STRATEGIC ALLIANCES I

 

Large merger and acquisition transactions typically grab the business headlines,

especially as they are recently staging something of a comeback. Out of the

headlines, but equally important, is the rapidly growing use of strategic alliances

as a method of business development and growth. In this newsletter, the first of

a series on this topic, we will outline the fundamentals of strategic alliances, and

attempt to account for their increasing popularity.

 

What is a Strategic Alliance?

 

A strategic alliance is a way for two or more companies with complementary

capabilities to work together for mutual benefit, in order to capitalize on a market

opportunity. The alliance enables the companies to exploit the opportunity more

rapidly, more profitably, and with less cost and/or risk than either could alone.

Alliances involve ongoing resource contributions from each partner in order to

create joint value.

 

Alliances give companies a way to leverage their existing skills while they quickly

and flexibly access the capabilities of others. An alliance is based upon shared

goals, which cannot be achieved without access to additional capabilities beyond

those that either partner alone currently possesses.

 

An alliance usually requires an open-ended agreement between two companies.

An open-ended agreement is one in which it is accepted that the agreement will

evolve over time. At its core, an alliance is a process of shared decision-making

and joint governance.

 

Motivations for Alliances

 

Alliances can be used to fulfill a broad range of corporate goals, including gaining

scale, reducing costs, accessing new skills, products, or markets, and sharing risk.

An alliance at an early stage of industry transformation can also be seen as a way

of acquiring an option on future developments.

 

Alliances are frequently focused on intellectual property and intellectual capital.

In addition, alliances allow a firm to more easily capitalize on serendipitous

discoveries, because the firm doesn’t need to singlehandedly build an entire

company around the discovery.

 

Even the largest companies cannot fund all the intellectual property programs

that they desire. Further, even those companies that can afford to develop the

necessary intellectual property may not be able to do so in a timely fashion.

 

If a firm has demonstrated a new technology on a least a prototype or pilot basis,

it has removed many questions regarding its efficacy. Thus, a firm with, say,

distribution or production capabilities, may want to partner with a firm that already

has the proven technology because it removes much of the risk of technology failure.

 

Intellectual property confers legal rights and protections to its owners. However,

even companies that possess demonstrated IP may not have the time or money to

defend it against infringement. Thus, it can be to the advantage of a smaller firm

to join forces with a firm that has greater legal capabilities.

 

Mergers and Alliances  

 

Executives need to think about structuring alliances in a way that is very different

from mergers and acquisitions. It is not about price. It is about scope and strategy,

and governance.

 

Potential alliance partners need to ask, what depth of commitment and interaction

is necessary to make a collaboration work? An alliance is an arrangement short of

merger, but deeper than an arm’s length contract. It generally has a much lighter

regulatory, accounting, and reporting burden than an acquisition, a very important

consideration.

 

Using an alliance can mean lower transaction costs. An alliance lets a company test

out the new direction and then retreat gracefully if it proves to be the wrong move.

This is less costly than acquiring a company and then divesting it. An alliance also

enables a gradual exchange of knowledge and skills while each partner maintains an 

interest in the business.

 

Alliances often succeed where acquisitions fail. Acquisitions, through rapid headcount

reduction and other common practices, can easily kill the entrepreneurial spirit that

drove the development of the value, thus jeopardizing the hoped-for benefits. The

alliance, by not threatening the people and processes that created the value, can

begin to grow and thrive, where an acquisition might result in an empty shell.

 

Structure and Process of Alliances

 

Alliance formation has three main elements: strategy, partner selection, and deal

structure. Strategy determines partner selection, and strategy and partner selection

shape the deal structure. The fundamental strategy driving an alliance changes

rarely or only slowly. In contrast, structure is often fluid; typically, it will be adjusted

over time to pursue new goals or to account for new partner capabilities.

 

In an alliance, each party retains its own management structure, but shares control

over the alliance’s pooled resources. Strong individual firm management does not

guarantee alliance success. Much of the management style that works for a large

bureaucratic entity will not work for a strategic alliance.

