Strategic Alliance

Restructuring
Strategies
 Background
• Joint venture is a separate business entity
– Participants continue as separate firms
– May be organized as partnership, corporation,
or any other form of business
– Formal long-term contract of 8 to 12 years
duration
• Characteristics of joint ventures
– Limited scope and duration
– Generally involve only two firms
– Involve only small fraction of participants' total
activities
– Each participant offers something of value
– Joint production of single products
– No sharing of assets/information beyond
venture
– Need not affect competitive relationships
– Joint property interest in subject matter of
venture
– Right of mutual control or management of
enterprise
– Right to share in cash flows of the enterprise
– Limited risk
• Timing similar to merger and acquisition
activity
– Correlation between mergers and joint venture
start-ups over 0.95
– Both stimulated by same factors affecting total
investment activity
 Joint Ventures in Business Strategy

• Goals/objectives of joint ventures

– Risk sharing
• Each participant diversifies risk
• Reduces investment cost of entering risky new area
• Realizes benefits of economies of scale, critical
mass, learning curve effects sooner
– Knowledge acquisition — learning experience
for both partners
• Shared technology
• Shared managerial skills in organization, planning,
and control
• Successive integration — joint venturing as a way to
learn about prospective merger partners
– Entry into new, expanded, foreign markets
• Augments financial or technical capabilities
• Reduces risk
• Foreign country may require joint venture with local
partner
– Financing — to raise capital
• Share investment expense
• Small company has product idea but no cash
• Joint venture with large company that has cash to
develop product
– Distribution/marketing
• To obtain distribution channels
• To obtain raw materials supply
– More favorable tax/political treatment
• Foreign ventures
• Antitrust issues — joint ventures increase rather
than reduce number of firms
– Long-run strategic planning — spider's web
strategy
• Provide countervailing power among rivals
• Small firms in a concentrated industry do multiple
joint ventures with dominant firms to form self-
protective networks
• Joint ventures and complex learning
– Goal of at least 50% of joint ventures is
knowledge acquisition
– Complex knowledge, embedded within
technological/organizational systems
– Learning-by-doing, teaching-by-doing to transfer
complex knowledge
• Classroom setting inappropriate
• May require successive adaptations to changing
circumstances
• Job incumbents may be able to teach task skills only in
operational setting
• Tax aspects of joint ventures
– Contribution of a patent or licensable technology
to a joint venture may have better tax
consequences than a licensing arrangement with
royalties
– Examples:
• One partner contributes technology
• Other partner contributes depreciable assets
• Depreciation offsets revenues
• Joint venture ends up with lower tax rate than any of its
partners
• Partners pay deferred capital gains if/when venture is
terminated
– Other tax aspects
• Limitation on operating loss carryovers
• Partnership status of unincorporated commercial
joint ventures
• Use of equity method in consolidating joint venture
into partners' financial statements
• Benefit of multiple surtax exemptions
• Joint ventures and hazardous industries
– High risk of worker, product, environmental
liability
– If joint venture is organized as a corporation,
only the joint venture's assets are at risk, not
those of participating firms
• Joint ventures and restructuring
– Joint ventures can be used as transitional
mechanism in a broad restructuring process
• Buyer can use joint venture experience to better
determine value of seller's brands, distribution
systems, and personnel
• Risk of making mistakes is reduced through direct
involvement with business
– Advantages — Nanda and Williamson (1995)
• Customers are moved to buyer over a period of time in
which both seller and buyer continue to be involved
• Buyer builds experience with new line of business
• Buyer receives managerial and technical advice and
assistance from seller during transition period
• Experience and knowledge developed during life of joint
venture enable buyer to obtain better understanding of the
value of acquisition
• Seller is able to realize higher value from sale than it could
have under immediate, outright sale when buyer must
necessarily discount purchase price because of lack of
knowledge about assets being purchased
• International joint ventures
– Widely used
– Reduce risks of expanding into foreign
environments
– May be legal requirement of local joint venturer
in some foreign countries
– Local partner's contribution likely to be in the
form of specialized knowledge about local
conditions
– Subject to clashes of different cultures
 Rationale for Joint Ventures

