Strategy Text Chapter 8 2-21-13 Student Version

8/11/2019 Strategy Text Chapter 8 2-21-13 Student Version

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Real World Strategy

Dyer, Godfrey, Jensen, Bryce

Chapter 8: Strategic Alliances

Opening Case: Tokyo Disneyland

When walking into Tokyo Disneyland, an excited tourist will immediately feel

transported into a uniquely American dream-world. Except for signs with Japanese subtext

under bolder English titles, few uniquely Japanese features stand out. In fact, when Tokyo

Disneyland first opened in 1984, no more than two of its 27 restaurants even sold Japanese

foods to visiting patrons.1Instead, it was easier to find hot dogs, popcorn, and

spaceburgers for a mid-ride snack. Indeed, nearly everything at Tokyo Disneyland is a

replica of the original Disneyland in Anaheim , California, from the Disneyland castle to

Disneys famous Main Street attraction. The only observable Japanese touch is the

enormous roof-covering over Main Street, a symbol reminding visitors that they truly are

in Japan, rainy season included.

Despite all appearances, the interesting thing about Tokyo Disneyland is that The

Walt Disney Co. is notinvolved in the day-to-day operations of the park. It simply collects a

licensing fee from Oriental Lands Co. (OL), a Japanese real estate firm that financed, built,

and runs both Tokyo Disneyland and its neighbor, Tokyo DisneySea Park. The two

companies came together in 1979 to form a strategic alliance and make the Tokyo-Disney

dream a reality. OL had what Disney did not 115 acres of open real estate on the outskirts

of Tokyo, financial resources, and knowledge of Japanese and Asian culture that could make

the venture a success. Disney had its brand, park design and management capabilities, and


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a host of movie characters for whom people would pay just to stand next to and snap a

photo (See Figure 8.1).

Forming the partnership was not necessarily a walk in the park. A Disney Resort in

Japan seemed to make sense given that Japanese tourists flocked to Disneyland in the

United States. Furthermore, since there are few or no imports or exports between foreign

markets in the leisure industry, there would be no negative side effects typically associated

with Japanese-US licensing agreements. But there were still risks involved. Would

Japanese and other Asians want to go to a Disneyland that wasnt in America? Would a

theme park work in a climate with rain, cold, and humidity? Disneys parks in the United

States were both vacation destination parks in warm weather cities in California and

Florida. Moreover, Disney was hurting financially during the late 1970s when it received

more than 20 offers from Japanese firms vying for the chance to partner with Disney to

build a park in Japan. Disney wanted to take advantage of the opportunity but saw the

risks involved and didnt have the capital to make the investment needed to build the park.

So, Disney did its due diligence of potential partners in Japan and eventually decided that

OL would be the best partner.

However, negotiating a satisfactory partnership agreement required that both sides

overcome cultural barriers and major disagreements. OL wanted Disney to contribute

funds to build the park, but Disney refused to contribute in any way toward the initial

investment. Disney also required a 50 year contract, a time commitment that frightened OL

when there remained so many unknowns. Moreover, Disney demanded a high licensing

fee of 10% on gross revenues. OL initially called Disneys terms a servile agreement.2

They wanted Disney to take partial ownership to share risk, wanted a lower licensing fee of


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5%, and wanted a contract for less than 50 years. It ultimately took more than four years of

negotiating before an agreement was finally made in 1979. In the end, Disney paid a sum of

less than 1 percent of the initial investment, received a license fee of 10 percent of gate

receipts, but did lower its license fee to 5% on non-gate receipt sales.3

Despite the difficult negotiations, the park has been a smashing success. In the face

of both the high interest costs from the $1.53 billion upfront investment required to build

the park and also the average 7.5% license fee to Disney, OL was able to make the project

profitable in four years. Tokyo Disneyland Resort has had more annual visitors each year

than either of Disneys parks in Los Angeles and Orlando, never dropping below 10 million

and reaching as high as 17 million visitors in 1997. The firms continued their partnership

through the years, working together to build Tokyo DisneySea Park in 2001.Together with

Tokyo Disneyland and a number of Disney-branded hotels, these parks make up the Tokyo

Disney Resort. Disneys Imagineering unit continues to design and develop new theme park

concepts and attractions. OL in turn markets and operates the entire Tokyo Disney Resort.

All in all, Disneys support through providing its image, know-how, and design skills

has been invaluable, and Oriental Lands management and execution is unparalleled by

Disneys other international partnerships. The Tokyo Disney Resort has received

540,191,000 total visitors since Tokyo Disneyland opened in 1983. OL, which runs little

more than the Disney parks near Tokyo, is now ranked as the second largest tourism-

leisure firm in the world, just behind Disney itself.4 The Tokyo Disney Resort generated

revenues of approximately US$4.15 billion in 2011, with Disney receiving about $300

million from its licensing fees. That sum is basically pure profits for Disney since they have

negligible costs associated with Tokyo Disneyland and no investment in assets. OL in turn


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came out of the deal with about US$690 million in operating profits. Up to this point,

theres no plan for a third park in Japan, but Disney has confirmedthat if there was, it

would be happy to work with Oriental Lands to make it a success.5

The Walt Disney-Oriental Land Company alliance illustrates how a strategic alliance

can be a vehicle for achieving key strategic objectives. Indeed, strategic alliances have

dramatically grown in importance over the past 25 years. Strategic alliances accounted

for only about 5 percent of the revenues of Fortune 1000 companies back in 1980 but by

2010 it is estimated that they accounted for almost one third of the revenues of Fortune

1000 companies. In Walt Disneys case, Tokyo Disneyland accounted for almost 20% of

Disneys total theme park profits in 2011. 6 So why are alliances becoming so popular?

