Managing Risks in Strategic Alliances PDF

^ Academy of MmiagemenI Executive, 1999, Voi, 13. No. 4 Managing risks in strategic alliances T. K. Das and Bing-Sheng Teng Executive Overview Managing the different...

^ Academy of MmiagemenI Executive, 1999, Voi, 13. No. 4 Managing risks in strategic alliances T. K. Das and Bing-Sheng Teng Executive Overview Managing the different kinds of risk in strategic alliances is a complex task. We propose a comprehensive framework of risk management with two components. First, we discuss the roles of relational risk and performance risk in alliance resource management. The overall goal is to gain access to partner firms' valuable resources while keeping one's own resources intact. To that end, alliance managers may choose from four orientations—confroJ, flexibility, security, and productivity. The second part of the framework focuses on various risks in the alliance management process, including the stages of partner selection, structuring, operation, and performance evaluation. Within each stage, we identify the key risk that may affect alliance success. These risks are related to fit, flexibility, collaboration, and planning for the future. Together, the two components of the framework provide insights and guidelines for managers to effectively deal with the major risks in the management of alliances. More and more firms are joining together in stra- KLM took a 25-percent stake in Northwest. By link- tegic alliances. The alliance activities of the thou- ing their hubs in Detroit and Amsterdam, the two sand largest U.S. firms are expected to account for firms offered transatlantic traveling under one 35 percent of their total revenue by 2002—up from brand. The results were highly encouraging: Their less than two percent in 1980 and 21 percent in combined Atlantic market share increased from 1997.' The number of alliances has been growing seven percent to 11 percent in just two years. Not at a rate of 25 percent per year since 1985.^ Every only did Northwest turn itself around financially, day many alliances are formed, but many are also but KLM also gained handsomely from its equity dissolved. The high failure rate may be due to investment, which grew from $400 million to $1.6 unique risks inherent in strategic alliances. We try billion.^ Despite its early success, though, the alli- to identify these risks, and provide suggestions for ance ran into trouble in short order because the managing alliances effectively. two disagreed on how much control KLM should Strategic alliances are interfirm cooperative have over Northwest.^ The relationship soon agreements aimed at achieving competitive ad- soured, as Northwest became understandably con- vantage for the partners. Such alliances are usu- cerned about KLM's takeover attempt. A culture ally forged when any single firm finds it either too clash between Northwest's heavily debt-financed difficult or too costly to pursue worthwhile busi- approach and KLM's cautious approach worsened ness objectives on its own. Although many firms the situation. have benefited from strategic alliances, many oth- This case shows that managing alliances is ers have been disappointed by poor performance, much more complicated and difficult than manag- and still more are skeptical about what an alliance ing single firms, mainly because of the additional could achieve for them. Strategic alliances are factor of managing the partner firm. In fact, studies generally seen as a risky strategy whose success have consistently shown that the failure rate of is often unrelated to an individual partner firm's alliances can be as high as 50 percent.^ Compared efforts. with such nonalliances as acquisitions and sub- Consider the alliance between Northwest Air- sidiaries, the success rate of strategic alliances is lines and KLM Royal Dutch Airlines,^ which started significantly lower.' Because there is a relatively in 1992, when Northwest went almost bankrupt and high level of failure risk in alliances, strategic 50 1999 Das and Teng 51 alliances must be classified as a high-risk strat- alliances, we suggest a differentiation between egy. Thus, firms need to develop a good under- relational risk and performance risk.'° While rela- standing of these risks and learn ways to system- tional risk is the risk of unsatisfactory interfirm atically deal with them. Many of these risks are cooperation, performance risk is all other factors uniquely present in alliances and typically absent that adversely affect alliance performance. in single organizations.^ Managers whose experi- Relational risk is concerned with the probability ence is in single-firm strategies may not have an that partner firms lack commitment to the alliance adequate appreciation of the nature and implica- and that their possible opportunistic behavior tions of the characteristic risks associated with could undermine the prospects of an alliance. Con- alliances. sider the example of the joint venture formed by Liz A systematic risk-based approach for alliance Claiborne and Avon." After Avon acquired Par- managers is lacking in the literature. We discuss fums Stern, a high-end cosmetics firm, Liz Clai- the practical implications of two established alli- borne regarded Avon as a direct competitor, and ance risk notions—relational risk and performance their relationship began to deteriorate. The joint risk—in alliance resource management. We then venture was eventually acquired by Liz Claiborne. analyze the risks involved in each stage of the As this case shows, partner firms—not surprising- alliance management process and suggest ways ly—tend to be interested more in pursuing their to cope with them. This framework can be applied self-interest than the common interest of the alli- to the entire range of alliances, from small and ance. Alliance partners are primarily motivated in large to domestic and international. enhancing their self-interest at the cost of the part- ner firms and even the alliance. Such opportunistic behaviors include shirking, appropriating the part- Relational Risk Is Unique to Strategic Alliances ner's resources, distorting information, harboring Risk is a significant concept in management stud- hidden agendas, and delivering unsatisfactory ies. Researchers have developed so-called risk products and services. Because these activities se- analysis techniques to aid investment decisions riously jeopardize the viability of an alliance, re- and strategic planning. In risk analysis, managers lational risk is an important component of the over- assign probabilities to a range of possible out- all risk in alliances. Relational risk is unique to comes based on several strategies under consider- strategic alliances and single-firm strategic moves ation. A computer program then calculates the dis- are not subject to such risk. When firms pursue tribution of net present value (NPV) of each market opportunities on their own, there is little strategy. Managers choose the one with the most need to cooperate with others, so that there is no desirable distribution of NPV. risk of unsatisfactory interfirm cooperation. Thus, relational risk is an unavoidable—and quite prob- In reality, though, managers may not know lematic— element of strategic alliances. about the kinds of possible outcomes, and it is very difficult for them to assign reasonable probabili- Performance risk is the probability that an alli- ties to possible outcomes. That is why managers ance may fail even when partner firms commit usually do not rely on probability estimation. themselves fully to the alliance. Despite the best Quantifying risk, while desirable, may not be the efforts of the partner firms, an alliance can still fail best approach in aiding complicated strategic de- because of internal and external factors (other cisions such as those in strategic alliances. In fact, than the relational risk discussed earlier). The research shows that managers are far more con- sources of performance risk include environmental cerned with negative outcome variances, or down- factors, such as government policy changes, war, side risk, than positive outcome variances.