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Strategic Alliance Development Factors

 

A strategic alliance is a link between two or more firms that enhances the effectiveness of the firms’ competitive strategies. More specifically, an alliance is a voluntary arrangement between two or more firms that involves the exchange, sharing, or codevelopment of products, technologies, or services. An alliance can be formed by firms located in similar or different positions in their respective industry-value chains. In alliances with scale and cost-sharing objectives, the partners often compete in similar markets and industries and have formed those alliances to achieve economies of scale or to reduce excess capacity. These alliances include joint R&D efforts, joint production of a particular component or subassembly, or the manufacture of an entire product.

Strategic Alliance Development Process
A strategic alliance development process should include a series of checkpoints that must be satisfied before the process moves forward. The process should be designed to ensure that key questions are posed and debated as the alliance moves through the formation process. The questions that should be addressed during strategic alliance development include:
• Are there clearly understood and agreed-upon objectives before alliance formation?
• How will the alliance be integrated with the parent firm’s strategy?
• Will there be cultural compatibility and organizational fit between the partners?
• Does the alliance leverage the complementary strengths of the partners?
• Will an exit strategy be defined upfront?
• Is there a monitoring process for new alliances?
• Have all the partnering risks been identified and accounted for?

Properly implemented, a systematic alliance development process will ensure that:
• Projects are strategic to the firm.
• Projects meet financial objectives.
• Projects move quickly through required corporate approval processes.
• Project risks and challenges are identified and understood by all parties involved in the alliance formation process.

Alliances are more than a price-driven, financial relationship shaped by contractual details. Three distinct elements distinguish alliances from other interfirm relationships:
1. The partner firms worry about themselves and their partners because they know that the success of the alliance depends on collaborative efforts.
2. The relationship involves the exchange of knowledge associated with technologies, skills, or products.
3. Trust plays a key role in the management of the alliance.

When alliance partners exchange knowledge, there is the risk that the knowledge could be used opportunistically by one of the partners. For example, when a major consumer products company entered China through a joint venture, they were surprised to discover that their partner had built a factory a few miles away making similar products and using product and packaging technology clearly appropriated from the joint venture. Although the joint-venture contract would have been replete with nondisclosure and noncompete clauses, theft of intellectual property still happened. This situation illustrates the reality of strategic alliances: a contract cannot predict all the potential competitive and organizational risks that an alliance creates. As a result, any firm going into an alliance must be prepared to deal with risk, which is why trust is so important. Trust is the decision to rely on another party (i.e., person, group, or firm) under a condition of risk.
In the absence of risk, trust is not necessary. Many contractual relationships between firms have minimal risk, which means the parties to the relationship have little reason to rely on trust. Strategic alliances, in contrast, are characterized by a complexity that ensures some level of risk and trust becomes a necessary element. Trust is critical in alliances because, invariably, it is impossible to write a contract that anticipates all of the possible contingencies. If it were possible to write an all-inclusive contract, trust would not be necessary and alliances would be simple to manage. Since neither is the case, we suggest that if managers seek to answer the question “Is my interfirm relationship a real alliance?” they ask a follow-up question: “Does trust play a role in the management of the relationship?” If the answer to the second question is no, the relationship is probably not an alliance and does not present the complexities and challenges of the relationships discussed in this chapter.

Types of Strategic Alliances
The term strategic alliance covers a broad array of possible interfirm relationships. The “classic” alliance is the equity joint venture, which is formed when two or more distinct firms (the parents) pool a portion of their resources in a separate jointly owned organization. In the case of two-partner joint ventures, the equity stakes may be equal or one partner may hold the majority. An equity joint venture could be formed via greenfield (i.e., new plant, new employees, etc.) or via a divisional merger whereby the parents contribute an existing division to the alliance. An example of a divisional merger was the one between Molson of Canada and Elders of Australia  . In this joint venture, both companies contributed their existing Canadian brewing operations to the joint venture.

