Strategic Alliance

Carina Loughner Management 301 Honor Option Fall 2006 A Guide to Strategic Alliances

As companies continue the trend towards becoming not only international but transnational companies, strategic alliances are becoming more critical to business operations. Due to the importance of strategic alliances managers must understand what they are, what their benefits and/or drawbacks are, what affects they have on operations and finances, and how to effectively and efficiently create and maintain them. With this knowledge managers will have the power to add substantial value to their company and create competitive advantage in the international marketplace. First, this paper will define strategic alliances and what can be considered a strategic alliance. Then, it will point out the advantages and disadvantages to strategic alliances. Next, it will show how alliances are formed, how to make them successful, and what important things to consider are when forming an alliance. Finally, it talks about how an alliance can fail and how to keep it from failing. According to Wikipedia, a strategic alliance is defined as “a mutually beneficial long-term formal relationship formed between two or more parties to pursue a set of agreed upon goals or to meet a critical business need while remaining independent organizations” In the business sense, it is “a synergistic arrangement whereby two or more organizations agree to cooperate in the carrying out of a business activity where each brings different strengths and capabilities to the arrangement.” From a management

2 viewpoint it can be defined as an “agreement in which managers pool or share a firm’s resources and know-how with a foreign company and the two firms share in the rewards and risks of starting a new venture (Jones).” Any way you define it, a strategic alliance seems to be a broad term for an agreement between potential or actual competitors (Hill). There are many different types of strategic alliances. Some types are obvious while others are still in debate about whether they can be considered a strategic alliance. The increasing number of alliances that are formed can be attributed to international expansion and the increase in technology (Hill). Strategic alliances can often be broken into two groups, contractual forms and equity forms. Contractual forms include licensing, franchising, joint R&D, management contracts, and turnkey projects. Equity forms include independent joint ventures and dependent joint ventures of a multinational company as new entities, and the purchase of an equity share and an equity swap as existing entities (Strategic Alliance). Outsourcing and contractual agreements can also be considered a strategic alliance. Licensing is the first form of a contractual strategic alliance. Licensing occurs when one company gives another company permission to use its intellectual property such as management techniques, manufacturing processes, or patents (Strategic Alliance). The downfall to licensing is that by handing out important information to foreign firms, competition may be created. Franchising is “a method of doing business wherein a franchisor licenses trademarks and tried and proven methods of doing business to a franchisee in exchange for a recurring payment, and usually a percentage piece of gross sales or gross profits as well as the annual fees (Strategic Alliance).” Franchises are easy to set up but the owner gives up a certain portion of control over the business. A joint

3 R&D is “a strategic alliance whereby two or more organizations agree to combine their technological knowledge and research and development to create new innovative products (Strategic Alliance).” A management contract is “an arrangement under which operational control of an enterprise is vested by contract in a separate enterprise which performs the necessary managerial functions in return for a fee (Strategic Alliance).” Management contracts are often formed where there is a lack of local skills to run a project. Finally, a turnkey project is “a project in which a separate entity is responsible for setting up a plant or equipment (e.g. trains/infrastructure) and putting it into operations (Strategic Alliance).” Contractual-based strategic alliances generally are short-term arrangements that are appropriate when a formal management structure is not required (Mosad). Outsourcing is currently under debate as to whether it is a type of strategic alliance or not. Outsourcing is defined as “the delegation of non-core operations from internal production to an external entity specializing in the management of that operation (Outsourcing).” This means that outsourcing involves transferring or sharing management control and/or decision-making of a business function to an outside supplier, which involves a degree of two-way information exchange, coordination and trust between the outsourcer and its client. The business segments that are typically outsourced include information technology, human resources, facilities and real estate management, and accounting (Outsourcing). Many companies also outsource customer support and call center functions, as well as manufacturing and engineering. The benefits of outsourcing are cost reductions, capital reductions, availability to production capacity and competence, releasing internal resources, both personnel and equipment, sharing risks

