STRATEGIC ALLIANCE

STRATEGIC ALLIANCE

From software to steel, aerospace to apparel, the pace of strategic alliances worldwide is accelerating. A strategic alliance is an agreement between firms to do business together in ways that go beyond normal company-to-company dealings, but fall short of a merger or a full partnership. Strategic alliances can be as simple as two companies sharing their technological and/or marketing resources. In contrast, they can be highly complex, involving several companies, located in different countries. Strategic alliances are becoming more and more prominent in the global economy.

 

Strategic alliances enable business to gain competitive advantage through access to a partner’s resources, including markets, technologies, capital and people. Teaming up with others adds complementary resources and capabilities, enabling participants to grow and expand more quickly and efficiently. Strategic alliances also benefit companies by reducing manufacturing costs, and developing and diffusing new technologies rapidly. Any firm opting for strategic alliance incurs certain costs and risks compared to a firm going alone. These risks include the loss of operational control and confidentiality of proprietary information and technology. In addition, the parties may deprive themselves of future business opportunities with competitors of their strategic partner. Alliances also raise the spectre of potential conflicts, loss of autonomy, difficulties in coordination and management, mismatch of cultures, etc.

 

TYPES OF STRATEGIC ALLIANCES 

Firms can enter into a number of different types of strategic alliances. These could include comparatively simple, more “distant” arrangements in which firms work with one another on a short-term or a contractually defined basis where the two parties effectively do not combine their managers, value chains, core technologies, or other skill sets. Examples of such simpler alliance vehicles include licensing, cross marketing deals, limited forms of outsourcing, and loosely configured customer supply arrangements. On the other hand, companies may seek to partner more closely in their cooperative ventures, combining managers, technologies, products, processes, and other value-adding assets in varying ways to bring the companies more closely together. Examples of alliance modes in this league include technology development pacts, coproduction arrangements, and formal joint ventures in which the partners contribute a defined amount of capital to form a third party entity. Finally, in even more complex strategic alliance arrangements, partners can take significant equity stake holdings in one another, thus approximating many organizational and strategic characteristics of an outright merger or acquisition.

 

In a study by Coopers and Lybrand (1997), they identified the following types of alliances, and found their clients were engaged in them as follows:

 

1.   Joint Marketing/Promotion, 54 per cent;

2.   Joint Selling or Distribution, 42 per cent;

3.   Production, 26 per cent;

4.    Design Collaboration, 23 per cent;

5.   Technology Licensing, 22 per cent;

6.   Research and Development contracts, 19 per cent;

7.   Other outsourcing purposes, 19 per cent.

 

Technology Associates and Alliances, a strategic alliance consulting company, lists the following types of alliances:

 

1) Marketing and sales alliances:

a)   joint marketing agreements;

b)   value added resellers.

2) Product and manufacturing alliances:

a)   procurement-supplier alliances;

b)   joint manufacturing.

3) Technology and know-how alliances:

a)   technology development;

b)   university/industry joint research.

Technology Associates and Alliances, suggests that alliances can be hybrids between these different types. For example, an R&D alliance may be a cross between a product and manufacturing alliance and a technology and know-how alliance, and a collaborative marketing agreement is a cross between a marketing and sales alliance and a product and manufacturing alliance. The important thing to remember is that there are various types of alliances, and they may range from simple licensing arrangement, ad hoc alliance, joint operations, joint venture, consortia, distribution, and value-chain partnership alliances to more complex hybrid alliances.

 

The simplest form of strategic alliance is a contractual arrangement. Contractual based strategic alliances generally are short-term arrangements that are appropriate when a formal management structure is not required. While the specific provisions of the contract will depend upon the business arrangement, the contract should address:

 

a)   The duties and responsibilities of each party;

b)   Confidentiality and noncompetition;

c)   Payment terms;

d)   Scientific or technical milestones;

e)   Ownership of intellectual property;

f)    Remedies for breach; and

g)   Termination                  

 

Examples of contractual strategic alliances are license agreements, marketing, promotion, and distribution agreements, development agreements, and service agreements.

