joint ventures: reality of success & failure - elixirr · joint ventures: reality of success...

Joint Ventures: Reality of Success & Failure

October 2011

© Elix-IRR Partners LLP 2011

Introduction

Increasingly companies are looking for innovative ways to structure their commercial arrangements

with their more strategic service providers, aiming to:

Incentivise vendors to improve performance

Retain control of core assets while leveraging 3rd party skills to improve performance and cost

Commercialise assets and turn a cost base into a profit centre

However, anecdotal evidence and hard-won experience often cause these models to be viewed

sceptically by senior management perceived “failure” of the JV model has the potential, if unaddressed,

to overshadow partnering considerations

The intent of this thought-piece is to examine the reality of Joint Ventures:

Analyse definitive sources and quantification regarding JV success and failure rates;

Compare with acquisitions and even term contract outsourcing;

Outline risk mitigants and approaches for your company to adopt to enhance chances of success

2 © Elix-IRR Partners LLP 2011

Contents

© Elix-IRR Partners LLP 2011 3

Overview of potential co-operative models

Joint Venture success and failure: overview of well-known views and assertions

Potential risk mitigants

Key success factors

Summary


Type of relationship, other than

Supply Agreement Description

HIERARCHICAL RELATIONS Through acquisition or merger, one firm takes full control of another’s assets and coordinates actions by

the ownership rights mechanism

JOINT VENTURES Two or more firms create a jointly owned legal organization that serves a limited purpose for its parents,

such as R&D or marketing

EQUITY INVESTMENTS A majority or minority equity holding by one firm through a direct stock purchase of shares in another firm

COOPERATIVES A coalition of small enterprises that combine, coordinate, and manage their collective resources

R&D CONSORTIA Inter-firm agreements for research and development collaboration, typically formed in fast-changing

technological fields

STRATEGIC COOPERATIVE

AGREEMENTS Contractual business networks based on joint multi-party strategic control, with the partners collaborating

over key strategic decisions and sharing responsibilities for performance outcomes

CARTELS Large corporations collude to constrain competition by cooperatively controlling production and/or prices

within a specific industry

FRANCHISING A franchiser grants a franchisee the use of a brand-name identity within a geographic area, but retains

control over pricing, marketing, and standardized service norms

LICENSING One company grants another the right to use patented technologies or production processes in return for

royalties and fees

SUBCONTRACTOR NETWORKS Inter-linked firms where a subcontractor negotiates its suppliers’ long-term prices, production runs, and

delivery schedules

INDUSTRY STANDARDS GROUPS Committees that seek the member organizations’ agreements on the adoption of technical standards for

manufacturing and trade

ACTION SETS Short-lived organizational coalitions whose members coordinate their lobbying efforts to influence public

policy making

MARKET RELATIONS Arm’s-length transactions between organizations coordinated only through the price mechanism


Many types of interorganisational model exist – JV isn’t always the right solution

Increasing

integration and

formalisation

in the

governance


© Elix-IRR Partners LLP 2011

A variety of organisational economic,

strategic & political motives for an alliance...

Source:

Elaborated from Agarwal and Ramaswami 1992; Auster 1994; Doz and Hamel 1999; Doz,

Olk and Ring 2000; Harrigan 1988a; Hennart 1991; Lorange and Roos 1993; Zajac 1990

…requirements will determine

best fit co-operative model

Requirements

Fitness for purpose of specific co-

operative models

Ability to agree a suitable model with

partner(s)

E.g.

Service

performance

Cost

Risk

Feasibility given cost

recognition and

VAT rules

5

Category Motive:

Organisational: Learning /

Competence Building

Learning & internalization of tacit, collective and embedded skills

Restructuring, improving performance

Acquiring means of distribution

Vertical integration, recreating and extending supply links

Complementarity of goods and services to markets

Gaining access to new technology

Legitimation, bandwagon effect, following industry trends

Economic: Market- Cost- &

Risk related

Obtaining economies of scale

Market seeking

Cost sharing, pooling of resources

Risk reduction & risk diversification

Strategic: Competition

Shaping / pre-emption /

Product & Technology

related

Diversifying into new businesses

Co-specialization

Developing products, technologies, resources

Achieving competitive advantage

Cooperation of potential rivals, or pre-emptying

Political: market

development

Overcoming legal / regulatory barriers

Developing technical standards

Contents





Key success factors

Summary

Joint Venture Success and Failure: Overview

About 11.3% of JVs were dissolved – for whatever reason – by 3 years old. 19.5% were dissolved by 5 years old.