4 with partners, quicker time to market, and better strategic flexibility (Mosad). Companies outsource for many reasons, but the most prominent reason is cost savings. However, some people believe that companies “are turning to outsourcing so that they can focus on what really differentiates them from their competitors, not just to save costs (Mosad).” Some of the drawbacks to outsourcing include the company loses control over resources, activities, competence, personnel, and day-to-day work (Mosad). The question is how the balance between what is good and what is bad will benefit the company if it undertakes outsourcing. There are several reasons a company should create a strategic alliance. Businesses use strategic alliances to achieve advantages of scale, increase market penetration, enhance competitiveness in domestic and/or global markets, and enhance product development. They are also used to develop new business opportunities through new products and services, expand market development, increase exports, diversify, create new business, and reduce costs (Small Business Notes). The main reason most companies create an alliance is to have the ability to access new capital for growth, for development of new products or services, or for entry into new lines of business. Strategic alliances allow firms to share the fixed costs of developing new products and processes. For example, an alliance between Boeing and a number of Japanese companies to build Boeing’s latest commercial jet liner was motivated by Boeing’s desire to share the $8 billion investment required to develop the aircraft (Hill). Another important reason to form a strategic alliance is the access to international markets (AllBusiness.com). Allying with a company in another country is often more efficient and successful than attempting to enter the international market alone. For example, many firms feel that if they are to

5 successfully enter the Chinese market, they need a local business partner who understands the business conditions, and has good connections (Hill). Having access to new distribution channels gives the company access to distribution channels that may otherwise be difficult or costly to penetrate on its own. Entering into a strategic alliance can even help an emerging company to enhance their credibility and reputation (Allbusiness.com). Strategic alliances can be advantageous particularly when dealing with high environmental uncertainty and rapidly changing technological innovation. They allow a company to focus on its core competency while sharing the total risk of the venture with another party (Paik). For small businesses, strategic alliances are a way to work together with others towards a common goal without losing their individuality. According to Small Business Notes, “Alliances are a way of reaping the rewards of team effort.” “However, while many organizations often rush to jump on the bandwagon of strategic alliances, few succeed (Mosad).” A strategic alliance is attractive, but it is not simple or easy to create, develop, and support. There are many implementation problems and strategic alliances often fail. The failure rate of strategic alliances is projected to be as high as seventy percent (Mosad). One of the major reasons for the failure of many alliances is dissatisfaction with the alliance relationship. A partner's dissatisfaction can result from outcome variables, the financial performance of the alliance, relational variables, or the degree of commitment or competence displayed by a partner to the alliance (Mosad). Another disadvantage of strategic alliances is that they give competitors a low cost route to new technology and markets. Many people have argued that Japanese success in the machine tool and semiconductor industries was built on U.S.

6 technology acquired through strategic alliances (Hill). Alliances have risk, and unless a firm is careful, it can give away more than it receives (Hill). “Creating and enhancing a sustainable alliance has both a cost and a value. It takes a long time to develop a new relationship, and the time dimension impacts the parties' profitability. Thus, the parties involved in such a relationship must have a philosophy about how they should run their ongoing alliance, recognizing the mutual interdependence of each partner. Each partner should consider that a poor alliance can easily be turned into problems. Indeed the best successful customer or business relationships, like the best marriages, are true partnerships that tend to meet certain criteria. (Mosad)” A good partner has three characteristics. First, a good partner helps the firm achieve its strategic goals. Second, a good partner shares the firm’s vision for the purpose of the alliance. Third, a good partner is unlikely to try to opportunistically exploit the alliance for its own ends. Thus, firms with reputations for “fair play” will probably make the best partners (Hill). Forming strategic alliances is often unfamiliar territory for managers. They need to clearly understand the goals, benefits and risks of an alliance, as well as the alternatives. There are many factors that must be taken into consideration before entering a strategic alliance, especially since choosing the right partner can either make or break the alliance. Forming a strategic alliance can be tricky, and since nearly seventy percent of all alliances fail it is imperative to create and maintain a tight bond with the other company in the alliance. There are four steps managers should take when forming a strategic alliance (Reid). First, they must make sure that their information technology organizations and their company is ready to partner with other companies. To do this a

