Why Joint Ventures Die

1. Why Joint Ventures Die • Companies cite joint ventures and alliances as illustrations of their bold strategies, and observers often interpret them as signaling new eras of cooperation in industries. • Yet the very pressures that typically give rise to alliances can also spell alliance failure. Not only does a joint venture face the usual competition of the market, it also is caught in the conflict between the partners. As a result, ventures are usually fragile. • Why do they die? Understanding why and how joint ventures die gives insight into how firms can make better use of them. Even though we focus on termination, it is worth reviewing the fundamental conditions that give rise to alliances in the first place because these fundamentals will help explain terminations.

2. Motivation for Joint Ventures A joint venture: • Occurs when two or more firms combine a part of their resources within a common legal organization. • One of the alternative modes which two or more firms can transact business. Reasons given by CEOs for choosing joint ventures range from these benefits: • Sharing risk • Exploiting economies of scale • Exchange of technologies • Differential abilities And In many cases, these are promoted by governments who stipulate shared ownership as the only channel by which to invest in a country, and the most common reasons are fear, profit, and learning.

3. 1. Fear It usually labeled “transaction cost theory”. When two firms transact on a long-term basis, problems usually arise due to the difficulty of these issues: • Settling future prices • Guaranteeing quality and delivery • Safeguarding technological • Strategic decisions As there is no guarantee that it would not fail, the necessity of stipulating contractual conditions increases with the complexity of the transaction and the difficulty of monitoring behavior. Also, contractual clauses regulating the development process are difficult to write and to enforce. Example: A supplier that initially gives a low price may claim unexpected costs in developing a new process. The fears in relying on an outside supplier increase when the buyer has to design specific components and is dependent upon the goodwill in the relationship that is not certain. The reasons why a joint venture tends to be the best alternative: • It requires mutual commitment of investment. • It provides incentives for both parties to perform according to their obligations. • It holds each side’s investment vulnerable to loss in the case of breach of contract or poor performance.

4. Lessons for the Design of Joint Ventures • Understanding of the reasons why joint ventures die gives some rules on how they should be designed. And there is no failsafe method of designing business plan and implementation. • A joint venture is especially difficult for simple reasons: • It is under the ownership of more than one firm. • Contracts do not make good reading. It is unlikely that any advice can make these contracts slimmer, but the following considerations might eliminate the need to reread the terms as often.

5. II. Profit • Increasing profitability can be gain by one of two ways • Between the firms in oligopoly, joint ventures can stabilize competition and improve industry returns • Boosted profitability can come from the reduction of costs or the creation new products and technologies. It can affect the competitive positioning of the partners in their industries • The example is the tie-up between General Motors and its Korean partners

6. General Motor and its Korean Partners • They facilitated the export of low-cost vehicles from Korea through a well-established distribution network in the U.S. • The cooperation between two companies served to slow the penetration of uncontrollable Japanese competitors, who were seeking to upgrade their auto lines into higher-priced level on the basis of profits earned on their commodity vehicles sales.

7. II. Profit (con’t) • Fear and profit are not mutually exclusive when firms cooperate by contract, by merging, or by frequent launches between the top management in an effort to improve their strategic positioning. • If the cooperation requires the disclosure of secrets, the transfer of technologies, or the sharing of brand labels, fear of the misuse of these assets will drive the partners to seek ways to enforce compliance with the agreement.

8. III. Organizational Learning • It is important to balance this perspective by considering the role of joint ventures in creating and transferring knowledge among firms. • Sharing knowledge is important in ventures between firms from different industries who seek to pool their distinct competencies. • Example of a joint venture between Honeywell and Ericsson

9. Honeywell and Ericsson • The purpose was to develop a telecommunications switch for the U.S. market. • Honeywell had considerable in-house expertise in software features desired by the end users, as well as, the ability to run a development facility in the U.S. • Ericsson had the switch technology and several years of experience in the international to development and sales of the product. • The development efforts resulted in a product that is fully adapted to the target market.