 

The most complex form of strategic alliance is a joint venture. A joint venture involves creating a separate legal entity (generally a corporation, limited liability company, or partnership) through which the business of the alliance is conducted. A joint venture may be appropriate if:

 (i) the parties intend a long-term alliance;

(ii) the alliance will require a significant commitment of resources by each party;

(iii) the alliance will require significant interaction between the parties;

(iv) the alliance will require a separate management structure; or

(v) if the business of the alliance may be subject to unique regulatory issues.

 

 In addition, a joint venture will be appropriate if the parties expect that the alliance ultimately may be able to function as a separate business that could be sold or taken public.

 

Historically, information technology and life sciences companies have sought minority equity investments from strategic commercial partners. This form of strategic alliance has gained increased popularity in the current economic climate. In many cases, the equity investment will also be accompanied by a contractual arrangement between the parties such as a license agreement or a distribution agreement. From the company’s perspective, an equity investment from a strategic commercial partner may be structured on more favorable terms than those obtained from venture capitalists, and it may increase the company’s valuation and enhance the company’s ability to secure future rounds of funding. Venture capitalists and underwriters generally view these types of strategic alliances as validating an early stage company’s technology and business model. In some cases, they have even become a condition to an underwriter taking a life science company public. The strategic commercial partner may desire this form of alliance to gain a competitive advantage through access to new technologies and to share in the upside of the other party’s business through equity ownership. 

The following section will focus on three broad types of strategic alliances: 

A.   Licensing arrangements,

B.   Joint ventures, and

C.   Cross-holding arrangements that include equity stakes and consortia among firms.

 

Each broad type of strategic alliance is implemented differently and imposes its own set of managerial skills, constraints, and coordination requirements needed to build competitive advantage.

 

A.  LICENSING ARRANGEMENTS 

In most manufacturing industries, licensing represents a sale of technology or product based knowledge in exchange for market entry. In service-based firms, licensing is the right to enter a market in exchange for a fee or royalty. Licensing arrangements have become more pronounced across both categories. In many ways they represent the least sophisticated and simplest form of strategic alliance. Licensing arrangements are simple alliances because they allow the participants greater access to either a technology or market in exchange for royalties or future technology sharing than either partner could do on its own. Within the pharmaceutical industry, for example, many of the technology sharing arrangements that allow a licensee to produce and sell products developed by the licensor. The relationship between the companies does not go beyond this level. Unlike joint ventures or more complex cross-holding/equity stake consortia, licensing arrangements provide no joint equity ownership in a new entity. Companies enter into licensing agreements for several reasons. The primary reasons are :

 

(1) A need for help in commercializing a new technology, and

(2) Global expansion of a brand franchise or marketing image.

 

Nicholas Piramal India Ltd (NPIL), for instance, has recently entered into a 5-year in licensing agreement with Genzyme Corp, USA, for synvisc viscose supplementation in the Indian market. Synvisc, which is used for the treatment of osteoarthritis of the knee, has sales of $250 million in international market. It expects the market size in India to be about Rs.200 Million. Johnson & Johnson, is expanding involvement in and commitment to biotechnology through new partnerships, licensing agreements, equity investments and acquisitions. Through its excellence centres such as Centocor and Ortho Biotech, and its global research, development and marketing operations to form an integrated enterprise that is well positioned to deliver biotechnology’s extraordinary promise to patients and physicians around the world.

 

B.  JOINT VENTURES 

Joint ventures are more complex and formal than licensing arrangements. Unlike licensing, joint ventures involve partners’ creation of a third entity representing the interests and capital of the two partners. Both partners contribute capital, distinctive skills, managers, reporting systems, and technologies to the venture in certain proportions. Joint ventures often entail complex coordination between partners in carrying out value chain activities. Firms enter into joint ventures for four reasons:

 

(1) seeking vertical integration,

(2) needing to learn a partner’s skills,

(3) upgrading and improving skills, and

(4) shaping future industry evolution. 