7 manager must asses whether the company has adequate skills, systems and processes, support, and governance. Second, managers must analyze whether or not a strategic alliance is financially right for their company. They do this by estimating quantifiable benefits such as revenues and savings, and costs such as labor and equipment, and state intangible benefits and risks in an easily understood format. Third, managers should create a list of potential partners and then score their viability. To increase the probability of selecting a good partner the firm should collect as much pertinent, publicly available information on the potential partners as possible (Hill). They should also ask staff, salespeople, line managers, customers, consultants, alliance brokers, analysts, etc to give suggestions about possible partners. Finally, managers should meet with their top prospect to explore its interest in an alliance and whether it is a good fit for the company (Reid). It should include face-to-face meetings between senior managers to ensure that the chemistry level is right (Hill). This is where they should evaluate similarities and differences. (Reid) Once a partner has been selected the alliance should be structured so that the firm’s risks are reduced (Hill). First, the firm can design the alliance to make it difficult to transfer technology not meant to be transferred. The design, development, manufacture, and service of a product can be structured to wall off sensitive technologies and prevent their leakages (Hill). For example, when General Electric and Snecma created an alliance to build aircraft engines, General Electric walled off certain sections of the production process to reduce the risk of excess transfer of technology (Hill). “Second, contractual safeguards can be written into an alliance agreement to guard against the risk of opportunism by a partner (Hill).” Opportunism in this case refers to the

8 theft of technology and/or markets. Third, both parties can agree to swap skills and technologies that the other covets, which ensures the chance for equitable gain. Crosslicensing agreements are a way to achieve this. Finally, the risk of opportunism can be reduced if a firm extracts a credible commitment from its partner in advance (Hill). There are many ways to maintain a successful strategic alliance. Most importantly the business partners must have a strong motivation for entering the relationship. Keeping up with communication and harboring trust is vital (Strategic Alliances). “Managing an alliance successfully requires building interpersonal relationships between the firms’ managers, which is referred to as relational capital (Hill).” Personal relationships can foster an informal management network which can be used to help solve problems arising in more formal contexts (Hill). The factors to look for in a successful alliance are individual willingness, motivation, and a strategic fit (Strategic Alliances). The manner in which the alliance is managed is another important factor (Hill). Each partner should have something of value to contribute to the relationship (Strategic Alliances). They should have clearly defined responsibilities and be agreed on a good dispute resolution system. For best survival opportunities the partners should develop ways of operating so they can work together smoothly. They should also build an effective communication system among many people at many organizational levels. Strategic alliances must not abuse the information they gain, they are flexible, and they respect one another (Strategic Alliances). Finally, they “should show a mutual integrity behavior and attitude towards one another in honorable ways that justify, enhance and sustain mutual trust and commitment (Mosad).” The business partners should also have a common long-term goal and they should want to make the relationship work to achieve that goal (Mosad).

9 Another good thing to look for is complementary assets and/or skills. Basically, neither can accomplish alone what they can achieve together. It has been argued that a determinant of how much acquiring knowledge a company gains from an alliance is its ability to learn from its partner. For example, in a study of fifteen strategic alliances where the focus was on alliances between Japanese companies and Western partners, it was found that the Japanese companies emerged from the alliance stronger than the western partner. This was attributed to the fact that the Japanese companies made a greater effort to learn from their partners. The Western companies viewed the alliance as a cost sharing or risk sharing device, rather than an opportunity to learn. Thus, to maximize the learning benefits from an alliance, managers must try to learn from its partner and then apply the knowledge within their own organization. (Hill) Cultural background has a very important role when deciding to form a strategic alliance. When the alliance is formed between parties from different cultures, an even higher level of complexity is usually involved in managing the venture (Paik). Managers must be aware of cultural differences when dealing with companies in foreign countries. One of the biggest problems managers face is a difficult juggling act, trying to cope with the different management styles, and trying to meet the possibly conflicting criteria for success that companies can impose (Lu). Differences of management style can be discerned in many areas, such as supervision style, decision-making, communication patterns, paternalistic orientation, and control mechanisms (Lu). Differences in management styles can damage performance. Strategic alliances can face other severe problems if cultural understanding is lax. These problems include a lack of coordination

