©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - -...

©2001 Prentice Hall Takeovers, Restructuring, and Corporate

Governance, 3/e Weston - 1

- - - - - - - - Chapter 14 - - - - - - - -

Joint Ventures



Background

• Joint venture is a separate business entity– Participants continue as separate firms– May be organized as partnership,

corporation, or any other form of business– Formal long-term contract of 8 to 12 years

duration



• Characteristics of joint ventures– Limited scope and duration– Generally involve only two firms– Involve only small fraction of participants'

total activities – Each participant offers something of value– Joint production of single products– No sharing of assets/information beyond

venture– Need not affect competitive relationships



– Joint property interest in subject matter of venture

– Right of mutual control or management of enterprise

– Right to share in cash flows of the enterprise

– Limited risk



• Timing similar to merger and acquisition activity– Correlation between mergers and joint

venture start-ups over 0.95– Both stimulated by same factors affecting

total investment activity



Joint Ventures in Business Strategy

• Goals/objectives of joint ventures– Risk sharing

• Each participant diversifies risk• Reduces investment cost of entering risky new

area• Realizes benefits of economies of scale, critical

mass, learning curve effects sooner



– Knowledge acquisition — learning experience for both partners• Shared technology• Shared managerial skills in organization,

planning, and control• Successive integration — joint venturing as a

way to learn about prospective merger partners

– Entry into new, expanded, foreign markets• Augments financial or technical capabilities• Reduces risk• Foreign country may require joint venture with

local partner



– Financing — to raise capital• Share investment expense• Small company has product idea but no cash• Joint venture with large company that has cash

to develop product

– Distribution/marketing• To obtain distribution channels• To obtain raw materials supply



– More favorable tax/political treatment• Foreign ventures• Antitrust issues — joint ventures increase

rather than reduce number of firms

– Long-run strategic planning — spider's web strategy• Provide countervailing power among rivals• Small firms in a concentrated industry do

multiple joint ventures with dominant firms to form self-protective networks



• Joint ventures and complex learning– Goal of at least 50% of joint ventures is

knowledge acquisition– Complex knowledge, embedded within

technological/organizational systems– Learning-by-doing, teaching-by-doing to

transfer complex knowledge • Classroom setting inappropriate• May require successive adaptations to changing

circumstances• Job incumbents may be able to teach task skills

only in operational setting



• Tax aspects of joint ventures– Contribution of a patent or licensable

technology to a joint venture may have better tax consequences than a licensing arrangement with royalties

– Examples:• One partner contributes technology• Other partner contributes depreciable assets• Depreciation offsets revenues• Joint venture ends up with lower tax rate than any of

its partners• Partners pay deferred capital gains if/when venture is

terminated



– Other tax aspects• Limitation on operating loss carryovers• Partnership status of unincorporated

commercial joint ventures• Use of equity method in consolidating joint

venture into partners' financial statements• Benefit of multiple surtax exemptions



• Joint ventures and hazardous industries

– High risk of worker, product, environmental liability

– If joint venture is organized as a corporation, only the joint venture's assets are at risk, not those of participating firms



• Joint ventures and restructuring– Joint ventures can be used as transitional

mechanism in a broad restructuring process• Buyer can use joint venture experience to

better determine value of seller's brands, distribution systems, and personnel

• Risk of making mistakes is reduced through direct involvement with business



– Advantages — Nanda and Williamson (1995)• Customers are moved to buyer over a period of time

in which both seller and buyer continue to be involved• Buyer builds experience with new line of business• Buyer receives managerial and technical advice and

assistance from seller during transition period• Experience and knowledge developed during life of

joint venture enable buyer to obtain better understanding of the value of acquisition

• Seller is able to realize higher value from sale than it could have under immediate, outright sale when buyer must necessarily discount purchase price because of lack of knowledge about assets being purchased



• International joint ventures– Widely used– Reduce risks of expanding into foreign

environments– May be legal requirement of local joint

venturer in some foreign countries– Local partner's contribution likely to be in the

form of specialized knowledge about local conditions

– Subject to clashes of different cultures



Rationale for Joint Ventures

• Transaction cost theory of the firm — why joint ventures over other contractual arrangements– Transaction costs