^ and economic recession; market factors, such as fierce competition and demand fluctuations; and internal factors, such as a lack of competence in Quantifying risk, while desirable, may critical areas, or sheer bad luck. Unlike relational not be the best approach in aiding risk, however, performance risk is part of every complicated strategic decisions such as strategic decision, because performance can those in strategic alliances. always fall below one's expectations. Whereas relational risk is created and is present only in alliances, performance risk relating to any under- There are also many types of risk. Thus, a more taking is something that is shared by all partner productive approach appears to be to refine the firms. For instance, joint bidding enables partner concept of risk by classifying it into different cat- firms to share the costs as well the performance egories of downside risk. In the case of strategic risk involved in a contract. Rather than pursue 52 Academy oi Management Executive November projects alone, firms use strategic alliances to re- tive, one key challenge for firms in strategic alli- duce their performance risk. Take the example of ances is to effectively protect themselves from los- Montreal-based Bombardier, which competes in ing critical resources at the same time as they business jets and small airliners.'^ In order to con- attempt the fullest use of their contributed re- trol development costs, the firm uses partners of sources. In order to do that, firms need to develop a many countries to share about half of the $1 billion sense of priority, or orientation, in managing alli- development cost for its newest business jet. These ances. We refer to alliance orientation as the one partner firms share the development and manufac- aspect of an alliance that a partner firm deems the turing costs of key parts of the plane. Similarly, most critical, and to which, accordingly, it pays the Boeing has arrangements with three airplane en- most attention.'^ For example, many firms have a gine producers^GE, Rolls-Royce, and Pratt & flexibility orientation in their alliances in order to Whitney—^to share the risk and cost of airplane adapt to changing conditions more easily. The development.'2 In both these cases it is clear that software company Lotus often negotiated vague the risk-sharing in their alliances refers to perfor- agreements so that changes could be accommo- mance risk only. We need to note, however, that dated. In fact, Lotus does not have formal agree- this performance risk is in addition to whatever ments in more than 50 percent of its alliances.'^ We relational risk the alliances may have for individ- suggest that there are two dimensions that are ual partner firms. important in what we have termed alliance orien- tation—the type of primary resource and the type of primary risk. The type of resource a firm brings Risks in Managing Alliance Resources to an alliance determines what is at stake, such as We now discuss the role of relational risk and possible losses. But the primary risk reflects what performance risk in alliance resource manage- hazard the firm faces—that is, the underlying rea- ment and show how they would influence the ori- son for possible losses. A firm's orientation in entations oi the partner firms in an alliance. A an alliance will depend on these two factors (see firm's unique resources and capabilities constitute Figure 1). the key foundation of its competitive advantage in the marketplace. Resource management, which is about identifying, utilizing, and securing valuable Two Types of Resources—Property and Knowledge resources, is a critical element in business perfor- mance. There are four different aspects in resource Firms may contribute various types of resources to management in strategic alliances: optimally us- an alliance,'^ including physical, financial, hu- ing one's existing resources; developing new re- man, technological, managerial, and organiza- sources; protecting one's resources, for example, tional resources. One useful way to classify these by avoiding unintended transfer and imitation; resources is in terms of the different protective and gaining access to other firms' resources if nec- arrangements they need. Resources can be classi- essary. fied as either property or knowledge." Resources When companies do business on their own, they are properties when there are clear property rights are involved in the first three aspects of resource and a firm's ownership is absolute and is protected management. Recognizing the importance of the by law. Physical and financial resources are ex- fourth aspect-—gaining access to resources^ has amples of properties, as are patents, contracts, led to the popularity of strategic alliances, which logos, and trademarks that are protected by law. are all about taking advantage of others' valuable The protection of properties has a fairly clear basis resources. Of course, alliances open up new oppor- and is easy to implement. Properties cannot be tunities for the first two aspects as well. Through freely obtained by others because of the ownership these strategies, firms Identify creative and more barrier. The protection of knowledge, however, re- productive ways of utilizing their own resources. lies on the knowledge barrier. That is, other firms They also discover fresh routes to developing new do not have an easy way of appreciating the tacit resources. skills and knowledge involved in one's technolog- While alliances are particularly effective and ical, managerial, and organizational resources. nimble in gaining access to others' resources, their Because the knowledge barrier is the only protec- disadvantage is that protecting their own re- tion against unintended transfer of knowledge, sources also becomes more complicated. Firms such knowledge may well be imitated by other need to explicitly protect their own resources from firms, thereby negating the associated competitive unintended transfers and imitations. advantage. There is little legal protection against Thus, from the resource management perspec- such loss. For example, in the case of Ciba Corning 1999 Das and Teng 53 Primary Risk Relational Risk Performance Risk Property (physical, Control Flexibility iinancial) Primary Resource Knowledge (technological, Security Productivity managerial) Strategic Alliance Orientations for Primary Risks and Resources Diagnostics, a joint venture between Ciba-Gelgy important than its knowledge resource. and Corning, both partner firms contributed such knowledge.'s Ciba is rich in its know-how in ther- apeutics and body mechanisms, while Corning Strategic Alliance