It Takes Two To Tango
For global companies, limitations on foreign ownership make an alliance the only route into some markets. In other markets, alliances provide an appealing way to accelerate entry and reduce risks and costs of going it alone. The US company Aetna Insurance, for example, recently announced a joint venture with Sul America Seguros, Brazils largest insurance company. Aetna is reportedly investing $300 million, with a possible $490 million more to follow, for a 49 per cent stake in the joint venture. The aim of the Brazilian based alliance is to accelerate growth and introduce new products in health, life and personal insurance and pensions. Aetna contributes expertise in products, information technology and servicing, while Sul America brings local knowledge, an extensive distribution network and sales system, and its leading market position.
Companies in emerging markets can find the idea of an alliance equally attractive. For those in a position of strength, it can be a powerful vehicle for growth, or a way to leverage low-cost manufacturing or a unique distribution network. Samsung of Korea has used several hundred technology licensing arrangements and joint ventures as vehicles to build a world-class electronics company (See Exhibit 1). Of almost 100 new businesses set up between 1953 and 1995, a quarter were initiated via joint ventures. For other local companies in emerging markets, alliances may appear the only way short of selling the company outright to survive once the home market has opened to new entrants bringing global brands or technology.
Given this pattern of mutual benefit, it is not surprising that alliances account for at least half of market entries into Latin America, Asia and Eastern Europe (See Exhibit 2). Some are successful. Nintendo and JVC both have alliances with Gradiente, Brazils leading electronic company, to manufacture and/or market products under their own brand names as well as under the Gradiente brand. The alliances have helped Nintendo and JVC build volume rapidly in an important market, while Gradiente has become a profitable company with revenues of over $1 billion and its own skills, market position, and manufacturing capacity.
Yet the popularity of alliances between emerging market and global companies, and their apparent win-win character, can mask their difficulty. They are hard to pull off and often highly unstable much more so from alliances between companies from similar economic and cultural backgrounds. Many have failed to meet expectations or have required extensive restructuring. Indeed, in recent years, numerous high-profile joint ventures in Asia and Latin America have been dissolved, restructured, or bought out by one of the partners.
Why are joint ventures in emerging markets proving so difficult? The answer lies in the fact that multinationals and companies in emerging markets must overcome formidable differences if they are to develop successful alliances.
First, most global companies are considerably larger than their emerging market partners, and possess deeper pockets and, often broader capabilities. This makes it hard to find equal, complementary pairings a balance that is the hallmark of successful and enduring alliances. Our research indicates that among alliances undertaken in India, the global company typically has 30 times the revenue of its local partner. One case makes the implications clear. A multibillion dollar world-wide leader in the consumer non-durables industry and a $70 million Indian company enjoyed a successful joint venture that trebled its market share in four years and became the third largest competitor in its industry. But the global partner then wanted to add capacity and make India a regional supply source for Asia and Africa. The local partners share of the necessary investment, about $17 million, represented almost a quarter of its annual turnover. When it declined to invest, the global partner ended up buying out the venture.
Other differences result from ownership structure, objectives culture and management styles. State-owned enterprises can make frustrating negotiation partners for multinationals because they have no single decision maker; instead, they have to seek approval from arrange of political constituencies. But a multinational can be an equally frustrating partner for a family-owned business if its country manager has to seek approval for decisions from other senior managers, while the patriarch or the matriarch of the family business can make decisions unilaterally. Different types of companies also have different agendas. The family-run business may be more interested in ensuring a steady stream of dividends for shareholders than maximising growth or short-term shareholder value.
These challenges do not mean that emerging market alliances should be avoided. But they do raise the stakes. Before entering these deals, therefore, prospective partners should ask three questions. Is an alliance really necessary, or would an outright acquisition, direct investment, or contractual relationship suffice? How sustainable will an alliance be, given the partners ambitions and strengths? And how should the strategy and tactics they adopt reflect the distinct challenges of alliances between global and emerging market companies?
Is an alliance really necessary?
