- October 28, 2022
- Posted by: Ramkumar
- Category: Strategy
Managing The Alliance Process
Over the past few weeks, we have seen a lot of announcements on strategic alliances where firms enter into a temporary arrangement of collaboration to undertake a mutually beneficial project. These alliances have a finite life after which firms may not wish to renew. Unlike acquisitions, where the buyer controls the target after the deal closes, firms in an alliance do not have authority over each other. Thus, alliances lie in the middle of an arms-length relationship between the customer/vendor and acquisitions at the other end. Firms in alliances remain legally independent, and for the alliances to succeed, intensive collaboration between the partners is essential. In this post, I provide insights into successfully managing the alliance process and share my experiences working on strategic alliances.
Strategic Alliances VS Mergers and Acquisitions
When we refer to alliances, we include equity alliances like JV and non-equity alliances like partnerships. After finalizing that it is a better strategy than organic growth and M&A, firms decide on alliances. Further, in strategic alliances, Due diligence precedes valuation and Negotiation, unlike in the M&A process. During the diligence phase, partners exchange confidential information to confirm that alliances get grounded on valid assumptions. Valuation and Negotiation in alliances focus on structuring the alliance and sharing gains between partners. Integration in alliances focuses on extracting desired synergies by optimally deciding what activities to integrate. Finally, partners can evaluate the outcome of the alliance process and the gains they receive. Partners can terminate the alliance when they decide they are not getting benefits.
The below table shows the critical differences between Alliances and M&A.
Alliances are complex, and as in M&A, parties involve consultants/attorneys at various stages. This complexity increases in equity investments like Joint ventures and minority investments. In the JV, parties create a separate legal entity, and the entity’s valuation is crucial to decide on the gain sharing.
Selecting The Right Alliance Partner
In an alliance, extracting and sharing synergies often becomes a subject of a dispute between the parties. For example, in an M&A deal, the acquirer takes all the synergies and pays a premium. Moreover, as partners operate as autonomous entities, their individual goals need not align with the alliance goals. Thus managing conflicts becomes crucial to make alliances successful. Hence collaboration between partners in an alliance is complex despite synergies.
Thus parties in an alliance must define a framework for collaboration. In my experience, parties in alliances encounter four scenarios:
- Both parties collaborate
- Only your firm collaborate
- Only other parties collaborate
- No parties collaborate
Let us take a scenario where one party collaborates, and the other party gains from free riding. If the other party gains from free-riding rather than collaborating, that party will stick to that decision, while if the other party does not gain from free riding, it is forced to collaborate. For instance, if two parties join together to develop a product, you will benefit from free-riding if the product gets developed without your contribution. In contrast, if there no product development happens, then you lose from free riding.
In another scenario, your firm may unilaterally collaborate while the other firm does not. Thus, your firm faces the cost of unilateral collaboration. If both parties’ investments are necessary, but you unilaterally collaborate, you face a higher cost of unilateral collaboration. However, if your firm gains valuable insights from unilateral collaboration that you can apply to other projects, you gain unilateral collaboration. Thus, a firm gains from unilateral collaboration when it can successfully develop products without input from other parties or gain crucial insights when working on the product that it can apply to other projects.
Thus any alliance will have four scenarios:
- Scenario 1:Both firms have to collaborate, and no parties gain from free-riding; each party does not have a cost to unilateral collaboration. Thus, there is an incentive for each party to collaborate, and we can call this scenario the best case for an alliance.
- Scenario 2: In the other extreme scenario, your firm does not collaborate irrespective of the action of the other firm. Thus, if the other firm collaborates, you gain from ride-sharing, and if the other firm does not collaborate, you do not encounter the cost of unilateral collaboration. This scenario is similar to a prisoner’s dilemma in Game theory, where one party does not collaborate irrespective of the other party’s actions.