And why did Disney choose a partnership instead of just building Tokyo Disneyland on its

own?


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What is a Strategic Alliance?

The Disney-Oriental Land company alliance illustrates how strategic alliances can

be a vehicle for achieving important strategic objectivessuch as lowering costs, creating

new sources of differentiation or entering new markets. Creating competitive advantage

with other firms is sometimes referred to as cooperative strategy or relational advantage.

A strategic alliancesometimes referred to as a partnership between firmsis a

cooperative arrangement in which two or more firms combine their resources and

capabilities to create new value.7 Strategy scholars sometimes refer to these types of

arrangements as cooperative strategywhere firms cooperate to create competitive

advantage through their collaboration.8Lets take a closer look at the Disney-Oriental Land

company alliance to understand why alliances are becoming so popular today.

One might reasonably ask why Disney didnt just build Tokyo Disneyland on its own.

Why share the profits with a partner? After all, Disney owned and operated their two

theme parks in the United States without the involvement of a partner. They obviously

knew how to run a theme park. Moreover, in hindsight it seems that Disney could have

made more money if they had built the park on their owncapturing all of the $690

million in profits that went to the Oriental Land Company in 2011. Instead they only got

$300 million in profits. So lets think about why Disney chose partnership instead of

pursuing a wholly owned Tokyo theme park.

The first question that Disney certainly must have asked with regard to Tokyo

Disneyland was: Do we have the resources and capabilities to build Tokyo Disneyland on

our own? The answer to that question seems like it would be yes. But its not quite as

straightforward as it might seem. Could Disney have acquired the 115 acres of land


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required for the park? Would Oriental Land Company have sold them the land? If so, at

what price? Moreover, would Disney have been effective at hiring, training, and managing

a Japanese workforce to operate the park? Disney had absolutely no experience managing

a Japanese workforce. Did Disney have the $2.0 billion investment required to buy the

land and build the park? If they chose to make the investment in Japan, what other

opportunities would they have to forego? Finally, and maybe most importantly, how

confident were they that Tokyo Disneyland would succeed? Tokyo was not a warm

weather vacation destination like California or Florida. Building a theme park in a new,

foreign environment came with a host of risks (indeed, when Disney built EuroDisney,

locatedoutside of Paris, it experienced a host of problems and the park struggled for

years).9 When companies face an opportunity that comes with risks, they may look to a

partner to share or mitigate the risks.

In this particular case, Disney solved most of these problems by partnering with OL.

OL provided the land and took virtually all of the investment risk. OL would run the park

so Disney didnt have to learn how to manage a Japanese work force. Moreover, the two

companies were able to share ideas on how to best localize the Disneyland park within the

Japanese environment. And most important, because OL made virtually all of the

investment, Disney didnt have to risk any capital investment and was able to deploy its

capital elsewhere. Disney would get its 10 percent return on gate receipts regardless of

the profitability of the park. In the end, the park proved successful and both OL and Disney

received value from the partnership. It is possible that Disney might have been just as

successful if it had built and run the park on its own. But its also possible that without OL

as a partner Disney might have made different decisions about how to build or run the park


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that would have hurt performance. So while Disney might have succeeded in building the

park without an alliance with OL, the alliance with OL clearly mitigated many of the risks

associated with the ventureand OLs resources and capabilities likely increased the

probability of success.

Today, many companies are increasingly using alliances to achieve strategic

objectives. The basic logic for alliances can be summed up in the adage: two heads are

better than one. Sometimes it just makes sense to combine the resources and capabilities

of two companies to solve certain problems or achieve particular objectives.

Companies may choose to cooperate at any stage along the value chain,10from research

and development, to manufacturing, to the marketing, sales, or service of products or

services. For example, BMW and Toyota are doing R&D together to develop new fuel cell

technology to increase fuel efficiency,11Intel and Micron have teamed up to manufacture

flash memory together,12and Target and Neiman Marcus have partnered to sell affordable

luxury brands.13 In these instances firms collaborate to improve their performance at

common stages of the value chain. In other instances a firm may team up with a firm at a

different stage of the value chain. For example, Apple and AT&T teamed up to sell the

iPhoneApple provided the phones and AT&T provided the cell phone service.14 While

there are different ways to categorize alliances, perhaps the most common way to

distinguish one type of alliance from another is by the mechanism used to govern the

alliance. We explain these different types of alliances in the next section.

Sidebar: Choosing between Make vs. Buy vs. Ally.

Companies have three choices when it comes to conducting any particular activitythat needs to be done to offer a product or service to a customer. First, they can make


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or conduct the activity themselves within the firm. Second, they can buyor purchase theactivity or input from another firm using an arms-length relationship, which means thebuyer purchases an input but with no obligation to have a long term relationship with thesupplier. Companies that send out a bid to numerous suppliers and then buy from thesupplier that offers the lowest price have an arms-length relationship with those suppliers.

The winner of the bid this month may lose next month.. Finally, they can allyoracquire the activity or input from another firm using an exclusive partnership relationshipwith that firm.

Companies want to conduct those activities internally that are most important to deliveringthe unique value they hope to offer. Disney prefers to create its own stories and charactersfor its movies, make its own movies, and run its own stores. These activities are mostimportant to its success with customers and therefore it wants to have control over thoseactivities.

However, companies cant do everything so they buy many inputs from other companies

using an arms-length relationship. Arms-length relationships work just fine for purchasingcommoditiesor inputs that arent differentiated on anything but price. For example,Disney doesnt have a partnership with suppliers that provide fabric for its characterscostumes or hot dogs and buns for its theme park restaurants. It can purchase those inputsfrom whatever supplier offers the lower price.. Similarly, automakers need to purchasebasic inputs like nuts and bolts (fasteners) from suppliers to put their cars togetherbutthey usually dont have a partnership with those suppliers. So what kind of inputs oractivities might qualify for a partnership relationshipa long term relationship where bothparties work closely to create new value together?

