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How to Choose the Right Partner for International Joint Venture

Worldwide interest in international joint ventures and strategic alliances has increased dramatically over the past decade. Companies recognize that technology and business processes are becoming more and more complex, making it difficult for one organization to possess alone the necessary competence to emerge in the global market. Joint ventures enable companies to get a fast access to new markets and distribution channels, reduce production cost, acquire new skills and competences, obtain cutting-edge technologies, and develop new products and services. Beyond that, such partnerships offer a possibility for companies to increase profit margin, lower financial risks, overcome legal and trade barriers, and accelerate economic growth. However, despite growing numbers and increasing significance of international joint ventures, many of them are unsuccessful. According to various studies, almost 50 to 60 percent of joint ventures fail to perform against the financial and strategic expectations of the partners (Geringer & Hebert 1991, Hennart et al. 1999, Yeheskel et al. 2004).

One of the most cited reasons for joint venture failure is the incompatibility between partners. Inter-partner fit is an essential factor influencing the performance of alliances. The choice of the right partner can yield important competitive benefits, whereas the choice of incompatible partner can lead to impassable problems. Thus, it is critical for companies to identify and understand effective partner selection criteria prior to entering into a joint venture. This is especially important in an international setting where differences in culture, infrastructure, economic development, and government policies increase the complexity of the context in which the alliance is embedded.

Selecting a suitable partner for an international joint venture is not an easy decision. It requires a host of complex considerations, including technological, financial, legal and organizational analysis. The criteria used for selecting a partner could vary significantly depending on the specific strategic context of the venture. Yet, there seem to be common factors that are crucial to formation and subsequent success of a joint venture. In this article I would like to define and discuss the critical criteria that could be universally applicable for choosing a joint venture partner.

Complementary resources and capabilities    

The primary selection criterion is a partner’s ability to provide technical skills and resources, which complement those of your company. If prospective partners can not satisfy this criterion, then formation of a joint venture should be a questionable proposition. Technical complementarity should be viewed as a minimum qualification for selection of a partner. Different types of skill and resources can be complementary and lead to successful strategic alliances. For example, an alliance can consist of one parent supplying technology and the other furnishing marketing or manufacturing capabilities.

Companies seeking complementarity in a joint venture have to determine a set of specific skills and resources they may need from a partner, as well as the relative priority among them. In order to determine these resources, managers need to thoroughly analyze their own firm’s capabilities and compare them to those deemed necessary for joint venture success. Depending on the company’s strategic objectives, managers can consider potential partner’s manufacturing capacities, product development skills and innovation experience. Complementary capabilities can also take form of partner’s access to local market knowledge, distribution channels, post-sales services networks, and regulatory knowledge.

Take an example of an American medical equipment company that wanted to expand sales of its product line in Europe. Because of its small size and limited name recognition, the company was hesitant about increasing penetration of the European market on its own. Instead, it sought assistance from a joint venture partner. Strategic analysis of the proposed investment suggested that the partner must be a recognized player in the medical supplies industry and have sufficient financial and marketing resources. The partner would also need to evidence the technological sophistication necessary to demonstrate the technical advantages of the American firm’s products. Companies not satisfying this set of criteria were rejected as possible co-ventures (J. Michael Geringer, 1991).

Unique competencies

An important criterion for gaining and sustaining a competitive advantage is having unique resources. That’s why companies should search for potential partners with unique (rare) competencies that can be leveraged in the alliance to create greater economic value. When evaluating a partner’s capability, managers should ask, ‘’What can my potential partner bring that is unique?’’ Unique competencies are abilities or skills possessed by a partner but not by other firms. Uniqueness consists of three aspects: 1) Unique capabilities that cannot be traded easily across companies. For example, interpersonal relationship with the business community and local authorities is such a capacity. It is individually embedded and cannot be sold to another company, particularly foreign one. 2) Unique capabilities that cannot be easily substituted. For example, a local partner with good government relationships is an absolute necessity for selling in government-controlled markets. 3) Unique capabilities that cannot be independently developed or replicated within a reasonable time frame. For example, it was extremely difficult, if not impossible for GE, as an American company, to independently develop a close relationship with the powerful European players. GE therefore had to turn to Snecma, a company that had a strong French identity and was closely linked with Airbus and its French and German partners.