 

Alliances are usually intended to be open-ended. Over time, markets, technologies,

and overall strategies of partners are likely to change. As a result, strategic alliances

should be governed by a clear, fair, and flexible set of rules. Rather than trying to

anticipate every problem that could arise among the partners, the governing

documents should place greater emphasis on the process for resolving business

disputes among the partners.

 

The stability or longevity of the alliance ought not to be a goal in itself; only the

success of the alliance strategy matters. Alliances are a means to an end, never

an end in themselves. Alliance longevity by itself is of little relevance—strategic

success is what counts.

 

Typically, alliance agreements will address issues that fall into four main areas:

partner contributions and distributions, control, allocation of risks and rewards,

and alliance termination strategies.

 

Although financial and legal arrangements are necessary parts of alliance structure,

three other elements—incentive alignment, decision processes, and evolution—are

critical in creating a structure that produces success. It is not the deal per se

that creates value, but the capacity of two partners to maneuver their alliance

through a thicket of uncertainties, changing priorities, organizational frictions,

and competitive surprises.

 

A potential alliance partner should be asking itself, what capabilities do we lack

in order to address the strategic opportunity or market niche? The search for

an alliance partner involves careful consideration of precisely which business

capacities are necessary to address the opportunity.

 

Valuation Considerations

 

The partners should assemble a business plan at the outset, with the full knowledge

that it is likely to change over time. The business plan articulates the expected path,

and the expected outcomes, given certain contributions of resources over time. It

should illustrate how the value is created, and how much value is expected to be

created, given certain assumptions regarding the most likely or preferred embodiment

of the plan. The value of the alliance should be measured at the outset, and at regular

intervals. The partners can then decide how and when this value is to be distributed.

 

The value of the alliance at any given point considers the incremental cash flows

from whatever source, that would not accrue absent the alliance. This means that

at a minimum, both incremental revenues and costs must be taken into account.

These incremental revenues and costs need to be monitored at regular intervals.

This will be important if the partners are receiving payouts based on the amount of

measurable value added over a given year.

 

Not all the expected returns can be precisely measured. Enhanced market share and

brand loyalty are important dimensions. New growth opportunities or strategic options

may be discovered. In addition, when organizations learn from each other, new

intellectual property rights may be created, and development of new knowledge

capabilities will almost certainly occur. Whether these less tangible capabilities are

capitalized on, or languish instead in obscurity, is up to management.

 

Performance metrics should be tied to the alliance’s strategic intent, while still allowing

for the capture of serendipitous, unexpected, or unsought benefits. Business history is

loaded with success stories based upon an accidental discovery of totally different uses

for the product, service, or research output of an alliance.

 

Conclusion

 

An important new capability, that not every company currently possesses, consists of

the knowledge of how to partner effectively with other business entities.

 

Because companies of whatever size, and in whatever industry, are increasingly finding

it necessary to use alliances to fulfill their business objectives, it is important to begin

to build an alliance capability within the organization. There needs to be as much

emphasis on alliance strategy as on strategic alliance. Firms cannot afford to treat

the current alliance as a one-shot deal, but must develop a strategy for how best to

use alliances to accomplish business objectives on an ongoing basis.

 

An effort should be made to set a congenial tone with prospective partners right from

the start. At every step of the way, the collaborative nature of the alliance should be

foremost in participants’ minds. If nothing else, this can help to offset the typically

competitive and mistrustful attitudes that exist between otherwise unrelated business

entities. An attitude of mutual goodwill and respect will make a tremendous difference

in the productivity and success of the alliance.

 

In this era, somewhat paradoxically, firms need to be simultaneously intensely

competitive and highly cooperative in order to maximize returns to their resources.

However, once each firm recognizes the complementary capabilities of the other,

the alliance phenomenon becomes less of a paradox.

Located just outside Philadelphia, Value Concepts LLC has been an independent valuation 
consulting firm since 1996. To learn more about us, visit our web site at www.valueconcepts.net .

Contact us by email at thoughts@valueconcepts.net , or call Nick Holt at 215-836-0419.

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