STRATEGIC ALLIANCES

A strategic alliance is a business arrangement in which two or more firms cooperate for their mutual benefit. Firms may combine their efforts for a variety of purposes including, but not limited to, sharing knowledge, expertise, and expenses as well as to gain entry to new markets or to gain a competitive advantage in one. Further, creation of a strategic alliance may turn actual or potential competitors into partners working toward a common goal. Use of strategic alliances has become a major tool for businesses that are internationalizing their operations. Therefore, use of strategic alliances has expanded dramatically over the past decade, and their use will continue to increase as we enter the 21st century.

This article provides an introduction to strategic alliances. First, characteristics of a strategic alliance are examined and examples are given. Second, the benefits of strategic alliances are discussed, and, third, choices involved in formation of a strategic alliance are explored. Finally, the special considerations for international strategic alliances are discussed.

CHARACTERISTICS

JOINT VENTURE-BASED STRATEGIC ALLIANCES.

Astrategic alliance is often, but not always, in the form of a joint venture. A joint venture is created when two or more firms work together to form a new business entity that is separate from its "parents." (Not all joint ventures fit this definition, joint ventures by acquisitions are exceptions. See below.) Ownership may be in equal or unequal shares, and may provide for changes in ownership of shares.

The most common kind is the joint venture through a subsidiary. In such an instance, two entities create a third separate entity with its own legal existence. For example, American Motors Corp. has formed a joint venture with government-owned Beijing Automotive Works, creating a third entity called Beijing Jeep.

Another is the joint venture by acquisition. It is created when one business purchases all or part of the shares of another. For example, in the 1990s, the Lear Corp. acquired interior components producer Masland Corp.

A third is the joint venture by merger. This is created when two or more companies are dissolved and incorporated into one surviving entity. For example, corporations A and B merge and their assets are conveyed to a newly created corporation C. After the merger, corporation C continues but corporations A and B are dissolved. It should be noted, however, that this legal mechanism is seldom used for international joint ventures.

STRATEGIC ALLIANCES NOT BASED ON JOINT VENTURES.

In general, a strategic alliance that is not in the form of a joint venture is formed for a limited purpose and is more narrow in its operations than the joint venture. Non-joint venture strategic alliances tend to be less stable and last for shorter terms than joint ventures. For example, United Airlines and British Airlines formed a strategic alliance for the purpose of marketing their North American and European routes in 1988. They did so because they were losing part of their market share to Delta and American Airlines. Within a year, however, the market shifted and they terminated the agreement.

LINKAGES THAT ARE NOT STRATEGIC ALLIANCES.

It is important to note that not all linkages between national or international businesses are strategic alliances. Examples of arrangements that do not create strategic alliances include licensing, exporting, franchising, and foreign direct investment agreements.

BENEFITS

The Internet, advances in telecommunications, and improved transportation systems have helped firms enter foreign markets and have contributed to the globalization of business. Simultaneously, they have facilitated the creation of strategic alliances.

The decision to form a strategic alliance depends on the needs and goals of the companies involved and on the laws of the countries in which the companies are doing business. (It should be noted, however, that discussion of the specific laws of various countries is beyond the scope of this article.) The auto industry is an example of an industry that relies heavily on strategic alliances. In the 1990s the auto industry began to rely heavily on joint venture strategic alliances as it expanded its operations in Mexico and Latin America. Auto makers began to demand more complete systems from their suppliers in Mexico, and engineering responsibility was transferred from the auto makers to their suppliers. In conjunction with this trend, auto makers are identifying Tier II and Tier III "partners" for the Tier I supplier. They are encouraging Tier I suppliers to enter joint ventures with other companies. And, in general, the Tier I suppliers have the authority to select their own suppliers and joint ventures partners except in areas such as safety and regulatory matters where control is crucial.

MARKET ENTRY.

A strategic alliance can ease entry into a foreign market. First, the local firm can provide knowledge of markets, customer preferences, distribution networks, and suppliers. This is especially true in Eastern Europe. Bestfoods is a food-processing firm that sells products such as Mazola corn oil. Bestfoods has formed strategic alliances with firms in several Eastern European countries that, in turn, market its products. A strategic alliance between British Airways and American Airlines was created in 1993 and designed to give the two airlines increased access to North American and European markets, respectively.

Sometimes, foreign countries require that a certain percentage of ownership remain in the hands of its citizens. For example, in Mexico, foreign investment is limited by law to 49 percent in specified areas, including bonding companies, firms that print and publish periodicals for national distribution, engine and car repairs, and operation of railway terminals. Thus, foreign firms cannot enter such markets alone; a joint venture is required.