First, inputs that can differentiate your productin the minds of customers may qualify as

strategic inputs that qualify for an alliance relationship. Automakers are much morelikely to want to partner with a supplier that provides important engine or drivetraincomponents that influence engine performance or reliability. Indeed, truck manufacturersoften partner with Cummins, a maker of truck engines and components, in the manufactureof their trucks.

Second, inputs that influence your brandor reputation are often viewed as strategic. Volvo,a Swedish manufacturer of cars and trucks, has tried to develop a reputation for selling carsthat are known for safety. Consequently, it has worked closely with suppliers of airbags,seat belts, structural steel, etc. to ensure that it has the latest and greatest safety featureson its vehicles. For example, it has long worked closely with Autoliv, a Swedish supplier of

seat belts and airbags to put pioneering safety technology into its vehicles.

Third, high value inputsor activities that comprise a high percentage of your total costs areoften viewed as strategic and therefore may qualify for an alliance. Companies that makerefrigerators, like General Electric, are more likely to partner with the supplier whoprovides the compressorthe component that costs the most and cools the refrigeratorthan the supplier of plastic trays or fixtures.


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Finally, some inputs or activities require significant coordinationin order to achieve thedesired fit, quality, or performance. For example, automakers must typically work closelywith the supplier that provides the HVAC system (Heading, Ventilation, and Airconditioning) for a vehicle. Why? Because designing the HVAC system for a car is not aneasy, standalone activity. The supplier must know the geometric constraints in the

dashboardhow much room they have for their design. The supplier must also knowwhere to run the lines to the vents throughout the car that deliver the heat or airconditioning. Moreover, the HVAC system influences, and is influenced by, the catalyticconverter and other engine components. Whenever you need to coordinate closely withanother firm to get the desired performance from their input or activity, you probably wanta partnership relationship.

Types of Alliances

There are three basic types of alliances that differ in how the alliance is governed to

split the gains from the alliance and protect each partners interests (See Figure 8.2). The

first type is a contractual or non-equity alliancewhere two or more firms write a

contract to govern the relationship.15 For example, when Disney wants to promote the

characters from a new movie, it will often create promotional materialslike a figurine or

a gameand partner with McDonalds to put them in a Happy Meal for kids. Then Disney

and McDonalds jointly pay for TV commercials to advertise the movie and the Happy Meal

promotional materials. These activities create value for both Disney and McDonalds and

the companies create a contract to govern the relationship. The contract specifies what

each party is to do in the allianceand what each party should receive if it fulfills its duty

in the alliance. Different types of non-equity alliances include licensing agreements (where

one firm licenses a resourcefor example, a brandor a patentfrom another firm in

return for a percentage of the revenues or profits),16supply agreements(where a supplier

may agree to develop certain customized inputs for a customer), or distribution agreements

(where a distributor or retailer may agree to provide certain customized services to help


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sell a product).17 In this type of alliance, companies do not take equity positions in each

other or form a joint venture. Companies tend to choose non-equity alliances when it is

easy to specify what each party is supposed to do in the relationshipand easy to specify

the rewards that should come from meeting those obligations. Non-equity alliances tend

to be less complex and require less interdependence and coordination than alliances that

involve equity. When the alliance requires the joint creation of new resources and

capabilities by the partners, companies often tend to opt for equity alliances or joint

ventures.

In an equity alliancecollaborating firms often supplement contracts with equity

holdings in alliance partners.18 For example, Toyota owns between 5-49 percent of the

equity of its 10 largest Japanese suppliers who it works with very closely in the

development and production of its automobiles.19 The fact that Toyota owns some equity


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in these suppliers aligns their incentives and encourages the suppliers to make investments

that benefit Toyota. For example, these equity investments encourage the suppliers to

locate their manufacturing plants next to Toyotas assembly plants to reduce the costs of

shipping and inventory. In similar fashion, many large pharmaceutical companies like Eli

Lilly, Merck, and Pfizer own equity positions in start-up biotechnology companies. These

equity positions give these large pharmaceutical firms the option to partially own new

biotechnology drugs that are developed. These options create incentives for companies

like Eli Lilly to provide financial resources to help develop a drug and any other support

that may increase the probability of success. If a new drug looks promising, Lillywill use

its sales force and distribution channels to sell the new drug around the world.20 In

situations where alliance parties need incentives to bring their best resources to an alliance

equity is often preferred to contracts as a way to align the incentives of partners.

Finally, a joint ventureis an alliance where collaborating firms createand jointly

owna legally independent company which is created from resources and assets

contributed by the parent firms.21 The parent firms jointly exercise control over the

new venture and consequently share revenues, expenses, and profits. Joint ventures are

preferred when firms need to combine their resources and capabilities to create a

competitive advantage that is substantially different from any they possess individually.

For example, Intel makes microprocessors and Micron makes advanced semiconductors

but both companies saw an opportunity in flash memory, the type of memory used in flash

drives and increasingly used in mobile devices like MP3 players and smart phones. Both

companies had some relevant skills and assets so they decided to each put in $1.2 billion in

cash and assets and create IM Flash, a new company jointly owned by Intel and Micron.22


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This allowed the new company to focus on the flash memory market and didnt deflect the

attention of Intel and Micron from their core businesses. In similar fashion, when GM

wanted to enter the Chinese market, it teamed up with SAIC, a Shanghai based automobile

company to create Shanghai-GM, a joint venture that brings together GMs expertise and

technology for making cars with Shanghais knowledge of the Chinese market and

experience managing a Chinese workforce.23

Typically, partners in a joint venture own equal percentages and contribute equally

to the ventures operations, as was the case with IM Flash. However, in some cases one

party may bring more resources to the venture which will lead to a higher equity stake.

