Strategic Alliances

Purposes: New Products, Markets, Efficiencies

A wide variety of businesses form strategic alliances with other businesses and organizations.  The most common reasons for entering alliances are to enter new markets, to develop new products requiring combinations of technologies beyond the business’s expertise, to gain marketing and competitive advantages, to bolster weak capacity in certain fields and to develop economies of scale.

Alliances provide businesses with competitive advantages in dynamic markets and industries undergoing rapid technological change and expanding markets.  Alliances may improve vertical integration in the production and distribution chain.

To a certain extent, traditional research departments in companies may hinder innovation and development of new technology because of their concentration on their past knowledge and proprietary property rights.  On the other hand, alliances may be freer to develop new product concepts through cross-sharing of information, assisting in resolving the partner’s problems, and cross-fertilizing each other's fresh concepts.

Alliance partners may develop radically new products.  When a new advancement is conceived by the alliance, the alliance partners may refine it into a marketable product.   In industries which experience modest technological change, alliances may have other values.  For example, international and domestic strategic alliances and alliance networks provide benefits such as expanding the scope of products, capabilities, and resources, promoting geographical expansion and access to emerging technology and increasing competitive advantage by offering broader product lines.

A diversity of structures are available.  An alliance may be formed through a direct relationship between the partners or a separate joint venture company.

Certain structural elements must be addressed.  An alliance agreement should clearly establish ownership and management rights.  Rights to new technology and new products should be agreed upon.  An alliance should define guidelines for managing the flow of information to its partners.

The probability of success of an alliance will be increased if the objectives of the alliance are well conceived and reviewed continually.  An alliance must be structured carefully to achieve business objectives which may change over time.

If alliance partners have divergent objectives, each partner should understand the other’s objectives.  Certain basic issues need to be addressed in every alliance.  Strategic issues include assigning markets and operations between the partners.  Financial criteria encompass profit, expense and investment considerations.

Most often, alliances are carefully structured through formal agreements.  Some businesses have entered informal, or loosely structured strategic alliances which lack clear alliance agreements and objectives. 

Alliances tend to decline when disputes occur over ownership, control, and precise allocations of resource shares.  If command and control structures are not well-defined, the partners may derive little or no benefit from loosely structured collaborative efforts.

Businesses encounter significant costs and hazards in informal and unstructured strategic alliances.  There may be no real control or direction over the activities of a loose alliance.  In addition, there is the risk of disclosing information and trade secrets to actual or potential competitors.

Strategic Issues
Research has shown that the essential features of successful strategic alliances are mutual trust and understanding.  Creation of long-term relationships are often the most productive arrangements. 

There should be a clear and consistent focus for an alliance consistent with the corporate objectives to develop products to meet market needs.  However, the partners should recognize that the focus of their alliance may shift as the needs of customers evolve and new technologies emerge.

Strategic questions include the following: 
A.       The territory of the alliance;
B.       The manufacturing rights;
C.       The exclusivity of rights;
D.      Control over future product development;
E.     The allocation of rights to specific uses of alliance products.
Decisions regarding the above factors determine the rights of each partner in the products of the alliance.

A.       Territory
A common alliance strategy is to collaborate with partners in foreign markets.  Joint development of similar products by alliance partners reduces risks through sharing costs and pooling resources.  Cooperative interaction results from regional alliances.  Distribution by one partner in its own market of the other partner's products eliminates duplication of selling and distribution infrastructure.

Many American technology companies enter alliances with Japanese and other companies in the Far East to manufacture and distribute products in Japan and the Far East.  These joint ventures provide several benefits to American companies, including gaining rapid access to large Japanese and Asian markets, sharing costs of establishing new manufacturing plants, obtaining new sources of products and obtaining equity investment from overseas companies.

B.       Manufacturing Rights
Each alliance must allocate manufacturing rights.  A small-scale technology company may relinquish broad marketing rights for a product but maintain substantial business by retaining the right to manufacture some or all of the partner's requirements or to supply main components.

Manufacturing rights create substantial benefits.  If the manufacturing partner earns profits on the transfer price of the product, it will generate operating earnings instead of passive royalties.  Typically, operating income is valued more highly by the investment community than a similar level of royalty income.  Moreover, retention of the right to manufacture may allow the manufacturing partner to spread its manufacturing overhead.  If the production process is an major component of the technology, retaining that right permits the manufacturing partner to protect and improve its technology base.  For a growing company which lacks the capacity to ramp up high volume production, an experienced manufacturing partner is critical.

If a manufacturer focuses on developing its manufacturing technologies, rather than product innovation, it will enter alliances with companies which have new products but lack manufacturing capacity.  In these cases, the manufacturer leaves the marketing to the partner and retains the manufacturing rights and royalty rights on the partner’s sales.  The manufacturer may combine production for marketing companies together with production of its own proprietary products, thereby generating substantial economies of scale and having a large portion of its overhead paid for by its partners.

C.       Exclusivity
In many cases, markets will be allocated on an exclusive basis.  However, in certain cases, it may be appropriate for alliances to be co-exclusive or non-exclusive.  Co-exclusivity refers to an arrangement in which the parties agree upon a specified number of partners in a given market for a particular period of time.  This may be effective if the objective is to establish a broad technology standard or to create a large market that would not be managed adequately by one partner alone.     

A company desiring to create an industry standard may utilize a co-exclusive partnering strategy.  Alliances may be entered among two or more manufacturers to produce the new product.  The technology company should reserve the right to produce and distribute its products.  By joining forces with leading producers, the technology company may gain broader credibility in its effort to create a technology standard.  By focusing upon a few partners, the technology company will be able to provide its partners with a degree of exclusivity.

