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Strategic Management Week 12 – Chapter 11

Strategic Alliances

Ch. 11 Learning Objectives

• Define a strategic alliance and give specific examples of strategic alliances. • Describe the different ways in which an alliance can create value • Understand how adverse selection, moral hazard and hold-up can destroy

value in alliances • Specify the conditions under which a firm's strategic will be rare and costly

to duplicate. • Describe when going-it-alone and acquisitions are not good substitutes for

strategic alliances. • Describe the bases that can reduce the threat of cheating in an alliance.

Where Are We in the SM Process?

Mission Objectives

External Analysis

Internal Analysis

Strategic Choice

Strategy Implementation

Competitive Advantage

Business Level Strategy

Corporate Level Strategy

How to Position a Business

in the Market?

Mode of Entry?

Vertical Integration? Diversification?

Strategic Alliance?

Which Businesses to Enter?

The Choice between Market and Hierarchy

BENEFITS

COSTS

MARKET HIERARCHY

Informational Efficiencies

High-Powered Incentives

Transaction Costs

Market Power

Authority

Coordination

Bureaucracy

Agency theory

Source: Collis and Montgomery, Corporate Strategy, 1997

Defining Strategic Alliance

• Any cooperative effort between two or more independent organizations to develop, manufacture, or sell products or services

• What level of inter-firm cooperation meets this? – Spot sales/ purchases – Ongoing sales/ purchases (informal or contracted) – Licensing Agreements

• Dr. Pepper, Coca-Cola, PepsiCo

• Marvel, Sony, Universal, Fox

Why? Create economic value by:

• accessing complementary resources and capabilities

• leveraging existing resources and capabilities

An alliance is an organizational form of exchange that:

• should produce a gain from trade due to some comparative or absolute advantage

Implication: Choose partners that are better at something than you are (complementary resources)

Three Types Of

Alliances

Nonequity Alliance

Contracts • licensing

• supply & distribution agreements

Joint Venture

Equity Alliance

Cross Equity Holdings

• partners own stakes in eachother

Joint Equity Holdings

• independent firm is

created

Intermediate Forms of Organization: A Continuum of Governance Arrangements

SPOT MARKET

INTERNAL HIERARCHY (full integration)

RANGE OF INTERMEDIATE FORMS

LONG-TERM CONTRACTS

STRATEGIC ALLIANCES

JOINT VENTURES

QUASI- VERTICAL

INTEGRATION (PARTIAL

OWNERSHIP)

Intermediate relationships may combine the benefits of both market transactions and internalization

Spot sales/ purchases

Long-term contracts

Agency agreements

Franchises

Vertical integration

Joint ventures

Informal supplier/ customer

relationships Supplier/ customer

partnerships

Low Degree of Commitment High

Low

High

Fo rm

al iz

at io

Different Types of Vertical Relationships

Source: Robert M. Grant, Contemporary Strategy Analysis, Basil Blackwell, 1995

Canada Mexico Wheat bushels/hr.

Bananas lbs./hr.

Exchange Rate:

1 bu. = 1 lb.

Canada: 2 hrs. = 6 bu. Wheat and 4 lbs. Banana, or 2 hrs. = 12 bu. Wheat

By trading, Canada can get: 6 bu. Wheat and 6 lbs. Bananas

Gains from Trade Motivation for Alliances

A ½ hour gain from trade!

Canada Mexico

Mexico: 2 hrs. = 1 bu. Wheat and 5 lbs. Bananas, or 2 hrs. = 10 lbs. Bananas

By trading, Mexico can get: 5 bu. Wheat and 5 lbs. Bananas

A 4 hour gain from trade!

Canada Mexico Wheat bushels/hr.

Bananas lbs./hr.

Exchange Rate:

1 bu. = 1 lb.

Gains from Trade Motivation for Alliances

How Strategic Alliances Create Value

Improve Current Operations

Shaping the Competitive Environment

Facilitating Entry and Exit

Value Creation

Improve Current Operations

• Economies of Scale • Learn from competitors • Manage risk/share costs

Improving Current Operations: Exploiting economies of scale

• a partner brings increased market share and/or manufacturing capacity

Learning from partners • a partner brings technology and/or

market knowledge Risk and cost sharing

• a partner bears a portion of the risk and/or cost of the alliance

How Strategic Alliances Create Value

Facilitating technology standards

Facilitating tacit collusion

• partners may agree on a standard and avoid a market battle for the standard

• partners may communicate within an alliance in subtle, legal ways whereas the same

communication between competitors outside an alliance would be illegal

How Strategic Alliances Create Value

Shaping the Competitive Environment:

Low-cost entry into new industries

Low-cost exit from industries

Managing uncertainty

Low-cost entry into new geographic markets

• a partner provides instant access and legitimacy

• a partner is an informed buyer

• alliances may serve as ‘real options’

• partners provide local market knowledge, access, and legitimacy with governments and customers