Vertical integration is a critical reason why many firms enter joint ventures. Vertical integration is designed to help firms enlarge the scope of their operations within a single industry. Yet, for many firms, expanding their set of activities within the value  chain can be an expensive and time-consuming proposition. Joint ventures can help firms achieve the benefits of vertical integration without saddling them with higher fixed costs. This benefit is especially appealing when the core technology used in the industry is changing quickly. Joint ventures can also help firms retain some degree of control over crucial supplies at a time when investment funds are scarce and cannot be allocated to backward integration or when the company has difficulty in accessing the raw material. By partnering with the suppliers to form a strategic alliance the firm can increase the stability of its supplies. The organizations forming the alliance will have a common goal and be better integrated. This will ensure that they all have a shared interest in making certain that the alliance is successful, including ensuring the supplies of materials, information, advice or any other necessary input to the alliance is met in a timely, efficient and consistent manner. A case in point is the Jindal Stainless Steel Ltd (JSSL), which plans to source raw materials from abroad. The company is planning strategic alliances with companies in South Africa, South East Asia and Europe for long- term supplies of ferro chrome, chrome ore and nickel. The whole objective of the alliance is to ensure that supplies are managed efficiently with resultant improvements in profitability. A strategic alliance can also rationalize supply chains. By selecting integrated suppliers, the number of links in a supply chain can be significantly reduced.

 

Joint ventures are quite common in India. In the highly capital-intensive industries such as automobiles, chemicals, pharmaceuticals and petroleum industries, joint ventures are becoming more widespread as firms seek to overcome the high fixed costs required for managing ever more scale-intensive production processes. In all these industries, production is highly committed in nature, which means that it is difficult for firms on their own to build sufficient scale and profitability in products that often face highly volatile pricing and deep cyclical downturns when markets collapse.

 

For instance, Telco (now rechristened as Tata Motors) is the leader in the commercial vehicle segment with a 54% market share in Light Commercial Vehicle (LCV) and 63% market share in Medium & Heavy Commercial Vehicle (M&HCV) (2003 figures). It garnered a market share of 21% in the utility vehicle (UV) segment and a 9% market share in the passenger car industry in a short span of three years. The company is open to alliances, but is not willing to enter into any alliance without a strong underlying reason. The view of the top management is that a strategic alliance should bring complementary strengths together. Around 85% of the Indian market consists of small cars and this trend is expected to continue for the next 10-15 years. Tata Indica, which is one of the best and technologically contemporary value propositions available, caters to this segment. Hence the company is primarily interested in an alliance with a global major who can offer a better proposition in the small car market than the Indica and who already has a presence in India. Second, the company is looking for a strategic alliance to enhance their product portfolio in the more premium or niche segments and to open the overseas markets for them.

 

Firms often enter into joint ventures to learn another firm’s distinctive skills or capabilities. In many high-technology industries, many years of development are required before a company possesses the proprietary technologies and specialized processes needed to compete effectively on its own. These skills may already be available in a potential partner. A joint venture can help firms learn these new skills without retracing the steps of innovation at great cost. For example, Voltas plans on leveraging its technology-sharing alliances with overseas collaborators, and in seeking fresh ones, for serving the domestic market. In the Air Conditioning and Refrigeration business, Voltas a new generation of clientele, such as multiplexes, shopping malls, entertainment centres, and establishments in the private telecom industry and hospitality. More than mere cooling, these clients seek solutions encompassing ontrolled environments, with clean and pure air, and energy-efficient systems. The company is well placed to deliver these solutions by leveraging the competencies of its range of partners – for example, the success of the Vertis brand of room and split air conditioners is yet another example of the success of alliances. The Vertis brand features advanced technology from Fedders International Inc. USA, one of the world’s largest manufacturers of air conditioners, with whom the company has a “manufacturing-only” joint venture. This alliance has resulted in a brand, which has moved from fifth place to second place in the Indian market in the space of two years.

 

Joint ventures are instrumental in helping firms with similar skills improve and build upon each other’s distinctive competences. Even though some of these joint ventures are likely to involve rivals competing within the same industry, companies may still benefit from close cooperation in developing an underlying cutting-edge technology that could transform the industry. In anticipation of WTO, MNCs are strengthening their ranks in India (either setting up new 100% subsidiaries or marketing tie-ups with major domestic players. Large local players are consolidating through brand acquisitions, co-marketing/ contract manufacturing tie-ups with MNCs etc) and to counter this threat, Cadilla Healthcare Limited (CHL), for instance, has formed joint ventures in some of the high growth areas with CHL bringing to table its strength in manufacturing and marketing and JV partners bringing in the technology. Firms can cooperate in a joint venture to develop and commercialize new technologies that may significantly influence an industry’s future direction. The need to maintain industry dynamism and momentum in research is a motivating force that drives drug companies to engage in joint ventures, even when they compete in existing product lines.

