Value Creation through Strategic Alliances - Literature review Example

Value Creation through Strategic Alliances Name Tutor Unit Code Date Introduction The structure of companies has evolved over time from tightly controlled structures into loosely-knit organisations. Present day companies have grown to become stretched-out entities composed of not only the employees but also other parties including the customers, suppliers, and partners. Serrat (2010) states that companies have come face to face with the ever demanding present day business difficulties, such as, increased worldwide competition, meeting changing customer expectations, reducing the product life cycle, getting by higher specialization or adjusting to the internet and communication technologies. As a result, it has come to be really tough for companies to compete effectively across the full product cycle. The methods and strategies for doing business that companies had come to be accustomed to have turned out to be virtually archaic. Therefore, the top management has been compelled to hunt for contemporary ways of doing business so as to survive in today’s business environment. The executives have had to rethink their strategies and adapt superior methods that are more responsive to the ever changing business environment. One of the most preeminent strategies that corporates have adapted to in order to fit in and enhance the firm value is strategic alliances. More than ever, in today’s business climate where cash is the king and credit is constricted, Hill (2007) argues that strategic alliances are an economical, smarter, and more reactive way to pursue strategic prospects and gain competitive advantages. In the past three decades organisations have embraced strategic alliances very much. This has brought about fresh synergies by either complimenting or enhancing each other’s strengths. Firms have used strategic alliances to help overcome some of these challenges and stay on in business while improving their value. Strategic alliances have mainly enhanced the firm’s competitive advantage through the ability to inspire collaborative efforts. Strategic alliances have enabled each firm to gain from the knowledge of the collective team as fast as possible. Without a doubt strategic alliances have come to be a necessary ingredient in today’s business environment. Literally, firms have no choice over strategic alliances when they desire to expand and grow their value. According to Seth and Chi (2005), strategic alliances have come to be the apt options for the partnering firms given that they have the right and not the burden to carry on and prolong their cooperation. There has been a lot of research work on the formation of strategic alliances as well as on the success, failure and challenges of strategic alliances. Little research study attention has been paid on the value that strategic alliances bring to the partnering firms. The aim of this paper is to discuss the value strategic alliances have created for the collaborating firms. In the following part I delve into the definition of strategic alliances. This is then followed by a literature review on the value creation through strategic alliances both theoretical and empirical. What are Strategic Alliances? Initially, strategic alliances were mainly in the form of joint ventures whose principal aim was to exploit the natural resources. However, the collaboration has developed and become wide leading to the spread of the concept in the form of formal inter-organisational associations. The idea has seen wide reception in companies dealing in international business. By and large, strategic alliances have gone through a very high rate of formation in the past three decades. Today, strategic alliances have taken many other forms to combat increased competition and globalisation. Indeed globalisation has pushed the development of international business strategic alliances owing to the accrued benefits including easy market entry and risk reduction amid heightened uncertainty and convolutedness in the current business environment. The concept of strategic alliances has been defined in different ways by different people. This is mainly attributed to the different objectives that the partnering firms aim to realise through enhanced collaboration. Therefore, the term has attracted different definitions from different people: Author and Date Definition Parkhe (1993) Strategic alliances are objectively lasting inter-firm cooperative activities, with networks that employ resources and/or governance structures from independent firms to collaboratively achieve distinct goals attached to the overall mission of each of the partnering firms. Varadarajan and Cunningham (1995) Strategic alliances entail a merger of particular resources and skills by the partnering firms so as to realise joint goals, as well as specific organisational objectives. Elmuti and Kathawala (2001) Strategic alliances are cooperative means through which to spread new technologies swiftly, to enter a new market, to circumvent governmental restrictions expeditiously, and to learn swiftly from the top firms in a given field. Serrat, (2010) Strategic alliance are formed voluntarily and involve recognised agreements among the partnering firms to combine their wherewithal to achieve a joint set of objectives that meets their dire needs even as they operate as independent entities. Hitt et al. (2010) Strategic alliances are a partnership between firms whereby capabilities, resources, and core competences are brought together to pursue mutual interests. Hitt et al. (2010) states that in a strategic alliance the partnering firms, albeit independent, share gains from the partnership and contribute to the administrative control over the performance of assigned tasks. Each