Moreover, over time a firms priorities may change which can lead to one partner

purchasing the equity stake of the partner. For example, in 2012 Intel decided that IM

Flash was less of a priority so it sold $600 million of its stake in the company to Micron.24

Many joint ventures end with one partner selling some or all of its ownership stake in the

joint venture to its partner.

In addition to distinguishing alliances by the type of governance arrangement (e.g.,

non-equity, equity, joint venture), alliances are sometimes categorized as either vertical

alliances or horizontal alliances. A vertical allianceis an alliance between firms who

are positioned at different stages along the value chain (e.g., a supplier and buyer) whereas

a horizontal allianceis between two firms who do not have a supplier-buyer relationship

and are typically positioned at a common stage of the value chain (e.g., competitors). 25 To

illustrate, Toyotas relationship with its top 10 suppliers are considered vertical alliances

the output of one of the firms is the input of the other. Vertical alliances are usually


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formed to combine unique resources, create new alliance-specific resources, or lower

transaction costs between two companies who are already transacting.

In contrast, the Shanghai-GM partnership is a horizontal alliancethe partners

conduct activities at a common stage along the value chain which means they conduct

similar activities internally. In this case both of them manufacture automobiles. Horizontal

alliances can also occur between companies who dont do the same activities but do

complementary ones. Horizontal alliances are often created to pool similar resources, or

combine complementary knowledge. We discuss these different ways to create value in

alliances in the next section.

Sidebar: Bose: Working with Suppliers in Vertical Alliances

Bose Corporation, known for its sound systems and pioneering innovations in acoustictechnology, has also been a pioneer in establishing what it calls JIT II Partnerships withsome of its suppliers. A JIT II partnership (named after Toyotas Just-In-Time deliverypractice with suppliers) is a relationship with a supplier that involves the followingcharacteristics:26

- Bose selects a supplier that it believes has the best capabilities to meet its needs and

agrees to give the supplier all of its business.

- The supplier must give Bose its best pricing on products. Bose can bid a product on themarket if it doesnt think it is getting the best prices.

- Bose gives the supplier an evergreen contract meaning that as long as the supplierperforms according to expectations the contract rolls over for another year.

- The supplier agrees to provide at least one In plant representative who will work atBose for 40 hours per week. This person replaces the Bose buyer and production plannerand essentially works for Bose procurement and logistics. Duties involve placing purchase

orders placing orders on Bose Letterhead, monitoring materials requirements, andassisting with manufacturing planning. Bose interviews and approves the In-plant repand essentially treats the rep as a Bose employeethe In plant has access to Bosefacilities, personnel, and computer systems and even gets a performance review.

Lance Dixon, Bose director of procurement and logistics, initiated JIT II partnerships whenhe realized that by working more closely with key suppliers, both Bose and the suppliers


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could reduce costs. Says Dixon, Suppliers are normally outside of your company trying tosee through the window into what you are doing. We open the door and let them in to dothe work together.27 G&F industries, a Bose supplier of plastic components for BoseSpeakers, and has been a JIT II supplier for 20 years. G&Fs In plant rep Chris Labontesays that working inside Bose every day gives him the information he needs to help G&F

better meet Boses needs. Being here onsite at Boseallows me to get the right jobsrunning at the right times with the right quantities, says Labonte, Its a real positive, opentrusting and non-adversarial yet direct relationship.28

JIT partnerships have lowered Bose administrative costs by more than 20 percent. Bosesimply doesnt have to hire as many people because its supplier partners do a lot of thework that employees previously did. Bose claims it also reduced inventory and logisticscosts by more than 25 percent as a result of its JIT II partnerships due to better planningand increased supplier efficiency delivering exactly when Bose needs components. Ofcourse, suppliers like having a partnership with Bose because they have guaranteed salesand they can plan more effectively for their own production runs. So both Bose and its

partner suppliers are better offwhich is the primary goal of an effective partnership.


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Ways to Create Value in Alliances

Alliances are a vehicle for creating new value by bringing together the

complementary resources and capabilities of two (or more) different firms. As discussed

in earlier chapters, the primary strategic objective of firms is to build resources and

capabilities that allow a firm to offer unique value to customers, either through low cost or

differentiation. Alliances are a vehicle for accessing the resources and capabilities of

another firm that will help you lower your costs or differentiate your offering. So how do

you know if you can create new value with a partner? There are four29 primary ways to

create value with an alliance partner:

1. combine unique resources,

2. pool similar resources,

3. create new alliance-specific resources,

4. lower transaction costs.

We will examine each of these different ways to create value in partnerships. It is also

worth noting that these are not mutually exclusive ways for creating value in an alliance.

Alliance partners may use several of these ways of creating value in a single alliance.

1.

Combine Unique Resources

The first way that firms create value through an alliance is by combining unique

resources to create an even more powerful offering. This is what Pixar and Disney did to

dominate computer-animated films.30 Pixar contributed computer generated animation

(CGA) and story writing skills that brought to life unique stories in films such as ToyStory,

Finding Nemo, Cars, and The Incredibles. Disney contributed world-wide film distribution

to the partnership and sold products involving Pixars movie characterslike Woody and


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Buzz Lightyearat its Disney stores and theme parks. No other film distributor had stores

or theme parks like Disney which could be used to make money off of memorable movie

characters. By combining unique resources Pixar and Disney created synergy that

increased profits for both firms. In fact, Disney eventually acquired Pixar to gain full

control over Pixars unique resources.31

In similar fashion, Target decided to first team up with high end designer Missoni,

and later Neiman Marcus, in a contractual alliance to bring high end fashion to the masses.

