Joint venture formation: Planning and knowledge-gathering for success

Companies should addresssome planning issuesafter a joint venture has beenidentified as a strategic option but beforenegotiations begin.

Joint

Venture Formation=

Planningand KnowledgeGatheringfor Success ANDREW

C. INKPEN

ver the past two decades there has been an enormous increase in the formation of domestic and international joint ventures. For many firms, joint ventures are no longer a peripheral activity but a mainstay of competitive strategy. If this is the age of “alliance capitalism,” as some writers have argued, joint ventures will undoubtedly become more important as a tool of competitive strategy. A driving force behind this trend is the realization by many firms that self-sufficiency is becoming increasingly difficult. Nevertheless, many joint ventures fail to achieve their potential and joint venture failure rates remain high, frustrating the efforts of many firms to capitalize on alliance strategies. Consider the following examples of recent unsuccessful partnerships, all of which were announced with a great deal of promise: Apple Computer and IBM formed two software joint ventures designed to challenge Microsoft’s supremacy. Hundreds of millions of dollars were invested in the two ventures, Taligent and Kaleida. Both ventures were dissolved a few years later with both partners having little to show for their cooperative efforts. In an effort to strengthen its telephony software skills, Motorola formed a joint ven-

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ture with Northern Telecom. The joint venture was terminated 18 months later amid reports of internal problems. Bell Atlantic and Olivetti formed a joint venture to compete with Italy’s state-owned telecom firm. Less than two years later, the venture was ended after months of disagreements between the partners. US West and Time Warner formed an alliance designed to exploit convergence between telecommunications and entertainment. A few years later the partners found themselves involved in a lawsuit in which US West tried to block Time Warner’s purchase of Turner Broadcasting. What happened? What makes for a successfully planned and negotiated joint venture? A joint venture is formed when two or more distinct firms (the parents) combine a portion of their resources to form a separate jointly owned organization. Unlike transaction-based negotiations, as in the buying or selling of firms, where the conclusion of the negotiation is the end of the discrete interaction, successful joint venture negotiations represent only the first step in a multiple-step relationship. How a firm benefits from a joint venture is highly dependent on what each

Helpful suggestions from David Bowen aye gratefully acknowledged. SPR.!NG 1999 33

Andrew lnkpen is associate professor of management at Thunderbird, The American Graduate School of Management. He holds a doctorate and MBA from the University of Western Ontario and qualified as a Chartered Accountant in Canada. He has taught at Temple University and the National University of Singapore and does extensive executive education teaching. His research focuses on various aspects of alliance and joint venture management, including knowledge transfer and learning, the role and development of trust, and partner bargaining power. He is also involved in a study of knowledge transfer in multinational firms. He is on the editorial boards of three journals and is the author of more than 30 articles, various book chapters, and over 15 teaching case studies. His recently completed projects include “Learning and Knowledge Acquisition Through International Strategic Alliances” (to be published in Academy of Management Executive) and “Knowledge Management Processes and International Joint Ventures,” to published in Organization Science. He is the author of The Management of International Joint Ventures: An Organizational Learning Perspective (Routledge Press, 1995).

partner is committed to do and actually does over an extended period of time. Joint ventures possess the feature of ongoing mutua1 interdependence and mutual vulnerability. Mutual interdependence leads to shared control and management, which contributes to the complexity of joint venture management and often creates significant administrative and coordination costs. And, because the partners remain independent, it is a joint venture fact of life that there will always be some uncertainty as to what one party is counting on the other to do. Unlike alliances such as R&D partnerships or licensing agreements, contractual agreements between joint venture partners are often executed under conditions of high uncertainty, which means it is unlikely that all future contingencies can be identified during the formation process. Nevertheless, it is our belief that adequate early planning can eliminate many of the problems that plague joint ventures. Early and careful planning may reveal whether a joint venture is the most appropriate strategic option. All too often, firms become too focused on getting their joint venture deal done quickly and lose sight of the larger strategic and financial picture. If joint ventures cannot achieve both strategic and financial objectives, they should not be formed. In this article, we examine a series of planning issues, summarized in Table 1, that should be taken into account when collaboration becomes a viable option. The issues, if properly dealt with, provide the foundation for a viable collaborative relationship. By carefully examining the issues before negotiations begin, the strategic issues associated with joint venturing can be addressed during the negotiation and formation processes.

JOINT VENTURE

Negotiations

PLANNING

for Mutual

ISSUES

Value Creation

Underlying every Joint Venture Formation are expectations by the partners that value 34