Orientations leads in medical technology. In this alliance, each We now discuss the ways in which firms with firm's know-how will be exposed to the other particular resource orientations can manage the firm—at least to some extent. two kinds of risks—relational and performance— A partner firm's resource contribution to an alli- inherent in strategic alliances. This will involve ance can be either primarily property or primarily managing issues such as control, flexibility, secu- knowledge. It would be rare for a firm's contribu- rity, and productivity (see Figure 1). tion to be equally split between property and knowledge. The primary resource is the type of resource that a partner firm deems more important Control Orientation and valuable. Multinational companies often con- When a partner firm contributes primarily property tribute capital, patents, tacit technology, and man- resources and considers relational risk to be the agerial expertise to their joint ventures at the same major risk, its concern is that its properties may be time. However, one particular type—property or misused and that the other party may reap undue knowledge^—is usually more heavily represented benefits. Although properties are protected or is believed to be more valuable to the firm. through legal ownership—and cannot be taken Clearly, the protection of one's primary resource away without the owner's consent—these can still should be a priority in the alliance. For example, be employed in unintended ways. For example, a Coca-Cola formed a joint venture with France's partner firm's financial and physical resources Groupe Danone in order to sell its Minute Maid may be deployed in such a manner that the new orange juice in both Europe and Latin America.'^ venture competes with its own business. In 1993, U S West invested $2.5 billion and obtained a 25.5 percent minority stake in Time Warner Entertain- Clearly, the protection of one's primary ment, a division of Time Warner Inc. The alliance resource should be a priority in the ran into trouble when Time Warner Entertainment alliance* proposed several deals with other telecommunica- tion companies, such as AT&T. U S West claimed that these deals would potentially compete with its Before the alliance, Coca-Cola was unsuccessful own local telephone franchise.^" These proposals in its orange juice business in Europe mainly be- were all vetoed by U S West. Apparently, with cause of the lack of effective distribution channels. considerable properties at stake, the orientation of Danone's delivery network provided the alliance the firm in such circumstances will be tighter con- with the primarily property-based resource—that trol—that is, making sure that its properties are is, distribution channels. Coca-Cola, by compari- used in consonance with its own interests and son, contributed both property, in the form of pro- intentions.2' In essence, the issue is about dealing duction capacity, and knowledge, in the form of with the relational risk of the alliance. marketing know-how. However, its contribution of Control can be achieved in different ways, such the property resource in this case was far more 54 Academy oi Management Executive November as contractual control, equity control, and mana- that are invested in the alliance. For example, a gerial control. Contractual control means specify- firm may plan to build a new production facility ing the details of usage of properties in the alli- but may be apprehensive that the market situation ance agreement. There should be explicit speci- may worsen. Thus, the key is to reduce the perfor- fication of when, where, and how money, plants, mance risk of the alliance, which can be achieved distribution channels, and patents are to be used. by reducing the probability of a failure, and by Equity control is about ensuring desirable behav- reducing the adverse impact of a possible failure. ior and outcome in an alliance through equity own- One way to enhance the odds of alliance success ership. While contractual control is useful in virtu- is to invest additional resources, but that could ally all alliances, equity control is relevant only if increase the adverse impact of a failure farther an alliance involves equity creation, such as joint along. Also, there is a limit to what additional ventures, or other equity arrangements, such as investments can do to help achieve desired results. minority equity alliances. Equity control can be External factors—such as the economy, market, exercised by having majority equity ownership, and competition—can sometimes be more impor- which implies more authority and bargaining tant than resource commitment. By this reasoning, power, or by inviting the partner on board, asking reducing the potential adverse impact of a failure the partner to take some equity position in the can be a safer course of action for controlling sig- alliance. Shared ownership aligns the interests of nificant performance risk. Firms therefore need to partners and deters opportunistic behavior. As a achieve a relatively high level of flexibility. Flex- result, more coUegial behavior may be expected. ibility enables a firm to minimize sunk costs, adapt When Procter & Gamble first entered the Russian to new situations, and recover more investment market in 1991, it did so with nonequity alliances. should the alliance fail. P&G transferred knowledge to its Russian partners so that they could produce P&G brand of products. Eventually, P&G realized that it needed to exercise Flexibility enables a firm to minimize more control over its alliances and chose to do so sunk costs, adapt to new situations, and through equity participation. In its latest alliance recover more investment should the with NBKh, P&G acquired a $50 million stake, and alliance fail. the alliance has thus far been successfui.^^ A third type of control for a partner firm is man- agerial, which ensures tight monitoring of alliance There are a number of ways for partner firms to be operations. To have one's own staff in key posts in flexible. First, they can opt for short-term, recurrent an alliance is a significant mechanism for effec- contracts. These contracts specify an incremental tive managerial control. Partner firms can also process of alliance making. Additional invest- have regular meetings to prevent sudden compli- ments beyond the initial amount are not made cations in operations. In an alliance between until the results of the preceding periods meet ex- Kodak and Chinon, a medium-sized Japanese cam- pectations. Merck, for example, adopted this ap- era company, Kodak insisted on having its division proach in its partnership with Astra AB of Swe- manager manage the relationship.^^ The manager den.