10 between teams, and differences in operating procedures and attitudes among partners (Mosad). Strategic alliances might create a future local or global competitor, lack clear goals and objectives, lack trust and opportunistic behavior, and have performance risk as a result of external factors, market factors and internal factors (Mosad). Managers have the ability to inspire, influence, change, and conduct thinking, attitudes, and behavior of people. They can “impact the alliance outcome through managerially controllable behavioral related characteristics that are reflection of managers' personalities and values (Rodriquez).” Managers from different national cultures should create and develop a common ground in the relationship facilitating communication and exchange. “Their management styles foster the redefinition of exchange relationships and suggest the emergence of a third culture (Rodriquez).” In maintaining a stable, long-term relationship, an international strategic alliance may need to develop its own culture and systems. The presence of a “third culture” facilitates the development of new, effective, and mutually acceptable ways to benefit from relationships. In order to build this “third culture” it should be possible for participants to negotiate their cultural differences. They should understand the benefits of converging, adapting, and assimilating values. And, reconfigurations of individual cultural differences are necessary and desirable by product of the relationship (Rodriquez). Managers must always be sensitive to the value systems and norms of an individual’s country and behave accordingly (Rodriquez). Values are ideas about what a society believes to be good, desirable, and beautiful (Jones). Norms are unwritten rules and codes of conduct that prescribe how people should act in particular situations (Jones). For example if a Japanese businessperson offers a business card, they expect it to be

11 thoroughly read and considered before putting it away. A good outline to follow when taking cultural differences into consideration for an alliance is Hofstede’s model of national culture which describes the fundamental differences that can be found in cultures. Another factor to consider when creating a strategic alliance is ethics. Business ethics concern the consideration of moral in corporate decision making. Managers may be confronted with a variety of ethical dilemmas, usually due to difference among national markets in what constitutes legal or acceptable practice (Phatak). Examples of these ethical dilemmas include child labor, sweat shops, “cooking the books”, fair practices issues, and occupational issues. In today’s global economy, managers often find it difficult to uphold ethical practices. To deal with the problem of the disintegration of ethical responsibility, managers can use organizational culture and ethical values to control the performance of employees and of other organizations (Daboub). As it becomes increasingly difficult to monitor behavior and enforce contracts, the traditional approaches will not work. For this reason, organizations must use clan control which utilizes social factors, such as corporate culture, traditions, shared values, and commitment, to control behavior (Daboub). To do this the organization should try to hire people who are compatible with organizational values and will socialize them in those values. Employees must also exercise a certain level of self-control (Daboub). Contemporary developments in business ethics also offer tools for dealing with the problem. These tools include the theory and practice of "global corporate citizenship", the integrated social contracting theory of economic ethics, and stakeholder learning dialogues as a way to cope with complex,

