Risks for Multinational Firms in International Ventures
Introduction
As for many multinational firms doing business in new and unfamiliar countries, it made sense to create joint ventures with local firms. After all, that local knowledge of customs, suppliers, and markets could save the newcomer months—maybe even years—of riding a painful learning curve.
However, new research on more than 3,000 American transnationals suggests that joint ventures are falling out of favor. What’s the reason behind these findings? Increasing forces of globalization such as increasingly fragmented production processes make the decision not to collaborate pay off.
For a multinational firm to do business in other country, there are methods and approaches available to enter the desired market. One of the most common and effective means of conducting business internationally is through joint venture or what is commonly called International Joint Venture.
In such mode of entry is the portrayal of relationship between two or more firms in a partnership. There will be documents and agreements that will serve as provisions as to the particulars of the business for both parties. The documents and agreements of the joint venture are critical to the success of the venture. The joint venture agreement forms the basis of the understanding between and among the parties. It is relied upon to ensure that all parties understand their roles, rights, responsibilities, and remedies in the conduct of the venture. Organizations enter into joint ventures in good faith but closely scrutinize the joint venture documents if anything goes wrong.
The importance of the documents is to cover, step by step, the critical elements to consider and include in the joint venture agreements. Time is spent on what should be included in the agreements and why they should be included. Equity participation, for example, may or may not be as important as operational control. Technical participation in the venture may or may not be as important as the intellectual property rights that may result from the venture.
However, by the time multinational firms decided to engage in the International Joint Venture, risks should also be anticipated since it is inevitable in such international partnerships. Moreover, central propositions in a behavioral theory of the firm applied to creating and managing International Joint Ventures have shaped up some potential pitfalls to such mode of entry ( 1963).
Why do most International Joint Ventures Breakdown?
Risks for Multinational Firms
Multi-national enterprises (MNEs) are more likely to use International Joint Ventures in centrally planned or hybrid economies when the local government prefers such cooperation, even if wholly-owned subsidiaries (WOS) are permitted (Tallman and Shenkar 1994). National governments often create incentives for MNEs to create International Joint Ventures with domestic partners; centrally-planned government interference is believed to be greater for WOS than International Joint Ventures.
Most created and operating International Joint Ventures that include an MNE and a small domestic partner have life spans of less than five years. The success and failure of such International Joint Ventures should not be judged by the length of their lives; the ability of the International Joint Venture in achieving multiple performance objectives should be the focus in valuing an ongoing International Joint Venture (1987).
Split Management between Multinational Firms and Domestic Partners
The division of management control between joint venture partners has been a long-standing matter of contention among scholars studying Joint Venture entry into emerging markets. Some Joint Venture scholars have suggested that Multinational Enterprises (MNEs) should secure dominant control of the Joint Venture’s management when engaging in Joint Venture with local emerging market partners ( 1984; 1997; 1997; 2001). These scholars argue that it is best for one of the partners (especially MNE partners) to dominantly manage the JV. In the contrary, other JV scholars argue that management should be shared by both MNE and local partners if the JV is to be successful. These scholars have advised MNEs to share control with local emerging market partners as much as possible (1985, 1993; 1994, 1996).
Most of the discussion about JV control has not explicitly considered another way of partitioning control: split control JVs. A small number of JV researchers (1983;1985, 1993; 1988;1989; 2001; 2002) have reported the phenomenon of split control JVs, sometimes even considering it from different perspectives or with slightly different terminology. Split control JVs are ventures in which the two partners agree to control distinct functional activities. This division of labor between the partners is not emphasized in shared management ventures. Rather, control over almost all value-creation activities is shared between the partners. The phenomenon of split control management is important because JV partners’ choice concerning who should control which particular activities influences the way value is created in the JV and eventually its performance.
Control is defined as influence exercised by the parents over the management of the venture (1983; 1983;1985; 1989). The control that is partitioned between the parents thus represents the relative influence of each parent on the management of the JV. Control is further conceptualized as a conduit through which parents’ firm-specific advantages are transferred to the venture. It is thus argued that if IV control is not properly partitioned between the partners, then JV performance is likely to suffer because of ineffective transfer of the parents’ firm-specific advantages to the venture. By proper partitioning of the JV’s management control, it means a fit between the parent’s firm-specific advantages transferred to the venture and the parent’s control over the corresponding value-creation activities of JV management.
