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STRATEGIC ALLIANCES WHY GO IT ALONE?

By: George W. Keeley

A strategic alliance is a cooperative arrangement between two or more companies where:

• a common business strategy and goals are established by all parties,

• each party shares specific strengths with the other, lending power to the venture, and

• resources, capital and risks are pooled for mutual (rather than individual) gain.

Most strategic alliances are created through the careful negotiation of a contractual arrangement. The contract produces a partial integration of the assets and resources of each party for a specific purpose - - to pursue a mutually beneficial business goal. By sharing resources, spreading costs and risks, a company can efficiently develop new products and new market opportunities with a strategic partner.

OVERVIEW

The number of strategic alliances in the U.S. is surging. More than 20,000 new alliances were formed between 1987 and 1992, compared with 5100 between 1980 and 1987 and 750 during the 1970s. Nearly 6 percent of the revenue generated from the top 1000 U.S. firms now comes from alliances, a fourfold increase since 1987. Japanese firms are far more experienced and comfortable, with alliances than U.S. firms. A recent survey revealed that 74 percent of Japanese CEOs think alliances are effective, while only 4 percent think they are dangerous; in the U.S. the respective numbers are 17 percent and 31 percent.

Alliances generally achieve a higher return on investment (17%) than U.S. industry in general (11%). The higher return is a direct result of leveraging partners' resources and assets, requiring lower investment to produce greater incremental returns. Alliances also showed a greater success rate (60%) than outright acquisitions (50% success) or venture capital arrangements (25% success).

Basic types of strategic alliances include:

• Licensing technology or intellectual property

• Joint research and product development

• Cross-purchase agreements

• Manufacturing arrangements

• Sales/marketing arrangements.

FORMING AN ALLIANCE - KEY ISSUES
Protecting Confidential Information

One of the first matters to be settled by the parties to a possible strategic alliance is a formal agreement designed to preserve the confidentiality and ownership of sensitive technical and business information and to restrict the disclosure of information to outside parties.

In pursuing an alliance, the parties will invariably exchange a variety of proprietary information about their current and proposed business activities. Once the alliance is established, additional information and data will be exchanged by the parties or transferred to a joint venture entity owned by the parties.

A mutual nondisclosure agreement is essential to protect the interest of all parties. The agreement should define what constitutes "confidential information" and clearly state the recipient's obligations with respect to the disclosed information.

Due Diligence Investigation

Completion of preliminary negotiations will generally lead each party to conduct an investigation of the other party's capabilities to perform their duties under the alliance. By doing a "due diligence" investigation, a party determines basically whether a proposed company is a suitable partner. The scope and depth of the investigation depends on the nature of the contemplated joint activity.

Antitrust Issues

Each alliance requires an analysis of its potential effects on competition in the markets where the alliance will operate. Ancillary restrictions on competition between alliance participants may raise significant antitrust concerns. Joint price setting, limits on competition with the alliance, assignment of primary responsibility for markets or customers, exclusive arrangements and restrictions on output are the types of issues which must receive a careful legal review.

Contributions

What will each company bring to the party? Capital contributions of cash, intellectual property (patents, trademarks, copyrights), technology transfers or licenses, distribution network, market access, personnel and other transfers of resources are key components of the alliance agreement.

Control

Whether the alliance is conducted by a joint venture entity (controlled by a designated joint venture management team) or through an alliance agreement, specific control methods need to be negotiated. There are four basic approaches:

• One party has the right to make the decision.

• One party has the right to make the decision, but only after consulting with the other parties.

• One party has the right to make the decision, but only with the approval of the other parties which shall not be unreasonably withheld.

• The decision can be made only with the approval of all (or some majority) of the parties.

The third option is most likely unworkable. Studies indicate that he last option actually is most likely to produce a thorough, well-reasoned result - - although achieving such a consensus will take more time and effort.

Dispute Resolution

Disputes will arise as the alliance pursues its goals. What markets to enter, what products to develop, what distribution channels should be used, who should be hired, and the like are all issues that the alliance will face. The alliance agreement needs to provide a mechanism to resolve these matters internally (there's no time for a court or arbitrator to reach a solution).

Risk/Reward Sharing

The sharing of risks and rewards is central to a strategic alliance. This issue is generally the most fiercely negotiated item in any alliance agreement. Profit sharing in proportion to each party's ownership interest in the alliance is often used. This does align the interests of all parties because each seeks to maximize profit. Losses can be shared in the same manner or limited to the extent of capital contribution. Great care must be taken in defining how net profits will be calculated.

Royalty arrangements also may be used. Here, one party pays the other an amount based on alliance sales (units or dollars). Usually the party paying the royalty also has final authority over costs incurred.

Transfer pricing is common where one party makes a product and another party markets it. The transfer price is the price the manufacturing party sells it to the marketing party. Percentage of resale price, cost plus and fixed price methods are all common methods used to determine transfer pricing.

Exit Triggers

A party often desires to have the right to exit from an alliance if business circumstances change or other events occur. The alliance agreement should clearly state what events or circumstances "trigger" the right of a party (or all parties) to exit the alliance. Some common exit triggers include:

• Term of alliance expires

• Alliance fails to meet objectives

• Substantial default by a party

• Unresolvable dispute between the parties

• Change in control/ownership of a party

• Adverse government action (tax laws, antitrust, etc.)

• Alliance achieves its goal

CONCLUSION

In negotiating strategic alliance agreements, the issues of confidentiality of information, contributions, control, allocation of risks and rewards, and exist strategies generally require substantial negotiation. If the parties approach that negotiation creatively and work cooperatively to consider a variety of options, provisions can be negotiated that provide acceptable protection to all parties and support a common strategy.