What is Strategic Alliances? Types, Reasons, Pitfalls

What is Strategic Alliances?

Strategic alliances can be a vehicle for achieving important strategic objectives—such as lowering costs, creating new sources of differentiation, or entering new markets. A strategic alliance—sometimes referred to as a partnership between firms—is a cooperative arrangement in which two or more firms combine their resources and capabilities to create new value.

Strategy scholars sometimes refer to these types of arrangements, in which firms cooperate to create competitive advantage through their collaboration, as a cooperative strategy or a relational advantage.

Companies can choose to cooperate at any stage along the value chain, from research and development to manufacturing to the marketing, sales, or service of products or services. Although there are different ways to categorize alliances, perhaps the most common way to distinguish one type of alliance from another is by the mechanism used to govern the alliance.

Companies have three choices—summarized as make, buy, or ally—when it comes to conducting any particular activity that needs to be done to offer a product or service to a customer.

• First, they can make, or conduct the activity themselves within the firm.
  
  
• Second, they can buy, or purchase, the activity or input from another firm, using an “arm’s-length relationship,” in which the buyer purchases an input with no obligation to have a long-term relationship with the supplier. Companies that send out a “bid” to numerous suppliers and then buy from the supplier that offers the lowest price have an arms-length relationship with those suppliers. The winner of the bid this month might lose next month.
  
  
• Finally, they can ally, or access, the activity or input from another firm, using an exclusive partnership with that firm.

Four kinds of inputs and activities might qualify as “strategic” inputs that merit forming an alliance relationship.

• Inputs that can differentiate your product in the minds of customers. Automakers are much more likely to want to partner with a supplier that provides important engine or drivetrain components that influence engine performance or reliability than one that provides fasteners. For example, truck manufacturers often partner with Cummins, a respected maker of truck engines and components, in the manufacture of their trucks.
  
  
• Inputs that influence your brand or reputation. Volvo, a Swedish manufacturer of cars and trucks, has tried to develop a reputation on the safety of its cars. Consequently, it has worked closely with key suppliers, including Autoliv, a Swedish supplier of seat belts and airbags, to put pioneering safety technology into its vehicles.
  
  
• High-value inputs or activities that make up a high percentage of your total costs. Companies that make refrigerators are more likely to partner with the supplier who provides the compressor—the component that costs the most and cools the refrigerator—than with the suppliers of plastic trays or fixtures.
  
  
• Inputs or activities that require significant coordination in order to achieve the desired fit, quality, or performance. Whenever you need to coordinate closely with another firm to get the desired performance from their input or activity, you probably want a partnership relationship.

---

Types of Strategic Alliances

Nonequity or Contractual Alliance

The first type is a contractual or nonequity alliance, in which two or more firms write a contract to govern their relationship. The contract specifies what each party is to do in the alliance—and what each party should receive if it fulfills its duty in the alliance.

Different types of nonequity alliances include:

• Licensing agreements, in which one firm receives a license, or permission to use a resource, such as a brand or a patent, from another firm in return for a percentage of the revenues or profits.
  
  
• Supply agreements, in which a supplier might agree to develop certain customized inputs for a customer.
  
  
• Distribution agreements, in which a distributor or retailer might agree to provide certain customized services in order to help sell a product.

As the name nonequity alliance suggests, companies do not take equity positions in each other. They also do not form a joint venture. Companies tend to choose nonequity alliances when it is easy to specify what each party is supposed to do in the relationship, as well as the rewards that should come from meeting those obligations.

Nonequity alliances tend to be less complex and to require less interdependence and coordination between the companies than alliances that involve equity. When an alliance requires the joint creation of new resources and capabilities by the partners, companies often tend to opt for equity alliances or joint ventures.

Equity Alliance

In an equity alliance, the collaborating firms often supplement contracts with equity holdings in their alliance partners. For example, Toyota owns between 5 and 49 percent of the equity of its 10 largest Japanese suppliers, who all work very closely with Toyota in the development and production of its automobiles.

The fact that Toyota owns some equity in these suppliers aligns their incentives with Toyota’s needs and encourages the suppliers to make investments that benefit Toyota. For example, Toyota’s equity investments encourage its suppliers to locate their manufacturing plants next to Toyota’s assembly plants to reduce the costs of shipping and inventory.

