Importance of strategic alliances

Importance of strategic alliances Introduction Strategic Alliances are becoming very popular in present scenario. In business environment these days alliances are becoming essential building blocks for companies to achieve more effective and efficient market place. This kind of cooperative arrangement helps organizations to achieve goals and objectives better through cooperation rather than competition. Seeing the importance of strategic alliances it is very important for the partners to form effective business relationship which helps in achieving cooperative objectives. Formation of alliances may encounter several problems that can affect further business relationships. This essay is divided into 3 parts. First part defines strategic alliances and steps in their formation. Second part identifies major problems in alliance formation with the help of academic theories and case studies. Third part discusses the importance of partner selection and gives examples of successful partner selection. Strategic Alliance Strategic alliance is an agreement between two or more firms or companies reaching on the objective of common interest. Strategic alliance is a trading partnership that enhances the effectiveness of the competitive strategies of the participating firms by providing for the mutually beneficial trade of technologies, skill, or products based upon them. These alliances can range from informal agreement to formal contract depends on the length of contract in which partners are involved in transfer of capital, technologies, and personnel. Alliances between partners consist of basically four necessary characteristics: 1 The two or more companies remain independent even after forming an alliance to pursue their objectives. The companies involved in the alliance share the common benefit, competitive advantage and manage the performance of task. The partner firms get involved in achieving common objective by contributing on a regular basis in one or more key areas of alliance, e.g. technology, product, personnel, etc. Trust is another characteristic that can evolves and develop between partners during the operation of an alliance which comes from the selection of right partner. Stages in Alliance formation 1). Purpose of alliance: There are various factors which are driving the companies to enter into alliances which are globalization of market, rapid change in technology, increased in competition, high cost of RD etc. Out of various corporative purposes there are eight purposes (Figure.1) on which companies are focusing for alliance formation. Four out of eight strategies- as strategic because these purpose impact on the competitiveness and future position of alliances. Other four purpose deal with the operational purpose. Purpose of Business Alliance Strategic Operation Figure 1. Purpose of Alliance 2). Motives and objectives of Alliance: Motive describes various reasons for which companies are going for alliances formation and how they achieve the desired objective. Motive for alliance formation can consist of cost advantages, decreasing risk and uncertainty, organizational learning, managing industry structure and timing. Objective of alliance deals with the outcome of the process. 3). Partner Selection: Partner selection plays a very important and vital role in the formation of alliance between the companies. Note: Please refer to the third part of this essay for more information about the importance of partner selection and relevant theories. 4). Types of alliances: Strategic Alliances are basically identified into two types: Alliances between non-competing firms Alliances between competing firms These both alliances are further divided into four types which are: Cartels, Competitive alliances, Co-operatives and Collaborative. Cartels This type of alliance is basically comes under competing firms involves in the operation purpose. This alliance operate in the businesses like diamond, petroleum, semi conductor chips producers dealing in field of product supply, price fixing or sharing common infrastructure. Competitive alliance This kind of alliance is generally between the companies or firms who are very strong rivals and basically competitors. It serves the strategic purpose and is specially designed for the companies dealing in global or regional geographical area. The companies in this alliance enjoy the competitive advantage. Some of the examples of competitive alliances are: GM and Toyota who are assembling automobiles; Siemens and Philips developing semiconductors etc. Co-operative alliance This alliance is applicable for non-competing firms focusing on operational purpose. companies share cost and facilities with customers or suppliers. They are involved in co-development or distribution of goods and services. Collaborative Collaborative alliances are common in non-competing companies involves in strategic objectives. The main purpose of this alliances is in the collaboration of activities like joint marketing efforts, entering new market, and developments of new technologies or new product between the companies. 5). Decision making and coordination between management: Many of the alliances fail due to the poor decision making by the management. For the success of alliance it is important that all members should agree on the specific decision, policy, rule etc. in the formation of alliance. Problems Encountered in Alliance Formation Strategic alliance is a popular choice for a company who wants to grow. Careful consideration on forming an alliance is a very crucial part for its success. Many recent studies discuss success factors of alliances and give less importance to the problems encountered in its formation. There is a danger for alliance to break because of problems arising at the very beginning of its formation. Seven of the major problems encountered in the formation of alliances are discussed below. 