Nonequity alliances involve no exchange of equity and no new company is formed. There are many variations on nonequity alliances, including: licensing and technology exchange, joint research and development, joint product development, and joint distribution or marketing. New forms of nonequity alliances are being created all the time. Unlike equity joint ventures, nonequity relationships are easier to form and dissolve, and they typically involve less complex corporate gover nance and partner management issues. On the negative side, nonequity relationships often suffer from unclear strategic objectives and a lack of equity signals that the alliance may be temporary. A fascinating example of the speed with which a nonequity alliance can be formed and accomplish its goal is the collaboration that occurred in 2003 to deal with SARS. With oversight from the World Health Organization, laboratories from three continents that normally compete with each other instead worked in a joint effort to discover the identity and genetic code for the disease. The effort took only about two months, an unprecedented development in medical history.

The third category of strategic alliance is the minority equity alliance. The Nissan Renault arrangement mentioned earlier is an example of a minority equity alliance. In this alliance one parent makes a minority investment in the other, and under this umbrella a variety of deals are made. Minority equity alliances are used quite frequently in industries with high technological uncertainty, such as telecommunications, software, and biotechnology. In these instances a minority equity alliance can be a hedge, in that the larger firm may have an option to later purchase a majority equity stake in its smaller partner. Minority equity alliances are also used when there are government restrictions on full acquisition. Such restrictions exist in many industries and in many countries. In the United States, for example, there are restrictions on foreign ownership of airline companies and television stations.

Alliances may also incorporate various structural elements. Global One is an example of a complex alliance that combined minority equity investment and an equity joint venture. Global One was an alliance among Deutsche Telekom, France Telecom, and Sprint, formed in 1994 (operations began in 1995) and terminated in 2000. The structure of the alliance is shown in figure 4.1. France Telecom and Deutsche Telekom held a 10 percent stake in Sprint and each owned 50 percent of Atlas, the joint venture of the two companies formed prior to the formation of Global One. Atlas held a two-thirds ownership interest in the European operating unit of Global One and Sprint held a one-third interest. France Telecom and Deutsche Telekom, through Atlas, held a 50 percent ownership interest in the Global One World operating unit; Sprint held the remaining 50 percent. The alliance was troubled from the beginning, with financial difficulties and conflicts between the partners. When the alliance was terminated, France Telecom took over Global One.

Why Companies Use Strategic Alliances
The last two decades have witnessed a proliferation of international strategic alliances. There are multiple reasons firms choose to use strategic alliances; indeed, it is unusual for an alliance to be formed for a single strategic reason. More likely, a combination of the following reasons leads to an alliance.

Speed of Action
Alliances can help firms react swiftly to market needs and build leadership positions quickly. In many international-market entry situations, a wholly owned subsidiary may be legally possible. However, the time it would take to create the subsidiary may simply be too long. In China, which has seen several hundred thousand joint ventures over the past 20 years, it is possible in most industries to form a wholly owned subsidiary. However, the complexity of doing business in China has led most firms down the alliance path, deciding that entering China on their own will take too much time. Wholly owned subsidiaries in China may have difficulty winning contracts, getting licenses, and building local relationships.   Alliances also play a key role in time-to-market decisions and in allowing firms to quickly access new technology.

Risk Sharing
Many international business decisions entail significant risks, and these risks are often viewed as unacceptable for any one firm to bear on its own. The oil and gas industry has been using alliances in the upstream exploration area for risk-sharing purposes since its inception. In this industry, the financial stakes are enormous and the regional geopolitical environment in which oil and gas exploration occurs is complex. For example, the Sah-Daniz Production Sharing Agreement in the Caspian Sea in Azerbaijan includes seven partners: BP (operator–25.5%), Statoil (25.5%), the State Oil Company of Azerbaijan Republic (Socar–10%), LUKAgip (10%), NICO (10%), TotalFinaElf (10%), and TPAO (9%). This partnership was formed in early 2003 to begin the first stage of development. Risk sharing is also a large concern in other areas, such as R&D, pre-competitive standard-setting activities (such as the next-generation mobile telephony standard), and where there are large uncertainties with new markets and new technologies. In all these cases firms may prefer an alliance to going it alone.