Given the differences between partners and the complexities of managing a relationship, a reasonable (but rarely asked) question is: Why are we forming an alliance in the first place? If the main benefit of an alliance would be inside knowledge of customers, government, and suppliers, for example, the global company should ask whether it might be possible to hire five or ten key people who would bring those relationships.
In China and India, acquisitions and direct investments by overseas companies have increased, although alliances are still the main vehicle foreign companies use to enter the market. The proposition of wholly foreign-owned enterprises in China rose from less than 10 per cent of incoming investment in 1991 to 25 per cent in 1995. Many global companies have operated as wholly owned entities in Latin America for decades.
Acquisitions can be equally effective for emerging market companies. Many companies have responded to globalisation by looking to joint ventures or broad-based technology licensing arrangements with international partners, particularly when they needed to bridge a technology gap. But Indias Piramal group, for example, has expanded its pharmaceuticals business at a compound annual growth rate of almost 60 per cent since
1988, largely by acquiring other local pharma companies that already have non-equity licensing arrangements with global concerns.
Other emerging market companies are experimenting with virtual alliances piecing together the technology or abilities they seek without forming an alliance. One large Indian textile manufacturer aspired to enter the clothing business, but lacked manufacturing technology and marketing expertise. Rather than form an alliance, it cobbled together what it needed by hiring experienced people, persuading the equipment manufacturers to serve as technical consultants, and licensing certain technologies. Since embarking on the programme four years ago, the company has grown by 150 per cent. Such a strategy would not suit all companies, however; the learning and co-ordination of relationships it involves call for highly developed skills and consume a great deal of management time.
These alternative approaches are especially relevant when technology is readily available and global brands are not needed. Cheap, double-edged razor blades based on common technology continue to take 83 per cent of the Indian market, for example, despite the introduction of high-quality blades by Gillette in 1993.
Will the alliance last?
When an alliance is deemed necessary, both companies should assess at the outset how the partnership will it evolve whether it is a marriage of equals that will endure, or something else. Achieving an equal balance in an emerging market is particularly challenging because of differences in culture, skills, and objectives that we mentioned. Such alliances are also vulnerable to rapid regulatory change. (How alliances evolve).
Two factors influence the sustainable and likely direction of an alliance: each partners aspirations that is, them will to control the venture and relative contributions. Aspirations can tip the balance. Does the global partner desire full control in the long run? (If he does, the alliance is likely to wind up in acquisition or dissolution.) Or does it want a permanent alliance in which the local partner provides specific elements of the business system, as with Caterpillars long-standing relationships with its local distribution and service partners? Is the emerging market players focus on the home market, or does it harbour global ambitions? If it does, and it wants to compete on its own against the multinational, conflict inevitable.
Ultimately, though, the evolution of an alliance will be driven by each partners contributions. Examples of valuable contributions might include privileged assets (ownership of mining rights or oilfield reserves, for example); advantaged relationships such as access to regulators, operating licences, and exclusive distributor relationships, or intangible assets such as such as access to regulators, operating licences, and exclusive distributor relationships; or intangible assets such as brands, marketing, manufacturing, technology, management expertise, and patents.
Usually, the global company contributes tangibles, such as technology, brands, and skills, that grow in importance over time. The local partners contributions, on the other hand, are more likely to be local market knowledge, relationships with regulators, distribution, and possibly manufacturing - assets that may fade in importance as its partner becomes more knowledgeable about the market, or as deregulation undermines (sometimes overnight) the value of privileged relationships or licences.
Manufacturing cost leadership can also be fleeting in a globalising economy. If the local partner essentially provides an escort service, it will almost certainly become less important. A survey of Chinese joint ventures indicated that Chinese partners systematically deliver less value than expected in terms of sales, distribution and local relationships.
To assess whether an alliance will be a marriage for life and how it will evolve, partners in emerging markets should catalogue the current contributions of each partner, plot how they are likely to shift (See Exhibit 3), and negotiate to insure that the venture will be successful or to protect shareholders against likely shift in power.