Goal compatibility

Each partner of a joint venture must clearly understand what other participants expect from the union. Joint ventures only tend to work as long as each partner perceives that he is receiving benefits or is likely to benefit in the near future. Because of differences in objectives, what is good for one company may be a disaster for the other party. For example, the joint venture between GM and Daewoo was unsuccessful, largely because two firms had different goals and as a result were largely incompatible. Daewoo was seeking growth and access to new markets while GM’s overriding goal was to achieve reasonable financial returns. Because the financial returns were negative, GM management was unwilling to make further investments to achieve the growth desired by Daewoo. As a result, they ended their partnership – both losing substantial investments in the joint venture (Hitt, Tyler, Hardee & Park, 1995).

Goal compatibility provides to a joint venture a stable environment, reducing uncertainty and stimulating commitment of partner organizations. At the same time, goal correspondence does not necessarily mean that partners have exactly the same goals. It means that partners’ objectives are not in conflict and are understood by each other. When one or both partners don’t clearly state their objective, venture failure is almost inevitable.

Financial resources

When establishing a joint venture, companies must be sure that their prospective partner can generate the level of financial resources necessary for maintaining the venture’s efforts. Partner’s inability to fulfill its financial commitments can create turmoil for the venture and its managers. Particularly in the early stages of a joint venture, when large negative cash flows are more likely to be encountered, partner’s resource constraints can jeopardize the entire alliance. In order to ascertain that the potential partner is a financially solid company, managers need to consider the following factors:

  • Profitability. A partner’s portfolio of revenue streams has a strong impact on the joint venture in terms of the capital contribution, financial commitment and availability of resources for deployment towards the venture. It is essential therefore that a prospective partner has the potential to generate sufficient financial resources to support the joint venture;
  • Liquidity. A partner’s liquidity is critical to the joint venture operations as it affects the venture’s ability to pay off short term liability and immediate financial obligations;
  • Asset Management. A crucial factor in formulating a joint venture is the asset liquidity of a prospective partner. It helps establishing a regular pattern of maximizing return on investments.

Financial solidity of potential allies can initially be examined on a general quantitative basis with an assessment of their financial reports (income statements, balance sheets, cash flow – retained earnings/equity leverage, etc.). A partner’s return of investments, financial ratios, insurance availability, credit ratings, government loans or other outstanding debt and overall profitability should also be investigated. Managers must take special care in evaluating a potential partner’s financial reports because very often accounting practices and reporting requirements vary from country to country and may, in some cultures, be distorted in order to put forth a more favorable financial profile. For this reason, it is recommended to make full use of due-diligence procedures, including speaking directly with a potential ally’s suppliers, buyers, bankers, and other associates to gain insights in the true financial situation of the potential partner.

Human capital

Before establishing a joint venture, managers have to examine skills and experience of those people who will be managing and directing the alliance from the partner’s side. In order for two companies to learn, create and grow by strengthening specialized capabilities, personnel from each must work closely and smoothly together. Therefore the experience, knowledge, flexibility, adaptability, language fluency, cultural awareness and commitment that people on each side of the alliance bring to the partnership table are very important. Differences in management style and decision making orientation may result in corporate culture shock, frustrating management from each partner and hindering the development and maintenance of good rapport.

The critical questions here are, ‘’Does a potential ally have the human capital that understands and can respond to the marketplace, distribution channels, sales practices, and negotiating methods in the overseas arena? Do they know the competition, exude customer service and have experience in overall business management methods? Can they do the work that is needed on a day-to-day basis and are their skills being upgraded to do the work that will be needed tomorrow?’’

Organizational culture

In many respects, organizational culture defines the personality of a company. Organizational culture reflects what a firm believes in and is willing to sacrifice in order to achieve its goals. Examination of a potential partner’s organizational culture can provide a sense of where the firm has been in the past, where it currently is, where it plans to be in the future and if it can realistically get there. It also allows managers to assess the degree to which partners are strategically compatible. For example, companies may differ in terms of their work ethic, their moral values, their management beliefs and the degree to which they are dogmatic or open to other standards.

Managers can assess a potential partner’s organizational culture by analyzing its values and objectives. Objectives are typically derived from mission statements that specify a firm’s shared values, principles and purpose for existing. It is important for managers to assess the underlying standards, ethics and beliefs that a potential partner holds dear and compare them to their own. A careful examination of values, mission and objectives can provide understanding of potential partner’s nature and degree of professionalism. Clearly articulated missions and objectives indicate the degree to which potential partners have thought about their business, attend to detail, focus on perceived competencies, embrace diversification, have entrepreneurial tendencies and are long-run vs. short-run in orientation. The key question managers should ask when evaluating a potential joint venture partner is ‘’How well does our company’s ‘reason for being’ match up with that of potential partners and how compatible are our professional standards?’’ Strategic incompatibility on this issue can cause significant problems for a joint venture from the very beginning.

