Strategies in action

Strategies in Action

The Dramatic Shift from Equity-Based Partnerships to Non-Equity Based Contractual Forms of Partnerships

 

Strategic Partnerships/Alliances

            Strategic partnership or alliance is a formal agreement between two or more business organizations to pursue a set of private and common interest through the sharing of resources in contexts involving uncertainty over outcomes. Strategic partnerships may be classified in various ways; they may seek exploration or exploitation purposes. They may be cross-border or domestic, be governed as equity ventures or as contractual agreements, involve dyads of partners or multiple partners. They may link firms in different stages of the value chain or seek the benefit of scale by connecting companies in the same stage of the chain. The resources shared may be complementary or they may constitute a pool of similar resources. Depending on its purpose, a strategic partnership may be temporary or enduring ( 2003). 

            Strategic alliances, according to (2001), are collaborative organizational agreements that use resources and/or governance structures from more than one existing organization. Strategic alliances have three important characteristics.

• The two or more partnering firms remain independent subsequent to the formation of the alliance.


• Alliances posses the feature of ongoing mutual interdependence, in which one party is vulnerable to the other. Mutual interdependence leads to shares control and management, which contributes to the complexity of alliance management and often creates significant administrative and coordination costs.


• Because the partners remain independent, there is uncertainty as to what one party is counting on the other party to do

 

Strategic Objectives of Inter-firm Partnerships

            The overall strategic objective of alliance partners is the pooling of resources to create value in a way that each of the parents could not achieve by acting alone. Value creation refers to the process of combining the capabilities and resources of the partners to perform a joint task that has the potential to create monetary or other benefits for the partners. Although the perceived value to each of the parents need not be the same, each alliance partner must gain some benefits for an alliance to be the preferred option (1986 , 2001). Some of the strategic objectives of firms in forming alliances are:

• To gain economies of scale by pooling economic activities such as raw materials supply, manufacturing, and marketing and distribution.


• To reduce risk and promote stability. Alliances may be an attractive option for large, risky projects because neither partner bears the full cost of the venture activity.


• Legitimacy (1990, 2001 ). Firms may seek established partners to capitalize on the partner’s reputation. This objective may be prevalent in cases where small firms seek cooperative relationships with larger firms. Legitimacy concerns also may exist when firms try to enter international markets. A local partner may provide the necessary legitimacy for firms that are unfamiliar and uncertain about local conditions.


• To gain access to another firm’s knowledge or ability to perform an activity where there are asymmetries between firms ( 2001).

 

Equity and Non-equity Based Alliances

            Strategic alliances can take various forms. They can be classified according to equity involvement in the partnership. Some alliances are equity based while others do not involve any equity input. Equity alliances can take two forms: the first is the most well known form of strategic alliance, joint venture. The second is equity participation by which a company owns certain shares of another company for the purpose of control influence. Non-equity alliances include a variety of contractual agreements consisting of technology agreement, Research and Development (R&D) partnership, marketing agreements, supplier agreements, franchising, licensing, and production sharing ( 2002).

 

 

 

 

Equity Alliances

Shared Equity/Joint Venture

            Shared-equity alliances entail the foundation of a new business, commonly referred to as a joint venture ( 1998). Joint ventures are the most common form of strategic alliances, which means that two or more firms create an independent business unit by contributing their share of equities. Joint ventures are considered independent legal entities from their parents.

            A classic example of a joint venture is the creation of Caltex by Chevron and Taxaco in the 1930s. Going into the alliance, Chevron was successful in exploration and production in the Middle East and Taxaco had a strong distribution and retail network in Latin America, Europe, Africa, and Asia. Chevron needed retail markets for its Middle East crude; Taxaco needed a supply source for its overseas downstream operations. Caltex was formed as a shared-equity venture to solve the dilemma for both companies ( 1998).

 

Principal Stages: Features of Joint Ventures

1. Initial Stage

            Initially, a firm makes a strategic decision of whether to enter a joint venture with another firm (or firms) for the purposes of achieving economies of scale, reducing risks/costs, accessing markets/resources, developing technology or products, and learning from the partner (partners). If the benefits of a joint venture outweigh its costs and risks, the firm decides to engage in a joint venture ( 2002).

2. Formation Stage

            Once the choice is made for a joint venture, the second phase of the process starts. At this point, a number of follow-up decisions need to be made. Such decisions are primarily concerned with whom to choose for a partner and what type of joint venture would be suitable for the purpose defined. With regard to the type of joint venture, the ownership pattern and benefits sought from the partner would be important factors ( 2002).