The annual death rate has two peaks: “early infant” at 2 years and “mid-life crisis” at 5 years old


Original sources point to the potential for JV “mortality”

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

Age: 1 Age: 2 Age: 3 Age: 4 Age: 5 Age: 6 Age: >6

Hazard Rate: JV beingacquired

Hazard Rate: JV beingdissolved

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

Age: 1 Age: 2 Age: 3 Age: 4 Age: 5 Age: 6 Age: >6

Domestic JVs

International JVs

All JVs

Age of JV Age of JV

% o

f J

V M

ort

ality

% o

f J

V M

ort

ality

Kogut’s definitive work analysed the life-cycle of JVs…

…indicating significant time sensitivity

…need to care for the very young and those in older age Source:

The Stability of Joint Ventures: Reciprocity and Competitive

Rivalry, J. Kogut, Warwick Business School, Booz Allen Hamilton,

Mercer, Outsourcing Center

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0%

JV Dissolution by end 3rd year

JV Dissolution by end 5th year

JV Acquisition by end 3rd year

JV Acquisition by end 5th year

Acquisitions Failure rate

Startegic Alliances General Failure Rate

Outsourcing Contract (all) Renegotiation Rate

Outsourcing Contract (HR Scope) Renegotiation Rate

Outsourcing Contract( IT Scope) Renegotiation Rate

40% of strategic alliances [fail].

…failure to pick the right partner, to

agree goals up front…lack of relationship

and chemistry

…inadequate and erratic

communication…

interference by parents

Booz Allen Hamilton ”



However, JV’s fair no worse than other alliances and partnership arrangements,

such as acquisitions

More than half of acquisitions fail

“ Mercer Management Consultancy ”

50% of acquired companies kept at arm’s

length…

15% fully integrated… 9% symbiotic….

Half of all transactions end in failure

Warwick Business School

“

” “

…so it’s about getting the right deal to yield a

reasonable balance of benefits over a period of time

Source:

The Stability of Joint Ventures: Reciprocity and Competitive

Rivalry, J. Kogut, Warwick Business School, Booz Allen Hamilton,

Mercer, Outsourcing Center


Telefonica O2

• Started of as a joint venture formed in 1985 between BT Group (60%) and Securicor (40%) and known as Cellnet.

• In 1999 BT Group acquired Securicor's 40% share of Cellnet and the company was later rebranded as BT Cellnet.

• BT Cellnet was rebranded as "O2" in 2002

• In 2005 Telefónica acquired BT Group's European mobile telecommunications businesses

Radianz

• In 2000 Reuters (51%) entered into a joint venture with Equant (49%) to establish Radianz.

• Radianz provided an IP platform to deliver content and conduct transactions along with network connectivity and security to end-users and combine Reuters networks with Equant’s technology.

• In 2004 Reuters acquired Equant's 49% stake and then sold 100% of Radianz to BT.

Sainsbury

• IT outsourcing to Accenture.

• Initiated in 2000, the 10 year contract was terminated 3 years early as new CEO decided to bring its IT operations back in-house

• During its term the venture transformed Sainsbury’s IT capabilities providing a stable platform for growth whilst halving the operating costs of IT

JP Morgan

• IT outsourcing with IBM.

• The 7 year contract was entered into in 2002 and terminated in 2004 following JP Morgan's merger with Bank One on the basis that the merged bank now had enough capacity in-house to manage its own technology.


Many JVs and Outsourcing may count toward the hazard rate but go

on to becoming something else: this is not necessarily failure

Contents





Key success factors

Summary



Identification and quantification of risks is a vital step in managing them

Consistency of strategy & objectives

• Congruence of strategies and long term goals

• Identify potential conflicts; seek to harmonise explicitly

Compatibility of culture and

expectations

• Compatible oragnisational structures?

• Corporate cultures?

• Problem solving approaches similar?

• Chemistry?

Selecting partners

• Similar intent in market?

• Financial viability?