^** Merck started with a distribution agreement exercised managerial control through frequent in- that allowed it to market Astra's new drugs. Initial teractions and communications, which helped success led Merck to set up a new venture to han- make the alliance work. dle a wide range of Astra products. Encouraged by satisfactory results, Merck strengthened the tie by inviting Astra to take a 50 percent stake in the Flexibility Orientation venture. It is apparent that, as compared with long- When performance risk is the major risk and a firm term agreements, recurrent contracts are more contributes mainly properties, its orientation in the adaptive to changes in the environment and the alliance will be flexibility. Flexibility enables a needs of the partner. partner firm to be free from rigid, engaging, and Second, partner firms can choose alliance forms long-term agreements, enhancing the ability to that are relatively less engaging. Whereas joint adapt to changing circumstances. Because the ma- ventures and minority equity alliances represent jor risk is that the alliance may fail even if the more engaging forms, the less engaging ones in- partners are fully committed, the firm should be clude licensing, funded research, shared distribu- concerned about losing its invested resources—in tion and product-bundling. Less engaging alli- this case, mainly properties. The firm may not be ances not only require less investment and are able to recover financial and physical resources more easily terminated, but their termination usu-  Das and Teng 55 ally also does not mean incurring huge costs. In based competition is gaining in momentum. Thus, the biopharmaceutical industry, joint ventures rep- firms often form alliances to learn others' knowl- resent only 20 percent of all alliances. Most of the edge. Alliances become learning races,^' in which alliances are so-called virtual, or informal, alli- the partner that more quickly grasps the other's ances that involve no separate entities. For exam- knowledge gains more bargaining power and ob- ple, Abbott Laboratories has formed many market- tains an upper hand in the relationship. For in- ing alliances with biotech companies such as stance, JVC of Japan and Thomson of France are North American Vaccine (NAV).^^ Whereas Abbott direct competitors, as they both make VCRs. In profits from getting NAV's products to the market, their alliance, it was clear that JVC wanted Thom- NAV benefits from Abbott's massive sales force son's knowledge of the fragmented European mar- plus a one-time payment of $42 million and royal- ket, while Thomson was interested in technologi- ties on sales. Such agreements are relatively easy cal know-how.^-^ In this case, whichever partner to terminate and are considerably more flexible acquires the needed knowledge will reap benefits than joint ventures. faster. Third, partner firms can emphasize exit provi- As we mentioned earlier, the protection avail- sions in the alliance arrangements. Exit provisions able for knowledge is essentially the knowledge lay out how an alliance termination will be exe- banier, as there are hardly any clear ownership cuted, should there be one. Specific costing and rights. Such rights are difficult to delineate be- pricing formulas should be featured explicitly, so cause that involves protecting something that is that there is no uncertainty about who gets which basically tacit in character. Thus, firms may rela- part of the alliance. Although ownership rights of tively easily obtain other firms' valuable knowl- properties are fairly clear, alliance activities can edge in an alliance. Some scholars warn that joint eventually blur the ownership contours. Without ventures with Japanese firms are eroding the com- exit provisions, investing firms may be concerned petitive advantage of American firms because Jap- that they will be dragged into ownership disputes. anese firms are motivated by a need to learn while Thus, the utility of exit provisions is that the in- American firms are motivated by a need to avoid vesting firm will feel less concerned about the investment.29 Of course, it could go in the other recovery of their initial investment. In the alliance direction as well. For instance, the U.S. company between IBM and Russian PC maker Kvant for the Ralston Purina had an alliance with Taiyo Fishery assembly and sale of IBM PCs in the Russian mar- Company of Japan for 20 years. The alliance was ket, the partners negotiated "an escape clause that later terminated by Ralston Purina after it con- permitted either partner to leave the alliance due cluded that it had successfully acquired Taiyo's to changes beyond its control in the local mar- local knowledge through the alliance.^"^ Given the ket."^^ In 1995, two years after the alliance was relational risk involved with knowledge resources, formed, the Russian parliament amended the pre- firms need to deal with knowledge imitation and vious legislation that allowed IBM to import PC focus on securing their distinctive know-how. parts free of tariff. Because the key motivation be- Hence, knowledge security should be the alliance hind the alliance was to take advantage of the orientation. tariff difference between complete PCs and PC To ensure such security, firms should attempt to parts, IBM concluded that it did not make sense to limit the exposure of tacit knowledge and know- stay in the alliance any longer. Thanks to the es- how to their partner firms. Instead of forming alli- cape clause, IBM was able to exit swiftly and even ances, such as joint ventures, in which firms work retrieve its equipment. Structural flexibility al- closely, firms may choose to form alliances in lowed IBM to avoid a major loss in this case. which partners work separately—as in the case of funded R&D and outsourcing agreements. Unau- Security Orientation thorized learning tends to be curbed when the op- erations of an alliance are carried out separately In the case of a partner firm that contributes by partner firms. Firms should also make it clear mainly tacit knowledge and know-how to an alli- prior to alliance formation that they are aware of ance, but is concerned about high relational risk, the possibility of unauthorized learning and are the issue is the security of contributed resources. committed to preventing it from happening. Once Relational risk here is mostly in terms of the like- this message is conveyed, false expectations on lihood of one's technological and managerial the part of the other party will be minimized. Ac- know-how being stolen by a partner firm. Obvi- cordingly, those who are interested only in secretly ously, knowledge plays an increasingly important acquiring knowledge will be discouraged. Finally, role in today's competitive market and knowledge- firms should also warn their alliance staff to be 56 Academy oi Management Executive November careful about unauthorized sharing of sensitive visited AT&T's Bell Labs and failed to identify pos- knowledge and information. It is helpful to specify sible technological know-how that could be used the kind of information that can be shared. at NCR.^2 Although the acquisition was not an al- liance, it illustrates that not all knowledge can be simply transplanted without modification. Supe- l/naufhorized learning tends to be curbed rior knowledge can be productive only if it meets when the operations of an alliance are the needs of the alliance. carried out separately by partner firms. Risks in Different Stages of Alliance Management Productivity Orientation So far we have discussed the role of relational risk When high performance risk is the major risk and and performance risk in alliance resource man- the firm contributes mainly knowledge, there is a agement. Now we turn to the role of these two types concern that one's knowledge—in combination of risk in the overall process of alliance manage- with other resources^—may not result in acceptable ment. Alliance management can be viewed as a alliance performance. To deal with this risk and process consisting of various stages.