1). Difference in culture and attitude One of the biggest problems encountered by the partners in the alliance is the difference in culture. Alliance brings together two different international companies with their cultural differences like language, ego, manners, attitudes and approaches. Language barrier is an important problem in cultural mismatch. In alliance formation process companies have to communicate to each other. Language is one of the communication means. Companies are also differently operated based on lets say western and eastern manners. For example, companies in the USA evaluate their performance on the basis of profit and market share whereas companies in Japan evaluate their performance based on operations that they choose to make. Example case: The Rover/Honda Alliance Rover Honda alliance was formed in 1979. Poor management of Rover would need a good managerial example like for instance from Japan. Honda received the huge network of suppliers and got chance to learn European style. This alliance was formed for the strategic purpose and falls under competing type of alliance. These two companies are from different cultural backgrounds. According to Rover it took 6 years out of 10 to understand the business style of Honda. This alliance shows the importance of cultural background. Honda claims to waste this time in learning the culture of the company instead of putting all attention on business production and its introduction to the market. Thus the problem of cultural difference may be time consuming process and has to be considered at the time of formation of alliance. 2). Lack of Trust Lack of trust between the companies may cause firms not to make an alliance at all or to end it in a later process. Lack of trust brings the problem of lack of commitment in alliance. In order to form an alliance, companies have to see if they can trust each other. Trust reduces the uncertainty and risk in the alliance. Suzuki-Maruti Alliance This alliance was formed on October 2, 1982. Suzuki-Maruti alliance is a collaborative alliance. At the starting point Maruti had 74% of shares and Suzuki had 26%. However, after India opened the door for globalization venture, shares were changed into 50-50 partnership. However, after competitors entered Indian market the new expansion plan with 15 billion rupees was made. Suzuki requested raising the equity shares which gave wrong impression for Indian government that Suzuki wanted to take over them. However, as both companies realize the importance of trust, they decided that in every 5 years if chairman is chosen from Suzuki than managing director must be from Maruti and vice versa. This agreement was not followed by Maruti so courts had to solve this problem. This example case shows that trust can be broken later on. Its negative side resulted in the involvement of court. The reason for this situation may be poor trust at the start which grew into greater conflict or the trust was broken with time. In any case, companies have to consider the dangers and negative effects of lack of trust during the alliance formation or even afterwards. 3) Lack of Coordination between management Many alliances fail due to the poor decision making by the management. This is caused by the lack of coordination between management teams in alliances. In business practice it happens that members in alliance do not agree on the specific decisions. It happens sometimes that companies go for some major project on its own by applying their own marketing strategy for products without considering the other firm. In the formation of alliance it is usually agreed to decide on the commitments of top managements, but due to the poor management it may sometime affect the alliances in long term and results in failure. Example case: Queensland Minerals Limited At the time of venture it has been agreed that Boards of Director for Queensland Mineral must be 4 equally from both parent companies. And out of which VHI is responsible for managing the staff. Apart from that Amcon is responsible for sound financial practice and is more efficient than VHI. Further problem started with the management process in the alliance as Amcon wanted to expand Queensland Mineral Ltd. Whereas VHI did not want the expansion. As there was no proper coordination between management of both companies this resulted in the change of management structure. So finally they came up the result to make 50-50 management structure. 4). Operational risk This kind of problem arises in the later part of alliances but in order to come over this problem and for the successful alliance partners should monitor the operational risk. This problem is encountered by partners when they are involved in different trade practices. The main aim of alliances is to pursue the business to achieve the common goal. But when partners involved in business for the self interest like delay in production of good or not delivering goods on time may affect the other partner. This situation causes breakup of alliance or take over. Example case: Goodyear-Sumi-tomo Goodyear has a Joint production alliance with Japans Sumi-tomo. These two companies produce tyres for each other in different area, one in Asia and other in North America. They remain competitors in many markets. Being a competitors alliance will be in danger side and have more chances of failure because competitor will always remain competitors even if they have alliance. 5). Performance risk It consists of chance of failure of alliance if companies fulfil all the aspects for successful alliance formation. This performance risk may evolve from various environmental conditions like introduction of new policies by government, war, market condition like recession or demand and supply gap. On the other hand long term orientation has its own value in alliance. In this partner view the alliance as least semi permanent which means the condition which comes in future should be adapted as it is by partners. In order to come out of this problem partners should settle a reasonable, concrete objective at each stage of formation of alliance. Vodaphone and China Alliance These companies formed alliance on January 9, 2002. They made this alliance of RD of wireless data services. These companies consider all the possible forward-looking statement with known and unknown risks and uncertainty. They carefully consider the performance risk that there is a chance of unexpected events which may break alliance. In the annual report on year ended on 31 December 2000, the registration filed by the China mobile described uncertainty and risk for the future. If any of risk, uncertainty or assumptions were wrong it affects the future results and may differ from the expected. Still they were doing well in the alliance. This kind of alliance comes under competitive alliance type where both company serves the strategic purpose. 