategy & Competitive Advantage in Diversified Companies , 2009). The dangers in the new field where the company lacks any expertise would be many and the success of such mergers depends on how easily these dangers are identified and managed efficiently. The management led by Gianni was a total failure in identifying changes in the technology and market. The acquisitions they made in 1990’s were without proper planning and resulted in increasing the debt of the company. Most of these mergers came under the category of unrelated diversification. The acquisitions were done at the time when these firms were having business at its peak and therefore FIAT had to spend huge amounts for acquiring that. After acquisition these firms failed to show the same vigour in performance and this resulted in complete loss. So the timing of acquisition, the negotiations for pricing etc were not proper. At least they could have sold such firms without wasting time to avoid further loss. If properly planned, the management could have done that and could have protected the mother firm. Some of firms like CASE were merged without even knowing the amount of debt in that firm. Such carelessness and lack of seriousness and planning was the result of highly inexperienced management and the fall of such a giant is purely because of the inefficient management. Some of the people who headed the organization during this period of crisis, like Fresco, did not have any experience in the Automobile field. The risk associated with an unsuccessful attempt of unrelated diversification or merger is very high. It would damage the original business because attention as well as resources would be diverted from that. This would result in poor management of original business and the diversified business resulting in total collapse of the firm. Therefore it is highly necessary to plan carefully before taking decisions for mergers under unrelated diversification. Studies conducted in a number of related and unrelated diversification revealed that most of the unrelated diversification has resulted in failure (Focus vs Diversification, 2009). In the case of FIAT, at the crucial time when the company should have concentrated on automobiles to improve technologies and to make different models (related diversification) the company took the wrong decision for mergers and acquisitions of firms that were not related to automobile industry. The poor management of the original business resulted in introduction of STILO, a car that failed completely in the market mainly because of lack of proper design and poor quality. This is the main reason behind the fall of FIAT. There are two factors, which determine the success of mergers and acquisitions. One is synergy. If it comes under unrelated diversification the possibility for synergy is very scarce. The second factor is the common core or unity. That is there should be common technology, common markets as well as common managerial as well as technological processes. In the case of unrelated diversification this unity would not be met in most cases and this is the reason attributed to its failure (Focus vs Diversification, 2009). In the case of the FIAT there was no common market or technology in its acquisition ventures that eventually resulted in failure. According to Trautwein (1990) the success of mergers or acquisition depends on its mode of entry, mode of acquisition and mode of integration. The motive for mergers should focus on data available, goals to be achieved and the process of decision. A merger undertaken without consideration of these facts is likely to fail. None of these aspects were given careful consideration by the inexperienced management of FIAT. Thus it could be seen that the failure of fiat was the result of its ventures into unrelated businesses without proper planning. Such mergers were made with poor planning in timing as well as pricing. The company did not know about the debts of some of the merged firms before merging. So it could not obtain expected profits from mergers. Moreover, merger initiatives were undertaken in a period when the company would have given more focus to its auto section. Lack of concentration in this section and increased competition in the market lead to failure of its products in the market which eventually resulted in the failure of FIAT. 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Oxford: Oxford University Press. Winter, S.G. (1987). ‘Knowledge and competence as strategic assets’. In: Teece, D. (ed). The competitive challenge: strategies for industrial renewal. Cambridge, Mass: Ballinger Publishing. Read More