^^ Here, we enhance the odds for success, firms need to focus focus on four essential stages of a strategic alli- on the productivity of knowledge, that is, on how ance—selecting partners, structuring the alliance, its knowledge and know-how should be used to operating the alliance, and evaluating alliance yield effective results in an alliance. The superior performance. We examine in some detail the key knowledge of individual partners often fails to risk issues—and their management—relevant to bring about superior alliance performance. Be- each of the four alliance stages. (See Figure 2.) cause of incompatible organizational routines and cultures, partner firms often do not work together efficiently. For example, large firms with rigid or- Risks in Achieving Partner Fit: Selecting Alliance Partners ganizational cultures sometimes have trouble working with smaller firms, which tend to have The first stage in forming alliances is the selection more dynamic and informal cultures. In 1983, AT&T of partner firms.^^ This is not an easy decision and Olivetti formed an alliance in the end-user because there are many different criteria for a market in office equipment.^i Although both firms good partner. Bleeke and Ernst^^ suggest that cer- had significant amounts of complementary re- tain patterns of alliances tend to fail, among them sources, the alliance was later dissolved be- alliances between competitors, between weak and cause AT&T's bureaucratic organizational cul- strong firms, and between weak firms. They sug- ture clashed with Olivetti's dynamic and gest that alliances of strong equals are more likely entrepreneurial culture. Thus, firms need to fig- to succeed. Others suggest that high levels of in- ure out ways to expeditiously integrate these terfirm trust^^ and complementarity of resources^'' intangible elements of their systems. are essential conditions. Another reason for unsatisfactory alliance per- From the point of view of risk, partner selection formance is that firms have what has been called boils down to the risk of finding a fit between internal stickiness, because of which they fail to partner firms. Partner firms have resource fit and adopt partner firms' superior knowledge and strategic fit. Resource fit refers to the degree to know-how. To address this problem, firms need to which partners possess compatible resources, that overcome organizational learning barriers and let is, resources that can be effectively integrated into knowledge and know-how cross firm boundaries. a value-creating strategy. Strategic fit is the de- In contrast to the learning races associated with gree to which partners have compatible goals in high relational risk, the issue here is the inability the alliance. These two types of fit need to be to make learning happen and the resulting lack of achieved simultaneously in an alliance. Hence the desired integration of each other's knowledge. special risk of failing to ensure proper partner fit. Unsatisfactory performance may also result Resource fit is important for alliance partners when superior knowledge and know-how are used because resources and capabilities of alliance outside their appropriate context. When AT&T ac- partners are ultimately responsible for alliance quired NCR, it hoped to transfer its know-how in performance. Indeed, it is the need for critical re- the telecommunications field to the PC business. sources that motivates firms to approach their po- The strategy did not work, partly because such a tential partners. Resource fit means that partners' transfer was not feasible. A group of engineers resources are somewhat related; they either com- 1999 Das and Teng 57 Alliance Management Stages (1) Risks in finding fit Selecting alliance Do both resource fit and strategic fit No The alliance s lould not be partners exist between the partner firms? form ed. yes (; ) Risks in maintaining flexibility No Mismanagem Stnictui ing the Is there a balance between structural Poor perfo allicmce ilexibility and rigidity? Yes r ' C) Risks in managing collaboration No Mismanagem Operating t be alliance Is there a balance between cooperation Poor performance. and competition? Yes r 1 } Risks in planning for the future No Mismanagem Evaluating he alliance Is there a balance between a short-term Poor perfc rmance. and a long-term orientation? Yes Effective alliance perfonnance FIGURE 2 Managing Risks and Their Impact on Performance plement or supplement each other's resources. In finding resource fit, partners often risk ignor- Complementary fit is needed when different ing the question of compatibility of strategic objec- resources of partner firms can be effectively tives, or strategic fit. Strategic fit of the alliance combined to pursue a market opportunity. For means that the firms know each other's real objec- example, alliances are often formed by large phar- tives in the alliance, and that these objectives can maceutical firms, which provide financial and be accommodated in the alliance without harming physical resources, and small biotech firms, which the alliance or the partner firms. Many firms provide technological resources. Hewlett-Packard falsely assume that partner firms share objectives and Nokia of Finland formed an alliance to de- in an alliance. In fact, firms often harbor hidden velop hand-held communications devices that agendas in alliances. For instance, alliances are combine a mobile phone with a computer.^^ The often used as a cover from eventual acquisition*" alliance was intended to draw together the com- or divestiture.^2 Even if hidden agendas are not plementary resources of HP, the second largest present, an alliance may serve vastly different pur- computer company in the US, and Nokia, the lead- poses for the individual partners. One firm may ing European mobile phone producer. seek market penetration, another reputation. A supplementary fit is created when similar re- Knowing each other's real objectives in an alliance sources are brought into the alliance by both part- is not an easy task. However, not knowing is dan- ners to achieve competitive advantage, such as for gerous, and often leaves a firm in a vulnerable achieving economies of scale, economies of scope, position. In the alliance between Northwest and and first mover advantage. The oil and gas indus- KLM, Northwest did not fully realize KLM's inten- try increasingly relies on supplementary alliances tion to gain substantial control over its partner. As in an effort to control costs. British Petroleum and a result, an equity alliance evolved into a corpo- Mobil, for example, combined their European rate governance battle.^^ downstream operations in order to save costs and Partners need not necessarily worry about hav- gain from economies of scale.^^ Texaco and Shell ing different objectives. The key is whether these Oil, on the other hand, combined their U.S. refining objectives are compatible, that is, whether they and marketing operations into a joint venture.''^ can be achieved simultaneously. When different 58 Academy of Management Executive November objectives are not in line, there will be no compat- ness, whereby members in an ongoing relation- ibility. General Motors and South Korea's Daewoo ship are linked with each other in some tangible formed an alliance, although GM was interested way. Partner firms are in the same boat and the mainly in staying with existing models and keep- relationship cannot be terminated easily. Strategic ing costs down, and Daewoo was more interested alliances have often been seen as being too in upgrading technology and designing new mod- loosely coupled, so that they lacked a strong au- els.'