SHARING RISKS AND EXPENSES.

Another major benefit of a strategic alliance is that the firms involved can share risks. For example, in the early 1990s, film manufacturers Kodak and Fuji joined with camera manufacturers Nikon, Canon, and Minolta to create cameras and film for an "Advanced Photo System." The strategic alliance (which was not based on a strategic alliance) was terminated in 1996 after the film and camera were developed. But it benefited the parties, because, by developing a common product for the market, they shared expenses and they minimized the risks that would have been involved if two or more of them had developed new, but noncompatible, formats. They avoided the potential for the kinds of losses suffered by the Sony Corp. when its Betamax format for videocassette recorders was rejected by the public in favor of the VHS format.

SYNERGISTIC EFFECTS OF SHARED KNOWLEDGE AND EXPERTISE.

A strategic alliance can help a firm gain knowledge and expertise. Further, when partners contribute skills, brands, market knowledge, and assets, there is a synergistic effect. The result is a set of resources that is more valuable than if the firms had kept them separate. For example, in the early 1990s, Motorola initiated an alliance among various partners, including Raytheon, Lockheed Martin, China Great Wall, and Nippon Iridium, to develop and build a global satellite-based communications network. This new network, called Iridium, allowed the partners to develop and implement a worldwide, space-based communications network.

GAINING COMPETITIVE ADVANTAGE.

Similarly, a strategic alliance can help a firm gain a competitive advantage. For example, a strategic alliance can be used to take advantage of a favorable brand image that has been established by one of the partners. (Establishing a brand image is a lengthy, expensive process.) It can also be used to gain shelf space for products. For example, PepsiCo formed a joint venture with the Thomas J. Lipton Co. to market readyto-drink teas throughout the United States. Lipton contributed brand recognition in teas and manufacturing expertise. PepsiCo, as the world's second-largest soft-drink manufacturer, shared its extensive distribution network.

FORMING A STRATEGIC ALLIANCE

After the decision is made to enter a strategic alliance, a firm faces many choices. Some of them relate to management and others relate to the law.

SELECTING A PARTNER.

A firm must consider many factors as it selects a partner. First, it must select a firm with a compatible management style. For example, it is said that an alliance between the United Kingdombased General Electric Corp. and a German firm called Siemens failed because their management styles were incompatible. On the other hand, a strategic alliance between General Mills and Nestle, through a firm called Cereal Partners Worldwide (CPW), is viewed as a success because of the compatible styles of their managers.

Second, it is important to consider the partner's products and services. A strategic alliance will probably work best if the firms involved complement but do not compete directly with each other. This is true in the case of General Mills and Nestle. Both produce foods, but the CPW joint venture is for the marketing of cereal in Europe. Nestle has marketing expertise and distribution networks in Europe, but it does not make breakfast cereals.

Third, the potential risks of the alliance should be considered. To do so, the two potential parties must gather as much information about each other as possible before entering an agreement. For example, has the potential partner entered other strategic alliances? Did they succeed or fail? Why? Is the potential partner financially stable? Do the potential partners share common strategic goals (a common vision) for the alliance?

Finally, it should be noted that there are situations in which a privately owned firm may form a joint venture with a government as its partner. This has occurred in Latin America in lumbering and in the discovery, exploration, and development of oil fields. The government controls the resource, but it wants the expertise of a firm that has experience in developing that resource. Similarly, with the collapse of communism in Central and Eastern Europe, in 1989 and the early 1990s, privately owned firms from Europe and the Western Hemisphere formed joint ventures with state-owned firms in the formerly communist countries.

MANAGEMENT DECISIONS.

In strategic alliances based on joint ventures, division of management must be carefully planned. There are various mechanisms through which management of such a strategic alliance can be shared. One involves shared management in which each party participates fully in management. This requires a high degree of cooperation.

A second mechanism is through assignment of management to one party. In such arrangements, the responsibility is usually assigned to the partner that owns the majority of the stock in the joint venture.

A third mechanism is through delegation to executive managers of the joint venture. In such an arrangement, executives are hired to run the joint venture. They may be hired from the outside or transferred from the firms that own the joint venture. The executive managers are responsible for day-to-day operations and decisions. The firms that own the joint venture do not get involved in day-to-day operations.

FORM OF OWNERSHIP.