Economies of Scale and Critical Mass
A third and quite straightforward reason to use an alliance is to create economies of scale in a way that broadens scale without broadening the firm itself. For instance, small firms may seek to match the economies of scale achieved by their larger competitors. The benefits could come from manufacturing, distribution, purchasing, or some other value-chain activity. The small firms may participate in networks that create scale to achieve common objectives such as buying power or coordinated foreign market entry. The ease of communication created by the Internet has greatly facilitated creation of networks designed to jointly perform common tasks.

Learning New Skills
In bringing together firms with different skills and knowledge bases, alliances create unique learning opportunities for the partner firms.  By definition, alliances involve a sharing of resources. In some cases, the shared resources are strictly financial, limiting partner learning opportunities. In other cases where the firms contribute complementary skills, alliances create an opportunity for firms to access the knowledge of their partners—new knowledge that, in most cases, would not have been available without the alliance. Partner firms that use this access as the basis for learning can acquire knowledge useful for enhancing partner strategy and operations. In chapter 9 we discuss learning and knowledge management in more detail. But as an example of alliance learning here, consider the following statement about interfirm relationships by John Browne, CEO of BP: “Any organization that thinks it does everything the best and need not learn from others is incredibly arrogant and foolish. . . . You have to recognize that others may actually know more than you do about something—that you can learn from them.”

Exploration
Alliances can be the basis for exploring new business opportunities. Firms may be interested in new businesses or markets that have already been developed by other firms. An alliance with a first-mover firm can provide the opportunity to learn about the new business. Also, an alliance may be formed to learn about the partner firm, perhaps as a precursor to a deeper relationship or an acquisition. An alliance may also be used to help in the sale of a business. If a business does not have an easily determined market value, a firm may agree to a partnership with a potential buyer as the basis for setting the market value. Finally, an alliance may be used to learn more about a competitor or even as the basis for coopting a competitor to become an ally.

No Choice
This final reason for the formation of an alliance is not really strategic. “No choice” means that a company is forced to use an alliance for of one of the following reasons: (a) government requirements that foreign direct investment can be made only with a local partner involved; (b) the new market is too complex or difficult for a firm to enter on its own; or (c) not forming an alliance puts the firm in an indefensible competitive position. Although joint-venture requirements have disappeared in many countries, they still exist in certain markets and industries. When GM entered the Chinese automobile industry in the mid-1990s, the Chinese government required a joint venture, regardless of GM’s preferred entry mode.

 

Why the Number of International Alliances Continues to Increase

The reasons provided above explain why firms choose to use strategic alliances. On a worldwide basis, the use of alliances continues to grow each year. There are various explanations for this rising trend in the number of alliances:
• Deregulation. Many countries continue to deregulate industries and invite foreign competition, often in the form of alliances.
• Strengthening of intellectual property laws. In the past firms have been reluctant to enter new markets in industries such as pharmaceuticals and biotechnology for alliances because of fear of losing intellectual property (IP) to partners. In various countries, the strengthening of IP laws has alleviated that fear, increasing the willingness of foreign firms to collaborate.
• Globalization. The continuing spread of global ideas, concepts, and competition creates ever increasing pressure on firms to globalize; alliances are a fast-response competitive weapon.
• Innovation in alliance design. New types of alliances are constantly being invented, thus increasing the range of strategic choices that firms have for forming alliances.
• Strategic importance of speed. Speed and time to market continue to mandate the need for fast competitive response.
• Increased skills in alliance management and alliance exit. Relative to a decade ago, firms are, on average, much more sophisticated in alliance management (both entry and exit). As opposed to the ad hoc approaches that used to characterize alliance management, many firms have learned, often from bitter experience, that alliances cannot succeed without effective alliance management processes.
• Easier communication across long distances. The Internet has greatly simplified the ability of firms to communicate with distant international alliance partners.
• Unbundling of the value chain or “skeleton companies with brains.” As firms continue to focus on core activities, alliances play a key role in allowing them to participate in noncore activities without a wholesale exit from these activities.

