Vertical and Horizontal Alliances

1. Vertical and Horizontal Alliances James Oldroyd Kellogg Graduate School of Management Northwestern University j-oldroyd@northwestern.edu 801-422-7888 650 TNRB

2. Alliances-How far have we come? • “Alliances are mere transitional devices and because of this they are destined to fail” • Michael Porter • “Many so-called alliances between Western companies and their Asian rivals are little more than sophisticated outsourcing arrangements -- the traffic is almost entirely one way” • Hamel, Doz, and Prahalad • “Avoid alliances like the plague.” • Reich and Mankin

3. Alliances Growing as a Source of Revenue Alliances as a Percentage of Revenue for Top 1,000 U.S. Public Corporations Source: Columbia University, European Trade Commission, Studies by BA&H, AC.1983-1987, 1988-1993, 1994-1996, 1999

4. Total business conducted through alliances 50% 40% 40% 30% 30% 20% 20% 10% 3-5% 0% 2000 2005 2010 1990 Source: EIU Global Executive Survey Andersen Consulting, Warren Company

5. Alliances-How far have we come? • “If you think you can go it alone in today’s global economy, you are highly mistaken”(Jack Welch, CEO of GE) • “Microsoft can’t make it alone, but together anything is possible.”(Bill Gates, Chairman of Microsoft) • “Our approach is to develop long term relationships with companies that offer a unique advantage with General Motors. The Alliance Strategy is our major thrust.”(John F. Smith, Jr., Chairman & CE of General Motors)

6. Corporate Evolution and Alliances • Moving from Managing a Portfolio of Products... • To Managing a Portfolio of Businesses... • To Managing a Portfolio of Relationships

7. Alliances vs. Acquisitions: Stock Market Response to Announcements Average Stock Market Gains(Average over 10 day window following announcement) .84 percent Percent Stock Market Gains Following Announcements (in percentages) 0 percent Alliances* Acquisitions** (Acquirers) * Source: Dyer, Kale & Singh, 2001 ** Source: Bradley, Desai, & Kim, 1988

8. IN TODAY’S NEWS, OUR COMPANY HAS DECIDED TO BUY ANOTHER DYING COMPANY IN A BUSINESS WE DON’T FULLY UNDERSTAND. OUR STOCK ROSE FIVE POINTS ON THE ANNOUNCEMENT I LIKE TO THINK OF IT AS OUR COMPETITIVE ADVANTAGE. WHY DOES OUR STOCK GO UP EVERY TIME WE DO SOMETHING BONEHEADED?

9. THE STATUS OF OUR STRATEGIC ALLIANCE IS “DOOMED.” OUR PONDEROUS AND INEFFICIENT MANAGEMENT SYTLE CAUSED THEIR BEST PEOPLE TO QUIT AND CREATE A COMPETING COMPANY. WE MUST FIND A WAY TO DESTROY THAT NEW COMPANY. I’LL SEE IF THEY’RE INTERESTED IN A STRATEGIC ALLIANCE.

10. Benefits: Speed (vs. acquisition or greenfield) Access to key complementary assets Removal of potential competitor Maintain incentives for partner management Drawbacks: Lack of control; must share decision making Potential spillover of knowledge and capabilities Organizational clashes may impede ability to collaborate Strategic Alliances

11. HISTORICAL VISION PARTNERSHIP VISION TOTAL SYSTEM ECONOMICS • INTERNAL FOCUS 100% 80% CUSTOMER 50% ECONOMICS 60% MY 20% MY ECONOMICS 40% ECONOMICS SUPPLIER 20% 30% ECONOMICS 0%

12. CREATING VALUE BY FOCUSING ON THE SYSTEM TRADITIONAL RELATIONSHIP STRATEGIC PARTNERSHIP VALUE TO CUSTOMER VALUE TO CUSTOMER VALUE TO SUPPLIER VALUE TO SUPPLIER