Target had long been playing a unique tune among box-store discounters in an effort to

differentiate itself from Wal-Mart as a place for the younger generation to get affordable

fashion. It hoped that partnerships with designers could boost the image of Tar-zhay as

more upscale consumers like to call Target. It first teamed with Missoni in 2011 to offer a

line of Missoni designed products through its 1700 plus stores.32 The demand for Missoni

products at Target quickly swept up every available item, leaving many customers

disappointed that they had missed out. The sheer volume of traffic online caused the

Target website to crash for nearly a whole day.33 This led to announcing a similar

partnership with high end retailer Neiman Marcus in July of 2012with the idea to bring a

larger number of designers to the masses through Target. Target brought size, scale, and

distribution to these partnership relationships whereas Missoni and Neiman Marcus

brought a chic factor that Target simply could not replicate on its own.34

Companies typically combine unique resources to create new products, enter new

markets, or to avoid the costs of entering different stages of the value chain (e.g. for

example, Pixar decided not to invest in movie distribution, instead relying on the

distribution resources and capabilities that Disney had already built).


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Sidebar: Learning Alliances: Creating Value by Sharing Complementary Knowledge

Combining unique resources includes combining intangible resources in the form of

knowledge. These types of learning alliances are increasingly popular and the goal of

these types of alliances is for each alliance partner to learn something that they believe will

be a valuable addition to their capabilities in the future. For example, in the early 1980s

General Motors was being trounced in the small car marketplace by Toyotaa company

that had pioneered the Toyota Production System. The Toyota Production System, also

called lean manufacturing, was different from the mass production techniques used by

General Motors and was particularly good for small production runs building multiple

models in the same plant. GM wanted to learn more about the Toyota production system

so it could build small cars more profitably. But what would entice Toyota to share this

knowledge with GM? As it turns out, in the early 1980s the U.S. government started to put

quotas on automobiles imported from Japan. This meant that Toyota could only sell a

limited number of vehicles in the United States and if it wanted to sell more, it would have

to manufacture cars in the United States. Toyota had never tried to build cars with

American workers and wasnt sure how well its production system would work in the

United States. So it agreed to form an alliance with GMcalled the New United Motor

Motor Manufacturing, Inc. (NUMMI)to manufacture small cars for GM and Toyota in the

United States. GM had a closed down plant in Fremont California that it brought to the

alliance as well as many automobile workers and managers. Toyota agreed to take full

responsibility for the manufacturing process, including using former GM employees to

install and operate the Toyota Production System. The alliance lasted more than 25 years

as GM learned manufacturing processes that it took to its other plants and Toyota learned


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practices related to managing a U.S. work force that it took to four plants that it

subsequently built in the United States.

In similar fashion, when Visa wanted to learn about how to bring financial literacy,

and credit cards, to a younger crowd, it turned to an unlikely partnerMarvel Comics. To

that end, Visa and Marvel jointly developed a unique comic book addressing money

management issues, starring The Avengers and Spiderman. Imagine Spiderman and Hulk

discussing different options for financing Spidermans new big screen TV! That will grab

the attention of teenagers. Through the partnership Marvel learned to use its comic books

for educational purposes and Visa learned about a unique way to educate potential

customers. This was a case where both partners also brought unique resources to the

relationship. Learning alliances are typically designed in order for firms to acquire

knowledge that will upgrade their internal capabilities.

2.

Pool Similar Resources

A second way that alliances create value is by pooling similar resources to achieve

economies of scale that neither firm could achieve on its own. For example, as described

earlier, Intel and Micron wanted to get into manufacturing flash memorya business that

required billions of dollars of investment in plant and equipment. So they decided to

create IMFlash, a joint venture designed to produce flash memory products. By splitting

the cost of the plant and equipment, the two companies were able to build a much larger

plant and through economies of scale produce flash memory at a lower cost per unit.35

This value didnt necessarily require combining unique resources, just the pooling of total

resources to achieve economies of scale in the R&D and production of flash memory.


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The same can be said for some alliances in the oil and automobile industries. BP

and Statoil formed a joint venture to share the costs of international oil exploration and

production activities.36 By pooling their financial resources and knowledge of oil

exploration and production, these two firms were able to lower the risks associated with

costly oil exploration and production activities. By sharing the costs of the drilling

equipment and the other fixed assets associated with drilling for oil, they were able to

lower the fixed cost per barrel for each partner. Firms typically pool similar resources to

achieve economies of scale or share the risks associated with conducting a particular

activity.

Create New Alliance-Specific Resources

A third way that alliances create value is when partners create new alliance-specific

resources. Alliance-specific resources are those that are created specifically to help the

partners achieve the alliance objectives. In many cases these new resources are built or

created to improve the ability of the partners to coordinate their joint work. To illustrate,

Toyota Boshoku, a Toyota seat supplier, built its factory next door to Toyotas factory37

because seats are bulky and costly to ship. So building the plant nearby lowered the costs

of inventory and shipping to Toyota. Then, to further reduce shipping costs, Boshoku

decided to build a conveyer belt to take seats directly from its factory into Toyotas. The

factory plant and conveyor belt were new resources that were created to support

Boshokus transactions with Toyota. These investments substantially lowered

transportation costs, inventory costs, and the costs associated with having face-to-face

meetings. In comparison, General Motors did not have an alliance relationship with its

seat suppliers. As a result, the suppliers did not build their factories nearby. Not


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surprisingly, GM and its seat suppliers had higherinventory and transportation costs and

this gave Toyota and Boshoku a cost advantage.38

Visa represents another example of alliance partners creating an alliance-specific

resource. In the 1970s Bank of America and a group of other financial institutions decided

to form a joint venture company with the purpose of building a credit card business.