Competitive Risks and Problems with Alliances
The reasons for using alliances must be weighed against some potential costs and risks. Although every business involves risks associated with new entrants, demand and supply fluctuations, changing government regulations, and so on, there are several key sources of risk in these alliances. The risk most often considered is that of partner-opportunistic actions. The risk of partner-opportunistic behavior plays a pivotal role in all alliances, not because all economic agents behave opportunistically all the time but because it is difficult to differentiate those that do from those that don’t. The risk of opportunism refers to the extent of loss incurred by Partner B if Partner A behaves opportunistically. Opportunistic behavior could result from exposing valuable firm knowledge to another organization. Alliances, and more specifically technology licensing agreements, have been blamed as one of the reasons that the United States lost out to Japan in the electronics and various other industries. Given that knowledge sharing is one of the elements of a true alliance, the risks of sharing this knowledge must be acknowledged.

A second type of risk involves the inability of a partner firm to execute its share of the agreement. When an alliance is formed, the partners must assess each other’s competence and decide how tasks will be performed. Before the partners have worked together, they have little information about each other’s skills. So if one firm leads the other to believe it can perform certain tasks when it cannot, it may be impossible to achieve the objectives of the alliance.

A third type of risk, asset specificity, is associated with the specific resources and efforts devoted to building a cooperative relationship. These resources and efforts may have no transferable value if the alliance is terminated. A fourth risk is that of a zero-sum game. Although this chapter is based on the objective of creating mutual value (i.e., both partners realize benefits from the alliance), one view is that alliances can become a learning race, with the partner that learns faster becoming the winner.8

Although we believe this phenomenon is relatively uncommon, zero-sum outcomes do occur and often lead to painful alliance dissolutions. In addition, the firm that gains a reputation for “starting and winning alliance learning races” will find a shrinking pool of potential alliance partners.
Finally, one of the most important costs, particularly for firms that are not experienced with alliances, is the volume of management time required. In many cases, this time is disproportionate to the size and importance of the alliance, leading some analysts to suggest that alliances should be used only for peripheral activities. Although we disagree and believe that proper alliances can yield significant benefits, we acknowledge that they often involve significant coordination costs. The various stages of an alliance, from negotiation to implementation to dissolution, can take a lot of managerial time. The case study that follows illustrates the life cycle of an alliance and the collaborative issues that consume managerial energy.

Unavoidable Issues with Alliances
From the discussion of alliance risks, we suggest that there are several issues that are unavoidable when it comes to alliance management:
• Alliances involve uncertainty and ambiguity. This uncertainty and ambiguity add to the managerial challenge and are one of the main reasons alliances involve significant coordination costs.
• The partner relationship will evolve in ways that are hard to predict. Alliances are formed for strategic reasons and as strategies and competitive environments evolve, so must alliances.
• Alliances remain vulnerable to many types of destabilizing factors regardless of the strategic logic underpinning their formation.
• Today’s ally may be tomorrow’s rival. As one article said, “Successful companies never forget that their new partners may be out to disarm them.”
• The partners will eventually go their separate ways. All alliances eventually will end, which means firms must be realistic in considering alliance longevity.