13. EXPANDING THE PIE • Leverage the full resources of suppliers to create value for the end customer • Develop partnerships with key suppliers to optimize the system (lower total systems costs)

14. Toyota Engineering (7,000 Engineers) LEVERAGING THE RESOURCES OF PARTNERS Remaining 250 Tier I Suppliers (10-15,000 Engineers Top 35 Affiliated Suppliers (5-6,000 Engineers) Toyota can leverage its value creation resources by 5-15x by involving suppliers in the Extended Enterprise

15. THE VALUE OF A NETWORK CHANGES AS MEMBERSHIP INCREASES Single Firm 3-Firm Network 6-Firm Network Connections: 0 3 15 Directions: 0 6 30 As the number of nodes in a network increases arithmetically, the value of the network increases exponentially (n2 growth). Small improvement efforts that ripple through the network can dramatically increase the value for all members.

16. Toyota’s Supplier – Customer Interface Surface Contact vs. Multiple-Point Contact (Correct) Top Execu- tives R & D R & D Top Execu- tives Manufacturing Manufacturing Quality Assurance Quality Control Quality Assurance Quality Control Sales Purchasing Point Contact (Wrong) Customer Supplier

17. CREATING EFFECTIVE PARTNERSHIPS • Build supplier trust • Use new processes of supplier selection and evaluation • Create multiple functional interfaces to facilitate system learning • Make dedicated/customized investments

19. Multi Functional Interface Individual owns the process • Risks: • Your Employees can be Bought by Competition • Customer Contact Changes • Benefits: • Clear Accountability • No Redundancy Your Firm Customer’s Firm Organization owns the process • Risks: • Multiple Sales People with Competing Priorities • High Coordination Costs • Unable to Bring it All Together for the Customer • Benefits: • Relationships are “Sticky” • Relationships cut across multiple dimensions Coordinated by an Account Manager Your Firm Customer’s Firm

20. THE FUTURE…. • Supply chain management will become increasingly important for competitive advantage • Teams of companies will increasingly compete with other teams (extended enterprise); lean teams will win • Leveraging the full resources of the extended team will be critical • Leading companies will increasingly use partnerships--though not with all suppliers

21. Horizontal Alliances

22. Deals-off WallStreet Journal Sep 27, 2001Coca-Cola Co. and Procter & Gamble Co. said they abandoned plans to create a $4.2 billion joint venture combining their juice and snack businesses, in a move that analysts say is good for Coke but leaves P&G to deal with two underperforming brands on its own. The joint announcement comes nearly two months after the two sides signaled they were discussing paring back the deal to a "partnership" focusing on research and development of new juice products. P&G had also hoped to include the distribution of its Pringles potato chips on Coke trucks. Instead, the two companies said they now will "independently pursue opportunities to grow their respective businesses."

23. In the News – Cokes New Focus Coca-Cola and P&G agreed in September to abandon their idea of a joint venture to market Minute Maid juices and P&G's Sunny Delight and Pringles. The deal would have combined a fast-growing Coke business with two declining P&G brands. In the process, Coca-Cola came to a realization it might have made earlier: that Minute Maid could play a key role in the Atlanta company's drive to expand beyond carbonated soft drinks.It is part of an effort to more effectively integrate Minute Maid and other Coca-Cola noncarbonated businesses into a global distribution system that has long focused on soft drinks, according to Steven Heyer, a Coca-Cola president who oversees noncarbonated beverages and marketing. A top priority, Mr. Heyer says, is to create global brands out of existing products.Among Minute Maid's recent offensives: a new orange juice. Primarily a producer of orange juice that is mixed from concentrate, Minute Maid threw in the towel earlier this year to Tropicana and other makers of freshly squeezed and processed juice by introducing Simply Orange, a new "not from concentrate" juice. Minute Maid set its new product apart from competitors with its package, an attractive clear-plastic carafe.