 

C.  CROSS-HOLDINGS, EQUITY STAKES, AND CONSORTIA

 

The third category of strategic alliance includes some of the more complex forms of alliance arrangements. These alliances bring together companies more closely than licensing and joint venture mechanism. Broadly amalgamated together as consortia, these alliances represent highly complex and intricate linkages among groups of companies. The term consortia is used to focus on two types of complex alliance evolution:

 

(1) Multipartner alliances designed to share an underlying technology and

(2) Formal groups of companies that own large equity stakes in one another.

 

In either case, consortia represent the most sophisticated form of strategic alliance and involve complex coordination mechanisms that often go beyond the boundaries of individual firms .

 

BENEFITS OF STRATEGIC ALLIANCES 

 

In the new economy, strategic alliances enable business to gain competitive advantage through access to a partner’s resources, including markets, technologies, capital and people. Teaming up with others adds complementary resources and capabilities, enabling participants to grow and expand more quickly and efficiently. Strategic alliances also benefit companies by reducing manufacturing costs, and developing and diffusing new technologies rapidly. Alliances are also used to accelerate product introduction and overcome legal and trade barriers expeditiously. In this era of rapid technological changes and global markets forming alliances is often the fastest, most effective method of achieving growth objectives. However, companies must ensure that the objectives of the alliance are compatible and in tune with their existing businesses so their expertise is transferable to the alliance.

 

Many fast-growth technology companies use strategic alliances to benefit from more established channels of distribution, marketing, or brand reputation of bigger, better known players. However, more-traditional businesses tend to enter alliances for reasons such as geographic expansion, cost reduction, manufacturing, and other supply-chain synergies. As global market opens up and competition grows, midsize companies need to be increasingly creative about how and with whom they align themselves to go to the market.

 

Firms often enter into alliances based on opportunity rather than linkage with their overall goals. This risk is greatest when a company has a surplus of cash. In recent years, Mercedes-Benz and Toyota Motor Corporation have been investing surplus funds into seemingly unrelated businesses, with Benz already facing difficulties as a result. Especially fast-growing companies rely heavily on alliances to extend their technical and operational resources. In the process, they save time and boost productivity by not having to develop their own, from scratch. They are thus freed to concentrate on innovation and their core business.

 

1.   Entering New Markets 

The Coopers & Lybrand study rates growth strategies and entering new markets among the top reasons for forming strategic alliances (Coopers and Lybrand, 1997). As Ohmae (1992) points out, (companies) simply do not have the time to establish new markets one-by one. In today’s fast-paced world economy, this is increasingly true. Therefore, forming an alliance with an existing company already in that marketplace is a very appealing alternative. Partnering with an international company can make the expansion into unfamiliar territory a lot easier and less stressful for a company. According to the Coopers & Lybrand (1997) study, 50 percent of firms involved in alliances market their goods and services internationally versus 30 percent of non allied participants. For instance, Tata Motors has short listed Brilliance Automotive Holdings of China to set up a joint venture for producing cars. Tata Motors, which recently acquired the commercial truck facility of Daewoo Motors in South Korea for Rs.465 crore, is also reported to be scouting for another joint venture in Northern China in order to have a full-fledged presence in China.