In situations where the parties to an alliance need incentives to bring their best resources to the alliance, equity is often preferred to contracts as a way to align the incentives of partners. For example, many large pharmaceutical companies, such as Eli Lilly, Merck, and Pfizer, own equity positions in start-up biotechnology companies.

The large pharmaceutical firms’ equity positions give them the option to be part owners of new biotechnology drugs the start-ups develop. This option of owning a stake of a potentially profitable new drug creates incentives for companies such as Eli Lilly to provide financial resources to help develop a drug, as well any other support that might increase its probability of success. For instance, if a new drug looks promising, Lilly will use its sales force and distribution channels to sell it around the world.

Joint Venture

The final form of alliance, a joint venture, is one in which collaborating firms create and jointly own a legally independent company. The new company is created from resources and assets contributed by the parent firms. The parent firms jointly exercise control over the new venture and consequently share revenues, expenses, and profits.

Joint ventures are preferred when firms need to combine their resources and capabilities in order to create a competitive advantage that is substantially different from any they possess individually.

For example, Intel makes microprocessors and Micron makes advanced semiconductors, but both companies saw an opportunity in flash memory, the type of memory used in flash drives and in mobile devices such as MP3 players and smartphones. Both companies had some relevant skills and assets, so they decided to each put in $1.2 billion in cash and assets and create IM Flash, a company jointly owned by Intel and Micron. The new company focused on the flash memory market and did not deflect the attention of Intel and Micron from their core businesses.

In similar fashion, when GM wanted to enter the Chinese market, it teamed up with SAIC, a Shanghai-based automobile company, to create Shanghai-GM, a joint venture that brings together GM’s expertise and technology for making cars with SAIC’s knowledge about the Chinese market and experience managing a Chinese workforce.

Typically, partners in a joint venture own equal percentages and contribute equally to the venture’s operations, as was the case with IM Flash. However, in some cases one party might bring more resources to the venture, which will lead to a higher equity stake. Moreover, over time, a firm’s priorities might change, which can lead to one partner purchasing the equity stake of the partner. For example, in 2012 Intel decided that IM Flash was less of a priority so it sold $600 million of its stake in the company to Micron. Many joint ventures end with one partner selling some or its entire ownership stake in the joint venture to the other partner.

Vertical and Horizontal Alliances

In addition to distinguishing alliances by the type of governance arrangement (e.g., nonequity, equity, joint venture), alliances are sometimes categorised as either vertical alliances or horizontal alliances. A vertical alliance is an alliance between firms that are positioned at different stages along the value chain, such as a supplier and a buyer. Toyota’s relationships with its top 10 suppliers are considered vertical alliances—the output of one of the firms in the relationship is the input of the other.

Vertical alliances are usually formed to combine unique resources, create new alliance-specific resources, or lower transaction costs between two companies that are already transacting. The Strategy in Practice feature describes the details of how Bose handles vertical alliances with its suppliers.

In contrast, a horizontal alliance is between two firms that do not have a supplier-buyer relationship and are typically positioned at a common stage of the value chain (e.g., competitors). The Shanghai-GM partnership is a horizontal alliance. The partners conduct activities at a common stage along the value chain, which means they conduct similar activities internally. In this case, both of them manufacture automobiles.

Horizontal alliances can also occur between companies that do not do the same activities but do complementary ones, such as Electronic Arts developing games for the Sony PlayStation. Horizontal alliances are often created to pool similar resources, or to combine complementary knowledge.

---

Reasons for Strategic Alliances

Today, many companies are increasingly using alliances to achieve strategic objectives. The basic logic for alliances can be summed up in the adage, “Two heads are better than one.” Sometimes it just makes sense to combine the resources and capabilities of two companies to solve certain problems or achieve particular objectives.

Alliances are a vehicle that allows a company to access the resources and capabilities of another firm in order to create value by either lowering its costs or differentiating its offerings.

Let’s look at some of the ways:

Combine Unique Resources

The first way that firms create value through an alliance is by combining unique resources to create an even more powerful offering. Companies typically combine unique resources to create new products, enter new markets, or avoid the costs of entering different stages of the value chain. For example, Pixar decided not to invest in movie distribution, instead relying on the distribution resources and capabilities that Disney had already built.