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will be created. Thus, the first planning issue deals with a question about value creation: As a potential joint venture partner, will you have a mutual value creation perspective that respects and supports your counterpart’s collaborative objectives? Or will you view collaboration as a way to achieve an independent objective in a zero sum game atmosphere? Because joint venture partners rarely have the same strategic objectives, their views of value creation will likely be different. However, this need not be a significant issue as long as the partners both understand their partner’s objectives. Indeed, a recent study by Todd Saxton found that partner strategic similarity was not related to alliance performance. Nor does joint venture longevity influence joint venture value creation. Many firms view joint ventures as intentionally temporary and recognize that their ventures will not last indefinitely. If a joint venture termination is an orderly and mutually planned event, the joint venture may well be evaluated as extremely successful. Recently, a large US company ended a long-standing joint venture with a Japanese firm. The divisional president of the US firm indicated that although the partnership was sound and the alliance had been very successful, the alliance no longer fit with firm strategy. This joint venture, like most of the ventures we have studied, was formed with the expectations of a long-term relationship and no specific timetable for termination. Given that partner interdependence is required to make a joint venture function, it is our belief that firms should seek to create mutual value with their potential partners, rather than try only to enlarge individual benefits. This means that joint venture negotiators must walk a fine line between strong negotiating tactics and the realization that the party across the table will become a partner, possibly for many years if the negotiation is successful. Obviously, in the negotiation process, a firm must seek to maximize its own benefits. But, over the life of the joint venture, how a partner firm benefits depends on the joint venture value jointly created. Thus, joint

Kou-Qing Li is associate professor at the Shanghai University of Finance & Economics where he teaches marketing management, negotiations, and pricing. He holds a master degree in economics from Shanghai University of Finance & Economics. A visiting research scholar at Thunderbird and a consultant for various Chinese companies, he is the author of several books in the areas of pricing planning, principles of commercial economics, business negotiations, and commodity futures. His research focuses on negotiation and marketing strategy in China. Recently completed projects include “Dual-concern Model and Negotiation Strategy Choices” published in Foreign Economy and Management and “A Study About the relations Between the State-Owned Wholesaling and Direct Selling of Industrial Enterprises” published in Commercial Economy Research.

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venture negotiations will not only be a process of value exchange for the two sides but a process of value creation. The partners may have nothing to share if they do not create value jointly. Moreover, the individual negotiators sitting across the table could find themselves working side-by-side in the new joint venture. It is not unusual for managers on joint venture negotiating teams to find themselves in positions such as joint venture president or general manager. In the absence of a mutual value creation perspective during the negotiation, there is a much higher probability that openness and trust will be lacking in the negotiation. Consider the following example of an unsuccessful joint venture. In this instance, one of the two partners was unwilling to reveal its true joint venture intent, leading to questions about hidden agendas and ulterior motives: We formed an alliance with Firm X. They told us that their evaluation of the alliance would be 30% based on the financial results of the alliance and 70% from elsewhere. The problem was that they did not want to talk about the 70%. We assumed that they were interested in getting into the telecommunications industry and that this was criiical in linking up with us. We also assumed that they wanted to sell their products to the alliance. However, we never knew for sure. For a joint venture to be successful, it cannot be one-sided. All parties need an incentive to form and remain in a joint venture. Although some authorities argue that mutual value creation is an inappropriate focus given the often transitional nature of joint ventures, recent research and our interviews with many alliance managers indicate that a focus solely on “what’s in it for me” will not lead to successful collaboration. It may lead to unstable relationships that are value-creating for one partner and not the other. Thus, assuming that collaboration is viewed as more than a short term means of filling gaps in compe36

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tencies, mutual value creation should be the objective from all parties. This is the perspective adopted by Warner-Lambert Company in its many strategic alliances. A major alliance with Pfizer Pharmaceuticals, formed in 1996 to jointly market a new drug developed by Warner-Lambert, is a good example. The director of strategic alliances for WarnerLambert’s pharmaceutical business described the Pfizer alliance: We live by the concept of co-destiny. We believe that our destinies are intertwined, so what is good for our business ally is good for us. Note that this perspective also means ensuring that concessions in negotiating do not tilt the balance in favor of the partner. When the joint venture begins, levels of bargaining power commensurate with ownership and resource contributions should be the objective. Over time, as partner strategic missions, expectations, loyalties, and resource mixes change, the balance of bargaining power in the joint venture will inevitably shift. Research by Andrew Inkpen and Paul Beamish describes how learning by one partner can lead to a shift in bargaining power and eventual joint venture instability.

INITIATING PARTNER RELATIONSHIPS AND KNOWLEDGE When firms decide to initiate joint venture discussions, negotiations will be shaped by the initial relationships that exist between the firms. Potential partners will often be uncertain about working together, particularly if they have not previously worked together. On the other hand, new joint ventures that start with an existing stock of “relationship assets” may begin with a honeymoon period that effectively buffers the firm from early breakup. Previous cooperative ties between joint venture partners can generate an initial base of interpartner trust. If firms have worked together in the past, they should have some understanding about each other’s

skills, capabilities, and willingness to follow through on promises. It is possible that experienced partners can forgo the relationship building processes that will be necessary for partners working together for the first time. However, our research has shown that prior experience between partners is not necessarily a predictor of joint venture success. Although a firm may have worked with its partner for many years in non-joint venture relationships, the formation of a joint venture creates a new degree of intimacy between the partners. A prior partner relationship may influence the structure of the relationship (e.g., the equity split) and smooth the start-up period. But because a joint venture establishes a new organization, there are new managerial roles that have to be learned by the two partners. These new roles can be so different from those of prior relationships that the worth of prior knowledge and its impact on the joint venture management experience are limited. Thus firms must ensure that the need for relationship building is clearly established and understood prior to negotiations regardless of past relationships. We have observed some very unsuccessful relationships in which firms assumed a successful prior relationship, such as a licensing agreement, was a predictor of joint venture success. Ideally, firms will be able to enter the negotiation process with substantive knowledge about their potential partners, including why the other firm wants a joint venture, the firm’s strengths and weaknesses, and the firm’s reputation and experience with joint ventures. Detailed knowledge about the potential partner can help in planning the negotiation strategy and increasing the probability of collaborative success. Knowledge about the partner can also be a source of bargaining power in the negotiation process. When firms think they understand their partners and do not, joint venture failure will often be the result, which is what happened in the following example as described by a joint venture manager we interviewed:

Both partners were naive about the other partner’s capabilities and about the nature of the joint venture. The American partner did not grasp the implications of the changing industry structure and how that would impact the joint venture performance. They did not appreciate the Japanese philosophy. The Japanese partner expected a much leaner partner, one that was prepared to work hard on the joint venture’s behalf. They sensed that management in the American partner was not committed to the same things they were.

ESTABLISHING WILLINGNESS TO BEAR RISKS Beyond the obvious risk of time and energies wasted if a joint venture fails, forming a joint venture involves several different types of risk. The sources of risk should be identified and tolerance to the risks determined before forming the venture. One risk involves the investment in relation-specific assets. When a joint venture is formed, the partners must invest in various assets to create the new business. The risk is that some of the assets, such as plant and equipment and human assets, may have limited alternative uses if the joint venture is ended. For example, the Japanese automakers Subaru and Isuzu have a joint venture plant in Indiana to jointly manufacture Subaru and Isuzu vehicles. The plant is unusual in that it is really two assembly lines under one roof with only a few shared facilities, such as the paint shop. In the event that one partner seeks to leave the relationship, it is unlikely that another automaker would be willing to invest in this unusual arrangement. Thus, both partners have made relation-specific investments that have limited value outside the joint venture. Committing relation-specific assets to a joint venture is always a risky decision. The decision must be supported by expectations that future cash flows from the venture will SPRING

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exceed the costs of these assets. Firms must ask: What is the probability that our partner will behave opportunistically and not honor the venture agreement? The higher the probability, the more risky the investment in relation-specific assets. A second, and perhaps much more critical type of risk, is competitive risk associated with loss of technology and markets. The practice of partnering with competitors is becoming commonplace. GE partners with Pratt & Whitney to build aircraft engines; General Motors jointly builds cars with Toyota; and Warner Lambert and Pfizer jointly market pharmaceutical products. Research has found that joint ventures between direct competitors, those with significant operational overlaps, are less likely to endure. The rationale is intuitive: Just because rivals collaborate does not mean they cease to be rivals. When partners are also competitors, the potential for conflict is exacerbated and the partners must ensure that sensitive information is not passed on. Firms that are not competitors when a joint venture is formed may become competitors if it is terminated. We have studied about 40 Japanese-American joint ventures in the US automotive sector. Most of the Japanese partner firms were entering the United States market for the first time. About one-third of the joint ventures were terminated after two to three years, with the Japanese partner acquiring the businesses in all but one case. The result? The American firms’ former partners were now their competitors; the American firms had helped their competitors establish a long-term presence in the US market. A third type of risk involves the intangible assets of firm reputation and image. To exploit the equity of the Virgin brand, Richard Branson has formed numerous joint ventures in businesses such as cosmetics, soft drinks, railways, and retailing. His typical joint venture strategy is to contribute the brand and public relations expertise and rely on other firms to put up the capital. If these or other businesses fail because of partner mismanagement, there is the risk that the brand may become associated with failure. As another 38

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example, assume a US consumer goods firm is interested in entering the China market. A local Chinese partner is found, and a joint venture is formed to manufacture and market the US firm’s brand in China. The US firm has now risked its brand equity in forming a joint venture. Nonperformance by the Chinese partner could irreparably damage the American firm’s reputation in China and perhaps elsewhere. On the other hand, the Chinese firm also risks its reputation. In some cases, Chinese firms have abandoned their local brands in order to gain access to foreign technology and management only to see the joint venture fail, local brand awareness erode, and rights to the partner’s foreign brand lost. There are two additional sources of risk. When a firm forms a joint venture with another firm, it may disrupt a pre-existing interfirm relationship. For example, Firm X may be a customer of Firm Y. Firm Z is a competitor to Firm X. If Firm Z forms a joint venture with Firm Y, Firm X may decide that for competitive reasons it can no longer buy from Firm Y. Finally, there is the risk of joint liability that may be created when a firm enters into a joint venture. The challenge for firms before beginning negotiations is to consider the level of investment and related safeguards necessary to create a viable joint venture. An unwillingness of one partner to determine risk prior to negotiating is illustrated in the following example: Every single issue with our partners involves a protracted negotiation. If we say ten, they will say five. It doesn’t matter if the issue is significant or not. If we say let’s do “x” because “x” makes sense, they will challenge us. They will even sign off on an issue and then want to renegotiate. Or they will keep delaying until it is too late to do what we want to do and we have to do it their way. Even minor decisions require senior management approval. There is a tremendous unwillingness for anybody in our partner’s company to accept risk.

