In 2005, Thomas L. Friedman wrote the bestseller: The World is Flat: A brief history of the twentieth century. He analyzed the globalization, primarily in the early 21st century.
The book raised my curiosity and interest in understanding the dynamics of global economies and their implications. I observed that since late 80s, early 90s, these dynamics have been driving a surge in structured business relationships between firms in several industries, domestic and abroad. These relationships range from simple joint selling to mergers & acquisitions (Figure 1). Each one of these relationships represents different degrees of risk, scope, involvement, capital investment and potential returns.
While there is this spectrum of business relationships, the use of Strategic alliances and Joint Ventures has been and still is growing with an increasing number of multi-national entities. I am identifying my view of the fundamental difference between a strategic alliance and a joint venture in figure 2.
Strategic alliance is an arrangement between two or more firms to work together in any part of the value chain, from basic research to after sales support. Joint venture involves creation of a separate, independent entity. Both of these business arrangements have certain advantages and some special challenges.
What are the benefits?
Companies have several and varied reasons to form alliances. Most of the times, the potential partners see synergistic effect due to perceived complementary strengths. They expect to leverage the relationship to gain a competitive and/or differential advantage, access a new market, mitigate or share risk, realize economies of scale and scope, share expertise in one or more areas such as technical knowhow and decrease resource costs (labor, material, logistics etc.).
If a company intends to enter a foreign market, it may face local government requirement for a certain percent of local ownership. This can generally be accomplished through a joint venture arrangement.
While Joint Venture and Strategic Alliance participants share the gains, they also mitigate and/or share the risk of loss and failure. The attractiveness of these arrangements, therefore, increases if the business endeavor presents a risk to the “balance sheet”.
Economies of scale and scope can be realized when two or more entities combine their resources and strengths. They can optimize efficiencies and drive innovation. This may allow them to effectively compete against one or more entrenched industry players.
Creating alliances can also fill in existing gaps, for example, a large telecom company did not have sufficient knowledge and expertise in the area of electronic miniaturization. It gained such an expertise by forming an alliance with a small European company. Subsequently, it led to the acquisition of the smaller company.
Firms from countries with highly developed economies form relationships with entities in developing countries to realize huge cost savings in labor, material and many times logistics. Businesses in developing countries benefit from advanced technical and operational know-how and access to capital.
What are the fundamental requirements for partner selection?
Finding and selecting the right joint venture or strategic alliance partner can be quite challenging. The strategic objectives of the potential partners must be complementary and synergistic. The objectives need not be exactly the same, but they cannot be in conflict for the venture to succeed. This requires a clear and complete understanding of each other’s goals. The challenge is that the parties may not always share this information clearly and completely. Why? This is because the concerned parties may be afraid of being exploited.
The potential relationship must also be synergistic in terms of skills and competencies. Most frequent areas for such skills and competencies match are managerial expertise, technical know-how, resource access, geographic and political access and production facilities.
All parties involved must establish mutual trust and commitment to the venture. No matter how well all other aspects mesh, without trust and commitment, the venture will either fail or stagger. One key requirement for establishing trust and commitment is to share information related to objectives, intents and organizational culture.
What are the typical organizational structure alternatives?
The organization and management structures in such business arrangements vary and are generally customized to each venture. Typical structures used are:
- Parent – Child - – - The “Parent” company is generally the majority owner or brings the most valuable resources to the table
- Shared Management – - – Both parent companies share decision making responsibilities. In some situations, it is accomplished by having equal number of managers in controlling positions such as board of directors. In many other situations, the number of managers will vary with the functional group or area of expertise.
- Arm’s length – - – This is where the management of joint venture acts independently of either of the parent company. This is generally not the case in new joint ventures unless the parent companies agree to recruit managers from outside the companies.
- Rotating structure – - – This is a situation where the companies forming an alliance and/or joint venture agree to rotate key management positions between the firms. The key executives are assigned definite and fixed term lengths.
There are numerous and varied reasons for companies to form strategic alliances, joint ventures or other cooperative business relationships. All of these, however, have one item in common, that is, they are all expecting to create synergies for better market and financial performance.