--------

Chapter 14
Joint Ventures

--------

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 1

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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 2

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

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 4

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 5

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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 6

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 8

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 9

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 12

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 13

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 14

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 15

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 17

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 18

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 19

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 20

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 21

 Reasons for failure

Inflexibility problems similar to other longterm 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22

 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

2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23

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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 24

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 26

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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29

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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30

 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 resourcebased 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 32

 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)

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 33

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34

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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 36

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39

 Move to other alliances as attractive possibilities emerge Access to people who would not work directly for them

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 40

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 41

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 42

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 43

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 44

 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

2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 45

 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
2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 46

 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 - 47