firm can as well make continuous influences in particular strategic areas, such as technology. This indicates that strategic alliances create inter-dependence among autonomous business units. The alliances too generate new-fangled benefits to the partnering firms. The benefits can be in form of real assets or intangible assets. It is out of this benefits that the partnering firms find need to make long-term engagements. Strategic alliances can be formed in two ways: horizontally and vertically. Horizontal alliances typically entail a collaboration between two or more firms at the same level of production. On the contrary, while vertical alliances encompass a collaboration between two or more firms in a particular industry but the firms are at different levels of production. Different forms of strategic alliances also exist with a characteristic indication of the varying strategies and methods chosen by the partnering firms to manage the alliance and exert control on the partners. Each form seeks to pull off particular objectives that are formed depending on the nature of the association, its resources, and products and services. However, the kind of a strategic alliance is very much swayed by the local market conditions including the state of the competition. For instance, Isorait (2009) identifies four different kinds of strategic alliances. These include: joint ventures, affiliate marketing, outsourcing, and technology/product licensing. Contractor and Lorange (2002) divide the alliances into five categories; technology transfer and improvement, licensing, franchising, joint research and development, joint ventures and marketing agreements. According to the intent of the alliance, Lee et al. (2013) classify the strategic alliances into technology alliance, resource alliance and marketing alliance. Literature Review The Value of Strategic Alliances Strategic alliances have widely been embraced not only because firms will substitute their products and services but also because every partner in the alliance will realise greater benefits emanating from that cooperation. In this way the partnering firms are able to accrue greater value from the strategic alliance. The value of the strategic alliance can broadly be connected to two main perspectives. First, under the transaction cost perspective and second, under the resource based perspective. Transaction Cost Perspective Under the transaction cost perspective forming strategic alliances can significantly reduce relative costs for partnering firms. This viewpoint takes a comparative approach where organizations weigh the costs of exchanging resources with the environment, against the bureaucratic costs of performing activities in-house. Hitt et al. (2010) states that when external transaction costs are lower than in-house bureaucratic costs, strategic alliance come to be more attractive. It is through dtrategic alliances that partnering firms coalesce and choose different arrangements that are intended to cut on the total production costs and the transaction costs. Besides, minimisation of transaction costs through strategic alliances increases the probability of maintaining competitive advantages. By and large, the transaction cost perspective is founded on the view that the partnering firms in a strategic alliance aim to realise a minimum cost arrangement. However, the strategic alliance would not just react to reduce the costs, it is proactive in view if the fact that there may be a positive end result inform of fresh products and services, different markets, renewed management concepts, innovative organisations, and first-hand technology that would otherwise not materialise. Resource Based Perspective Under the resource based perspective strategic alliances create firm value through the potential synergy for the resources pooling by two alliance partners. Through strategic alliances, the partnering firms aim to be able to use valuable resources that they together have. Nohira and Garcia-Pont (2003) states that a firm entering a strategic alliance has access to strategic competences it desires by linking with its alliance partner with such competences, such as scare resources or competitive skills, or pooling its current resources with the partner owning similar one. Through a resource based perspective firms aim to maximise their individual value. In this way, the partnering firms endeavour to optimally use the resources through which they capture more value than through other resource arrangements. Competitive Advantage This view postulates that the effective and efficient use of the strategic assets of each firm will give the alliance competitive advantage. Porter (1998) emphasizes the utilization of resources and capabilities to create a competitive advantage that in the end results in superior value creation. Partnering firms combine some of their resources and capabilities in strategic alliances in order to create a competitive advantage. The partnering firms seek to gain from the resultant collaborative advantage on a mutual basis. Also Das and Teng (2001) argues that strategic alliances value-creating potential makes them an important source of competitive advantage. The partnering firms that can effectively cope with environmental uncertainty and obscurity, and proactively reposition themselves in the competitive markets. According to Porter (1985), a firm achieves a competitive advantage when it has a strategy through which it creates value and the strategy that is not in use by either an existing or potential player at the same time. If the firms implement their value creating strategies efficiently, they will be able to enhance their performance by facilitating the firm with competitive advantage to beat existing or potential players. To gain competitive advantage, a firm