Risks in National & Organizational Culture Differences
Growth in global markets and technologies has led to a dramatic rise in cross-national joint ventures even though joint ventures are considered to be risky (1992:1989; 1993). An estimated 37-70% of international joint ventures (IJVs) are reported to suffer from performance problems leading to costly failures (1989; 1995;1985). Culture differences between joint venture partners have usually been considered a major factor that might influence venture failure or unsatisfactory performance (1993; 1985).
Despite different definitions of culture, there is a general consensus among organizational researchers that culture refers to patterns of beliefs and values that are manifested in practices, behaviors, and various artifacts shared by members of an organization or a nation (1980; 1993).
Because organizations are, in many ways, embedded in the larger society in which they exist, research on culture differences of cross-national businesses should examine both national and organizational cultures. But with few exceptions (1990; 1996;1996) past studies have not been concerned with culture distance at both levels. Nowadays, such unattended concerns have caused risks to international mergers especially to Multinational Firms. (1990) found that, whereas organizations from different nations differ in fundamental values, organizations from the same nation differ only in organizational practices. The authors therefore concluded that when both national and organizational cultures are examined, the former should be operationalized in terms of values, and the latter in terms of core organizational practices. (1996) also found that in international and domestic mergers and acquisitions, national and organizational cultures are separate constructs with variable attitudinal and behavioral correlates. As such, although national and organizational cultures have been regarded as separate constructs, it is also widely accepted that organizational culture is nested in national culture. (1996) reported that work units perform better when their management practices are compatible with the national culture. They advocate that management practices should be adapted to national culture for high performance.
In the context of both mergers and joint ventures, scholars have generally argued that alliances between culturally similar partners are more likely to be successful than alliances between culturally dissimilar partners. Consequently, this has been in only fewer instances since most participating mergers in the international joint ventures are literally different in each other’s culture. This becomes a difficulty that eventually brings about risks. Unfortunately, the affected ones are those multinational firms trying to make partnership with the domestic market.
(1993) define culture as “social glue,” which serves to bind individuals and creates organizational cohesiveness. They state that in alliances “selection decisions are generally driven by financial and strategic considerations, yet many organizational alliances fail to meet expectations because the cultures of partners are incompatible” (1993). Indeed, cultural incompatibility may cost more than strategic incompatibility in organizational alliances. Different culture types create different psychological environments for the joint venture or the merged company, and differences in practices have a negative influence on performance (1993). Thus, “the degree of culture fit that exists between combining organizations is likely to be directly correlated to the success of the combination” (1993).
Furthermore, cross-national joint ventures have been reported to suffer from communication, cooperation, commitment, and conflict resolution problems caused by partners’ value and behavior differences, which in turn cause interaction problems that adversely influence joint venture performance (1988;1994; 1991; 1994). Values and behavioral differences between culturally distant partners influence interpretation and responses to strategic and managerial issues, compounding transactional difficulties in international joint ventures ( 1997).
Instability of Joint Ventures Resulting into Risks
In the greater part of previous studies, instability has been treated as a dependent variable to indicate the IJV’s ultimate destination. As a result, various factors contributing to instability have been identified, including conflicts in shared management, cross-cultural differences, ownership structures, characteristics of the sponsors, and external environmental forces. These factors straightforwardly generate risks for both participating firms in the IJV with more threats on transnational mergers or the Multinational Firms than the domestic player.
Interpartner conflict in co-management
A key feature of IJVs is shared management between partners from different countries. Partners could disagree on just about every aspect of an IJV’s management. Therefore, interpartner conflict in co-management is often a driving force for instability (1983; 1989). (1988) found that differences between the partners in founding goals, strategic resources, and corporate cultures were responsible for shorter JV duration. On the other hand, joint ventures between direct competitors were found more likely to fail because potential interpartner competition and conflict undermined the partnerships (1996; 1997).