• Involved in all exchanges and organizing activities

• Affect allocation of resources



– Complementary production• Joint use of assets or inputs to produce outputs

which cannot be attributed to any single input• Synergy — output is more than sum of inputs• Complementary asset defined as one whose

value in production process depends upon combination with other assets/technology

• Problem arises when complementary assets have different owners



– Specialization• Asset's productivity increases with its

specialization to other inputs used in production• Specialization increases risk of loss to owner of

complementary asset if other inputs are withdrawn

• Nonrecoverable portion of investment cost of complementary asset lost if other inputs withdrawn

• Owners of other inputs can expropriate owner of complementary asset by taking greater share of output



– Leads to pre-investment arrangements to promote confidence in joint use of assets• Choose transaction-cost-minimizing form of

pre-investment arrangements• The greater the transaction costs relative to

output value, the more critical the search for economizing organizational form

– Contractual arrangements• Costly to write and enforce• Repetitive transactions would require repetitive

contracting



– Joint ownership• More likely with greater frequency of exchange

of inputs• Frequency of transaction improves prospects of

recovering investment cost of specialized asset• Joint ventures more appropriate than merger

where:– Complementary production involves only small

subset of each participant's assets– Complementary assets have limited service life– Complementary production has limited life



• Reasons for failure– Inflexibility problems similar to other long-

term contracts– Implementation requires substantial

commitments of managerial resources– Joint ventures do not last as long as

planned• About 70% are disbanded before scheduled

maturity• On average they do not last as long as one-half

the term of years stated in agreement



– Reasons for disbanding joint ventures• Inadequate preplanning• Technology did not develop as expected• Disagreement between parties on approaches to

joint venture objectives• Refusal to share knowledge with counterparts in

venture — firms wants to learn as much as possible but not to convey too much

• Inability of parent companies to share control or compromise on difficult issues

– Public policy concerns — conflict with firms' long-term strategies



Joint Ventures and Antitrust Policy

• Often subject to regulatory scrutiny• Court actions brought under:

– Clayton Act — for real or potential anticompetitive effects

– Sherman Act — for cartel behavior, boycotts, exclusion of competitors



• Main objections raised in legal actions– Threat of industrywide collusion– Loss of potential competition– Restraints on distribution

• Industry characteristics that make collusion difficult– Heterogeneous products– Inequality of costs– Rapid and unstable changes in demand,

supply, and technology



– Ease of entry and expansion– Dissimilarity in firm strategies and policies– Many firms– High price elasticity of demand– Substitutability among products on demand

side– Likelihood of additions to supply of products

by other firms if one firm restricted supply– Difficulties in enforcing collusion; high risk

and cost of being detected



Outsourcing

• Involves use of subcontractor, supplier, or outside firm to perform some percentage of total production of product

• Has grown substantially during first half of 1990s

• Reduced manufacturing cost by 10 - 15%• Represents a different form of arm's-length

alliances similar to joint ventures



• Advantages– Facilitates rapid growth– Avoids need to build required competencies

within company– Modern version of use of division of labor to

increase efficiency– Reduces costs

• Limitations– Personnel to monitor outsourcing activities– Firms may produce components at cost lower

than outside suppliers as they become more experienced



– Firms may change outsourcing needs as their strategies change with experience

– Firms may limit number of outsourcing firms used in order to improve communication, and retain competition among suppliers

– Firms may not control product quality– Resistance from trade unions– Flexibility and speed needed for building to

order may be found only by producing within the company

– Firms may use their own resources more efficiently



Empirical Tests of the Role of Joint Ventures

• Business and economic patterns — (Berg, Duncan, and Friedman, 1982)– Industry joint venture participation increases

with:• Average firm size - only pervasive influence

across all industries• Average capital expenditures• Average profitability



– Technologically oriented joint ventures • Joint venture participation rises with average

R&D intensity• Joint ventures substitute for R&D in chemicals

and engineering industries, but not in resource-based industries

• Long-term R&D substitution effect stronger than short-term effect

• Significant negative impact on large firms' rates of return in chemicals and engineering in short run, although long-run effect on rate of return not significant



– Industry level — technological and nonhorizontal joint ventures• Strong positive effects on R&D intensity — joint

ventures and R&D are complements at industry level

• Joint ventures have significant negative effect on industry average rates of return