12 interdependent, "messy" problems (Daboub). Global corporate citizenship deals with the sense that the business organization becomes a global citizen with global responsibilities. The integrated social contracting theory of economic ethics deals with the idea that ethical norms should be binding on human moral agents. Finally, stakeholder learning dialogues deal with the potential for joint learning as different perspectives on the shared problem as well as preconceptions about relationships between "selves" and "others" are tested and recast. (Daboub) Contracts and ethics are more difficult to monitor in alliance relationships, as responsibility may be fragmented. To counter this, companies need to select ethical partners at the outset and then foster appropriate legal and ethical norms at the individual level and across the relationship (Daboub). The good reputation of a partner allays the fear that the partner may be opportunistic, reduces the cost of monitoring an agent, and lessens the likelihood that a partner may shirk responsibilities (Daboub). “By reducing costs and the problems of contracting, reputation should have a positive effect on the success of an alliance (Daboub).” The challenge is to create a cross-organizational culture in which the interests and the values of the partners coincide. Overall, the most important thing to have when trying to uphold ethical practices in a strategic alliance is trust. “The conception and practical day-to-day operations must be in alignment with the common goals and objectives communicated, agreed upon, and held accountable to in the alliance formation (Paik).” If not, then the alliance is prone to failure. There are many reasons why an alliance can fail. Recognizing that an alliance is broken and taking steps to mend the various relationships are vital if a company is to realize its expected return on investment from the alliance (Eaves). There are two main reasons that alliances fail. First,

13 the business model on which the alliance is based is inappropriate. Second, the relationship between the alliance partners has broken down which can compromise the levels of trust. These two factors account for ninety-four percent of failed alliances (Eaves). In order to prevent these two things from happening managers must look for the symptoms of failure. These symptoms include interpersonal problems, an “us” and “them” mentality, the failure of team members to communicate critical information, high attrition rates, and the failure to reach target milestones and timelines (Eaves). Unfortunately, these symptoms often go unrecognized until it is too late because in many corporate cultures, openly discussing failure is perceived as political or unprofessional. If the alliance does fail, yet both partners want to keep trying they can renew the relationship. This is done in a three step process. First, audit the relationship diagnosing the root causes of the problems. Second, conduct relationship planning, build a joint contract, and deal understanding. Third, design a relationship management infrastructure and draft a procedural agreement (Eaves). Organizations should mend broken alliances or terminate them as quickly as possible so that important resources are not eaten up by the failing alliance. An example of a failure story is the collapse of GM sales of its Pontiac LeMans in the US market in 1990, down 39 percent from a 1988 peak as a result of the GM strategic alliance with the Deawoo group (Mosad). All companies in strategic alliances are prone to failure, and some can fail for several reasons. For example, the alliance of Volvo and Renault married the two largest enterprises in their respective countries for economic objectives that virtually all industry experts applauded. Three years after its founding, the alliances split apart in a bruising argument that left observers reassessing the future of alliances and of European

14 integration. Six factors that undermined the Volvo-Renault alliance are identified as misalignment of senior and operating managers, path dependence, alliance re-contracting, leadership style, cultural differences, and time (Bruner). As strategic alliances become more prevalent and as more companies turn to outsourcing, companies will lose their national identities and their autonomy. However, the future of strategic alliances will always be unknown because outside forces could arise that would cause the alliance to either fail or succeed. Such forces include political factors such as war and changes in laws, economic factors such as increased barriers to entry and economic growth, environmental factors such as natural disasters, technological forces such as new communication pathways, socio-cultural factors, and demographic forces (Jones). Creating a strategic alliance is like a marriage. There is a courtship period, when both parties get to know one another. Then there is a ceremony, or contract to do business, which binds both parties to certain terms and conditions. Also, there can be conflicts between the couple. If the relationship becomes unsatisfactory for either party, there is a divorce. Thus, unhappy relationships, many leading to divorce, are an all too common outcome, mostly due to undesirable human behavior. (Mosad) When created and maintained properly strategic alliances can add value and create competitive advantage for a managers firm.

15 Works Cited

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16 Reid, Douglas A. “A CIO’s Guide to Forming a Strategic Alliance.” CIO Insight Whiteboard. Mar 18 2002. . Rodríguez, Carlos M . “Emergence of a Third Culture: Shared Leadership in International Strategic Alliances” International Marketing Review. London: 2005.Vol.22, Iss. 1; pg. 67, 29 pgs “Strategic Alliance.” Wikipedia, The Free Encyclopedia. 31 Oct 2006, 03:57 UTC. Wikimedia Foundation, Inc. 4 Nov 2006 . “Strategic Alliances.” Small Business Notes. 2 Nov 2006. .