Types of Joint Ventures

• Exploiting Symmetrical Competencies – These kinds of joint ventures are established between firms to exploit the existing similar competencies that each partner possesses. These types of joint ventures are formed to leverage combined resources and competencies of partners that would enhance economies of scale or economies of scope of the venture, which in return would eventually add to competency levels of the partners ( 2002).


• Deploying Asymmetrical Competencies – Firms that have different resources and competencies establish joint ventures that benefit from such diverse capabilities. One partner’s resource and competency superiority compensates for the deficiency of the other partner. In order for these types of joint ventures to work, there must be diverse but complementary competencies provided by each partner. The majority of joint ventures fall into this category (2002).


• Creating New Competencies – This type refers to joint ventures where partners intend to create new competencies that no partner possesses. Because no partner alone is capable of generating capabilities needed, partners cooperate to build competencies that would provide benefits for each joint venture partner ( 2002).

3. Operations Stage

            Partners closely watch operations of joint venture and would like to know how the joint venture is managed and what results are achieved. They are time-by-time directly involved in its management by assigning board directors and other managerial staff. Two of the most important decisions that parents need to make are performance assessment and control ( 2002).

4. Outcome Stage

            Based on their overall satisfaction with the joint venture, parent companies decide to either continue to be a partner or to leave the joint venture. Their overall satisfaction could be based on the number factors. Some are related to the poor performance of the joint venture or serious conflict with the other partner ( 2002).

           

            A joint venture involves the creation of a legally separate company of which the alliance partners are normally founding shareholders. The partners normally provide finance, and other support resources including some personnel, until the venture is able to develop its own. The aim of the joint venture is typically that the new company should ultimately become a self-standing entity with its own aims, employees, and resources quite distinct from its parent shareholders (1998).

 

Equity Participation

            In equity participation, one partner owns a certain percentage of equity stakes in another firm. Sometimes it could be a cross holding, by which the partners hold some percentage of equities of each other. It is believed that an ownership of substantial equity in a company provides insights into and some control over that company’s strategies and operations. Firms that have equity relationships feel closer to each other than companies that do not have such ties ( 2002).

            General Motors is one example of a firm that uses equity participation. General Motors has effectively used its equity participation on Isuzu and Suzuki to penetrate the Japanese automobile market by co-production and co-marketing.

An example of cross-equity (cross holding) alliances is evident in Mitsubishi Bank. Mitsubishi Bank owns 5 to 10 percent of fifteen companies that constitute the core of the Mitsubishi group. In turn, these companies own shares of Mitsubishi Bank and of several other companies in the group. These ownership positions carry unspoken but real agreements that the companies will have preferred business relationships with one another ( 1998,).

 

Non-Equity Alliances

            Firms can still form alliances without any equity ownership. This type of collaboration is called a non-equity alliance. The major forms include licensing, franchising, management contracts, turn-key operations, subcontracting, buyer coalitions, supplier partnership, R&D partnership, marketing agreements, technology partnership, and joint production. According to  (2004), Non-equity alliances embrace a wide variety of cooperation, with a wide variety of organizational concentration. A non-equity alliance can yield different levels of dependence, associated with different heights of exit barriers or switching costs, and this requires different degrees of governance

 

Types of Non-equity Alliances

Licensing – in a licensing agreement, a firm, the licensor, grants the rights of using its patents and trademarks, technology, or know-how to another company, which is the licensee. In return, the licensee agrees to pay a royalty or other form of payment, usually based on either production volume or sales, as agreed upon by two parties.

Franchising – is a special form of licensing in which the franchiser grants the use of a brand name, trademark, business system, and other property rights to a franchisee that agrees, in return, to pay a fee based on the volume of sales. The explosion of franchising throughout the world was brought about by the expansion of major franchising companies such as McDonald’s, Burger King, Kentucky Fried Chicken (KFC), Pepsico, Coca-Cola, Hilton Hotels, and Holiday Inns. Franchising works similarly to licensing except that franchising is considered a more continuous type of relationship between a franchiser and franchisee. In addition, the franchiser exerts more control over the franchisee to assure product or service quality (2002).

Joint Marketing – often two firms reach a marketing agreement by which each company helps each other in marketing others’ products or services. Although the nature of marketing collaboration varies from one industry to another, the collaborators aim at promoting each other’s products and services to customers (2002).

R&D Partnerships – an increasing number of firms have been collaborating to research and develop new products or technologies. Firms pool their resources by sharing the costs of a huge capital outlay of a project or combine their human and technological resources and capabilities to introduce an innovation ( 2002).