Four paths
Emerging market alliances tend to evolve along one of four paths (See Exhibit 4). The first is that trod by successful long-term alliances, such as Samsung - Corning, established in 1973 as a 50:50 joint venture to make CRT (cathode ray tube) glass for the Korean electronics market. Samsung needed a technology partner to pursue its strategy of integrating vertically into electronics, components and materials; Corning wanted to expand in Asia. The joint venture had about 20 per cent of the global market, revenue of $695 million, and net income of $49 million in 1996, with investments in Malaysia, India, China and eastern Germany. Heineken and Anheuser-Busch also have a number of successful alliances with brewers in emerging markets, in which the local partner continues to produce and sell its local brand for the mass market, while producing, or importing and selling the global partners brew as a premium brand.
The second path involves a power shift toward the global partner, often followed by a buy-out. Take the case of two consumer goods companies that formed an alliance to target the Indian toiletries market. At the outset, their contributions were balanced. The global company brought international marketing experience, world class management systems, and additional volume to fill local manufacturing capacities. The local company brought the technology to make soap from vegetable fat (the use of animal tallow is banned in India), low cost manufacturing, local market knowledge and established products and brands. The global company wanted access to an enormous and potentially lucrative market; the Indian company aimed to increase its capacity utilisation and enhance management and marketing skills and systems.
Gradually, however, the balance of power shifted. The global partner succeeded in getting an organisation up and running, and gained local acceptance for its product, whereas the India company was prevented from filling its capacity by slower than expected sales. Moreover, the expected transfer and skills to the Indian partner never materialised, while its own brands which had been transferred to the joint venture, suffered. The alliance was dissolved by mutual consent in 1996.
The way an alliance has been structured and managed can determine its outcome. In one 50:50 joint venture, an emerging market company brought important relationships, brands and distribution skills that might have led to a sustainable alliance had the venture been structured differently. But the global partner enhanced its own bargaining position by placing its people in key positions in marketing, manufacturing and finance; introduced its own products and brands; built the manufacturing plant; and imposed its systems and culture in day to day operations. The venture reportedly lost money for several years until it was bought out by the global partner, whereupon performance improved. Notwithstanding this outcome, the emerging market partner may have rated the exercise a success, since it sold its 50 per cent stake at a premium.
The third path sees a shift toward the emerging market partner. Local partners sometimes do build their bargaining muscle, increase their ownership stake, buy out their global partners or exit the alliance to form other partnerships. Sindo - Ricoh illustrates how a powershift toward the local partner can lead to restructuring and continued success of an alliance. Sindo has been Ricohs exclusive distributor in Korea since 1962. It built low cost manufacturing capability, expanded the relationship to a 50:50 joint venture, then took majority ownership with a 75 per cent stake. In 1996, it boasted sales of $309 million in net income of $38 million.
The fourth path is competition between partners, followed by disillusion or acquisition of the venture by one of them. A 50:50 joint venture between GM and Daewoo to manufacture cars in Korea lost money until Daewoo acquired it outright. The partners had incompatible strategies: GM wanted a low cost source for a limited range of small cars; Daewoo aspired to become a broad line global auto manufacturer. Conflict and collision often resulted when partners fail to agree on whether the joint venture or the parent companies will compete in related product areas or in other countries.
Finally, although alliances are often likened to marriages, a successful alliance does not have to last. Success is measured by duration, but whether objectives have been met. Take the joint venture between GE and Apar to make light bulbs for the Indian market. The arrangement was dissolved after only three years, yet GE emerged from it a leader in the Indian lighting industry, and Apar was handsomely remunerated.
Recognising what path an alliance is following and how its balance of power is shifting is critical to ensuring that both partners have the opportunity to satisfy their objectives. Our research in Asia and Latin America and a growing body of experience identifies some practical steps that companies can talk to address the challenges of emerging market alliances. n
(To be concluded)
Ashwin Adarkar is a consultant, and Asif Adil and Paresh Vaish are principals in McKinseys Mumbai office; David Ernst is a principal in the Washington DC office.
(Reprinted with permission from the McKinsey Quarterly, Number 4, 1997)