• Transaction cost theory of the firm — why

joint ventures over other contractual
arrangements
– Transaction costs
• Involved in all exchanges and organizing activities
• Affect allocation of resources
– Complementary production
• Joint use of assets or inputs to produce outputs which
cannot be attributed to any single input
• Synergy — output is more than sum of inputs
• Complementary asset defined as one whose value in
production process depends upon combination with
other assets/technology
• Problem arises when complementary assets have
different owners
– Specialization
• Asset's productivity increases with its specialization
to other inputs used in production
• Specialization increases risk of loss to owner of
complementary asset if other inputs are withdrawn
• Nonrecoverable portion of investment cost of
complementary asset lost if other inputs withdrawn
• Owners of other inputs can expropriate owner of
complementary asset by taking greater share of
output
– Leads to pre-investment arrangements to promote
confidence in joint use of assets
• Choose transaction-cost-minimizing form of pre-
investment arrangements
• The greater the transaction costs relative to output
value, the more critical the search for economizing
organizational form
– Contractual arrangements
• Costly to write and enforce
• Repetitive transactions would require repetitive
contracting
– Joint ownership
• More likely with greater frequency of exchange of
inputs
• Frequency of transaction improves prospects of
recovering investment cost of specialized asset
• Joint ventures more appropriate than merger
where:
– Complementary production involves only small subset of
each participant's assets
– Complementary assets have limited service life
– Complementary production has limited life
• Reasons for failure
– Inflexibility problems similar to other long-term
contracts
– Implementation requires substantial commitments
of managerial resources
– Joint ventures do not last as long as planned
• About 70% are disbanded before scheduled maturity
• On average they do not last as long as one-half the term
of years stated in agreement
– Reasons for disbanding joint ventures
• Inadequate preplanning
• Technology did not develop as expected
• Disagreement between parties on approaches to joint
venture objectives
• Refusal to share knowledge with counterparts in
venture — firms wants to learn as much as possible
but not to convey too much
• Inability of parent companies to share control or
compromise on difficult issues
– Public policy concerns — conflict with firms'
long-term strategies
Joint Ventures and Antitrust Policy

• Often subject to regulatory scrutiny

• Court actions brought under:
– Clayton Act — for real or potential
anticompetitive effects
– Sherman Act — for cartel behavior, boycotts,
exclusion of competitors
• Main objections raised in legal actions
– Threat of industrywide collusion
– Loss of potential competition
– Restraints on distribution
• Industry characteristics that make collusion
difficult
– Heterogeneous products
– Inequality of costs
– Rapid and unstable changes in demand, supply,
and technology
– Ease of entry and expansion
– Dissimilarity in firm strategies and policies
– Many firms
– High price elasticity of demand
– Substitutability among products on demand side
– Likelihood of additions to supply of products by
other firms if one firm restricted supply
– Difficulties in enforcing collusion; high risk and
cost of being detected
 Outsourcing

• Involves use of subcontractor, supplier, or

outside firm to perform some percentage of
total production of product
• Has grown substantially during first half of 1990s
• Reduced manufacturing cost by 10 - 15%
• Represents a different form of arm's-length
alliances similar to joint ventures
• Advantages
– Facilitates rapid growth
– Avoids need to build required competencies
within company
– Modern version of use of division of labor to
increase efficiency
– Reduces costs
• Limitations
– Personnel to monitor outsourcing activities
– Firms may produce components at cost lower
than outside suppliers as they become more
experienced
– Firms may change outsourcing needs as their
strategies change with experience
– Firms may limit number of outsourcing firms
used in order to improve communication, and
retain competition among suppliers
– Firms may not control product quality
– Resistance from trade unions
– Flexibility and speed needed for building to
order may be found only by producing within the
company
– Firms may use their own resources more
efficiently
 Empirical Tests of the Role of Joint
Ventures