Avoidable Issues with Alliances
Apart from the unavoidable issues, there are two additional issues or risks that can be circumvented:
• Alliances do not have to be very difficult and expensive to manage. Alliances can involve significant managerial time, especially when a firm has little experience in managing alliances or when the prior experience between the partners is limited. However, the last decade has seen growing competencies in alliance management. As firms gain experience with alliances and build effective control systems, these partnerships do not have to be viewed as expensive and difficult to manage.
• Core competencies will not necessarily be appropriated by your partner— that is, “sleeping with the enemy.” As we have acknowledged, alliances do create competitive risks and there are enough cases of knowledge theft to suggest that companies must be aware of these risks. Fortunately, a firm can take a few easy steps to protect intellectual property in strategic alliances.

 

Partner Selection Criteria and Managing the Alliance Relationship

Partner selection is one of the most important decisions in the formation of a strategic alliance. Choosing the wrong partner can result in years of interfirm conflict and failure to achieve alliance objectives. In some cases, a firm may have only one candidate. For example, when GM entered the China market in the 1990s, the partner had already been selected by the Chinese government. GM competed with Ford and won the right to form a joint venture with Shanghai Automotive Industry Corporation. GM did not get to choose its partner; its only choice was whether or not to bid for the project. In most cases, firms choose their alliance partners from several possible partners.

In partner selection, there are two key considerations: strategic fit and organizational fit. Few managers would question the importance of strategic fit; indeed, strategic fit is typically the focus of most analysis. Alliances are formed for strategic reasons and, therefore, firms seek a partner that helps accomplish those strategic objectives. An analysis of strategic fit addresses questions such as “What are our competency gaps?” and “What are the options for filling these gaps—alliances, acquisitions, or internal greenfield development?” If it is determined that an alliance is the appropriate choice, a partner must then be found that has the complementary skills. There may be many such partners; there may be only one; or there may be none. Regardless of how many potential partners are identified, strategic fit requires that the partner selected help accomplish the strategic objectives.

Further, finding good strategic fit is necessary but not sufficient for success.
The partners must also be able to work together and achieve a strong organizational fit. Together, strategic fit and organizational fit represent the focus of partner-selection decisions. Ignoring organizational fit in favor of strategic fit can lead to serious implementation problems. The organizational fit is crucial because, as John Browne of BP argued, you never build a relationship between your organization and a company or a government—you build relationships between people. Many alliances fail in implementation because the people working together make or break the deal, and many organizations wait until after the deal is struck to address such organizational issues.

Alliance Management and Design
In considering alliance design and management structure, the prospective partners should, quite obviously, try to create an entity that allows them to achieve their collaborative goals. One key issue is how the alliance will be controlled.
Control refers to the process by which the partners are involved in the decision making and the extent to which they have active roles in the strategy and operation of the alliance. In some cases, a partner may play a limited role because it lacks relevant managerial skills or knowledge. In many international joint ventures, local partners provide the access and government connections but act as silent partners when it comes to day-to-day operations. In other cases, all the partners play meaningful managerial roles. In an independent venture (a relatively rare phenomenon), the alliance operates autonomously from its parents.

Many firms believe that they should not enter the alliance unless they get control. What these firms often fail to understand is that there are different levels of control. At one level, there is strategic control, which refers to the ability of the partners to control the strategy of the alliance, shaped primarily through the alliance’s board of directors. At a different level, there is operational control, which involves control over the actual operation and functioning of the alliance. For operational control, the key question is whether one of the partners has been designated as operator. In most oil and gas alliances involving exploration, one of the partners is the designated operator and the other partners will have agreed to this arrangement. Other operational control questions are concerned with who controls the technical processes and who controls market access. A third level of control, applicable only to equity-based alliances, involves equity ownership. Specifically, how will the equity be divided? One school of thought says that equal ownership is preferable because it forces the partners to agree, since none of the partners can outvote the others.