Sometimes, the unique resources that the partners combine are intangible resources in the form of knowledge. Such “learning alliances” are increasingly popular. The goal is for each alliance partner to learn something that it believes will be a valuable addition to its capabilities in the future.

For example, when Visa wanted to learn about how to bring financial literacy, and credit cards, to a younger crowd, it turned to an unlikely partner—Marvel Comics. Visa and Marvel jointly developed a unique comic book addressing money-management issues, starring Marvel characters.

Pool Similar Resources

Alliances create value is by pooling similar resources to achieve economies of scale that neither firm could achieve on its own.

For example, Intel and Micron wanted to get into manufacturing flash ­ memory—a business that required billions of dollars of investment in a plant and equipment. So they decided to create IM Flash, a joint venture designed to produce flash memory products. By splitting the cost of the plant and equipment, the two companies were able to build a much larger plant and, through economies of scale, produce flash memory at a lower cost per unit.

This value did not necessarily require combining unique resources, just the pooling of total resources to achieve economies of scale in the R&D and production of flash memory. In addition to achieving economies of scale, another reason firms pool similar resources is to share the risks associated with conducting a particular activity.

Create New Alliance-Specific Resources

Alliances create value through new, alliance-specific resources. Alliance-specific resources are those that are created specifically to help the partners achieve the alliance objectives. Alliance-specific resources can be owned by one partner or jointly held. Firms typically create alliance-specific resources to increase the efficiency of doing business together or to expand the available resources of all the partners.

Lower Transaction Costs

Alliances create value is by lowering transaction costs. Alliances that create value through lower transaction costs are primarily trying to increase efficiency and lower the costs between transactors in the value chain: buyers and suppliers.

By transaction costs, we mean all of the costs associated with making a transaction happen. In most companies, purchasing personnel, sales personnel, and attorneys are primarily responsible for finding and negotiating agreements with suppliers of inputs and buyers of outputs.

If alliance partners can create relationships with suppliers or buyers based on mutual trust, then they do not have to employ as many purchasing or sales personnel. They also do not have to employ as many lawyers to write costly contracts to protect their interests.

---

Pitfalls in Strategic Alliances

The issue of protecting one’s interest in an alliance are not without risks. When a company agrees to an alliance, it loses some of its independence. It must rely on its partner to produce and perform as expected.

Just as there are incentives to cooperate in alliances, there are also incentives for companies to act opportunistically, to take advantage of a partner if the situation presents itself. So managers need to be aware of the two major ways that partners can take advantage of one another in an alliance: hold-up and misrepresentation. (You can remember these two forms of opportunism as H&M.)

Hold-up

Hold-up occurs when one partner tries to exploit the alliance-specific investments made by another partner. In the case where Toyota Boshoku built its factory next to Toyota’s, this created an opportunity for Toyota to “hold up” Boshoku by opportunistically renegotiating lower prices after Boshuku made the investment.

After Toyota Boshoku built its factory next door to Toyota, it was highly committed to Toyota; its investments could not be easily redeployed to serve other customers. It was important for Boshuku to make sure that Toyota would be trustworthy and not try to negotiate lower prices after Boshoku built its factory next door. So it created an equity alliance with Toyota, in which Toyota owned 49 percent of Toyota Boshoku’s stock.

Managers must be aware that whenever they make investments in equipment, facilities, or processes that are customized to a partner—and therefore not easily redeployable to other uses—there is the potential for the partner to hold up their company.

Misrepresentation

Misrepresentation occurs when one partner in an alliance creates false expectations about the resources it brings to the relationship or fails to deliver what it originally promised. For example, suppose a start-up biotechnology company is developing a new drug to fight Alzheimer’s disease. It needs additional resources to conduct clinical trials in order to get approval for this new drug.

To convince a pharmaceutical company to provide the necessary resources, the biotech start-up could misrepresent how far along the drug is in the development pipeline. Or it could overstate the effectiveness of the drug in initial clinical trials A company that considers entering into an alliance with a firm that brings intangible resources to an alliance—such as local market knowledge or relationships with key political figures—needs to research its partner thoroughly to guard against this form of ­ opportunism.

Ultimately, however, misrepresentation is a hazard that firms face when doing business with others of questionable moral character. The only true way to protect against misrepresentation is to partner with trustworthy individuals and firms.