The company may adopt a strategy of licensing its product to a number of manufacturers.  However, releasing control over technology is a difficult and speculative decision so this approach is less common.

D.      Right to Control New Product Development
The considerations involved in allocating product development rights and responsibilities are similar to those in determining manufacturing rights.  Control of the technology and spreading overhead are critical issues.  Other strategic implications may be involved such as the right to control development of a product to allow the company to build a foundation to control communications with government authorities which administer the industry such as the FDA.

When one partner is given the right to pursue independent development, it may be desirable to limit such development if product standardization is required.  In technology licensing, development should be coordinated.  Otherwise, partners may develop incompatible products, thereby weakening the standard.  A joint venture for the development of new products based upon a core technology should require that development of variations of the core product maintain compatibility.
E.       Use of Products
Defining markets by scope of usage may generate market expansion.  An alliance may allocate to one partner the right to exploit a specific use of the technology in that partner’s particular market specialty.  The companies thereby share costs and risks and take advantage of the partner's established distribution channels.

Technology companies adopt this alliance strategy by forming joint ventures with companies for limited uses of their technology.  These companies gain access to new market areas and retain the flexibility to pursue other markets independently.  An alliance may be divided by geographic territory and limited to specific products.  By limiting the territory and product scope, a manufacturer may retain the right to produce and sell products independently or with other partners.

Alliances with clearly defined objectives and limited scope of use may create flexible alliance structures.  A manufacturer may license particular variations of a product to a strong marketing partner.  It may retain the right to use its own sales staff to sell in a defined market sector which is serviceable by a smaller sales force.  Hence, the manufacturer can take advantage of the larger distribution company to market in its broad distribution channels, yet retain the rights to sell directly in specialty markets.

There are risks in creating alliances based upon scope of use.  For new technology, all potential uses may not be fully appreciated.  In these cases, the partners should carefully review possible long term uses of the technology. 
If the strategic purposes of a technology have not been carefully explored and agreed upon, valuable rights may be lost.  In a license alliance, a licensee may discover that a desired use does not fall within the licensed scope of use, in which case the licensee must attempt to negotiate a new license or lose those rights.

Licensing agreements must be carefully crafted to ensure that the permitted scope or field defines applications which are commercially distinct from other products.  The agreement must avoid conflicts in each partners' distribution systems.     In an alliance between a technology company and a diversified manufacturer, the manufacturer may be given the right to include portions of the technology company’s product in the manufacturer’s products.  However, if the manufacturer later enters the same market as the technology company, it may threaten the technology company's core business.  Hence, it may be important for the smaller technology company to have the right to terminate an alliance in the event of a threat to its primary business by its larger partners.

Risks and Tradeoffs
Organizations enter strategic alliances due to market and industry forces in spite of the increased risks.  Companies should weigh the costs of managing complexity and business risks against the benefits.  Research has indicated that in a most cases the benefits outweigh the costs. 
There are tradeoffs between using conventional organizational relationships such as joint ventures or acquisitions and entering alliances.  In alliances, partners lose some control over alliance activities and may encounter risk of transferring sensitive inside information. 

Strategic alliances may involve certain hazards and complexities.  Management must address the need for control of the operation of the alliance.  In alliance networks consisting of several partners, it may be desirable to diffuse control throughout the alliance partners.  Group leadership skills are require for managing alliance networks.

New Management Model
Management of an alliance may require new concepts and a new management model.  A key question is how to manage a strategic alliance network to promote the exchange of new information and change.  An alliance must maintain active communication channels.  New product or production methods, or market changes such as changing tastes or preferences should generate management responses.  Communications channels provide information about new kinds of production processes and new marketing concepts which provides a basis for new corporate opportunities. 

Improving Communication
Alliance partners must communicate extensively with each other.  When a problem requires new information, partners may consult outsiders who are able to provide useful information, thereby extending the alliance network.

If only one of the partners maintains direct customer contact, the other partners may become isolated from customer needs and weaken the focus alliance's focus.  Partners need to continually work to eliminating communication barriers between the partners.

Finding New Partners
Alliances with privately owned firms are often desirable because these firms offer greater flexibility and quicker decision making than public and large corporations.  Companies may be more comfortable developing alliances with organizations with similar cultures and objectives. 

Many businesses expend considerable resources assessing potential partners in alliances.  Such companies have substantial experience in exchanging information and advice and exploring new collaborative efforts as well as engaging in short-term projects.  It is desirable to maintain a wide variety of contacts in order to build a base for future alliance collaborations.

Companies which overlook cultivating new contacts lose opportunities to participate in future alliances and alliance networks.  Many companies maintain strategic data on a variety of domestic and foreign companies in their industries to identify strengths, weaknesses, motives, culture, resources, and strategic objectives of potential partners.  Personal contacts provide obvious sources of future partnerships.

Strategic alliances are formed by businesses in all industries to permit expansion as well as increase efficiencies.   Alliances are effective in the development of new products, new technologies, new capacity to enter new markets or in the maintenance of markets in the face of strong competition.

Each alliance should focus upon the creation of new opportunities through the merging of each partner’s capabilities and resources.  A partner contributes its own specialized knowledge, technology and marketing know-how to the alliance.

An interactive and flexible alliance may become a dynamic organism with its own life and growth if it is properly structured and energized.  Alliances may generate interactive change through infusion of new ideas.

It is essential to form and manage strategic alliances effectively.  Successful alliances are most commonly based upon a carefully conceived and detailed alliance agreement and a thoughtfully structured management system.  A successful alliance needs strong commitment and involvement from the highest management levels of each alliance partner.

In structuring the strategic aspects of an alliance, the partners must understand the basic issues and apply them to meet their own business objectives.  Each partner must have a strategic long-term business plan and organize the alliance to achieve its objectives.