Credit cards were new at the time and the banks were hoping to get customers to widely

use them. The new joint venture company was named Visa and the company then built

the Visa brand with customers through marketing and advertising. The Visa brand was

perhaps the most valuable resource created through the alliance because it allowed

member banks to issue credit cards that were immediately recognizable to customers.

Over time, many other banks and financial institutions wanted the benefits of issuing a Visa

credit card so they joined the private membership association that owned Visa. Visa finally

become a public company in 2007 but its primary owners are still the banks that were part

of the private membership association that established Visa.39 Firms typically create

alliance-specific resources to increase the efficiency of doing business together or to create

new jointly held resources.

Lower Transaction Costs

A fourth way that alliances create value is by lowering transaction costs by creating

trust-based relationships. Bytransaction costs, we mean all of the costs associated with

making a transaction happen.40 In most companies, purchasing personnel, sales personnel,

and lawyers have primary responsibility to find, and negotiate agreements with, suppliers

of inputs and buyers of outputs. If alliance partners can create relationships with suppliers

or buyers based upon mutual trust, then they dont have to employ as many purchasing or


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sales personnel. They also dont have to employ as many lawyers to write costly contracts

to protect their interests.41 One study of Toyota and General Motors found that Toyotas

procurement and legal costs were one half those of General Motors.42 The study concluded

that General Motors and its suppliers had higher transaction costs because they didnt trust

each other; so they spent a lot of time negotiating agreements and writing legal contracts.

In contrast, Toyota had developed relationships with their supplier partners that were

based on mutual trust. One thing that Toyota had done to build trusting relationships with

some suppliers was to purchase a minority stock ownership stake in the supplier. Because

Toyota partially owned the suppliers stock, suppliers felt that Toyota would behave in a

trustworthy manner. Alliances that create value through lower transaction costs are

primarily trying to increase efficiency and lower the costs between transactors in the value

chain.

The Risks of Alliances

The issue of protecting ones interest in an alliance is realalliances are not without

risks.43 When you agree to an alliance, you lose some of your independence as a company.

You rely on your partner to produce and perform as expected. Moreover, just as there are

incentives to cooperate in alliances, there are also incentives for companies to act

opportunisticallymeaning they might try to take advantage of a partner if the situation

presents itself. So you need to be aware of the ways that a partner can take advantage of

you in an alliance: either through hold-upor misrepresentation. You can remember these

two forms of opportunism as H&M.


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Hold-Up

Hold-up occurs when one partner tries to exploit the alliance-specific investments

made by a partner.44 In the case where Toyota Boshoku built its factory next to Toyotas,

this created an opportunity for Toyota to hold-up those investments by asking for price

decreases. Once Toyota Boshoku built its factory next door to Toyota, it was highly

committed to Toyota because these investments could not be easily redeployed to service

other customers. Toyota could choose to opportunistically renegotiate prices after

Boshuku made the investment. It was important for Boshuku to make sure that Toyota

would be trustworthy and not try to negotiate lower prices after it built its factory next

door. So it created an equity alliance with Toyota, with Toyota owning 49 percent of

Toyota Boshokus stock.45 So be aware that whenever you make investments in

equipment, facilities, or processes that are customized to a partnerand therefore not

easily re-deployable to other usesthere is the potential for your partner to hold you up.

Misrepresentation

Misrepresentation occurs when a firm selects a partner that creates false

expectations about the resources it brings to the relationship or fails to deliver what they

originally promised.46 For example, a start-up biotechology company may find that it

needs additional resources to conduct clinical trials in order to get approval for a new drug

it is developing to fight Alzheimers disease. To convince a pharmaceutical company to

provide the necessary resources, it may misrepresent how far along the drug is in the

development pipeline. Or it may overstate the effectiveness of the drug in initial clinical

trials. A company that considers entering into an alliance with a firm that brings intangible

resources to an alliancesuch as local market knowledge or relationships with key


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political figuresneeds to research their partner thoroughly to guard against this form of

opportunism. Misrepresentation is a hazard that one faces when doing business with

others of questionable moral character. The only true way to protect against

misrepresentation is to partner with trustworthy individuals and firms.

The bottom line is that while alliances have the potential to create value, they are

also fraught with challenges and risks. Alliances cause independent firms to become

interdependentwhich means they must work effectively together to succeed. This may

explain why some studies of alliances have found that trust between partners is the most

important ingredient for alliance success. Below we examine four ways that companies

attempt to protect themselves from opportunism and build trust with their alliance

partners.

Personal Trust.

The first way to prevent against opportunism by a partner is to only initiate

partnerships with people who you know to be trustworthy. These would likely be

individuals you have known for a long time, such as family, friends, classmates, or others

within your social network. Of course, you need to know them well enough to be able to

judge their characterand you need to be accurate at evaluating their character. This type

of trust is sometimes called goodwill trust because you are relying on the goodwill of the

other party to protect your interests. Some research has shown that compared to U.S.

firms, Japanese firms are much more likely to rely on personal trust to govern their

alliances. As a result, they often have a long honeymoon period of meetings, dinners, and

even activities like singing karaoke to get to know individuals in the other firm before

deciding whether they think they can trust the firm enough to enter into a partnership.


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This is often frustrating for U.S. firms who are more willing to write contracts to govern

their alliances than to rely on personal trust.

