August 25, 2015, by John Colley
Strategy briefing – Strategic Alliances: A Panacea?
Recently there has been substantial growth in the number of strategic alliances.
They are seen by management as a way of sharing risk and acquiring resources and capabilities. We will focus on equity based alliances in this article; more commonly referred to as Joint Ventures (JV’s)
The EE example
In 2010 Deutsche Telecom and France’s Orange agreed a 50:50 joint venture named EE in which to place their respective UK mobile telecommunications infrastructure assets. The new EE branding was to fully replace Orange and T- Mobile from 2012.
Neither were UK market leaders, however, their combined subscribers at 28M would make them so. This would be in an industry where the player enjoying the most network traffic, also earns the highest returns.
The alliance would allow rationalisation of masts, shops, marketing and overhead costs, and provide greater hand set negotiating power. Savings were estimated at £0.5Bn a year. Combined sales would be in excess of £7Bn.
Theoretically this provides an ideal alliance as it cuts costs and increases market power, concentrating marketing expenditure and creating a clear market leader.
A £12Bn offer from BT at a time when EE was considering a floatation ensured the venture also rewarded the owners.
Joint Venture failure
Not all strategic alliances are as successful as EE. The failure rate in terms of destroying value and non-delivery on expectations is in the order of 50%-70% (Ertel and Gordon, 2008).
So why is there such a high failure rate?
Many consultants, writers, and academics advocate alliances as a way of gaining resources not otherwise accessible. Examples include access to overseas markets, modern technology, effective distribution, developing market power, scale economies and avoiding a formidable competitor.
These are all benefits achievable through an alliance together with lowering partner risk. The creation of EE had many such benefits. They also had a clear plan for exiting the joint venture through sale or floatation.
Ineffective exit arrangements
Difficulties in creating effective exit arrangements often lie at the heart of delivery failure with so many alliances.
Lack of agreement for clear sale or float can then make it very difficult disposing of a sizeable interest in a business where the other partner is uncooperative and is likely to hold pre-emption rights. Indeed in such circumstances the shareholding is virtually unsaleable except to the other partner who may be offering a low price.
Bleeke and Ernst (1995) found that the median lifespan of a JV is 7 years and 80% end in sale to the other partner.
In part, this scenario can be addressed at the initial negotiation by determining clear objectives and exit routes once the objectives are achieved.
However these are rarely adequate or comprehensive. It seems strange that one has to negotiate exit arrangements simultaneously with, and in as much detail as at entry.
A consequence of weak and uncertain exit arrangements is a tendency for partners to escalate investment despite clear failure of the alliance to achieve its’ objectives (Inkpen and Ross, 2001).
There are a number of reasons for this, including perceived high exit barriers, partner and senior management concern over losing face, and inability to effectively assess JV senior management performance.
JVs usually take a very long time to negotiate; therefore partners become reluctant to terminate the venture. The exit difficulties severely suppress exit consideration to the extent that a sale may have been preferable in the first place.
Partners need to consider whether they would be better selling the business rather than entering an alliance which will severely restrict ultimate exit options.
Is the JV really a slow exit? If so it will destroy value compared to a straight sale.
Weak or strong alliances?
Another common view is that a business can remedy many of its inadequacies through a JV with a partner able to compensate the specific weaknesses.
The theory may be rather more attractive than the reality. Certainly alliances between two weak players usually produce a larger weak player.
One example in the UK DIY business was Focus Do It All.
This sector is dominated by strong players in B&Q, Wickes, and Homebase. The rest of the industry was largely fragmented and attempts were made to form a strong fourth player.
This started with WH Smiths Do It All (bought from LCP Home Improvements which itself was a merger between Big K and Calypso). This then became a strategic alliance with Boots’ Payless DIY to form Do It All.
Suffering from WH Smiths tendency to deposit unwanted senior management, their share of the business was eventually sold to Boots for a £1 gift voucher. Boots then sold to Focus (DIY) Ltd for £68M who also acquired and merged Great Mills. The entire edifice continued to underperform and eventually went into receivership around 2011.
Ultimately alliances of weak players produce more weak players. The problems of weak management and poorly located stores could not be overcome.
Alliances of the strong with the weak are rarely successful for the weaker player and may not be for either. It usually results in a sale at a low price by the weaker player. The JV is often dominated by the stronger player.
This then destroys any hope of the weaker player selling to anyone else. The subsequent exit negotiation is severely compromised by the lack of competitive tension, and the absence of alternative options for the weaker player.
Whilst working for a major multinational, strategic concerns emerged regarding an insulation business we owned.
The business was no longer core, however it did have some links with our major core business; hence there was some reluctance to divest.
The insulation subsidiary was running on obsolete technology licensed from a U.S. provider, and needed capacity expansion as the market was growing rapidly and capacity was exhausted.
The costs of new technology and capacity expansion were somewhere in excess of £20M; which was coincidentally about the value of that business.
The parent company was unwilling to fund such investment for a non- core business. The Group CEO agreed a 50:50 JV for the insulation subsidiary with a much larger multinational conglomerate, around ten times our size, which had a major insulation division and advanced technology.
The partner would provide the necessary investment, technology (under licence), new product development and marketing. We would provide the current business, selling and distribution as we had close links with the relevant UK customers, plus the various central services such as IT systems, HR, Finance and Accounting and so on.
Following a protracted negotiation the JV was formed and the new technology introduced with the capacity expansion.
The market then contracted and a prolonged period of poor results ensued. The partner developed its links with distribution and the JV formed its own sales force.
We became very much the weaker player. Our holding in the business became unsaleable, except to the partner as the JV was dependent for the critical elements of licensed technology and product development on the other party.
Ultimately, we brought little to the JV and would have achieved much higher proceeds from a complete sale in the first place.
Whilst strategic alliances can result in acquiring capabilities, market position and funding, they often destroy value and fail to achieve their objectives.
It is important that clear objectives are set at inception and exit arrangements determined in some detail in preparation for the achievement of objectives.
Partners entering alliances need to fully consider whether a complete sale could create more value; in view of the constraints an alliance introduces at exit.
Partners need to be highly objective when assessing alliance performance, to avoid escalating investment despite clear evidence of failure.
Dr John Colley is Director of MBA Programmes at Nottingham University Business School. He was previously Group Managing Director of a FTSE 100 business, and Executive Managing Director of a French CAC 40 business. He currently chairs a listed Plc and is non-executive director of several private equity businesses. John is an ESRC/FME Senior Fellow.
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