 

Often a company that has a successful product or service has a desire to introduce it into a new market. Yet perhaps the company recognizes that it lacks the necessary marketing expertise because it does not fully understand customer needs, does not know how to promote the product or service effectively, or does not understand or have access to the proper distribution channels. Rather than painstakingly trying to develop this expertise internally, the company may identify another organization that possesses those desired marketing skills. Then, by capitalizing on the product development skills of one company and the marketing skills of the other, the resulting alliance can serve the market quickly and effectively. Alliances may be particularly helpful when entering a foreign market for the first time because of the extensive cultural differences that may abound. They may also be effective domestically when entering regional or ethnic markets. Asian Paints, the largest paint-maker in India, acquired a strategic stake in Singapore-based Berger International in 2002. Asian Paints now appears to be trying to gain control over the Berger brand in some key regional markets like Pakistan. Berger International, which is now a subsidiary of Asian Paints, has entered into a strategic alliance with Karachi-based Berger Paints Pakistan, which is owned by the Mahmood family. Berger International will provide technical consultancy and strategic advice to Berger Pakistan, which is the second largest paints company in Pakistan. Berger Pakistan will also have the right to import products from Asian Paints.

 

2.   Reducing Manufacturing Costs 

Strategic alliances may allow companies to pool capital or existing facilities to gain economies of scale or increase the use of facilities, thereby reducing manufacturing costs. In the increasingly competitive European automobile market, when the Japanese are seeking to gain market share as they did in the U.S. during the 1980s, many European companies have formed joint ventures to reduce manufacturing costs. Ford and Volkswagan are jointly planning to make four-wheel-drive vehicles in Portugal, and Nissan and Ford intent to build a plant in Spain to produce vans. These companies will benefit from cost sharing and will reduce expenses by building and operating facilities in relatively low-cost countries, at least by West European standards. Companies may also reduce costs through strategic alliances with suppliers or customer reaching agreements to supply products or services for longer periods and working together, meet customers’ needs, each partner may apply its expertise, and benefits may be shared in the form of lower costs or new products.

 

3.   Developing and Diffusing Technology

 

Alliances may also be used to build jointly on the technical expertise of two or more companies in developing products technologically beyond the capability of the companies acting independently. Not all companies can provide the technology that they need to effectively compete in their markets on their own. Therefore, they are teaming up with other companies who do have the resources to provide the technology or who can pool their resources so that together they can provide the needed technology. Both sides receive benefit from the partnership. Technology transfer is not only viewed as being significant to the success of a strategic alliance, according to Hsieh (1997): “host countries now demand more in the way of technology transfer”. As evidence of this growing trend, Hsieh cites China as a prime example.

 

For example, Tata Consultancy Services (TCS) and ANSYS Inc, a global innovator of simulation software and product development technology, have entered into an alliance that will help their clients accelerate product development dramatically and simultaneously enhance the quality and reliability of their designs through integrated digital prototyping. The industries that will benefit include automotive, power, heavy machinery, consumer products and electronics. Customers will derive increased productivity in the design and production processes by 70-90 percent. By pooling resources to develop software products built upon the expertise of each company, TCS and ANSYS Inc intend to create a new market and reap the associated benefits.

 

4.   Reduce Financial Risk and Share Costs of Research and Development

 

Some companies may find that the financial risk that is involved in pursuing a new product or production method is too great for a single company to undertake. In such cases, two or more companies come together and agree to spread the risk among all of them. One example of this is found in strategic alliance between the Rs.235-crore Elder Pharma, which has 25 international partners for strategic alliances, has entered into a tie-up with Reliance Life Sciences. The company is focusing on dermatology and the tie-up with Reliance is to obtain aloe vera extracts for cosmetics. Elder has launched a dedicated skincare division with products under El-Dermis brand and plans to launch a number of over the counter products in the skincare segment.

 

5.   Achieve or Ensure Competitive Advantage

 

Alliances are particularly alluring to small businesses because they provide the tools businesses need to be competitive. For many small companies the only way they can stay competitive and even survive in today’s technologically advanced, ever-changing business world is to form an alliance with another company. Small companies can realize the mutual benefits they can derive from strategic alliances in areas such as marketing, distribution, production, research and development, and outsourcing. By forming alliances with other companies, small businesses are able to accomplish bigger projects more quickly and profitably, than if they tried to do it on their own. According to Booz, Allen and Hamilton the world has entered a new age - an age of collaboration - and that only through allying can companies obtain the capabilities and resources necessary to win in the changing global marketplace. Self-reliance is an option few companies will be able to afford (Booz, Allen and Hamilton, 1997).