can use a business strategy that deploys its array of resources over that it controls directly and the resources are well to breed a competitive advantage. Porter (1985) also points out that strategic alliances are formed on the basis of five forces: bargaining power of suppliers, bargaining power of buyers, threat of new entrants, threat of substitute products, and rivalry among firms in the same industry. He provided three generic strategies: product differentiation, cost leadership and focus that firms can combine with the five forces so as to beat competition. Moreover, strategic alliances are formed to protect the partnering firms against strategic uncertainty. Knowledge Sharing and Technology Transfer Parise and Henderson (2001) indicates that strategic alliances are planned and conducted to share organizational resources so as to create more advanced competencies that are valuable, inter-transferable, rare and non-substitutable. Among the top resources that the partnering firms seek to share is knowledge and technology. This way strategic alliances create collective value that is more than the value created by each individual firm. According to (Olivia, 2001), in more efficient markets, strategic alliances are a better value-creating strategy given that there is a high symmetry of information flows between firms, suppliers and customers. This leads to valuable knowledge sharing. Jensen and Meckling (1991), proposed the optimal knowledge application theory, which when applied to the formation of a strategic alliance translates into a more cost-effective way than mergers and acquisitions in knowledge sharing. To show the manner in which strategic alliances improve their efficiency through knowledge application Grant and Baden-Fuller (2004) have developed an applicable knowledge accessing theory. On the other hand, Chan et al. (1997) argues that in some circumstances the cost for knowledge transfer may well be very high, particularly when there is mutual development for a new product or innovative technology. This is because such strategic alliances always call for explicit proficiency or involve information that is utterly sensitive. So, these kinds of strategic alliances are anticipated to provide greater value boost for the partnering firms than those who do not encompass the specific knowledge or sensitive vital information. Furthermore, Chen and Chen (2003) put forward a ‘learning effect’ argument as one of the reasons for firms to partner. Some resources shared by inter-firm cooperation can be readily engaged minus extra learning process, such as marketing information or outsourcing distributions. But, some other resources, mainly technology allied ones, still need far-reaching learning before using them. Under technology strategic alliance, some technologies are freely applicable via licensing or outsourcing after reaching the alliance agreement by partnering firms. Still others might be of no use lest partnering firms take extra effort to learn through their own research. Therefore, learning effect is very important for cooperative partners in the strategic alliance. Most firms in the technological space have very well embraced knowledge and expertise sharing through formation of strategic alliances. Typically, different technological companies have come to be through a particular knowledge or technology that they have developed or they are competent in. However, the companies do falls short of the required expertise in other areas. As a result, a vacuum is created. The companies have come to accept that they can acquire or use the lacking expertise through the use of strategic alliances (Soares, 2007). For instance, Toshiba has firmly embraced strategic alliances through the belief that no single company can exceptionally control any technology or business. Strategic alliances for a key part of the company’s corporate strategy. Based on this pedestal, Toshiba has propelled itself up the ladder and is now a top technology company globally. The company has partnered with Apple Computer (multimedia computer products), Microsoft Corporation (hand held computer systems), Siemens and IBM (create semiconductors and in engineering). Lenovo presents another classic example of how strategic alliances in the technological space can enhance growth and expansion thereby creating value for the company. Lenovo had for a long time desired to grow into a leading multinational company. But, even as the company dominated the Chinese market in manufacturing personal computers and laptops, it found it had to enter and penetrate other markets out of China. Amid fierce competition from prominent foreign players (Hewlett Packard and Dell), Lenovo faced an uphill task in growing and expanding its business both locally and in foreign markets. The company felt that it could not generate satisfactory profits under such a squeezed business environment. This pressed the company so hard that the top management finally opted to partner with IBM. Through this partnership, the companies agreed that Lenovo would take over IBM’s personal computers and laptop business with US$1.75 billion. IBM was also facing squeezed margins in this business line in China. In return, IBM was to benefit by being China’s PC maker’s “favoured supplier” of support services as well as customer financing. Out of this partnership. Lenovo realised a four-fold increase in sales revenue with a dollar amount exceeding twelve billion. Other gains include access to a larger international market and manufacturing rights for IBM branded PCs over a period of five years. Cisco has also drawn a lot of attention due to the multifarious strategic alliances it is involved in. The company has not only grown itself but has withstood the test of time by the simple business strategy based on