In the case of a strategic alliance based on a joint venture, a form for doing business must be chosen. Usually the joint venture is created as a corporation, but the laws of each country vary as to types of corporations that are available and the legal requirements imposed on each. Usually, a joint venture is created under the corporate laws of the country in which it will be doing business. But this is not always true. For example, sometimes, a different country may be selected because it offers tax or other legal advantages. Countries that are sometimes selected for tax reasons include, for example, the Bahamas, Lichtenstein, and Monaco. It should also be noted that not all joint ventures involve a corporation. Occasionally, there may be legal reasons to create a joint venture under a form such as the limited partnership.

A lawyer or lawyers must be consulted with regard to the choice of business organization and its formation. And, in the case of an international strategic alliance, lawyers licensed to practice in each of the nations involved should be involved. For example, there is no reciprocity with regard to legal practice under the North American Free Trade Agreement. The laws and legal systems of the United States and Mexico differ significantly. Therefore, an agreement between a Mexican and a U.S. firm should be reviewed by Mexican as well as U.S. lawyers. Within the European Union (EU), in contrast, there is reciprocity with respect to legal licensing and it is possible, legally, for a lawyer licensed in one EU country to handle an agreement in another EU country. Even in the EU, however, the need for expertise with respect to applicable laws may compel a party to hire a team that includes lawyers trained in the legal jurisdictions of each country whose laws may affect the agreement.

In addition to specifying a form for the business organization, the agreement on which the strategic alliance is based covers topics such as management responsibilities, financial matters, and decision making. Other clauses depend on the needs of the individual parties.

SPECIAL CONSIDERATIONS IN
DESIGNING AN INTERNATIONAL
STRATEGIC ALLIANCE

There are some special concerns that must be faced by firms entering international strategic alliances, especially if a joint venture is involved. One area relates to intellectual property rights (IPR). IPR includes technology transfer as well as patent, trademark, and copyright protection. IPR rights are often transferred or shared in the context of an international joint venture. Yet, this can be a particularly risky area for a U.S. partner, because U.S. IPR laws are far more protective than is the case with respect to IPR laws in other countries. Host-country laws may allow IPR rights to lapse more quickly than is true under U.S. law. Also, lax enforcement of IPR laws in host countries may lead to problems. This is an area in which the advice of legal counsel and careful drafting of documents are crucial.

A second area of concern relates to finance. At least three sets of concerns should be addressed with respect to currency and exchange rates. First, exchange rates may fluctuate dramatically. For example, when Mexico faced a financial crisis in 1995-96, it caused major concerns for U.S. companies involved in joint ventures with Mexican firms, because exchange rates between the United States and Mexico changed dramatically. In November 1994, the Mexican peso was trading for slightly over three pesos per U.S. dollar. The exchange rate had dropped to a low of 7.7 pesos per U.S. dollar as of March 1995. As of June 1999, the Mexican peso is trading for just over ten pesos per U.S. dollars. Therefore, the form of currency to be used in payments between companies from two countries must be addressed. Second, the potential for inflation must be considered. For example, inflation in Mexico reached an annualized rate of 64 percent as of February 1995. Although economic reforms have reduced Mexico's inflation to an annualized rate of 22 percent (comparing January 1999 to January 1998), inflation in Mexico continues to be much higher than in the United States. Third, interest rates can be affected by financial instability. For example, as of 1999 Mexico was still dealing with the aftermath of its debt crisis. Interest rates were relatively high as compared to those in the United States, and loans were difficult to obtain through Mexican banks. Such problems are not unique to dealing with Mexico. Exchange rates, payment (in whose currency?), the potential for varying rates of inflation in the two (or more) countries involved, and sources of loans are important considerations when an international strategic alliance is created.

A third area of concern relates to the potential for political instability. Instability in Yugoslavia in 1999 means that the companies of that country are not likely to be selected as potential partners for strategic alliances. Similarly, concerns about the need for democratic reform causes businesses to proceed carefully when investing in the People's Republic of China. That is one of the reasons why U.S. businesses are encouraging the Clinton administration to support the admission of China to the World Trade Organization.

LOOKING AHEAD

Strategic alliances have become increasingly popular in international business. They provide businesses with various benefits including access to markets, sharing of risks and expenses, synergistic effects of shared knowledge and expertise, and competitive advantages in the marketplace. There are risks to be considered and cautions to be exercised as a firm enters a strategic alliance. But, as businesses continue to globalize, strategic alliances will continue to be a major tool for the firms involved.