24. Wallstreet Journal June 3, 2002 CINCINNATI -- After nearly becoming joint-venture partners last year, Procter & Gamble Co. and Coca-Cola Co. are fighting over the lucrative business of adding calcium to orange juice. P&G filed a patent-infringement suit against Coke on Friday, alleging that the Atlanta beverage company wrongfully used a technology it licenses exclusively to Coke's main rival. In a complaint filed in U.S. District Court in Cincinnati, P&G claimed that Coke's Minute Maid Premium Calcium Original and Premium Calcium Home-Squeezed Style orange juices are using a calcium-fortification technology that P&G developed and licenses exclusively to the Tropicana juice unit of PepsiCo Inc. Alleging "severe and irreparable" damage, the Cincinnati consumer-products company said it is seeking an injunction to stop the alleged violation of its patent, which it received in 1988. P&G also said it is seeking monetary damages and interest. A Minute Maid spokesman called the suit "totally without merit" and said Minute Maid has produced calcium-fortified juice since 1987 under a technology it developed itself, has held a patent on that technology since 1989 and hasn't changed its process for adding calcium.

25. The Scope of Inter-corporate Linkages Contractual AgreementsEquity Arrangements Traditional Nontraditional No New Firm Creation of Entity Dissolution Contracts Contracts of Entity Arm’s-length Joint Research Minority Nonsubsidiary JV Mergers and Buy/Sell Equity JVs Subsidiaries Acquisitions Contracts Investments of MNCs Franchising Joint Product Equity Fifty-fifty Development Swaps Joint Ventures Licensing Long-term Unequal Sourcing Equity Agreements Joint Ventures Cross- Joint Manufacturing licensing Joint Marketing Shared Distribution/ Service Standard Setting/ Research Consortia Strategic Alliances Based on: Yoshino and Rangan, 1995

26. Reduce Risks Size or Uncertainty Associated with Project Preempt Competitors Flexibility/Option Value Gain Efficiency Economies of Scale and/or Scope Speed to Market Access Complementary Skills New market entry; synergy-sensitive skills Learning Acquire New Skills Gain Market Knowledge and Experience Monitor Competition Politics Sensitive Industries Regulations Market Access Why Seek a Partner? 1 4 2 5 3

27. Challenges for Horizontal Alliances • Leveraging each partner’s resources while protecting proprietary know-how; many horizontal alliances are inherently learning races. • Building trust with potential competitors; simultaneously cooperating and competing (Co-opetition) • Less ability to “control” partner decisions (relative to supplier alliances). 1 2 3

28. Favorable Conditions for Horizontal Alliances • The partner’s strategic goals converge while their competitive goals diverge. • (e.g., Philips and Du Pont collaborate to mfg. compact disks; neither invades the other’s market) • The size, market power, and skills/resources of partners is modest compared with industry leaders; an attempt to catch up. • (e.g., Japanese chipmakers collaborate to develop chips; U.S. automakers collaborate on autobody and battery technology). • Each partner believes it can learn from the other and at the same time limit access to proprietary skills • (e.g., Xerox and Fuji alliance; Xerox gets access to Japanese market and technology in Japan; Fuji participates in copier business; Fuji believes it can protect film business while Xerox believes it can protect worldwide copier business)

29. The Logic for Joint Ventures • Alliance objective is characterized by a high degree of uncertainty, such as R&D alliances (need incentives to bring best technology) • Desire to create a “new culture” (resources, processes, values) that fit the new opportunity. • Desire to limit liability of parent companies. • Superior way to measure alliance performance (separate P&L)

30. Keys to Horizontal Alliance Success • Identify Partners with: • Strategic Fit: Compatible resources, assets, and capabilities • Cultural Fit: Compatible cultures and work processes • Establish clear performance objectives & monitor performance • for the alliance and requirements for each partner; make technology transfer dependent on meeting performance requirements • Develop plan to learn from partners • Invest in absorbing key skills/technology from partners while protecting protect proprietary knowledge/skills as much as possible. • Use appropriate “governance” mechanisms • Build trust and align the incentives of partnering firms (e.g., joint stock ownership is superior to legal contracts for eliciting knowledge transfer). • Create a “Strategic Alliance” function in your firm • Assign responsibility to acquire and codify knowledge with regard to effective alliance management practices.