AGREEING ON WHAT IS ESSENTIAL AND WHAT IS NEGOTIABLE Before negotiations begin, firms should have a clear idea of negotiable and non-negotiable issues. Over time, joint venture-experienced firms tend to learn what works and what doesn’t work for their organizations. These firms will have internalized a set of firm-specific guidelines based on prior experience. For example, one large American multinational firm has decided that all joint venture products will have its labels and brands, not those of its partners. As well, this firm has decided not to enter any ventures with less than 51 percent ownership. Although the pros and cons of these various decisions can be debated, the firm now puts the brand and equity terms on the table early in discussions with potential partners. This speeds up negotiations and moves the discussions to issues that are negotiable. Other firms have specific requirements about technology transfer and the joint venture management structure. Some firms have decided that they are not good at joint ventures and will use them only in specific circumstances. Of course, firms must adhere to local regulations, which may include restrictions on foreign ownership or expectations about technology transfer. Firms without a history of joint venturing will have a more difficult time determining what details are essential. For example, the question of equity ownership is often a difficult issue in joint venture negotiations. One CEO we interviewed explained that in his opinion, 50/50 relationships were preferable because it forced the partners to mutually solve problems. He argued that if one partner used its majority ownership in board meetings by saying “we are doing it my way,” that partnership is in trouble. Clearly, other firms would disagree with this perspective, although the research into the question of joint venture performance and equity ownership is inconclusive. Our advice to firms joint venturing for the first time is to establish a negotiating position based on the strategic rationale for partnering, the necessary financial investment, the technology involved, and

the strategic importance of the venture. The counter to the above arguments is that firms must be careful not to include so many essential details that joint venture flexibility is lost or the partner walks away. As well, firms must be fully aware of the alternatives and outcomes if an agreement is not successfully negotiated. In early 1998, Northwest Airlines and Continental Airlines negotiated a major alliance. Prior to the alliance announcement, it was expected that Delta Air Lines would acquire Continental. However, the Delta acquisition deal collapsed. According to an article in The Wall Street Journal, the major reason why Delta was unable to acquire Continental was Delta’s insistence that Delta pilots would have a greater say in areas such as salaries and flight schedules. In an industry where pilot seniority usually decides pay and scheduling, this was unacceptable to Continental pilots and management, When Delta refused to back down, Continental looked for another partner. Delta’s refusal to compromise on a key issue cost them the deal.

VALUING THE IMPORTANCE INDIVIDUALS

OF

In a recent Harvard Business Review article, John Browne, CEO of British Petroleum, stated, “You never build a relationship between your organization and a company.... You build it between individuals.” This is a critical point and one that often gets overlooked by firms involved in forming, managing, and terminating multiple ventures. Managers often lose sight of the reality that partner trust and forbearance are directly linked to the strength of interpersonal relations. In any alliance, the strength of interfirm relationships is largely a function of the relationships between individual managers who are involved in the day-to-day venture management. When partners have not collaborated in the past, the possibility of untrustworthiness is heightened because relations are in a developing stage and managers are uncertain about the skills, knowledge, and objectives of their counterparts. SPRLVG

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Without strong relationships between individuals at this stage, trust will not develop. In a worst-case scenario, if enemies are created in the negotiation process, it is unlikely any cooperative agreement that emerges will be successful. Given the importance of interpersonal relationships, the individuals who will be involved in joint venture negotiations should be chosen carefully. We strongly suggest that firms involve operational managers in the Joint Venture Formation process, beginning with initiation of potential ventures through to formation and startup. By operational managers, we mean managers from the firm’s operational units, not from headquarters staff. Involving operations managers in the negotiations means that dealmakers and business development specialists do not drive the process. We heard from one business development manager that his bonus was based on the number of deals completed. Suffice it to say, he had little interest in the actual outcome of the joint ventures he negotiated. Who will manage the joint venture? Ideally, managers involved in the formation process will also become part of the joint venture management team. The managers who will actually manage the joint venture and the partner relationship are in the best position to ask tough questions early in the process. These are the people expected to produce results when the joint venture is formed and, therefore, will want answers to key operational and strategic questions during a negotiation. To be successful joint venture managers, however, these managers must also be capable of working in a collaborative relationship with multiple bosses, high levels of ambiguity, and often non-aligned performance objectives of the partners. After the joint venture is formed, firms are often surprised when their partners object to their choice of managers. This occurs frequently in international joint ventures. Sometimes the problem is with misunderstandings about the meaning of job titles, in other cases, the partners resent their lack of involvement in managerial decisions. Consider the following case of mistaken expectations about 40