forming partnerships with other companies. The company has formed an intricate partnership with international companies through integration, channel, technology, and industry solutions. The multifaceted program also covers service providers that provide a range of consulting, outsourcing, resale, services, and technology integration to offer customers a comprehensive collaboration strategy. Resource Dependency Firms also find that it is necessary to boost their value through forming strategic alliances based on the sharing of key resources that they do not have individually. This is because the alliances help to stabilise the flow of resources required by a firm and they reduce the uncertainty provoked by the firm. However, even as such alliances are mutually dependent by the partnering firms, there may be some disproportionateness between the partners. In such an instance, one firm could be more hooked on a certain strategic alliance than the other. For example, small start-up companies may be looked for as strategic alliance partners owing to their access to specific technology know-how and steadfast research capabilities. Lee et al. (2013) find evidence that small-size companies have more negotiating power in strategic alliance undertakings than big ones, given that bigger corporations like to find small companies as the cooperative partner for their particular technological proficiency. They also find that private firms align with state-run firms in the Chinese capital market. Private enterprises all the time depend more on the strategic alliance with state-run enterprises due to their governmental background and privileged right for financing from state-run commercial banks. Ease of Entering a Market Today the world is filled with new inventions in computers and technology, telecommunications, engineering and in many other fields. This has simplified the process of international expansion and growth for many businesses. The international markets come along with immense value for the company through enhanced economies of scale and range in marketing as well as distribution through the global value chain. However, the cost element remains such a huge inhibitor to many businesses intending to spread internationally. In this case, a strategic alliances with an existing international firm or local firm in the destination market comes in handy. Through the partnership, a firm may well be able to entre a foreign market without much trouble and at the same time save on costs. Furthermore, (Soares, 2007) indicates that firms may well avoid other challenges asspciated with entering a new market, such as the deep-rooted competition and antagonistic government regulations. These kinds of strategic alliances are also pricy when it comes to a situation where a firm seeks to enter in an industry in which the partner(s) is reputable. This means that the firm will see a high success rate since the products or services will receive wide acceptance. Moreover, the strategic alliance may enhance the brand of the firm therefore enhancing its value through an enhanced brand image. There are also circumstances when big firms seek to expand their product offering. They may find the contribution by smaller firms to be very much invaluable, especially when the smaller firms can penetrate the market quickly. Risk Sharing Risk sharing is also a prominent justification for firms to enter into a strategic alliance. This is particularly important when a firm seeks to enter in a new market, or when the market is characterised by high volatility and uncertainty. The cutthroat competition also makes it very much challenging for a firm to penetrate a new market or sale a new product. But if the firm forms a strategic alliance with another firm, their collaborative effort may enable the firms to mitigate or control the latent business risks. Other Valuable Benefits Apart from the various value adding channels for strategic alliances, there are several other ways through which partnering firms may still be able to enhance their value. Firms also look into the probable financial gains that can be realised from the strategic alliance. Financial indicators are an important tool used to measure the value of a strategic alliance. Measurement of financial outcomes indicates on the performance. That’s why they are used widely by many companies to measure their overall performance. The financial outcome indicators also reflect on the realisation of strategic goals meaning that if the strategic alliance supports the overall strategies of the partnering firms, the financial goals will as well be realised. This forms a key foundation for the strategic alliances that aim to make profit or reduce cost. The profits can only be realised if there was a high prospect at establishment, and there exists a strong bond between the partnering firms. Besides, the partnering firms should refrain from opportunistic actions, conflicts, existence of trust, and commitment by the top management (Shenkar and Reuer, 2006). Strategic alliances can also add value to the partnering firms by improving its organizational flexibility. Such flexibility can help the partnering firms to cope with the changing demand from the market more successfully. Given that shaping a strategic alliances does not craft a new united organizational entity, forming a strategic alliance can radically reduce the agency costs for partnering firms. Under the inter-firm cooperation, there constantly exists an agency cost that the running for the partnering firms are averse to release their resources control, but the strategic alliance can sidestep such costs (Chan et al. 1997). Delimitations According to Karen et al. (2000), the failure rate of strategic alliances is quite high. Karen et al. (2000) indicates that it is hard to