Another view is that majority ownership is the best option because majority ownership means control. Our view is that majority ownership in an equity joint venture provides some control but should never be the sole lever of control. Control can be exercised in various ways beside equity stake, such as managerial selection, contribution of key technologies, and responsibility for key alliance tasks. We have observed numerous cases in which the majority owner was frustrated by an inability to influence certain aspects of the alliance.
Given the different types of control possible, there are several questions that firms should consider as they design their alliances and plan for alliance management and operation:
• What elements of the alliance are most important to its success (e.g., market access, technology, financing)?
• Of these key elements, is one of the partners better suited to have control? Or should control be shared?
• What are the most powerful levers of control and which partner has them?
• In the event that the partners wish to share control, can a sharedmanagement alliance succeed?
• If one of the partners is designated as operator, what role do the other firms play as nonoperators?
• How will an operator handle a nonoperator that tries to be a hands-on partner (i.e., “you operate or we operate” does not work as expected)?
• How will the firms control and protect their technology?

The following is a list of possible areas of partner conflict in an equity joint venture:
• Dividends
• Exports
• Financing of venture alliance expansion
• Transfer pricing for products supplied by the partners
• Choice of suppliers
• Divestments
• Role of each parent
• Product pricing
• Growth versus return on investment (ROI) for the alliance
• Criteria and evaluation of management
• Selection of alliance managers
In addition, various other things can go wrong. Trust can break down, strategies can change, alliance champions may leave, collaborative value may not materialize as expected, the cultures of the partners may not mesh, their systems may not be effectively integrated, and so on. In short, the potential for alliance problems will always be high.

Key Planning Issues for the Success of an Alliance

Mutual Value Creation
• Have both short- and long-term collaborative objectives been clearly established? Will an alliance help you achieve those objectives?
• Will the alliance negotiation be focused on joint economic success and mutual value creation or will it lead to a one-sided outcome?
• What will happen if an agreement cannot be reached in your alliance negotiations?
Besides an alliance, what are your options for achieving strategic objectives?

Initial Partner Knowledge
• What do you really know about your partner and your ability to work together? What are the partner’s strengths and weaknesses? How much experience and success does the firm have with alliances?
• Has your prior experience with the potential partner created a strong level of interfirm trust? Can that trust play a key role in current negotiations and will the individual managers who built the trust be involved in the planned alliance?
• Is your partner a competitor or likely to become a competitor at some point in the future? What role will your firm’s knowledge play in determining whether or not your partner becomes a competitor?

Risk
• How much risk are you willing to bear? What are the implications if the alliance is terminated and the business is sold to your partner?

Essential Terms
• Have you clearly determined the issues that are nonnegotiable? Are you willing to compromise on these issues in the case of unique collaborative opportunities?

Individuals’ Roles
• Do you know the role that your counterpart negotiators will play in the future alliance?
• Will these individuals be the managers you have to work with when the alliance is formed? Or will a new set of managers be assigned to operational roles?
• Do your counterpart negotiators have personal incentives associated with a successful alliance negotiation?
• Will operational managers be involved in the negotiations? Have these managers initiated the potential alliance?
• What will the alliance top management team look like? Will your partner have any objections to your choice of managers? Based on the relationship between partner and the competitive environment the alliance faces, what skills should the alliance managers have?

Alliance Governance and Trust
• Do both parties understand that successful alliances will undergo a series of transitions as the partners learn more about each other and competitive dynamics shift?
• Do venture partners recognize that the alliance negotiation is a means to an end? No matter how well the alliance is negotiated, issues of organizational fit and implementation will be critical in contributing to alliance success.

Alliance Governance and Trust
• Do all partners understand the importance of flexibility in the negotiation process and the contractual agreement?

Cross-Cultural Issues
• Are the managers who will be involved in the negotiation and venture management familiar with the national culture of the partner? If not, are there other internal or external advisors who can be consulted?
• Is your partner skilled in cross-cultural management?

Flexibility and Review
• Is review time built into the alliance formation and negotiation plan

When properly managed, alliances create the foundation for global opportunities that may be difficult or impossible to exploit independently.

 

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