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senior management in a joint venture with French (50.01% equity) and Swedish (49.99% equity) partners. The JV agreement provided for the JV chairman to come from the French firm and the venture CEO to come from the Swedish firm. What the Swedish firm failed to consider was that in France, the chairman, or President Directeur G&-&ale (PDG), usually acted as both the chairman and CEO. The Swedish firm thought that the chairman would be someone who looked after board meetings and left the day-to-day business to the Swedish CEO. As it turned out, the PDG was a very authoritarian manager who fully intended to manage the JV his way. The Swedish firm CEO appointee was relegated to a non-CEO role and the partners were in heated conflict before the JV began operating. Later, when the Swedish firm attempted to replace their appointed CEO with a stronger manager, the PDG would not accept the appointment and refused to let the new CEO on the JV premises. Swedish firm management now concedes that it did not do its homework and failed to properly plan for the JV senior management. Had it realized how powerful a French PDG could be, it would never have agreed to let its partner appoint the JV chairman. In summary, whatever the reason for misunderstandings, firms must ensure that their plan for the joint venture top management team is discussed during the negotiations. This means that preliminary decisions about joint venture management must be made before negotiations begin. It is better to face the issues early rather than assigning a manager to the joint venture and then finding out that your partner objects to the choice, leaving the assigned manager to wait months to determine his or her fate.

BUILDING JOINT VENTURE GOVERNANCE AND TRUST There are a variety of potentially difficult governance issues that must be resolved before a joint venture can begin operations, including top management positions, board composi-

tion, reporting expectations, and partner monitoring. The optimal governance structure will depend on various factors, such as alliance objectives, the level of investment, technological conditions, and partner time horizons. Although an in-depth analysis of these issues is beyond the scope of this article, firms must recognize that the nature and form of joint venture governance structures will evolve over time as the joint venture strategy emerges and partners interact. Ultimately, what determines joint venture governance structures is the level of trust between the partners. Noncontractual safeguards are more likely when there is a high level of trust between the partners. For example, in cases of high trust, the joint venture agreement can be less detailed because of the low threat of partner opportunism. Governance costs under conditions of distrust will be greater and procedures will be more formal, such as more detailed contract documentation, more frequent board meetings, closer scrutiny of the agreement by lawyers, and more communication between partner headquarters and the joint venture. As a high level of trust develops, safeguarding procedures and monitoring costs can be reduced. For example, in new alliances between firms without any common cultural background or prior interactions, the basis for trust may be absent when the alliance is formed. In this case, the partners may have no choice but to rely extensively on contracts and monitoring. As interactions increase and partner managers get to know each other, trust may increase, at which point monitoring may no longer be necessary. When negotiating joint ventures, managers must recognize the important role that trust plays, and will continue to play, if the joint venture is to be successful. They must also recognize that as trust increases, governance will become easier and less reliant on strict contractual details. Where there is too strong an initial focus on formal control, problems can arise, as the following quote indicates: Our objective was to maintain control over the joint venture. We put our

toughest, most authoritative manager into the joint venture. He was not going to lose control. He lasted about 18 months. In this example, both partners realized that their respective choices for senior joint venture management positions were a mistake. After replacing both managers, strong trust developed between the top venture managers and the joint venture became very successful. Negotiating and forming a joint venture initiates a dynamic relationship that goes through a series of transitions to be successful. Yves Doz’ research found that successful alliances were highly evolutionary, going through a series of interactive cycles of learning, reevaluation, and readjustment. Failing projects were highly inertial, with little learning by the partners. The implication is clear: As new knowledge is obtained and levels of interpartner trust shift, joint venture managers must be willing to make changes in their cooperative relationship. With the success of a joint venture, trust usually increases. But trust may also decrease over the life of the relationship. For example, when a joint venture is formed, there is a subjective probability that a partner will cooperate. Experience will lead to adjustment of the probability, which in turn may lead to a shift in the level of trust.

CONFRONTING NATIONAL CULTURE ISSUES Although it has become a cliche to say that managers in today’s competitive environment must have a cross cultural perceptive, we continue to be surprised at how many firms involved in international joint ventures are inadequately prepared to deal with national culture issues. For example, we discussed the Swedish firm that did not fully understand French corporate governance. In another case, a US multinational assigned a manager to a South Korean joint venture in Seoul. This manager built a heated doghouse for his dog SPRING

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that he brought from the United States. Because he deemed this an essential relocation cost, he decided that the joint venture should pick up the cost of the doghouse, not realizing or caring that this type of cost would be highly inappropriate as an employee expense in Korea and potentially a major embarrassment for the US firm. Luckily for the US firm and the manager involved, a more senior manager got wind of the doghouse and made the manager pay for it himself. The surprising thing about this example is how the U.S. firm was put in such a position. Just as knowledge about the strategy and objectives of potential partners are critical, so is knowledge about the partner’s national culture if the proposed joint venture is international. Ideally, individuals slated to negotiate and manage the joint venture should have a solid cross-cultural knowledge base. If they don’t, rather than muddle through the negotiation hoping for the best (and maybe experiencing the worst), firms must ensure that either internal or external expertise is obtained. Rather than react to cross-cultural issues, firms should try to anticipate and head off problems before they occur. For example, it should not be a surprise to discover, as did a large number of American firms we studied, that Japanese firms view price negotiations with their customers as a last resort in the event that financial problems arise. As well, it should not have been a revelation, as it was to many firms, that Japanese automotive customers expect annual cost reductions in return for more secure customer-supplier relationships.