Legal Contracts

In most cases when firms initiate a partnership, they write a legal contract to

protect their interests. A contract is a substitute for personal trustlegal contracts are

usually used to help protect the interests of alliance partners and to spell out the

obligations and expectations of the partners. If someone violates personal trust, there is

no real economic recourse other than ending your friendship or relationship. But if

someone violates a contract, you can sue the other party in court to get some economic

recourse. This threat of a lawsuit can be an important incentive for partners to perform

according to legally established obligations and expectations. Most contracts have clauses

that clarifygovernance issuesin the alliance (such as how decisions will be made, how

profits will be split and how disputes will be resolved), operating issues(such as what

performance is expected, how intellectual property will be shared and protected), and

exit/termination issues(such as the conditions under which partners can exit the alliance or

the contract can be terminated (see Sidebar: Common Clauses in Alliance Contracts).

Sidebar: Common Clauses in Alliance Contracts

Governance Clauses

Residual Rights Clauses: In contractual alliances parties often specify how the profits orassets created from the alliance is to be split among the partners.

Equity/Ownership Clauses: Equity alliances or joint ventures must specify what percentageof equity is owned by each of the partners.


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Voting Rights Clauses: Specify the number of votes assigned to each partner in an alliancefor decision making. This usually corresponds to equity ownership in equity alliances.

Minority Protection Clauses:Specify the kinds of decisions that can be vetoed, if any, byfirms with a minority interest in the alliance.

Dispute Resolution Clauses: Specify the process by which disputes among partners will beresolved.

Operating Clauses

Performance Clauses: Specify the specific duties and obligations of each of the partners,including warranties and minimum performance levels required to satisfy the contract.

Non-Compete Clauses: Specify product markets or businesses that partners are restrictedfrom entering.

Intellectual Property Right Protection Clauses: Specify what intellectual property orconfidential information brought to the alliance by partners is not to be used by the partneror shared outside of the alliance without the partners written consent.

Intellectual Property Right Creation Clauses: Specify ownership rights to intellectualproperty (e.g., patents) created as a result of the alliance.

Exit/Termination Clauses

Preemption Rights clauses: Specify if one partner wishes to sell its equity, it must first offer

to sell the equity to the other partner.

Initial Public Offering (IPO) Clauses: Specify conditions under which partners in equityalliances or a joint venture will pursue an initial public stock offering.

Call/Put Option Clauses: Specify the conditions under which a partner can force a partnerto sell its shares (or a partner can force the other partner to buy its shares) and at whatprice.

Termination Clauses: Specify under what conditions the contract can be terminated and theconsequences of termination for each partner.


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Shared Ownership/Financial Collateral Bonds

Another approach taken by alliance partners to align incentives and to build trust is

through shared equity or through a financial collateral bond. When one partner owns a

financial stake in the partner, as Toyota does with some of its supplier partners, it has an

incentive to cooperatively help the partner be as financially successful as possible because

it shares in the partners profits. By having your partner purchase a stake in your

organization, you align the incentives of both partners to work together. Another way to

do this is by having a partner post a financial collateral bond that it will lose if it doesnt

perform according to a specified contract. For example, when purchasing a new home the

home buyer most often put a certain amount of money into an escrow account (this is a

financial collateral bond) that it will lose to the seller if it does not follow through on the

contracted sales agreement. In similar fashion, fast food chains like McDonalds will often

partner with franchisees, individuals who purchase a franchise from McDonalds which

gives them the right to operate a McDonalds outlet at a particular location. The franchise

fee is essentially put into something like an escrow account while McDonalds monitors the

franchisee to ensure that it operates the outlet according to McDonalds guidelines. If the

outlet fails to provide McDonalds quality food or service (which McDonalds checks by

sending in inspectors), McDonalds can keep the franchise fee and take away the franchise.

Reputation

While in some cases partners do act opportunistically in the ways described earlier,

it is worth noting that firms that do so can gain a reputation as an unethical partner. This

may close the doors to future alliance opportunities. So if it is easy to prove that a partner

has not lived up to its obligations, and if the partner has a reputation to protect, this may


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also build trust in the alliance. For example, if Toyota took advantage of suppliers that

built their factories next to Toyotas, this could tarnish its reputation. Future suppliers

would be careful to avoid making these value-creating investments. Of course, relying on

reputation alone to protect your interests is risky because your partner may decide that the

value of behaving opportunistically in the short run is worth the risk to its reputation.

Building an Alliance Management Capability

Strategic alliances have become a fast and flexible way to access complementary

resources and capabilities that reside in other firms. Yet, alliances are fraught with risks,

and almost half of them fail. In such an environment, the ability to form and manage

alliances more effectively than competitors can itself become an important source of

competitive advantage. In chapter three we discussed the importance of a firm building

internal resources and capabilities which can be used to accomplish key strategic

objectives. One of those capabilities is an alliance capabilitythe focus of the final section

of this chapter.

So how do some firms develop a capability at successfully forming and managing

alliances? Professors Jeff Dyer, Prashant Kale, and Harbir Singh conducted an in-depth

study of 200 corporations and their 1,572 alliances to learn how firms can systematically

manage alliances to maximize success. They found that a companys stock price jumped

roughly 1 percent, on average, with each announcement of a new alliance, which translated

into an increase in market value of $54 million per alliance.47 While all companies seem to

generate some value from alliances, some companiessuch as Eli Lilly, Oracle, and

Hewlett-Packardsystematically generate much more than other firms.


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How do they do it? By building a dedicated strategic alliance function within the

company. Companies like these appoint a vice president or director of strategic alliances

with his or her own staff and resources. The dedicated function coordinates all alliance-

related activity within the firm and is charged with creating processes to teach, share, and

leverage prior alliance management experience. Companies with such an alliance function

achieved a 25 percent higher long-term success rate with alliances and generated almost

four times the market wealth whenever they announced the formation of a new alliance.