Cross-cultural differences
Cultural differences often influence the way in which the partners in an IJV make strategic decisions and solve problems. For example, Japanese and American managers tend to see interfirm alliances very differently: the former treat them as primarily interpersonal relationships whereas the latter see them as enduring by design, irrespective of the specific managers involved (1987). (1993) point out that in IJVs in Japan, cross-cultural differences “lead to endless, energy-and-time consuming debates – futile talk that produces a lot of heat and prevents the company making the decisions it has to.” The positive effect of cultural differences on IJV instability has also been evidenced in empirical studies with larger samples (1991; 1992; 1994; 1997). However, the findings of several recent studies demonstrate that the relationship between partner cultural differences and IJV stability may be more complex than previous research has suggested.
Control/ownership structures
The structure of parent control has been found to influence IJV instability, although the direction of this effect remains ambiguous. (1993) found that a dominant management structure can minimize coordination costs and hence outperform shared control IJVs. However, an unequal division of ownership may give the majority holder greater power which may be used to the detriment of the minority owner. Therefore, a balanced ownership structure in which partners’ bargaining power is evenly matched is more likely to produce mutual accommodations (1988).
Characteristics of parents
Franko (1971) concluded that policy changes in the multinational enterprise (MNE) partner were responsible for IJV instability. When an MNE decides to tighten control over its foreign subsidiaries, it is likely to turn some IJVs into wholly-owned subsidiaries. Other partner characteristics, such as a parent firm’s financial problems (1999) and the partners’ prior IJV experience (1988; 1996; 1996) were also found to influence IJV instability.
External environments
Changes in external environments, such as local government policies and industry structures, may also influence IJV instability. It has been widely documented that unanticipated major changes in local political environments (e.g., changes in government policies regarding foreign direct investment in general and equity IJVs in particular) affect international business operations and contribute to IJV instability (1977; 1992;1992; 1994). The past several decades have witnessed such drastic changes in many countries (1990; 1995; 1994).
Industrial dynamics may also influence the evolution of joint ventures. For example, IJVs are found to be less stable in industries that experience intensive consolidation or volatile growth (1989, 1991; 1997).
Impact of Risks on Performance
Out of all the previous studies, (1988) was the only study that linked perceived risks to its performance in the IJV. (1988) study included duration and sponsor-perceived success as well as stability as indicators of performance. In her sample, 66.7% of the “unstable” ventures were judged as unsuccessful by one or more sponsors, echoing a high correlation between instability and partners’ assessment of performance.
While most researchers conceptually agree that the linkage of instability to performance is more than complex, many used the former as a proxy for the latter. Little research has been done to investigate the relationship and possible interactions between the two variables.
Conclusion and Recommendation
Multinational Firms desired to do business with foreign and unfamiliar countries must consider the risks stated above. Notwithstanding the fact that International Joint Venture is evidently a risky deal, there are still many transnational firms taking the chances of IJVs growing popularity and importance. Additionally, researches have shown that IJVs averaged only five years yet several companies still take the risks.
For managers considering a joint venture, there are some things to keep in mind before taking the step. First and foremost, separate and segregate the reasons for considering a joint venture. Additionally, make sure that you can’t buy those services or that knowledge through an arms-length contract that doesn’t require sharing ownership. Most of what managers want from joint ventures is likely to be available through such arrangements. Given the notion on how costly giving up equity is, view joint ventures as a last resort.
Another important thing to consider is the expectations. As a manager, clearly and openly lay out expectations for the partners in legal and informal documents prior to the creation of the entity for the reason that it would be clear as to what each party is providing. With this pace, it would create security and precautions right before the business is about to commence.
Then, try out partners without setting up a joint venture by conducting business with them in some way. This would test how the partners actually do business in the anticipation of the outcome. Bear this in mind – there’s no substitute for real contract with the whole organization. Lastly, specify simple exit provisions at the onset and then don’t be afraid to walk and go it alone.
In general, multinationals often create incentives to have joint ventures by penalizing the risk-taking involved in going it alone. The overall multinational body should have another look at its attitude toward joint ventures and make sure that managers on the ground don’t feel pressured having local partners.
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