THE IMPORTANCE FLEXIBILITY AND

OF REVIEW

Besides the importance of the negotiations to the success of joint ventures, there is flexibility in the joint venture agreement itself. One of the keys to a successful collaborative relationship is that the benefits to the partners are more than the deal itself. In other words, the scope of the collaboration expands beyond the narrow confines of the joint venture 42

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agreement. For example, a Japanese-American joint venture formed to supply Japanese automakers was initially independent of its American parent, relying on the Japanese partner for product technology and marketing support. Over several years, the joint venture became less independent as ties between the two partners increased. Plans were under way for the two partners to explore jointly several new international options. Both parents realized that pooling their knowledge made sense given the ongoing consolidation in the global automotive industry. As well, the joint venture had evolved into a related division of the American parent, with the parent focused on managing the partner relationship, not just the joint venture itself. According to the president of the American parent: The joint venture is treated exactly the same as our other divisions. The joint venture participates in all our meetings and all of the joint venture’s salaried employees have the same benefits as their counterparts at other divisions. This makes it easier to move people back and forth between the joint venture and parent. Firms that insist on highly restrictive and legalistic provisions in their joint venture agreements may find it difficult to increase or change joint venture scope as new opportunities arise. After joint ventures are formed, it is inevitable that the partners will learn more about each other, which may lead to new areas for collaboration. As a result, we believe that firms should plan on building into their agreements as much scope as possible for uncomplicated and non-legalistic changes. It has been said that Japanese firms prefer their joint venture agreements to be one page to allow partnerships to grow and evolve. While this may be an exaggeration, our research has found that Japanese firms tend to be less concerned with contractual detail than American firms. We have also heard American managers complain that their joint venture agreements were so detailed that it was impossible to change anything.

In addition to flexibility in the actual agreement, we believe it is important to have flexibility in the negotiation process. If the process is not going as planned, don’t feel forced into a corner. As well, ensure that there is time for review before a final agreement is signed. The review is designed to revisit the alliance intent and ensure that objectives will be met given the nature of the proposed agreement. This will mean slowing down the process but that is usually a good thing; it is better to ask questions before the joint venture is formed than after the agreement is signed. We often hear managers say that the problems associated with their joint ventures are the result of poor preparation and pressures to close deals quickly.

SYSTEMATIC JOINT VENTURE FORMATION After a decision to use joint ventures has been made, the focus of most managerial analysis is on the venture’s strategic rationale. Questions such as “What gaps in skills or market access can be filled by partnering?” and “What are our potential partner’s core competencies?” become of paramount importance. The danger is that the issues we have identified-venture management, governance, risk, culture, and so on-are not given sufficient attention, with the result that the partnering firms end up in reactive rather than proactive states. To ensure that the focus of Joint Venture Formation and negotiation processes incorporates systematic analysis of key alliance issues and is not overly narrow, some firms involved in multiple joint ventures have developed joint venture development processes. Their objective is to establish consistency in joint venture development and a common set of parameters with which to evaluate and monitor Joint Venture Formation and performance. A joint venture development process should include a series of checkpoints that must be satisfied before the process moves forward. The process should be designed to ensure that key questions are surfaced and

debated throughout the Joint Venture Formation process. The questions include: 0 Are there clearly understood and agreed upon objectives before venture formation? 0 How will the joint venture be integrated with the parent firm’s strategy? l Will there be cultural compatibility and organizational fit between the partners? l Does the joint venture leverage the complementary strengths of the partners? l Will an exit strategy be defined upfront? 0 Is there a monitoring process for new joint ventures? 0 Have all the partnering risks been identified and accounted for? Properly implemented, a systematic joint venture development process will ensure that: Projects are strategic to the firm. Projects meet financial objectives. 0 Projects move quickly through required corporate approval processes. l Project risks and challenges are identified and understood by all parties involved in the formation process. l l

KEY PLANNING QUESTIONS Regardless of how systematic and formalized the joint venture process becomes, firms must still ensure that issues are raised and questions answered. Table 2 provides a list of questions that should be addressed after deciding that a joint venture is a viable strategic option and before actual negotiations begin. This interim period is the opportunity to explore multiple issues and establish a solid base of knowledge for the negotiation. The questions in Table 2 are generic in the sense that they should be asked for any proposed joint venture. If you cannot answer the questions, your firm is not ready to enter joint venture negotiations. Alternatively, the answers may suggest that a joint venture is not the best course of action. Of course, the SPRING

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answers to the questions are contingent on various factors, including the firms involved, the nature of the proposed joint venture, the anticipated impact on firm strategy, and the collaborative experience of the firms involved.