How Strategic Alliances Create Value

Facilitating Entry and Exit:

Incentives to Misappropriate Value (Cheat): An alliance is an exchange context in which:

• partner inputs may be difficult to monitor

• actual value creation may be difficult to monitor

• value appropriation (allocating the value) may be:

• difficult to monitor

• subject to power dynamics

Challenges to Value Creation and Allocation

Three Forms of

Misappropriating Value

Adverse Selection

Moral HazardHoldup

misrepresenting the value of

inputs

providing inputs of lesser value than promised

exploiting the transaction- specific investment of partners

Challenges to Value Creation and Allocation

Holdup

• The threat of Holdup can act as a motivation to engage in strategic alliances in some circumstances

• If transition-specific investments would be needed by one or both parties (in a buyer-supplier relationship) under arms-length transactions, formalizing terms under a strategic alliance may be preferable

• See the textbooks’s example of Bauxite-smelting

Are strategic alliances rare? As a form of organizing economic exchange- No

The sources of value creation within alliances may be rare. [See the Disney-Pixar example in our textbook]

However,

• firms may form a combination of complementary resources within an alliance that is rare

• the stock of such complementary resources may be limited so that first movers have a rare combination

Sustained Competitive Advantage

Are strategic alliances costly to imitate? As a form of organizing economic exchange- No

However,

The resource combinations that create value in alliances may be very costly, if not impossible,

to imitate if:

• the organizational form per se is easily duplicated

• the value creating combination depends on social complexity (trust), causal ambiguity,

and/or historical uniqueness

Sustained Competitive Advantage

Substitutes for Strategic Alliances

• “Going it Alone” – The resources/capabilities sought in an alliance [to address

opportunities/threats] can sometimes be developed internally

– Think back to Ch. 6 for the drivers of vertical integration (uncertainty, opportunism, resource configurations)

– Prime conditions for SA over internal development: • Moderate transaction-specific investment requirement • Potential partners hold VRI resources/capabilities • Uncertainty is high (SA under “real options” logic)

Substitutes for Strategic Alliances

• Acquisitions – This may not be an optimal or even plausible course of

action though. – Prime conditions for SA over M&A:

• Legal constraints on acquisitions • M&A’s would limit a firms flexibility and high uncertainty exists • There is too much “baggage” attached to partners that would be

transferred to an acquiring firm (disposal of non-value creating components is costly/time-consuming

• Independence itself is valuable (e.g. Publicis, French advertising firm)

Sustained Competitive Advantage Are strategic alliances substitutable?

Substitutes for Strategic Alliances

Internal Development

Mergers & Acquisitions

If:

• no partner is available

• transaction-specific investment is high

• low uncertainty about the investment

If: • there are no anti-trust issues

• low uncertainty about the investment

• firms can be integrated easily

• value of combined firms is not tied to independence

Organizing for SA

• Explicit Contracts & Legal Sanctions – Requires anticipation – Boilerplate considerations (see Table 9.6)

• Establishment Issues • Operating Issues • Termination Issues

• Equity Investments (incl. cross-equity) – To what extent would the equity devaluation outweigh the

economic benefit of “cheating”

Organizing for SA

• Firm reputations – Can’t know the future è Look to the past – “Information about an alliance partner that has cheated is likely to

become widely known [with exceptions]” • Subtle cheating/origin of responsibility • Network diffusion of knowledge

• JVs – Best when p(cheating) is highest – Not foolproof though

• Trust – May allow partners to exploit opportunities that would be infeasible

with other mechanisms

Governance Responses to the Challenges of Value Creation and Allocation

Explicit Contracts & Legal Sanctions Equity InvestmentsJoint Ventures

Formal/Codified

• imposes costs for cheating

• creates mutual understanding

• conflict resolution

• aligns interests of partners through ownership of independent firm

• aligns interests of partners through ownership in each other

• direct effect • indirect effect

Organizing Strategic Alliances

Trust Firm Reputations

Informal

• the shadow of the future constrains cheating

• may allow partners to exploit opportunities that would be infeasible with other mechanisms

Organizing Strategic Alliances Governance Responses to the Challenges of

Value Creation and Allocation

These responses are not mutually exclusive:

• contracts may be used with equity investments and joint ventures along with firm reputation

and trust

• reputation and trust come into play in every type of alliance

Reputation and trust may be sources of competitive advantage because they are costly to imitate

Organizing Strategic Alliances Governance Responses to the Challenges of

Value Creation and Allocation

Ethics & Strategy

• Is the adage “cheaters never prosper” true in the US economy? • All three threats in strategic alliances (adverse selection, moral

hazard, & holdup) deploy deceit at some stage. • Considerations for potential ”cheaters”

– Legal – Consequences:

• 3rd- party enforcement or retaliation • Reputational

– Zero- vs. non-zero sum game: what are we assuming here? – Ethical