• Business and economic patterns — (Berg,

Duncan, and Friedman, 1982)
– Industry joint venture participation increases
with:
• Average firm size - only pervasive influence across all
industries
• Average capital expenditures
• Average profitability
– Technologically oriented joint ventures
• Joint venture participation rises with average R&D
intensity
• Joint ventures substitute for R&D in chemicals and
engineering industries, but not in resource-based
industries
• Long-term R&D substitution effect stronger than
short-term effect
• Significant negative impact on large firms' rates of
return in chemicals and engineering in short run,
although long-run effect on rate of return not
significant
– Industry level — technological and
nonhorizontal joint ventures
• Strong positive effects on R&D intensity — joint
ventures and R&D are complements at industry
level
• Joint ventures have significant negative effect on
industry average rates of return
• Event returns — McConnell and Nantell
(1985)
– 1972-1979; 136 joint ventures by 210
companies
– Average size = $5 million
– Two-day announcement period abnormal
return of 0.73% (significant)
– CAR over 62-day period up to announcement
day was 2.15% (significant)
– Relative size effect
• Dollar gains to large and small firms about evenly
divided — as in mergers
• Percentage gains higher for smaller firms
– Dollar gains scaled by amount invested in joint
venture
• Average premium is 23%
• Result lies in range of merger/tender offer premiums
– Gains from takeovers could be from synergy or
improved management; since joint ventures
involve no management change, gains must be
from synergy
 Strategic Alliances
• Informal or formal decisions or agreements to
cooperate in some form of relationship
between two or more firms
– Created out of uncertainty and ambiguity in
nature of industries
• Rapid advances in technology
• Globalization of markets
• Deregulation
 • Intensity of competition
• Reorganizations of capabilities, resources, and
product-market activities
• Blurring of industry boundaries
• Shortened product life cycle
• Altered value chains
– Represent forms of relationships that are
uncertain and ambiguous
• Characteristics of strategic alliances
– Need not create new entity
– Contract need not be specified
– Relative size may be highly unequal
– Less clear contributions and benefits
– Difficult to anticipate consequences
– Allow firms to focus on fewer core
competencies
– Often small resource commitments
– Limited time duration
– May involve relations with competitors and
complementor firms
– Synergistic value creation from combining
different resources
– Learning and internalizing new knowledge and
capabilities
– Can add more value to partnering firms by
creating organizational mechanism that better
aligns decision authority with decision
knowledge
– Can add value to partnering firms through
organizational flexibility
– Partner firms pool resources and expertise rather
than transfer specialized knowledge
– Managed actively by senior executives
– Evolving relationships
– Adaptability and change required over time
– Deliberate efforts to change direction of at least
one partner
– Blur corporate boundaries
– Can have multiple partners
– Require mutual trust
– Speed of change is increased
– Move to other alliances as attractive possibilities
emerge
– Access to people who would not work directly for
them
• Inter-firm alliances and M&As - (Hagedorn and
Sadowski, 1999)
– Sample of over 6,000 strategic technology alliances
and 16,000 M&As by the same group of nearly
3,000 firms
– Only 2.6% of alliances lead to M&A between same
partners
– Strategic alliances represent a form of exploratory
learning
• Inconsistent with encroachment hypothesis
• Encroachment hypothesis — larger firms use strategic
alliances to take over their smaller partners
– High technology industries and strategic
alliances
• Scan market-entry possibilities
• Monitor new technological developments
• Reduce risks and costs of developing new products
and processes
– M&As more likely as industries mature —
learning and flexibility become less important
• Success or failure of strategic alliances —
(Bleeke and Ernst, 1995)
– Collisions between competitors
• Involve core businesses of two strong, direct
competitors
• Alliances are short lived and fail to achieve goals
because of competitive tensions
– Alliances of the weak
• Two weak companies join forces hoping to improve
• Alliances fail because weak grow weaker
– Disguised sales
• Weak company joins with strong competitor
• Alliance is short lived and weak is acquired by strong
firm
– Bootstrap alliances
• Weak company may be improved so that
partnership develops into alliance of equals
• May succeed in meeting initial objectives and
exceed seven year average life span for alliances, but
one partner ultimately sells out to other
– Evolutions to sale
• Two strong and initially compatible partners initiate
alliance, but competitive tensions develop
• Outcome similar to bootstrap alliances
– Alliances of complementary equals
• Complementarity and compatibility lead to mutually
beneficial relationships
• Likely to last more than average seven year life span
of alliances
• Event returns — (Chan, Kensinger, Keown,
and Martin, 1997)
– Sample of 345 strategic alliances during 1983-
1992
– Positive and significant abnormal returns of
0.64% on announcement date
– Magnitude of returns similar to those for
announcement of joint ventures
– No evidence of wealth transfer between partners
in alliances
– No evidence that firms enter alliances because of
deteriorating past performance
– Subsamples
• Technology
– High-tech firm — significant abnormal returns of 1.12%
– Low-tech firm — insignificant abnormal returns of 0.10%
• Industry focus and presence of technological transfer
– Horizontal alliances between firms in same three-digit SIC
class that involve transfer or pooling of technology
experienced highest average significant abnormal returns of
3.54%
– Nonhorizontal alliances whose main objective is to position or
enter new markets have significant 1.45% return
– Horizontal nontechnical and nonhorizontal technical alliances
have positive but not significant returns