SUCCESSFULJOINT VENTURES: FINAL THOUGHTS To achieve a joint venture outcome of high performance, high partner trust, and high value creation, this paper has identified the key issues associated with the planning of a joint venture. Managers have to recognize that a knowledge-gathering phase is essential, not an option. Based on our research and discussions with many joint venture managers, too many firms jump into joint venture negotiations without adequate planning. The failure to properly plan a joint venture and, more specifically, to plan for the negotiation increases the probability of joint venture failure. Consider the following situation: A joint venture was started on blind faith. Each partner had some expectations about the other that were not met. There is an unresolvable conflict between the partners. One partner was willing to lose money in the joint venture for as long as it took to build up market share. The other expected faster production and higher efficiency. When the joint venture was formed, the partners thought they were in sync about prices and profit margins. That was an incorrect assumption. One partner wanted to make a quick buck and was skeptical of making long-term investments. It expected a profit in two to three years. The other expected the joint venture to lose money for five to six years. Although not all of the problems described in the previous example are the result of poor planning and negotiation, had both partners properly prepared for the 44

ORGANIZATIONAL

DYNAMICS

negotiation and addressed the issues raised in this paper, the joint venture either would have been more successful or it would not have been formed. Instead, the venture was formed with unclear partner understandings of how value would be created, why the venture should be formed, and what risks were involved. In other words, neither partner properly prepared for the joint venture. The firms muddled through a negotiation and formation process and ended up with a poorly performing joint venture that had little chance for success. In another example, in early 1998 Procter & Gamble and its Vietnamese partner were clashing over many different issues, including expatriate salaries and spending on advertising. Procter & Gamble offered to buy out the Vietnamese partner’s stake but this was described as “impossible” by the Vietnamese Ministry of Planning and Investment. So Procter & Gamble was faced with an under-performing venture, an unhappy partner, and an apparent inability of both partners to mutually create value. A few months later, and with the joint venture facing bankruptcy, Procter & Gamble increased its stake in the venture to 93% and capital was more than doubled to $83 million. Not all joint ventures need to go the way of the previous two examples. If joint ventures are negotiated in the spirit of joint strategic and economic outcomes and the partners carefully consider the issues identified here, many of the often intractable cooperative issues can be identified before they derail a joint venture. In some cases, after carefully considering these issues, firms may decide that a joint venture is not the right course. Perhaps the risk of partnering is too high or there are no competent managers to run the venture. Our view is that it is far better to discover these things before the venture is formed than to spend large amounts of capital and end up with a non-performing relationship that is difficult to end. To order reprints, call 800-644-2464 (ref. number 10344). For photocopy permission, see page 2.

TABLE 1: JOINT VENTURE PLANNING ISSUES PLANNINGI~S~E

IMPLICATION

The objective of successful negotiations: mutual value creation

Successful joint ventures cannot be one-sided. Mutual value creation and co-destiny should be the objective of all joint venture partners.

Initial partner relationships and knowledge

Firms should enter negotiations with knowledge about their potential partner, including: the firm’s joint venture objectives, the firm’s strengths and weaknesses, and the firm’s reputation and experience with joint ventures.

Perspective toward risk

Joint ventures involve various types of competitive and financial risks. The sources of risk should be identified and tolerance to the risks determined.

Negotiable and non-negotiable

Before joint venture negotiations begin, firms should clearly decide on issues that are negotiable and issues that are nonnegotiable.

The importance individuals

of

The strength of alliance relationships is largely a function of the relationships between individual managers. The individuals who will be involved in joint venture negotiations and management should be chosen carefully and as early as possible.

Joint venture governance and trust

Since joint venture governance structures will evolve over time as the venture strategy emerges and partner trust develops, firms should be prepared for these changes when initial contracts are negotiated. Too strong an initial focus on formal controls can lead to problems, such as poor managerial selection and excessive monitoring costs.

National

If the proposed joint venture is international, the individuals slated to negotiate and manage the joint venture should have a solid cross-cultural knowledge base.

cultural issues

The importance of flexibility and review

Joint ventures agreements should be as flexible as possible to allow for uncomplicated changes in venture scope. Flexibility and review time should also be built into the negotiation.

SPRNGlPPP 45

TABLE 2: QUESTIONS FOR JOINT VENTURE PLANNING Mutual 0

Value

Creation:

Have both short- and long-term achieve those objectives?

on joint

economic

been

0

Will

What will happen if you can’t reach an agreement in your are your options for achieving your strategic objectives? Partner

be focused

objectives

0

Initial

the negotiation

collaborative

success

clearly

established?

and mutual joint

value

venture

Will

creation

negotiations?

a joint

venture

or a one-sided Besides

help

you

outcome?

an alliance,

what

Knowledge:

0

What do you really know about your partner and your ability to work together? What and weaknesses? How much experience and success has the firm with joint ventures?

are the partner’s

0

Has your prior experience with a key role in current negotiations

trust? Can that trust involved?

0

Is your partner firm’s knowledge

the potential partner created a strong level of interfirm and are the individual managers who built the trust

a competitor or likely play in determining

to become a competitor at some point in the future? whether or not your partner becomes a competitor?

What

strengths

role

play

will your

Risk:

l

How much risk are you willing ness is sold to your partner?

Essential 0

What

are the implications

if the joint

Have you clearly determined the issues that are non-negotiable? in the case of unique collaborative opportunities?

Are you

willing

is terminated

and the busi-

Do you know the role that your counterpart uals be the managers you have to work with assigned to operational roles?