31. Optimal Strategic Alliance Solution Compatibility No but few Redeeming Synergies Value The Importance of Strategic and Cultural Fit Good Commercial Compatibility but High Organizational Integration HOWEVER, Difficult Remember Strategic Fit that it is the differences between the organizations that drive the formation of the alliance Low Low High Organization/Cultural Fit

32. The New Environment

33. Unprecedented visibility, quantity, quality and immediacy of information • Information costs are rapidly falling • Information asymmetries are disappearing • Markets (and in particular, prices and inventories) are becoming more transparent • Intellectual property is increasingly difficult to protect Information and transaction costs are disappearing • Opening of regulated markets • Fewer impediments to cross-border business • Single currency zones • Countries are competing with one another, offering aggressive incentives to attract companies • Fading cultural and language barriers Global boundaries falling • Increased growth and earnings pressure, shorter CEO tenures • Slowness is equated with unnecessary cost • Unnecessary cost are more visible and unacceptable • The rapid pace of technology change has infected everything Speed is driving value more than ever The economics of business are changing

34. Implications Company Implications Information and transaction costs are disappearing Harness savings with suppliers & squeeze costs out of the supply chain. Know customers intimately Good Bad Customers have perfect clarity of problems. Must deliver real value better than competitors. Can’t protect information Opportunities for new markets and globalization of production, sales and service Global boundaries falling Good Bad Increased competition, increasingly complex production, sales and service Focus on core business and provide best in class solutions. Use alliance to create complete customer solutions Good Speed is driving value more than ever Bad Become obsolescent rapidly. No long term success

35. ge led ow Kn Facets of Alliances Customers IPO Services NewVentures Suppliers CoreBusiness Services Competitors Alliance Partners Focus New Collaboration Ventures Self Correction INTEGRATION SEPARATION Source: Booz Allen and Hamilton

36. Monolith Inc. High value addedstep retained Sourcing Distribution Outsourced to low costprovider New companiesappear “instantly” These changes are restructuring industries and affecting how value is captured • Every crack of the value chain is infiltrated • Value chains are broken up, each link eliminated and/or optimized • Rapid adaptation is essential to survival • Each transaction exposed to the scrutiny of consumers and competition • Business forced to operate more globally than ever before

37. The Alliance Organization is greater than the sum of its parts THE SCOPE BECOMESLESS AND LESS... YET THE ORGANIZATIONACHIEVES MORE AND MORE • The organization accesses capabilities throughout the alliances • It may build, buy, borrow or lease depending on the circumstances • The network is greater than the sum of its parts • The Alliance Organization focuses on what it does best • It pushes all other activities outside its boundaries

38. The Alliance Organization organizes around and builds network equity • The Alliance Organization must manage its network equity: the value of the firm’s network of relationships with its customers, suppliers, alliance partners, and competitors • Companies have built great expertise and elaborate processes for managing physical assets (manufacturing facilities, products, retail locations) • The challenge is to shift to managing network relationships and treating these as assets • Companies must also shift from functional organization structures to relationship based structures • Many companies now have a new organization called business development that creates, broadens, and deepens network equity over time

39. COMPETITION Networks are competing with each other, for example, in the airline industry

40. COMPETITION 21,000 Financial institutions 23,000 Financial Institutions Credit cards and e-commerce

41. Austria • Belgium • Denmark • Finland • France • Germany • Greece • Ireland ArgentinaBolivia Brazil Chile ParaguayUruguay   Cambodia  Indonesia  Laos  Malaysia  Myanmar  Philippines  Singapore  Thailand  Viet Nam • Italy • Luxembourg • Netherlands • Portugal • Spain • Sweden • United Kingdom of Great Britain and Northern Ireland COMPETITION Mexico US Canada Governments