• Event returns — McConnell and Nantell (1985)– 1972-1979; 136 joint ventures by 210

companies– Average size = $5 million– Two-day announcement period abnormal

return of 0.73% (significant)– CAR over 62-day period up to

announcement day was 2.15% (significant)



– Relative size effect• Dollar gains to large and small firms about evenly

divided — as in mergers• Percentage gains higher for smaller firms

– Dollar gains scaled by amount invested in joint venture• Average premium is 23%• Result lies in range of merger/tender offer

premiums

– Gains from takeovers could be from synergy or improved management; since joint ventures involve no management change, gains must be from synergy



Strategic Alliances

• Informal or formal decisions or agreements to cooperate in some form of relationship between two or more firms– Created out of uncertainty and ambiguity in

nature of industries• Rapid advances in technology• Globalization of markets• Deregulation



• Intensity of competition• Reorganizations of capabilities, resources, and

product-market activities• Blurring of industry boundaries• Shortened product life cycle• Altered value chains

– Represent forms of relationships that are uncertain and ambiguous



• Characteristics of strategic alliances– Need not create new entity– Contract need not be specified– Relative size may be highly unequal– Less clear contributions and benefits– Difficult to anticipate consequences– Allow firms to focus on fewer core

competencies– Often small resource commitments– Limited time duration



– May involve relations with competitors and complementor firms

– Synergistic value creation from combining different resources

– Learning and internalizing new knowledge and capabilities

– Can add more value to partnering firms by creating organizational mechanism that better aligns decision authority with decision knowledge

– Can add value to partnering firms through organizational flexibility



– Partner firms pool resources and expertise rather than transfer specialized knowledge

– Managed actively by senior executives– Evolving relationships– Adaptability and change required over time– Deliberate efforts to change direction of at

least one partner– Blur corporate boundaries– Can have multiple partners– Require mutual trust– Speed of change is increased



– Move to other alliances as attractive possibilities emerge

– Access to people who would not work directly for them



• Inter-firm alliances and M&As - (Hagedorn and Sadowski, 1999)– Sample of over 6,000 strategic technology

alliances and 16,000 M&As by the same group of nearly 3,000 firms

– Only 2.6% of alliances lead to M&A between same partners

– Strategic alliances represent a form of exploratory learning• Inconsistent with encroachment hypothesis• Encroachment hypothesis — larger firms use

strategic alliances to take over their smaller partners



– High technology industries and strategic alliances• Scan market-entry possibilities• Monitor new technological developments• Reduce risks and costs of developing new

products and processes

– M&As more likely as industries mature — learning and flexibility become less important



• Success or failure of strategic alliances — (Bleeke and Ernst, 1995)– Collisions between competitors

• Involve core businesses of two strong, direct competitors

• Alliances are short lived and fail to achieve goals because of competitive tensions

– Alliances of the weak• Two weak companies join forces hoping to

improve• Alliances fail because weak grow weaker



– Disguised sales• Weak company joins with strong competitor• Alliance is short lived and weak is acquired by

strong firm

– Bootstrap alliances• Weak company may be improved so that

partnership develops into alliance of equals• May succeed in meeting initial objectives and

exceed seven year average life span for alliances, but one partner ultimately sells out to other



– Evolutions to sale• Two strong and initially compatible partners

initiate alliance, but competitive tensions develop

• Outcome similar to bootstrap alliances

– Alliances of complementary equals• Complementarity and compatibility lead to

mutually beneficial relationships• Likely to last more than average seven year life

span of alliances



• Event returns — (Chan, Kensinger, Keown, and Martin, 1997)– Sample of 345 strategic alliances during

1983-1992– Positive and significant abnormal returns of

0.64% on announcement date– Magnitude of returns similar to those for

announcement of joint ventures– No evidence of wealth transfer between

partners in alliances – No evidence that firms enter alliances

because of deteriorating past performance



– Subsamples• Technology

– High-tech firm — significant abnormal returns of 1.12%– Low-tech firm — insignificant abnormal returns of 0.10%

• Industry focus and presence of technological transfer

– Horizontal alliances between firms in same three-digit SIC class that involve transfer or pooling of technology experienced highest average significant abnormal returns of 3.54%

– Nonhorizontal alliances whose main objective is to position or enter new markets have significant 1.45% return

– Horizontal nontechnical and nonhorizontal technical alliances have positive but not significant returns

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - -...

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