Joint Ventures: Creating Value Against the OddsTom Herd
Joint ventures (JVs) have become a more prevalent way for companies to gain access to new capabilities, products, and geographies since the start of the most recent economic downturn. According to Accenture's analysis of large JVs with more than $500 million in contributed assets or revenues, worldwide JV volume has increased more than threefold since the recession of 2001-2002. The trend in North America has mirrored the global activity. JVs are also growing as a percentage of overall mergers and acquisitions activity at roughly the same rate, increasing from 0.30 percent of M&A activity during the recession of 2001 to 0.75 percent today, according to Thomson-Reuters (TOC) and Accenture (ACN).
Large corporations are forming joint ventures more frequently for several reasons:
Kicking the tires before buying.
Reduced access to credit and the importance of conserving cash during the current slow recovery have limited the ability of some companies to conduct M&A. Potential buyers want to see proven results from a potential combination before committing scarce capital.
Example: In May 2010, Eldorado Gold (EGO) exercised an option to purchase its JV partner, Brazauro Resources, after two years of positive results from their Tocantinzinho gold mining venture.
Uncertain valuations create uncertainty.
Uncertain valuations in a "too hot," then "too cold," and then "too hot again" marketplace make potential buyers hesitant to make the commitment—and make potential sellers reluctant to sell.
Example: Recently, Accenture assisted with the evaluation of a potential joint venture between an integrated oil and gas company and an independent downstream refiner. An outright acquisition would have been easier to govern and would have likely created more operational synergies, but the refiner hoped that it could ultimately land a more attractive offer when market conditions improve.
In investment-intensive industries such as oil exploration and pharmaceutical research and development, the investment portfolios required to succeed are often beyond the capital and risk profiles that a single company can tackle on its own.
Example: The Syncrude JV in Canada's Oil Sands provides its seven operating partners with a method to pool capital and mitigate risk from overexposure to a single project. As the world's largest producer of synthetic crude oil from oil sands, Syncrude's mining and upgrading projects can require investments of C$5 billion to C$10 billion. Moreover, since mining and upgrading bitumen into synthetic crude in remote northern Alberta is an expensive and environmentally sensitive proposition, Syncrude faces substantial risk that its operations or profitability could be interrupted by changing environmental regulations or by a drop in global demand for oil. Hence, even large and financially strong partners such as Imperial Oil and its majority owner, ExxonMobil (XOM), have strong incentives to share the capital demands and risks with other partners.
Operating efficiencies and customer responsiveness.
More cost-conscious and discriminating customers are demanding better selection, faster service, and greater value. The drive to make supply chains and distribution channels more efficient and responsive to market demand signals is causing retailers and upstream suppliers, for example, to create JVs that combine their capabilities to shorten their value chains.
Example: Wal-Mart's (WMT) in-store optometry customers have benefited from greater selection of contact lens options and faster delivery through 1-800 Contacts' leading-edge inventory management and distribution capabilities.
Rethinking How JVs Are Structured
Despite these successful JVs, many M&A practitioners believe it is even more difficult to create shareholder value through a joint venture than through traditional M&A. While Accenture's analysis has shown that traditional M&A destroys shareholder value approximately 50 percent of the time, our interviews with corporate development professionals indicate that joint ventures and other forms of alliance relationships fail to achieve their parent's strategic or financial objectives as much as 75 percent of the time. Joint ventures combine the integration challenges of mergers and the ongoing relationship management challenges of alliances, making them inherently complex to manage.
According to research Accenture conducted in 2009, companies that enter alliances and JVs most frequently cite overly optimistic projections and poor communications and relationships between parent companies as the two leading reasons for failure. Their executives cite lack of trust, widespread negative partisan perceptions, a suspicion that one party is benefiting more than another, and inefficient or inadequate communication as the most visible and troublesome symptoms of such poor relationships. Accenture's proprietary research indicates that chief executive officers cite lack of shared benefits between parent companies and poor communications as the leading causes of failures of their joint ventures.
There are several ways to strengthen the probability of success with JVs and create value for both parties:
Ensure that your goals and exit strategies are aligned with your partner's.
Explicitly share each parent company's strategic objectives and exit strategies when the JV is conceived and then revisit them together throughout the entire life cycle of the JV. After 25 years of production, the oft-cited JV between Toyota (TM) and General Motors has finally closed its doors, but the venture was concluded following considerable success. This revolutionary JV demonstrated that fierce competitors can co-exist in a successful venture. GM wanted to learn about lean production techniques while Toyota wanted to validate its production model in the U.S. These objectives were mutually compatible.
Clarify the principal owner and decisionmaker.
Although a traditional 50/50 ownership structure may be easy for partners to agree upon, it can erode speed and alignment of decisionmaking. We have seen 51/49 JVs used frequently in Asia and in Europe as a way for an established company to test the waters in a new culture or geography with a local partner while maintaining control of how its brand, assets, and intellectual know-how will be used.
Design a governance structure that balances synergy-achievement goals with risk. Parent companies must identify and plan for various ways that the JV can be abused, then implement tight controls and penalties to avoid such a situation. Conducting scenario analyses and role-playing—or employing a nonpartisan risk control officer to oversee the JV operations—can help minimize risk.
Build a Trusting Relationship
No governance structure can safeguard against all possible risks and misalignments of objectives and loyalties. Further, since strategic planning processes such as budgeting can be contentious and create tension between parent companies, leading practitioners of JVs and alliances often create specific forums outside the governance structure to nurture parent relationships. They also designate a separate set of representatives who are removed from daily JV operations to manage the relationship with long-term goals and vision in mind.
While there are several good reasons to embark on a joint venture, prospective partners should realize that JVs are often unusually challenging to govern and operate. The best and most experienced JV practitioners choose their partners wisely, then constructively manage their relationships outside the formal governance structure. These actions alone won't guarantee the success of a JV, but they provide a strong foundation.