10. III. Organizational Learning (con’t) • Knowledge can be transferred through a license or outright sale. The choice in forming joint venture may not be driven by fear but by the difficulty of transferring knowledge that is organizational in character. • One reason why joint ventures are commonly used among firms in international markets is to exchange the distinctive managerial skills of countries.

11. Causes of Termination of Joint Venture • Here is a sample of ninety-two manufacturing joint ventures formed in the United States in the late 1980s and early 1990s. • What form does termination took? • complete dissolution of the venture • represent a business failure on one hand, but can also reflect a fundamental conflict among the partners. • the acquisition of one partner’s share by the other or of one or both shares by a third party • regardless of the reasons for the differences in valuation.

12. Causes of Termination of Joint Venture (Con’t) From the data, it compared the share of joint ventures that died in each year, as a share of total ventures still existing in that year On average, about 13 percent of joint ventures existing at a given moment tend to die within the year, and roughly half of them by dissolution and half by acquisition. The data in this sample suggests that the third year of a joint venture is particularly hazardous, but much depends on external circumstances in the industry.

13. Causes of Termination of Joint Venture (Con’t) Deeper analysis revealed other interesting patterns. Acquisitions of joint ventures were more likely to occur under two kinds of industry conditions: few competitors and unexpected growth • few competitors In concentrated businesses, industries where a few firms dominate, joint ventures often serve two functions. • to restrict output and avoid price wars • to extend the life span of a firm that can no longer go at it alone in the industry

14. Asea Brown Boveri (ABB) and Westinghouse • The industry was concentrated and mature. Therefore, in the case of termination of the venture, it benefited the industry that one of the parties acquire the operation rather than leaving both parties to invest separately in further plant capacity. • the venture contract gave ABB a call option to buy the venture and Westinghouse a put option to sell. • The firm might prefer this way of divesting the business because it could not commit to divest it fully right away, or because the arrangement provided a hand-holding service until ABB could run the U.S. operations alone.

15. Causes of Termination of Joint Venture (Con’t) • The analysis of dissolutions presents a radically different profile. A primary factor in dissolution is whether or not the parties have other business agreements. Stability, in other words, is stronger between partners who have a history of partnership. • The study of joint venture termination provides two fundamental findings • ventures are often options to divest or to expand depending on the market • their stability is strongly affected by the familiarity and commitment of the partners.

16. Do not burden the JV • It is logical that partners will try to make sure they are getting something out of the venture. • In doing so, both generally suffer the temptation to burden the venture with excessive channels of remuneration. • Transfer prices on goods sold or bought from the venture of licensing fees and royalties.

17. This involve a fundamental problem: the financial evaluation look different to each partner. • Except there is a healthy venture, not only will one partner be more upset than the other but the management of the venture itself will be jeopardized. • To solve this problem, design the venture so that partners are equally interested in the profitability of the concern. • Let dividend be the primary source by which profits are divided. • Backdoor channels are encourages when governments impose rules on how equity is shared.

18. Choose the right benchmark for evaluation • Unreasonable expectations will plague the long term evaluation of the venture. • It is essential that the JV managers remember why they did the deal in the first place. • Consider the agreements signed by Honeywell in computers, Firestones in tires, etc : were these firms no longer willing to go at it alone? • In this case, the benchmark should be how the return on the venture compares to an outright divestment.

19. Build for the future • As in a business, the working out of conflicts and challenges requires the participation of effective managers. • It is important that the venture be supported by a wider relationship among the partners. • A harder task is to work out how the relationships of each partner, with other players in the industry, affect cooperation.

20. But as many firms have learned to their dismay, the growing number of joint ventures leads to unusual patterns of coalitions in an industry. • No joint venture should be accomplished without an analysis of the wider industry cooperative relationships as they stand today—and as they may evolve tomorrow. • Joint ventures in particular are often stepping-stones to something else. As tools of transition, they must be designed for success, but also with the flexibility for change. Managers should thus enter and manage these ventures with an understanding of how and why alliances die. • No organization is forever.