Strategy & Operations » Leadership & Management » Strategic alliance

A COMPANY would either buy up a rival to sell new products and services or take a punt setting up operations in a new market if it wanted to grow its business in less volatile economic times. While those options still exist, restricted access to bank capital has made businesses more cautious, with more companies considering strategic alliances to share their experience and expertise, reduce expenditure and spread their risk.

The idea is not new and there have been many notable success stories. US conglomerate General Electric (GE) has carried out many joint ventures, some of them becoming market leaders after starting from scratch. For example, it has had a 50-50 venture with the French state-owned aircraft engine maker Snecma since 1974, and GE SeaCo, which GE and Sea Containers of Britain formed in 1998, has become one of the world’s largest leasers of shipping containers.

In June 2009, Morgan Stanley and Citigroup launched a joint venture, Morgan Stanley Smith Barney. It combined Morgan Stanley’s wealth management unit with Citi’s Smith Barney brokerage division and became Wall Street’s largest retail brokerage.

Many joint ventures have also been set up across different industry sectors, allowing companies to dip their toes into market segments that ordinarily would be alien to them. Carmaker Volkswagen joined forces with German electricity distributor LichtBlick in 2009 to manufacture and market mini combined heat and power plants. French energy company GDF Suez created a gas and power-trading subsidiary with French bank Société Générale and acquired the bank’s interest to manage the business on its own. Supermaket chain Tesco, which created a joint financial services venture with Royal Bank of Scotland in 1996, bought out its partner in 2008 and is now preparing to offer current accounts and property loans.

However, Neil Dennington, principal in financial services at consultants AT Kearney, is not entirely convinced.

“There is a feeling that joint ventures are a good way of minimising capital expenditure, reducing risk and getting to local markets quickly,” he says. “As a result, we have seen more companies considering setting them up. However, while I can buy into the argument that the number of joint ventures is going to increase, I am not convinced that this means that they will work. In fact, I am more confident that the number of joint ventures that fail will outnumber those that succeed.”

And there have been some high-profile failures. In 2003, healthcare retailer Boots and supermarket chain J Sainsbury were forced to write off almost £10m after they pulled the plug on their 16-month, nine-store health and beauty joint venture. The two companies said they had been “unable to agree commercial terms for a rollout”. They invested a total of £8m in developing the trial and spent about £2m reverting the stores back to normal.

Sharing the rewards

Experts joke that there are two reasons why joint ventures fail: “joint” and “venture” – the terms simply do not register. One commentator, who asked not to be named, says that “in many cases, companies go into these arrangements thinking that they will only jointly share the costs of the venture but not the rewards or its management”.

Many of the problems associated with setting up joint ventures and trying to make them work stem from the fact that the parties involved do not specify or agree on a shared set of goals from the outset: how the venture is going to be managed and resourced, what its life cycle should be, and what happens when one or more of the parties wants to exit.

Abby Ghobadian, professor of organisational performance at Henley Business School, says that “all parties need to be clear about the purpose of the joint venture, and [ensure] that their goals and expectations are aligned. They also need to be clear about the level of financial and managerial commitment: how is the venture going to be run, for how long, by whom, and how will an appropriate level of resources be allocated to it. The project will soon become difficult to manage if these issues are not decided from the outset.”

A detailed financial commitment from all parties involved in the joint venture can help maintain focus, says Ghobadian.

“If companies put equity into a joint venture, there is a high-level commitment to make the project work,” she explains. “On the other hand, with non-equity strategic alliances, such as co-branding or joint procurement agreements, or a relationship where the larger industry player takes a stake for offering industry expertise rather than cash, there can be difficulties in trying to get broad engagement. This is particularly true if the nature of the joint venture is not really core to the business of one of the parties involved. Different-sized stakes for each party can also cause difficulties in allocating time and management commitments.”

Brian Livingston, director and head of M&A in the corporate finance team at accountants Smith & Williamson, says that companies need to be clear about who is going to be running the new entity, and how its staff and management team are going to be appointed.

“It may seem obvious, but the first point to establish is who is actually going to run the venture,” says Livingston. “While the parties may have equal shares, there may be an expectation that one will do more of the day-to-day running and use more of its resources to make it a success. It needs to be clear from the outset how the parties are going to manage it, and who will be involved from each company. It also needs to be made very apparent that the venture is being run in the interests of all parties, and not just one of the shareholders.”

Andrew Hornigold, a partner at international law firm Pinsent Masons, says that most joint ventures are separate limited liability companies with their own boards, often nominated by the participants. However, he adds that “this can lead to directors facing conflicts between the joint venture company’s interests and those of his nominating participant”.

Exit strategy

Experts also largely agree that one of the thorniest areas of setting up a joint venture is agreeing how a party can exit from it. If one participant wants to sell, the other party or parties normally have pre-emption rights before the interest can be sold to a third party. To set this up, the parties must agree in advance a methodology for determining a fair price. This may vary depending upon the circumstances of the exit. If the exiting party has defaulted by breaching the agreement between the parties, for example, the exit may be compulsory, and the company must sell at a price that reflects the default.

“A joint venture is like a prenuptial before a divorce – each party needs to make sure that they know what they are responsible for and what they will get if they exit the arrangement,” says Livingston.

In particular, lawyers say that companies need to be very wary of some exit strategies, such as so-called Texas shotgun clauses. In a Texas shotgun, one member picks a price at which that company will buy out the other member. The other member can either accept the offer and sell its interest at that price, or buy the offering member’s interest at the same pro rata price. In cases where the parties are deadlocked, more exotic exit arrangements such as the Russian roulette (an offer to buy or sell) or the Mexican shoot-out (a sealed bidding system) can be employed.

“In all cases, the common theme in any successful relationship is that the parties discuss the permutations at the outset,” says Hornigold. “No single solution is perfect, but finding a method that the parties believe is fair is the key to avoiding future heartache.”

Read more
Leadership & Management
Leadership & Management
Leadership & Management
Leadership & Management
Leadership & Management

DHL Supply Chain CFO: Why culture and communication matter more than ever

By Becky Taylor, CFO at DHL Supply Chain UK and Ireland