*" The alliance failed eventually, partly be- thority structure and significant commitment. cause of this mismatch between a cost orientation Structural rigidity helps consolidate the relation- and an R&D orientation. Since partners' objectives ship and force partners to focus on the success of often shift with the passage of time, it is impor- the alliance rather than on preparing for an exit at tant—and difficult—to anticipate future conflicts. any time. Because highly interconnected partners For example, firms can employ scenario analyses share more common interests, possible opportunis- to help assess how the alliance and the partner tic behavior will be contained. firms may evolve over time and how the evolution may change the relative positions of each partner. When KLM first invested $200 million in Northwest, The risk in maintaining a high level of its objective was a transatlantic alliance. Eventu- flexibility, however, is that flexibility is ally, KLM became interested in acquiring North- west as a way to get into the U.S. market. not always an advantage. Clearly, given the inherent conflict between flexi- bility and rigidity, firms should not be single- Risks in Maintaining Flexibility: Structuring the minded in their pursuit of flexibility. A balance is Alliance required between the two desirable but opposing In the second stage of alliance management, part- conditions.'*^ Because some alliance structures, ner firms negotiate the structure of the alliance.^^ such as funded R&D and licensing, are, by design, As we noted earlier, alliances can have various more flexible than others, such as joint ventures structures, ranging from joint ventures and minor- and equity swaps, firms may wish to bring in some ity equity alliances to joint production, joint mar- complementary elements. For example, in a flexi- keting, funded R&D, and licensing, each arrange- ble comarketing agreement, one firm may choose ment serving different needs. According to Yoshino to acquire the other's equity to strengthen the and Rangan,''^ managers with alliance experience bond. In an equity joint venture, firms can have stress the importance of having the most appropri- clauses that allow partners to renegotiate the deal ate type of alliance structure. at a future date. When Siemens and AUis-Chalm- As compared with single organizations, strate- ers initially hammered out their joint venture gic alliances denote a more flexible arrangement. agreement, they decided that they could renegoti- Indeed, flexibility is one of the key advantages of ate the deal and that Siemens would have the right alliances. Partner firms can afford to be involved to purchase the venture.""^ The two partners even- in alliances in various degrees. Because they tually did go through the renegotiating and Sie- share only a part of the total investment in an mens exercised its option. alliance, terminating a project is also easier. While mergers and acquisitions provide permanent ac- cess to other firms' resources, alliances enable Risks in Managing Collaboration: Operating the partners to gain access to those resources tempo- Alliance rarily—and with much more flexibility. In a highly After an alliance is structured and set up, partner competitive and volatile environment, the advan- firms work together to operate the alliance. The tage of being flexible is quite important for alli- risk becomes managing the collaboration, and ance formation and success. having either insufficient cooperation or too The risk in maintaining a high level of flexibil- much. Sufficient cooperation is the foundation ity, however, is that flexibility is not always an for a successful alliance as it is necessary ior advantage. Our earlier discussion on alliance re- partner firms to work for the realization of col- source management showed that flexibility is par- laborative advantage. Cooperation means that ticularly needed under certain circumstances. firms pursue common interests in the alliances, Structural rigidity—the opposite of flexibility—is so that they restrain their self-interested activi- often necessary as well. Structural rigidity in- ties that may harm their partners. In the absence volves a high degree of connectedness and tight- of sufficient cooperation, firms will tend to ex- 1999 Das and Teng 59 ploit the alliance and their partners for their In evaluating alliance performance, the risk is private interests. that a partner may rely completely on either a By contrast, overemphasizing cooperation or ig- short-term orientation or a long-term orientation. noring the importance of competition in alliances With a short-term orientation, partner firms view is also fraught with danger. In fact, a certain level alliances as transitional in nature and capable of of competition is essential in alliances because delivering only quick and tangible results. Part- private interests are inevitable. Competition im- ners demand quick results in the short run and plies that firms realize that their interests are not tend to be less patient with long-term investment entirely similar or compatible, so they attempt to and commitment. Consequently, alliance perfor- protect their own interests, even if it means under- mance evaluation will rely heavily on financial mining their partners. The difference between and market-based indicators. A short-term orienta- competition and opportunistic behavior, however, tion may well be valuable for an alliance, as alli- is that competition is open and legitimate whereas ances are often under pressure to deliver results in opportunistic behavior is self-interested with a rapid fashion. By the very nature of alliances as guile. Competition in alliances takes such forms joint entities, the partner firms probably cannot be as learning from partners, protecting one's own as patient as they are regarding their own sepa- tacit knowledge and personnel, and preventing the rate operation and performance. Tangible results alliance from becoming a direct competitor in are important to keep an alliance going. If short- one's core business. Competition is the universal term performance is ignored, the alliance may lose rule of the marketplace. Since strategic alliances its focus and fail to enlist sustained support of the are a combination of market transactions and in- partners. ternal operations, competition will still have an important role in alliances. Goodyear, for instance, has a joint production alliance with Japan's Sumi- Both cooperation and competition must tomo.''^ Although the two manufacture tires for be preserved in an alliance as dynamic each other in Asia and North America, they remain and permanent conditions. A sense of competitors in many markets. Alliances do not pro- vide a safe haven for colluding with competitors, competition should be interwoven with as competitors remain competitors even when they the spirit of cooperation. i have alliances. Oracle uses a concept known as co-opetition to manage its alliances—which On the other hand, a long-term orientation has its means that competition and cooperation are han- own value in alliances. When partners adopt a dled simultaneously. Whereas 30 percent of its al- long-term orientation, they view the alliance as at liances are with competitors, Oracle makes sure least semipermanent—an entity that will grow and that it does not lose any competitive advantage.