0

Do your

0

Will operational

0

What will the joint venture top management team look like? Will your partner of managers? Based on the relationship between partner and the competitive what skills should the joint venture managers have? Venture

to compromise

on these

counterpart

negotiators

managers

Governance

have

be involved

negotiators will play in the future when the joint venture is formed?

personal

incentives

in the negotiations?

associated Have

with

joint venture? Or will a new

a successful

these managers

initiated

joint

Will these individset of managers be

venture

the potential

negotiation? joint venture?

have any objections to your choices environment the joint venture faces,

and Trust:

0

Do both parties understand that successful joint ventures more about each other and competitive dynamics shift?

0

Do venture partners recognize that the joint venture negotiation is a means to an end? No matter how joint venture is negotiated, issues of organizational fit and implementation will be critical in contributing venture success.

0

Do the partners

Cross-Cultural 0

0

understand

the importance

Is review

of flexibility

will undergo

a series of transitions

in the negotiation

process

as the partners

and the contractual

learn well the to joint

agreement?

Issues:

If the joint venture is international, agement familiar with the national can be consulted?

Flexibility

issues

Roles:

0

Joint

venture

Terms:

Individuals’

46

to bear?

are the managers who will be involved in the negotiation and venture culture of the partner? If not, are there other internal or external advisors

and Review: time built

ORGANIZATIONAL

into the joint

DYNAMICS

venture

formation

and negotiation

plan?

manwho

SELECTED BIBLIOGRAPHY For a discussion of the rationale and structural issues associated with alliances and joint ventures, see Jordan Lewis, Pnrt~erships for Profit: Structuringand Managing Strategic Alliances (Free Press, 1990). For a strategic perspective on alliances, see Michael Y. Yoshino and U. SriniRangan, vasa Strategic Alliances: An Entrepreneurial Approach to Globalization (Harvard Business School Press, 1995). For a discussion of the planning, negotiation, and formation of a joint venture in China, see William H. Newman, Birth ofa SuccessfilJoint Venture, University Press of America, 1992. An overview of the benefits of alliances is presented in Rosabeth M. Kanter, “Collaborative Advantage: The Art of Alliances,” Harvard Business Review, 1994, Vol. 72, no. 4, pp. 96-108. Arvind Parkhe has written about the importance of concepts such as trust and reciprocity in “Messy Research, Methodological Predispositions, and Theory Development in International Joint Ventures,” Academy ofManagement Review, 1993, Vol. 18, pp. 227-268. The various aspects of international joint venture formation and management are found in Andrew C. Inkpen’s The Management of Intemational Joint Ventures: An Organizational Learning Perspective(London: Routledge Press, 1995). An excellent discussion of the competitive risks of collaboration can be found in Joel Bleeke and David Ernst, “Is Your Strategic Alliance Really a Sale?” Harvard BusinessReview, 1995, Vol. 73, no. 1, pp. 97-105. For a detailed empirical analysis of factors contributing to joint venture dissolution, see Seung Ho Park and Gerard0 R. Ungson, “The Effect of National Culture, Organizational Complementarity, and Economic Motivation on Joint Venture Dissolution,” Academy of Mimagement Journal, 1997, Vol. 40, pp. 279-307. Partner strategic similarity and alliance performance are examined by Todd Saxton in “The Effects of Partner and Relationship Characteristics on Alliance

Outcomes,” Academy of Management Journal, 1997, Vol. 40, pp. 443-462. The issue of alliance bargaining power and how it can shift during the life of an alliance is discussed in Andrew C. Inkpen and Paul W. Beamish “Knowledge, Bargaining Power and International Joint Venture Stability,” Academy of Management Review, Vol. 22, pp. 177-202. The extent to which alliances evolve in response to partner learning is studied by Yves Doz in “The Evolution of Cooperation in Strategic Alliances: Initial Conditions or Learning Processes?” Strategic Management Iournal, 1996 (Special Issue Summer), 17, pp. 55-83. For a perspective challenging our arguments on the merits of mutual value creation in alliances, see Gary Hamel, “Competition for Competence and Inter-Partner Learning Within International Strategic Alliancesl’ Strategic Management Journal, Vol. 12, pp. 83-104. The examples referred to in the article come from our own research as well as some published sources. The CEO of British Petroleum’s discussion of the importance of individual managers in alliances is found in Steven E. Prokesch, “Unleashing the Power of Learning: An Interview with British Petroleum’s John Browne,” Harvard Business Review, 1997, Vol. 75, no. 5, pp. 146-168. For a more complete discussion of the alliance between Northwest and Continental, see Scott McCartney, Susan Carey, and Martha Brannigan, “Delta Blues: How Northwest Beat the Top Contender to Control Continental,” The Wall Street Journal, Jan, 27, 1998, pp. Al, AlO. For an overview of Richard Branson and the diversity of the Virgin organization, see “Behind Branson,” The Economist, February 21, 1998, pp. 63-66. The reference to Procter & Gamble’s Vietnam joint venture is based on “P&G Squabbles with Vietnamese Partner,” Samantha Marshall, The Wall Street Journal, Feb. 27,1998, pp. AlO. SPRING 1999

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