42. InsourcedDecentralizedHR Services Bypass Shared Services and Leapfrog to Outsourcing Typically30-40%CostDifferential InsourcedHR SharedServices OutsourcedHR SharedServices Powerful economic forces are driving disaggregation • Transaction Cost Comparisons CONCEPTUAL Higher People &TechnologyInvestment Cost PerEmployee Typical Large Company(50,000 Employees) Outsourcer(1,000,000 Plus Employees) Source: Booz·Allen & Hamilton

43. Frequency of Alliances Percent of revenues from core business 1998 1998 1980 1980 Source: Dr. Peter Pekar, Jr.

44. Dell Case • Dell is the #1 PC company • Relentless focus on PC business. Reinvestment in core processes . • Inventory about 2 days • $7.3 billion profit over the last 10 years • Compaq lost the #1 PC company slot • Purchased service business from Digital Tandem Computers, and $100 million investment in a biotech company • Inventory about 60 days • $1.8 billion loss over the last 10 years

45. Leading companies balance tensions between the core business and the new venture... Core Wants... Venture Needs... Tension Core Assets Leverage core assets Protect core assets Experienced personnel from core Keep top talent Human Resources Rewards Entrepreneurship, risk taking Fairness and equity Leadership Strategic guidance, expertise New Venture Develops Distinctive New Venture Develops Similar Or Focus on core business Offering From Core Competing Offering With Core New revenue streamsmay compete Revenues/Growth New Venture Establishes Separate New Venture Leverages Core Assets Growth of traditional streams Assets (including brand) To Create New Offerings Redirection of financialresources New Venture Establishes Separate, Financial Resources New Venture Follows Core Company Continued investment in core Fast Track Decision-Making & Processes And Procedures Governance Processes Established policies and procedures Rapid decision making, tolerance of risk Speed & Flexibility New Ventures Sources New Ideas New Venture Sources Ideas From Independently Core Business Core business to contribute New Venture absorbs All New Ideas Control of new ideas Originator Of Idea In Core Involved Idea Sharing And Develops Independently With Development Of Idea Source: Booz·Allen & Hamilton

46. Importance of Speed Virtually every technology is guaranteed to become a commodity within 18 to 25 months. Once you acknowledge that, the only thing needed to ensure winning form is constant innovation. Naveen Jain founder of InfoSpace

47. Separation Hybrids Integration • BarnesandNoble.com • Wal-Mart.com • Nordstrom.com • Rite Aid and Drugstore.com • KBkids.com (KB Toys and BrainPlay.com) • Covisint (Autos) • EnergyLeader.com (Mid-Atlantic Utilities) • ForestExpress.com (Paper Products) • Land’s End • Office Depot • Walgreen’s • Target.com New Economy Organizational Structure The integration-separation decision need not be an “all or nothing” strategy. Choices exist along a continuum and it is possible to operate more than one model at the same time.

48. …By using key organization design levers such as establishing a separate organization structure Organization of New Ventures Efforts Embedded (9%) Hybrid (17%) Separate (74%) Total =23 (1) “Separate” refers to the establishment of a separate subsidiary or division (2) “Hybrid” refers to the combination of a separate subsidiary or division and embedded new venture efforts (3) “Embedded” refers to new venture creation and/or capture that lies within each business unit or division Source: BA&H Analysis

49. The Network Organization increases collaboration throughout the industry Suppliers New Ventures Complementors Competitors Core Business Customers Disintermediation End Customers Source: Booz·Allen & Hamilton

50. ROI for Alliances *top 1,000 public corporations in US Source: Dr. Peter Pekar Jr.