^° adapt to the changing environment in the future. Thus, the risk in operating an alliance is that part- As a result, more patience, investment, and com- ners often overemphasize either cooperation or com- mitment are likely to be generated. In evaluating petition. The challenge is to have both of them alliance performance, partner firms will look more present in an alliance. Without adequate coopera- at the overall state of the alliance—that is, coop- tion, alliances cannot be operated smoothly. Without eration and morale—rather than only the financial sufficient attention to competition, alliances will un- and market aspects of the alliance. Such a long- wittingly lose their competitive advantage and equi- term orientation is particularly helpful when there table rights and rewards. Both cooperation and com- is a high degree of uncertainty—for example, tech- petition must be preserved in an alliance as dynamic nological uncertainty—in the market. With a fairly and permanent conditions.^' A sense of competition long-term orientation, partners are better able to should be interwoven with the spirit of cooperation. overcome the initial problems in an alliance. Of- ten, however, alliance partners have the problem of expecting results much too soon. They dissolve Bisks in Planning for the Future: Evaluating alliances too quickly, before tangible results could Alliance Performance reasonably be expected to be achieved. In fact, The evaluation of alliance performance is a con- alliances are time-consuming projects because troversial subject, mainly because there is no gen- partner firms have to learn to work together erally accepted measure of alliance performance. smoothly and efficiently. Unfortunately, that takes The most practical approach is to separately ex- more time than most firms like. But partner firms amine the extent to which the alliance has served should be prepared for this extended process and the objectives of each partner. adjust their expectations accordingly. The experi- 60 Academy oi Management Executive November ence of Advanced Elastomer Systems, a joint ven- Emphasize protection oi your own primary re- ture between Monsanto and Exxon, is revealing in source. Remember that: this regard.^2 From the very beginning, the venture Risks are relatively low in protecting phys- was expected to be a quick success because it had ical and financial resources, including pat- outstanding technology and a rapidly emerging ents, contracts, logos, and trademarks {own- market. It took some time for managers to realize ership protected by law). that something was wrong—namely, the corporate Risks are high in protecting technological, culture. Because managers came from two suc- managerial, and organizational resources. cessful firms with very rigid and systematic deci- Be careful about unintended transfer of sion-making styles, they were uncomfortable with knowledge and imitation; you have little le- a more adventurous style needed in an emerging gal protection here. market. The managers, therefore, decided to de- sign and create an effective organizational culture Exercise control through contracts, equity, and and leader/manager profiles. These efforts eventu- management. Employ, as appropriate: ally paid off and the venture grew successfully, a Contractual control (specify usage of prop- lesson that there are many factors working against erties}. a quick success. Equity control (majority or shared owner- Given the importance of both short-term and ship). long-term orientation in alliances, the two need to Managerial control (have one's own staff in be integrated somehow. To reduce the risk in plan- key positions, regular meetings, frequent in- ning for the future—that is, the risk of relying on teractions and communications). only one time orientation—partner firms should settle on reasonable, concrete objectives for each Retain flexibility through short-term recurrent stage of the alliance management process. Ini- contracts, limiting commitment, and effective tially, financial and market measures should not exit provisions. You need the ability to adapt, to be emphasized. An incremental approach, which be free from rigid contracts, and to be able to allows both timely feedback and long-term adap- recover invested resources. Hence: tation, should work well with alliances. Have contracts specifying an incremental pro- cess of alliance making. Guidelines ior Managing Risks Avoid joint ventures and minority equity alli- ances in favor of less engaging forms such as Strategic alliances stand out as a high-risk strat- licensing, shared distribution, and product egy because a partner firm has less control over bundling. the alliance than it has over its own subsidiaries. Insist on specific costing and pricing formulas The two major types of risk in alliances—rela- and clear property rights, as alliance activi- tional risk and performance risk—represent two ties tend to blur ownership contours. major sources of unsatisfactory performance, one internal to the relationship and the other external Safeguard continued security by limiting expo- to the relationship. Alliance resource management sure to know-how: must explicitly take the unique alliance risks into Maintain the knowledge barrier by forming account. Partners should pay simultaneous atten- alliances in which partners work separately, tion to their resource procurement and resource such as in funded R&D and outsourcing protection strategies. agreements—^ unless you are willing to work Risks that are important at each stage of the closely with partners, as in joint ventures. alliance management process have also to be Make clear to partners and your own staff that managed. These risks relate essentially to balanc- unauthorized learning will need to be pre- ing the competing demands in each stage, such as vented. the demand for flexibility and the demand for ri- gidity. The risk is in ignoring any one of the oppos- Ensure increased productivity by emphasizing ing demands. superior alliance performance: The difficult task of managing risks in strategic Focus on knowledge productivity, particu- alliances can be carried out only if managers first larly by seeking compatibility of organiza- understand the complex nature of these risks. tional routines and culture of partners. Managers would do well to employ the following Identify and eliminate internal stickiness guidelines to effectively manage the various risks and learning barriers that prevent integra- in strategic alliances. tion with partner's superior knowledge. 1999 Das and Teng 61 Endnotes control: Developing confidence in partner cooperation in alii* ances. Academy of Managemenf Review, 23: 491-512. ' Harbison, I. R., & Pekcr, P., Ir. 1998. Smart alliances: A ^^Bruton. G., & Samiee, S. 1998. Anatomy of a failed high practical guide to repeatable success. San Francisco: Jossey- technology strategic alliance. Organizafionai Dynamics, 27(1): Bass. 51-63. ^Pekar, P., Jr., & Allio, R. 1994. Making alliances w o r k - " Yoshino, M. Y., & Rangan, U. S. 1995. Strategic afiiances: An Guidelines for success. Long flange Planning, 27(4): 54-65. enfrepreneuriaJ approach to glohalization. Boston; Harvard 'Economist. 