assess and measure the performance of strategic alliances. This is because strategic alliances have three main attributes that make it hard to track the performance. First, strategic alliances are largely defined as cooperative arrangements between independent firms that use different reporting processes and systems. Moreover, each firm seeks to achieve its own objectives from the strategic alliance. This makes it very difficult to come to an agreement on a single measure of performance and creates inducements to hide benefits and inflate costs. Also, by their very nature, strategic alliances are very difficult to plan, execute and maintain over time. They are faced with role ambiguity: uncertainty as regards particular roles may limit organizations from achieving their responsibilities to the alliance. Facing antitrust regulations can also limit the benefits of an alliance with a major partner and invite governmental mediation. Lastly, most firms receive some inputs from their parent companies, such as administrative services, customer data, raw materials, and in-turn offer outputs to them, generating convoluted transfer-pricing issues. For instance, before Airbus Industries was given a face-lift in 2001, the four conglomerate members made aircraft pieces and “sold” them to the joint venture. After that, the joint venture put together the parts to make airplanes and also carried out marketing activities for the planes. The companies could not arrive at the appropriate transfer prices given the partners’ sensitivity to sharing comprehensive cost data. There is another example involving two international technology companies that had formed a strategic alliance with the sole objective of jointly marketing a new product. More than 30 working teams were involved in this partnership. Up to 300-odd members spent 20 per cent to 60 per cent of their time on the activities pertaining to the strategic alliance. However, at one time a top manager from a partner firm was quoted saying that he had no factual awareness of the funds spent by the company on the joint venture, largely due to the secret expenditure that could not be accounted for comprehensively. This makes it exceedingly difficult to measure the true value gained through a strategic alliance. Time and again, strategic alliances do engender sales of related products for parent companies. This must be considered in assessing the alliance’s performance and value. So should longer term benefits like prospects for learning, enriched competitive positioning, and access to new technologies and markets. Strategic alliances are also limited by the reasoning that they characteristically hold a noncore position in the product or service selection of some companies. Given that this is an internal matter, the top management may opt to focus more on the key areas and pay little attention to the strategic alliance (Bamford & Ernst, 2002). Besides, strategic alliances also face a big threat of survival. For strategic alliances to survive the partnering firms ought to appreciate the objectives set for the alliance. Besides, the duties of each one partner must be well defined and agreed upon in meeting the overall alliance objectives. It is widely accepted that “if you fail to plan, you plan to fail”. In the same vain if strategic alliances do not set out clear objectives for their partnership, they tracking the outcomes may well not be possible. The abated partnership between the French firm Carnaud and British Metalbox Packaging is a classic example of failure is strategic alliances. This merger was not successful largely because of differences in making decisions and incompatible subsidiaries. These shortcomings are among the many other causes that pull down strategic alliances. By strategic alliances largely generate higher mutual gains for the partnering firms that exceed the disadvantages. For the strategic alliance to be able to pull through the challenges and succeed, the partnering firms are supposed to instil a change oriented corporate culture. The firms should as well support the alliance and show strong mutual commitment. This is because evidence suggests that firms with a culture supportive of the alliances leads to better results for the partners (Lee et al., 2013). Empirical Analysis on Value Creation Chiou and White (2003) conducted a study on the Japanese financial sector aimed at finding out the value of strategic alliances in the sector. Their findings indicate that firms forming strategic alliances in the banking/financial sector were able to earn greater returns. Most of their findings were consistent with the hypothesised statements founded on how successful strategic alliances in the Japanese financial sector are. Moreover, Chiou and White found out that there was an increase in the value gained by the partnering firms. The gains made by the firms were consistent with what Chiou and White (2003) refers to as the “wine-wine hypothesis”. On the “relative size hypothesis”, they found out that the smaller partners in the strategic alliance took home a larger portion of the gains resultant from the alliance. Also, Chiou and White (2003) discovered that strategic alliances formed between foreign and domestic firms and the strategic alliances involving domestic firms only do not differ from each other given that no one shows more power since both are, by and large, strategic alliances involving financial services. Gleason et al. (2003) analyses the market performances of financial services firms in the United States by separating them into different industry sub-groups (banking, investment services and insurance) and into distinct holding periods (6, 12 and 18 months following the announcement). They find that the partnering firms enjoy positive momentous abnormal returns owing to the