6). Relational Risk Relational risk deals with the chance that partners may lack commitment of the alliance and the partners are more intended to fulfil the self interest rather than common alliance interest. Relational risk is very important and unique in strategic alliance. At the formation of alliance companies should agree on certain points to overcome relational risk. If any decision is taken on marketing of product or new product development, the firms should not serve their own interests; rather they need to cooperate with each other. Example case: In 1993 U S West invested $2.5 billion in Time Warner Entertainment which a part of Time Warner Inc. This alliance went into problem in later part when Time Warner Entertainment signed various other contracts with other telecommunication industries like AT T. This will affect the U S West as these companies were come from its own local competitors. These all proposals are vetoed by U S West. 7). Risk of partner selection The last but not the least and consider to be very important problem or risk faced in alliances is partner selection. This is not an easy decision to take on selection as there are various criteria for choosing good partner. It happened in the past and present that most of the alliances fail just because due to the choice of wrong partner. It may happen when alliances were formed between competitors, between weak and strong firms. Before forming an alliance partners should go for strong equal equity and very high level of trust an commitment is requires in the selection of partners. When partners are selecting a partner at the time of alliance the partner should be both resource fit and strategic fit and serve the need of alliance. Importance of Partner Selection Selection of partners in the alliance considers to be the most important part. When partners enter into any alliance they have certain expectations and objectives. So it is very crucial for the management of companies to identify and understand the effective partner selection criteria before going for any alliance. It is a very complex decision to take. Basically poor decision taken on the partner selection may lead to fail of alliances. A successful alliance leads to the combination of partners serving towards the same goal. With the selection of right partner company may help themselves to grow more in future by the introduction of new technology, skill, personnel, access to new market, dividing risks. Selection of appropriate partners is the intensive process in the formation of alliance. Before going to any alliance partners must consider three features which helps in selecting right partner. Partners should have resources and capabilities to serve companies in achieving strategic goals. Partners must share long-term goals for the alliance Partners should not use the alliance just to learn new technology, relationship between customers and client without the equal contribution of strategies. As it is told before also that selection of partner is is very complex thing as a small decision may leed to failure of alliance. Companies may face problem in selection of partner due to some reason like: Lack of Information of partner Overestimation of capability Managerial Differences Lack of mutual trust between partners Cultural difference According to one of the theory called 3C in Business International (1992), in order to measure the potential resources and capabilities of partners, it is necessary to reduce this criteria to bring it down to three requisites C: Compatibility, Capability, Commitment which is very important in the selection of partner. Compatibility While selecting the partners it is easy to identify the good partner by seeing the compatibility of of partner from the past alliances. It has been seen that most of the alliance come from past tie-ups between the partners. Looking at the compatibility of the partner and forming an alliance is very simple and easy. It has been seen that building alliances with the known partner reduces the risk of failure in alliance. Capability Every partner when going into selection process partner it basically looks for the capability of the other partner. It depends on how they can serve the objective of alliance. It can may happen that one is good in technology, one is better in geographical area. So partner can serve the area in which he capable and cover that particular area whether geographical area, production, distribution etc. Commitment The parents may have capabilities and compatibility within but they must have believed in the alliance. Partners should have commitment towards the alliances, so any partner coming into alliance should have trust on other partners. They have to find the ways to come over any risks in future by serving towards the same goal. When talking about the selection of partners, partner firm should be resource fit and strategic fit. Resource fir refers to the degree of to which partners possess compatible resources. It is important for alliance partner because resources and capabilities are the main thing responsible for the alliance performance. For example: HP and Nokia form alliance to develop hand-held communication device that combine mobile phone with computer, where both companies draw the resources and capabilities. Strategic fit refers to the alliance where firms know each other real objective and that these objectives can accommodate in the alliance without harming the partner firm of alliance itself. For example: GM and Daewoo formed an alliance where GM interested mainly to remain with same model and keeping cost down and Daewoo wants to upgrade technology and design. Due to the mismatch of RD orientation and cost orientation alliance got failed. Conclusion This essay consist of three parts where in first part it explains about the strategic alliance and the stages involved, second part consist of problem encountered in the formation of alliance and final part covers the importance of partner selection. Strategic alliance is an important tool for attaining and maintaining competitive advantages. Many companies are forming alliance for the best quality and technologies or cheap labour and production cost. But sometimes company form an alliance without analysing capabilities and resources of partners of the life of alliance or lack with the objectives which may results in the failure of alliance.