- Scenario 3: In the third scenario, your firm does not gain any free-riding benefits. Thus your firm decides to collaborate, but the other party can choose to collaborate or not. If another party collaborates, your firm will face no cost of unilateral collaboration. However, if other firm does not collaborate, your firm will have a higher cost of unilateral collaboration. Thus, in this scenario, coordination with other partners becomes crucial.
- Scenario 4: In the final scenario, your firm gains free-riding benefits and zero cost of unilateral collaboration. Thus if the other party collaborates, your firm will not collaborate to enjoy free riding benefits, but if the other firm does not collaborate, you will collaborate.
Scenarios 3 and 4 are complex in an alliance, and other firms’ probability of collaboration influences your firm’s decision to collaborate. Thus, partner selection and communication with other partners become crucial in these scenarios. Firms must think not from their perspective but also the perspective of the other partner. For instance, if both parties face scenario 3, it is better to discuss and solve the problem jointly.
The historical track record of the partners is crucial to decide on the alliance partner. For example, if the firm has a track record of not collaborating, you should either not ally with them or implement the alliance gradually.
In scenario 2, where you do not collaborate irrespective of what the other firm decides, you need to decide if this decision is tactical because if your firm continues to gain from free riding, you will develop a bad reputation which will put your position in stitching future alliances in jeopardy. However, if both parties decide not to collaborate, you can terminate the alliance or agree to a collaboration strategy as long as the other firm does.
Thus trust in an alliance becomes successful, especially in scenarios 3 and 4. A background check and further checking on cultural compatibility become crucial to increase trustworthiness. In scenario 2, identifying a trusted partner is not enough, as you must resist the urge to exploit the other firm to gain free-riding benefits.
Valuation and Negotiation In Alliance
Valuing an alliance is an iterative approach and depends on the underlying synergies. Thus, valuing an alliance is a function of synergies and integration costs to realize the synergies. The integration costs in an alliance are less when compared to M&A because there is no control. During Negotiation, the parties must decide how to organize the alliance to extract synergies and share them. The firms need to finalize the scope of the alliance, the tasks each party must contribute, and the incentive each party will gain from the alliance. Further, the organizational structure must specify the channels of communication and coordination between the alliance partners.
Finally, when disputes arise, the parties in an alliance must decide the way to address these disputes. If the legal remedy is the right step or whether the parties are ready for an arbitration process. The focus for the parties in an alliance is not the size of the pie (how much synergy can get extracted from the alliance process) or the share of the pie (how much each party benefits from the alliance) but the size of the bite each firm gets.
Joint Ventures are more complicated relative to other forms of alliances because the equity investment reflects not only the distribution of profits between the partners but also the relative control each partner exercises on the decision of the JV. Further, parties to JV must decide the conditions under which the JV gets terminated and how they will share assets at that point.
Integration In Alliances
Making the alliances successful and extracting synergies requires setting up a separate PMO to oversee the integration process with a host of integration projects to realize synergies. Integration planning in alliances is not complex due to the limited scope of activities involved across the partners. However, cultural differences and organizational issues can impede collaboration across partners and create conflict.
The critical integration choice in an alliance links incentives, information channels and work practices of firms involved. The partners must decide when to operate autonomously and collaborate to realize synergies. Higher collaboration involves the free flow of information across partners and the standardization of processes to extract synergies.
Another conflict in an alliance is where each partner may compete with the other and want to move towards a future where the other partner becomes redundant. Thus, integration must balance the need to extract synergies and prevent partners imitate other capabilities. Integration in alliances must happen in phases because new information may alter the approach for extracting synergies as alliances evolve.
Alliances are difficult to manage and have a low success rate. Sometimes Alliances are more challenging than acquisitions when synergies are one-sided (one partner benefits more than the other) or there is a risk of the partner imitating the other partner’s capabilities. Thus unless both partners collaborate, it is likely that an alliance will fail. In addition, negotiating Alliances are challenging because of the diverse goals of the partners, competition, sharing of synergies and deciding on the exit channel.