Verifying assumptions

• Lack of transparency

• Omission of ongoing reviews

Financial stability of the venture

• Stable over time?

• Variations understood and accepted?

Review of legal agreements

• Avoid creating new risks in the legals

• Legals reflect the essence and spirit of the deal?

• Removal of ambiguity

No external advisor input

• Failure to keep objective

• Insufficient skill set in house

Due dilligence findings

• Consistency?

• Issues addressed?

Quantitative methods such

as NPV

Sensitivities as a learning

tool

Understand differences

between each party’s

baseline view and risk

occurrence view

(sensitivities)

Deliberately estimate

probabilities of risk items

Create scenarios including

pessimistic and optimistic

Use advisors to challenge

Avoid overt conservatism

Key Sources of Risk

Proven Methods for Risk Quantification



Risk sharing and mitigation

Traditional approach: allocate risks according to party best able to manage or absorb the risk

Legal Agreements

Earn Out Formulae

Risk Insurance

Contingency Plans

Conservative view

adoption

Risk management

through planning

Superior risk plan characteristics:

• Create a subteam, comprising negotiation, implementation and SME representatives

• Assign specific risk elements to individuals on point

• Consistency across the spectrum

• Allocate risk sharing acceptable to all: win-win

• Appropriate compensation in deal reflecting risk taken

• Maintain customer focus and intent to ensure uninterrupted customer satisfaction

• Reasonable balance between costs and benefits for all parties

• Safety valves: reasonable escape clauses; ability to flex; flexibility regarding enforcement; back up plans

• Wide acceptability by project team, senior management, external advisors

Threats to risk management

Hedging or insurance

not available

Unknown political inter-

ventions or changes to

polocy

Surfacing of new un-anticipated

risks without time to

manage them

Lack of partner co-operation

due to goal conflict

Unwillingness of one partner to share risk

Unpredictable

changes to legal,

regulatory or

institutional constraints

Lack of risk manage-

ment know-how

Complementary Approaches

1. Identify risk early…

•…from the moment brought to the team

2. Scrutinise assumptions…

•…for likelihood and variability

3. Identify key financial drivers…

•…and how linked to risks

4. Model impacts…

•Quantified for each financial driver

5. Runs sensitivities & scenarios…

•…to understand impacts

6. Assess risks to financials…

•…and payments with special care

7. Prepare trade offs…

•…help negotiators allocate risk sensibly, transparently

8. Balance interests…

•Incorporating risk management into project plan



World class approach to risk management

Contents





Key success factors

Summary

Key Success Factors

JV partners do not seek to micro manage the JV thereby alienating management

Strong and experienced management team

Robust and fair/open governance structure

Relationship of trust between the JV partners

Good cultural fit between the JV partners

Sound business case/business plan i.e. it is set up to succeed financially and not end up being a financial drain on the JV partners

Partners have an alignment of interests in making the JV succeed

Clear business purpose/objective for the JV


Several key success factors emerge for successful partnerships

Summary

There are many models of collaborative organisation: JV is only one of them

Likelihood of Joint Venture success or failure is similar to that of other collaborative

models. Such collaborative models tend to serve a purpose for a period of time…then

they evolve.

Potential risk mitigants are available; it’s smart to manage the key success factors and

benefit from experience of those who have gone before

For further discussion of this topic or to arrange for an Elix-IRR expert to review your Joint

Venture strategies, please contact us


Contact Us

17 © Elix-IRR Partners LLP

For further information on the research, please contact the following persons at Elix-IRR:

• Stephen Newton

Partner

Tel: +44 (0) 208 123 5867

Email: [email protected]

• Anthony Potter

Principal

Tel UK: +44 (0) 208 123 1687

Tel USA: +1 310 227 1678

Email: [email protected]

Elix-IRR is a Sourcing Advisory and consulting firm focused on providing business support through the entire sourcing lifecycle for

large-scale outsourcing and other complex sourcing transactions. Elix-IRR combines technical, operational and supply-chain

capabilities, supplemented by extensive outsourcing advisory operational experience across all aspects of the sourcing process.

With deep experience in the buy-side, sell-side, legal and advisory aspects of sourcing initiatives we provide high-impact services

to FTSE 100/ Fortune 500 and middle-market clients across the complex strategic sourcing landscape and guide our clients in

making the right supplier choices.

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