1995. Airline alliances: Flying in formation. July Business School Press. 22: 59-60. ^* Sherman, S. 1992. Are strategic alliances working? Forfune, * TuUy, S. 1996. Northwest and KLM: The alliance from hell. Sep. 21, 126(6): 77-78. Fortune, June 24. 133(12): 64-68, 70, 72. " Rule, E., Ross. N., & Donougher, M. 1999. Beating the odds: ^ Carey, S. 1996. Northwest in buy back preferred from KLM. Making a strategic alliance succeed. Pharmaceutical Execu- Wai! Street Journal. July 1: A3, A7; Tully, op. cit. tive. 19(1): 78-83. ^ Beamish, P. W. 1985. The characteristics of joint ventures in ^^ Bruton & Samiee, op. cit., p. 56. developed and developing countries. Columbia journal oi ^'Hamel, G. 1991. Competition for competence and inter- World Business. 20(3): 13-19; Harrigan, K. R. 1988. Strategic alli- partner learning within international strategic alliances. Stra- ances and partner asymmetries. In F. J. Contractor 8c P. Lorange tegic Management jouinal. 12 (Summer Special Issue): 83-103. (Eds.), Cooperative sfra(egies in in(erna()onai business; 205-226. 2^ Hamel, G., Doz, Y. L., & Prahalad, C. K. 1989. Collaborate Lexington, MA: Lexington Books; Park, S. H., & Russo, M. V. 1996. with your competitors—and win. Harvard Business Review, When competition eclipses cooperation: An event history anal- 67(1): 133-139. ysis oi joint venture failure. Management Science, 42: 875-890. 2^ Reich, R. B., & Mankin, E. D. 1986. Joint ventures with Japan 'Bleeke, J., & Ernst, D. 1991. The way to win in cross-border give away our future. Harvard Business Review. 64(2): 78-86; alliances. Harvard Business Review, 69(6): 127-135; Gomes- Hamel, Doz, 8f Prahalad, op. cit. Casseres, B. 1987. Joint venture instability: Is it a problem? ^ Beamish, P. W., & Jnkpen, A. C. 1995. Keeping international Columbia journal oi World Business, 22(2): 97-102; Kent, D. H. joint ventures stable and profitable. Long Range Planning, 28(3): 1991. Joint ventures vs. non-joint ventures: An empirical inves- 26-36. tigation. Sfrafegjc Management journal. 12: 387-393. ^' Gates. S. 1993. Strategic alliances: Guidelines ior success- ^Das, T. K., & Teng, B. 1999a. Instabilities of strategic alli- ful management. New York: Conference Board. ances: An internal tensions perspective. Organizofion Science, ^^ Economist. 1996. Fatal attraction. March 23: 73-74. forthcoming. ^^ See Das, T. K., & Teng, B. 1997. Sustaining strategic alli- ^Miller, K. D., 8f Leiblein, M. J. 1996. Corporate risk-return ances: Options and guidelines. Journal d Genera! Manage- relations: Returns variability versus downside risk. Academy oi ment. 22(4): 49-64; Brouthers, K. D,, Brouthers, L E., & Harris, Management journal. 39: 91-122. P. C. 1997. The five stages of the co-operative venture strategy '"We follow the exposition in Das, T. K., & Teng, B. 1996a. process. 7ournai o/ GeneraJ Management, 23(1): 39-52. Risk types and inter-firm alliance structures, journal oi Man- agement Studies. 33: 827-843; Dos, T. K., & Teng, B. 1998a. Re- ^^ Geringer, J. M. 1988. joint venture partner selection: Strat- source and risk management in the strategic alliance making egies ior developed countries. New York: Quorum; Beamish, process, journal oi Management. 24: 21-42. P. W. 1987. Joint ventures in LDCs: Partner selection and perfor- mance. Management International Review. 27: 23-37; Brouthers, "Stafford, E. 1994. Using co-operative strategies to make K. D., Brouthers, L. E., 8E Wilkinson, T. J. 1995. Strategic alliances: alliances work. Long flange Planning, 27(3): 64-74. Choose your partners. Long flange Planning, 28(3): 18-25. '^ Bryan, J. 1997. Success in strategic alliances: Begin small. The Gazette (Montreal), January 25: E3. Retrieved irom http:// ^^ Bleeke, J., & Ernst, D. 1995. Is your strategic alliance really web.lexis-nexis.com/universe/docum...). a sale? Harvard Business Review, 73(1): 97-105. '^Financial Times (London), 1998. Strategies for global sourc- ^Kanter, R. M. 1994. Collaborative advantage: The art of ing. February 20: Surveys M, 5. Retrieved from (http://web.lexis- alliances. Harvard Business Review. 72(4): 96-108; Das & Teng, nexis.com/universe/docum...). 1998b, op. cit. '^ Das & Teng, 1998a, op. cit. ^'Helfatp C. E. 1997. Know-how and asset complementarity '^ Segil, L. 1998. Strategic alliances for the 21" century. Strat- and dynamic capability accumulation: The case of R&D. Stra- egy & Leadership. 26{4): 12-16. tegic Management journal. 18. 339-360; Das & Teng, 1999b, '^Barney, J. 1991. Firm resources and sustained competitive op. cit. advantage, journal oi Management. 17: 99-120; Das, T. K., 8i ^New Yort Times. 1995. Hewlett venture with Nokia, October Teng, B. 1999b. A resource-based theory of strategic alliances. 5:D6. journal oi Management, iorthcoming. ^^ Crump, J. G. 1997. Strategic alliances fit pattern of industry "Miller, D., & Shamsie, ). 1996. The resource-based view of innovation. OiJ & Gas journal, March 31: 59. Retrieved from the firm in two environments: The Hollywood film studios from {http://web.lexis-nexis.com/universe/docum...). 1936 to 1965. Academy oi Management Journal. 39: 519-543. ^° Sullivan, A. 1997. Shell Oil, Texaco agree to join units. Wai! '^ Lewis, J. D. 1990. Partnership ior proiit: Structuring and Street Journal. March 19: A3, A8. managing strategic alliances. New York: Free Press. " Bleeke & Ernst, 1995, op. cit. '^Lavin, D. 1996. Coke in venture with France's Danone to *^ Nanda, A., & Williamson, P. J. 1995. Use joint ventures to distribute orange juice overseas. Wall Street Journal, Septem- ease the pain of restructuring. Harvard Business fleview, 73(6): ber 25: B8. 119-128. ^"Cauley, L. 1996. Time Warner, US West go to court this ^^ Tully, op. cit. week in bitter partnership feud. Wall Street Journal. March 12: B7. "Walters, B. A., Peters, S., & Dess, G. G. 1994. Strategic ^' For a discussion of the role of confidence in partner coop- alliances and joint ventures: Making them work. Business Hori- eration, see Das, T. K., & Teng, B. 1998b. Between trust and zons, 37(4): S-10. 62 Academy oi Management Executive November ^^Das, T. K., & Teng, B. 1996b. Strategic alliance structuring: ^ Narisetti, R., & Stern, G. 1997. Goodyear allies with a Jap- A risk perception model. Paper presented at the annual meeting anese tire maker. Wai! Street journal. February 5: A3, A4, of the Academy of Management, Cincinnati, OH. ^° Segil, op. cit. ^^ Yoshino & Rangan, op. cit. ^' Das & Teng, 1999a, op. cit. *' Das & Teng, 1999a, op. cit. *^ Finnie, W. C. 1998. Strategic partnering: Three case studies. ^Bleeke & Ernst, 1995, op. cit. Strategy & Leadership, 26(4): 18-22. T. K. Das is a professor of strategic management and Bing-Sheng Teng is an assis- coordinator o{ the Strategic tant professor of strategic man- Management and Business agement and public policy at & Society Area at the Zick- George Washington University. lin School of Business, Ba- He received his Ph.D. in strate- ruch College, City Univer- gic management from the City sity of New York. He was a University of New York. His re- senior business executive search interests are in strategic before entering academic alliances, cooperative and com- life and has over 100 publi- petitive strategies, risk issues cations. He holds degrees in management, and strategic in physics, mathematics. decision making. Contact.- (eng@ and management. Confacf: gwu.edu. TK^Das@ baruch. cuny.edu.