Joint Production – is also called co-production or productions sharing, where two or more companies contribute to the manufacturing of a final product. If each participating firm mastered in manufacturing certain parts of the product or at processes through cost minimization or differentiation, they would complement  in coming up with superior final product (2002).

 

 

 

 

 

 

Features of Non-equity based Partnerships

            Non-equity based partnerships are contractual agreements between firms. Contractual agreements affect the value chain activity of the firm and provide benefits for the firm’s sustainable competitive advantage (2002).

            Perhaps the main feature of non-equity based partnerships is flexibility. Contractual R&D partnerships according to  (2002), enables companies to increase their strategic flexibility through short-term joint R&D projects with a variety of partners. This flexibility in R&D projects with a variety of partners. This flexibility in R&D partnerships ties into the more general demand for flexibility in many industries, where inter-firm competition is affected by increased technological development, innovation races and the constant need to generate new products.

            Non-equity alliances cover technology and R&D sharing between two or more companies in combination with joint research or joint development projects. Such undertakings imply the sharing of resources, usually through project-based groups of engineers and scientists from each parent company. The costs for capital investment, such as laboratories, office space, equipment, etc. are shared between the partners. During the joint project, each organization is expected to commit and promote organizational interdependence between partners. Compared to joint ventures, the organizational dependence between companies in an R&D partnership is smaller and the time-horizon of the actual project-based partnerships is almost by definition shorter (1993).

 

Research and Development (R&D)

            R&D is regarded as the most valuable, strategic activity of corporations since it is the source of new competitive advantage. R&D is about the effective and efficient creation and deployment of new technology, products, and processes that may result in substantial financial return and competitive advantage to its producers and which may improve the quality of life of its consumers or society in general ( 2002,).

 

What are the reasons behind the shift from Equity-based to Non-Equity-based R&D Alliances between Firms?

            Joint ventures are considered as one of the older models of inter-firm R&D partnership. Joint ventures have become popular during the past decades. However, recent findings, reveal that joint ventures are gradually losing their popularity compared to other forms of inter-firm partnerships ( 1996; 1999 , 2002, ). Among the reasons why joint ventures are decreasing their appeal are high organizational costs combined with their high failure rate. More specifically, problems with the continuation of joint ventures are related to the risk of sharing propriety knowledge, the appetite for control by one partner and a variety of different strategic objectives (1999; 1985, 1988; 1985;  1999  2002,).

            Although there are clearly potential economic and technological benefits that result from firms venturing together, the failure rate of joint ventures is high. In a study conducted by  in 1991, they found out that among 880 joint ventures and cooperative alliances, only 45 percent of the companies were judged successful by all sponsors (1995, ). Some factors that lead to joint venture failure include significantly different goals of parent firms; perceptions of unequal costs and benefits; and conflicts over decision-making, managerial processes, and corporate values ( 1988;1983 , 1995). One of the major causes of dissatisfaction that may eventually lead to joint venture failure is shared ownership. Dual hierarchy potentially may result conflict between parent firms. Conflicts of interest due to divergent objectives and operational asymmetries may adversely affect a firm’s flexibility in decision-making and its ability to coordinate (2006).

 

            Perhaps one of the major causes of the shift from equity-based partnership like joint ventures to non-equity based partnerships like joint development programmes is the emergence and rapid growth of high-tech industries, particularly pharmaceuticals and information technology and other R&D intensive sectors (instruments and medical technology and consumer electronics) (2002). Given below is  analysis of the sectoral differences in terms of contractual R&D partnering:

• In pharmaceuticals and the information technology industry, one sees an above average preference for contractual partnering throughout the past decade (2002, ).


• Aerospace and defense industry shows rapid decline in the importance of contractual R&D partnering during the most recent decade (2002, ).


• In chemicals, electrical engineering industries, food and beverages, and metal products, which are all non-high-tech industries, joint ventures have had a inconsistent importance throughout most of the past decades (2002, ).


• In instruments and medical technology, a rather R&D intensive sector within medium-tech industries, joint ventures have gradually become less important as contractual R&D partnering has become the dominant mode of partnering (2002, ).


• In the automotive industry and consumer electronics, there appears to be two opposite developments: in the automobile industry it seems that contractual partnering is becoming less important, whereas the opposite seems to hold for consumer electronics (2002, ).

 

            Another cause of the dramatic shift is the demand for flexibility. Companies, especially those that belong to the high-tech and R&D intensive sectors are constantly looking for new technologies and products that will boost their competitive advantage. These companies are looking for partnerships between other companies that are more flexible.

 

Bibliography

 

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