So what did the alliance function do to help create such wealth? The research

showed that an effective dedicated alliance function develops the capability to perform four

key functions: it improves knowledge management efforts, increases external visibility,

provides internal coordination, and eliminates accountability and intervention problems.48

Improves Knowledge Management. A dedicated function acts as a focal point for learning

and leveraging lessons and feedback from prior and ongoing alliances. It systematically

establishes a series of routine processes to articulate, document, codify, and share alliance

know-how about the key phases of the alliance lifecycle. Indeed, many companies with

dedicated alliance functions have codified explicit alliance-management knowledge by

creating guidelines and manuals to help them manage specific aspects of the alliance

lifecycle, such as partner selection and alliance negotiation and contracting (see Figure 8.3).

For example, Hewlett-Packard has developed 60 different tools and templates included in a

300-page manual that can be used to guide decision making in specific alliance situations.

The manual includes such tools as a template for making the business case for an alliance, a

partner evaluation form, a negotiations template outlining the roles and responsibilities of


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different departments, a list of ways to measure alliance performance, and an alliance

termination checklist.

Increases External Visibility. A dedicated alliance function can play an important role in

keeping the market appraised of both new alliances and successful events in ongoing

alliances. Such external visibility can enhance the reputation of the company in the

marketplace and create the perception that alliances are adding value. The creation of a

dedicated alliance function sends a signal to the marketplace and to potential partners that

the company is committed both to its alliances and to managing them effectively. And when

a potential partner wants to contact a company about a potential alliance, a dedicated

alliance function makes an easy, highly visible point of contact. In essence, it provides a

place to screen potential partners and bring in the appropriate internal parties if a

partnership looks attractive.


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For instance, Oracle with its Alliance Online Website, has actually put the

partnering process online. Oracle describes the terms and conditions of different tiers of

partnership on its Web site and then allows potential partners to choose which level fits

them best. Alliance Online has allowed the company to enhance its external visibility and

has emerged as the primary means of recruiting and developing partnerships with more

than 7,000 tier I partners. It has also conserved human resources, allowing Oracles

strategic alliance function to focus the majority of its human resources on its 12 higher

profile, and more strategically important, tier III partners.

Provides Internal Coordination. One reason that alliances fail is because of the inability of

one partner or another to mobilize internal resources to support the alliance initiative.

Visionary alliance leaders may lack the power or organizational authority to access key

resources that may be necessary to ensure alliance success. A dedicated strategic alliance

function has the legitimacy required to access and coordinate internal resources across

different functions and divisions. An alliance executive at a firm without such a function

observed: We have a difficult time in supporting our alliance initiatives because many

times the various resources and skills needed to support a particular alliance are located in

different functions around the company. You have to go begging to each unit and hope that

they will support you. But thats time consuming and we dont always get the support we

should.

A dedicated alliance function helps solve this problem in two ways. First, it has the

organizational legitimacy to reach across divisions and functions and request the resources

necessary to support the firms alliance initiatives. When particular functions are not

responsive, it can quickly elevate the issue to a senior executive very quickly. Second, over


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time, individuals within the alliance function develop networks of contacts throughout the

organization. They come to know where various useful resources within the organization.

These networks also develop a degree of trust between alliance managers and employees

throughout the organization, thereby allowing them to engage in reciprocal exchanges in

support of alliance initiatives.

Facilitates Intervention and Accountability. One survey of alliances found that only 51% of

companies that form alliances have any kind of formal metrics in place to assess alliance

performance. Of these, only about 20% believe that the metrics they have in place are

really the appropriate ones to use. However, 76% of companies with a dedicated alliance

function had implemented formal alliance metrics. By contrast, only 30% of firms without a

dedicated function had developed and implemented formal alliance metrics.

To illustrate, Eli Lillys alliance function does an annual health check of its key

alliances, surveying both Lilly employees and the partners alliance managers. After the

survey, an alliance manager sits down with the leader of a particular alliance to discuss the

results and offer suggestions or recommendations. In some cases, Lilly found that it needed

to replace its alliance leader. When serious conflicts arise, the alliance function can help

resolve the dispute. One executive at Lilly commented, Sometimes an alliance has lived

beyond its useful life. You need someone to step in and either pull the plug or push it in

new directions.49 Alliance failure is the culmination of a chain of escalating events. Not

surprisingly, signs of distress are often visible early on, and if alliances are adequately

monitored, the alliance function can step in and intervene appropriately. The bottom line

is that developing processes to effectively form and manage alliances builds a capability at

generating value through strategic alliances.


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Summary

A strategic alliance is a cooperative arrangement in which two or more firms

combine their resources to create new value. There are three basic types of alliances: a

non-equity or contractual alliancewhere two or more firms write a contract to govern the

relationship; an equity alliancewhere collaborating firms often supplement contracts with

equity holdings in alliance partners; ajoint venturewhich is an alliance where collaborating

firms createand jointly owna legally independent company which is created from

resources and assets contributed by the parent firms.

The primary strategic objective of firms is to offer unique value to customers, either

through low cost or differentiation. Alliances are a vehicle for accessing the resources and

capabilities of another firm that will help you lower costs or differentiate your offering.

There are four primary ways to create value with an alliance partner:

1. combine unique resources,

2. pool similar resources,

3. create new alliance-specific resources,

4. lower transaction costs.

As partners work together to create new value, they have to build trust to ensure that they

cooperate effectively. There are four primary ways that partners build trust in alliance

relationships: 1) personal trust, 2) legal contracts, 3) shared equity/financial collateral

bonds, or 4) reputation. The ability to build trust with a partner has been often viewed as

the single most important thing to alliance success.


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