alliance announcements. Marciukaityte et al. (2009) find parallel proof that the market responds positively to strategic alliances announcements. More remarkably, they furthermore submit that the market has a more positive response to the announcements by the financial services firms that are lastly acquired by their alliance partners at a later time. Amici et al. (2012) focuses in detail on the market effect of banking firms in Europe and the United States on both strategic alliances and joint ventures. Besides the result of a positive correlation between the announcements and firm value, they also indicate that joint ventures create more value when there are non-banking financial partners involved in the case. Adams and Downey (2008) conducted a research on different industries, among them the banking industry. The researchers selected a sample for their study from different countries as well as press releases. Adams and Downey relied solely on commonly used financial ratios to form a measure along which to evaluate the performance of strategic alliances. They relied upon the SPSS software for further analysis, particularly to find if there was rationality. The findings show that all the ratios used indicated affirmative results in all the cases. Moreover, the results show that success was mainly boosted by higher operating margins. In their study, Adams and Downey used the operating margin to measure the company's operational efficiency and pricing strategy. The findings of the study go along with the main rationale as to why firms choose to enter into strategic alliances. Also, the results show evidence that entering into strategic alliances with firms with comparable fundamental competencies leads to greater internal efficiencies. Lee et al. (2013) looks into the impact of strategic alliance upon the value increase of firms based in South Korea. In consistent with the situation in developed countries, strategic alliance announcements of Korean firms return significant positive abnormal yields on the announcement day. Moreover, in view of the partnering firms’ location and alliances’ characteristics, they further show proof that the marketing alliances with involving firms from the most advanced G7 countries enhance the firm value by a larger proportion. Chan et al. (1997) and Das et al. (1998) conduct a study on the announcement effect of non-equity strategic alliances upon the firm value based on the United States stock market. They indicate that, just like in the case of joint venture formations, non-equity strategic alliances considerably boost the firm value on the announcement date as well. In addition, they suggest that the abnormal return generated by horizontal strategic alliances exceeds by a large margin the abnormal return realised through other forms of strategic alliances. The study by Chan et al. (1997) also indicates that the inherent motive attributable to the greater value realised through horizontal alliances. Their findings show that the higher increase in value is mainly as a result of either a combination of modern knowledge and skills or latest technology or consolidation of the market position of the partnering firm. Correspondingly, Das et al. (1998) find out that firms have a strong preference for technology strategic alliances as opposed to marketing strategic alliances for the same industry. Furthermore, maybe owing to the robust bargaining power small firms have in strategic alliance activities, the abnormal returns of them are much greater than the abnormal returns of bigger establishments. In recent times, more and more researchers have directed their academic attention to the wealth effect of strategic alliance announcements, even though most of them are still founded on the firms in the United States capital market. By analysing the value addition effect of 89 non-equity strategic alliances from the information and technology sector in the United States, Neill et al. (2001) claim that the strategic alliance announcements return a positive abnormal earnings for partnering firms on the announcement date. In addition, they show proof that there exists the announcements information leak for a definite period ahead of the announced date. From the perspective of features of strategic alliances, Swaminathan and Moorman (2009) and Ho et al. (2010) solely focus on the firms announcing marketing alliances in the United States capital market and find a positive connection between firm value and alliance announcement. Conclusion By and large, strategic alliances play a crucial role in todays globalised and very much competitive business environment. The alliances have in deed come to be a necessary strategic choice for firms seeking an easier route to increase their value through expansion and growth. The benefits range from cost minimisation, resource dependency, market entry, risk sharing, knowledge sharing and technology transfer, and enabling their competitiveness and business strategies. On the flip side, strategic alliances my lead to a decline in value due to failure if not handled carefully. The failures mainly result from little management attention, role ambiguity, inordinate performance measurement, and lack of full disclosure of each firm’s activities. Nonetheless, empirical evidence suggests that a mere pronouncement of a strategic alliances boosts the overall firm value of the firms involved. References Amici, A., Fiordelisi, F., Masala, F., Ricci, O., Sist, F., 2012.Strategic alliances and joint venture results in banking. Journal of Banking and Finance 37, 1386-1396. Ammann, M., Oesch, D., Schmid, M.M., 2011. Corporate governance and firm value: international evidence. Journal of Empirical Finance 18, 36–55. Bamford, J. and Ernst, D. 2002. 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