Historical performance

Examination of potential partners’ past performance is the next factor to access. While missions and objectives provide a feel for compatibility of purpose, passion and professionalism between potential allies, historical performance provides evidence of such. In examining this component, both quantitative and qualitative aspects of past performance should be considered. Quantitative factors, such as historical production capacity, profitability, sales volume, market share, cash flow, capital reserves, employee turnover rates and related trends help delineate the future possibilities of a partner. Qualitative factors, such as successful use of technology, research and development achievements, market entry methods, number of and performance in past alliances and management policies (for example, policies related to hiring, and firing and promotions), help delineate an organization’s embedded culture (e.g. collective-authoritarian, aggressive–passive; leader–follower, traditional–modern). The key question managers should ask here is ‘’Does a potential partner’s historical performance match its stated mission and objectives, and does such performance lend itself to our company’s objectives in the joint venture?

Host county legal environment

The legal aspect of institutional environment of the international joint venture’s host country is an extremely important factor in determining partner selection and a particular criterion that companies have to consider when establishing an international alliance. Institutional theory asserts that institutions define what is socially or legally appropriate within a particular country and, consequently, strongly influence organizational behavior and decision making processes. According to the research conducted by J.P. Roy and C. Oliver, among the various institutions that exist within the host-country institutional environment, rule of law and control of corruption appear to be particularly important elements in influencing performance of international joint ventures.

Rule of law is the extent to which people have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, the police, and the courts, as well as the likelihood of crime and violence. Rule of law in the host country defines and protects corporate activity, constitutes the grounds of organizational action, and ensures stability and order in the society that hosts an international joint venture. A lack of adequate legal protection increases uncertainty with respect to property rights and legitimate returns and restricts the means of legal recourse for victims of opportunistic conduct. Rule of law in different countries can be assessed using Global Competitiveness Report, published annually by the World Economic Forum, and the World Business Environment Survey, published by the World Bank.

Control of corruption, on the other hand, is defined as the extent to which public power is exercised for private gain, including both small and grand forms of corruption, as well as ‘capture’ of the state by elites and private interests. Control of corruption in the host country lessens the average firm’s likelihood of encountering corruption in its normal interactions with state officials in the society that hosts a joint venture. Managers can compare the level of corruption in different countries using World Business Environment Survey, published by the World Bank.

The success of any given joint venture highly depends on finding a partner that has resources, skills and assets that complement your own. However, besides the rational selection mechanism, where the alliance partner is chosen through a reasonable due diligence investigation, there are also some behavioral factors that may influence the selection process. The most important of them is trust. Mutual trust is a decisive factor that could have a profound effect on inter-partner relations. Without fundamental trust between the partnering firms, there is little chance for success of the venture. Managers need to be sure that they are working with earnest and ethical people who are not trying to undermine their company.

The problem with trust as a selection criterion is that it cannot be easily quantified and evaluated using rational assessment. Trust is a complex phenomenon that is determined by human chemistry between the partners, their moral, trustworthiness, transparency, ethical values and beliefs. To some extent, trust highlights the importance of intuition and feelings in the process of business partner selection. In this context, intuition is not considered as a magical sixth sense or a paranormal process; nor does it signify either random and whimsical decision making or the opposite of reason. Rather, intuition is a highly complex and highly developed form of perception that is based on years of experience and learning, on facts, patterns, concepts, procedures and abstractions acquired by a human being through his or her life. Einstein once said, “The only real valuable thing is intuition.” So, when choosing a joint venture partner, it is very important for managers to base their decision on rational selection criteria and at the same time trust their own experience and intuition, and act accordingly.

 

References

Geringer, J.M. (1991). Strategic determinants of partner selection criteria in international joint ventures. Journal of International Business Studies 22:1, 41–54.

Hitt, M.A., Dacin, T., Levitas, E., Arregle, J. L. & Borza, A. (2000). Partner selection in emerging and developed market contexts: Resource-based and organizational learning perspectives. Academy of Management Journal 43:3, 449–467.

Roy, J-P. & Oliver, C. (2009). International joint venture partner selection: The role of the host-country legal environment. Journal of International Business Studies, 40:5, 779-801.

Wood, Van R., Dennis A. Pitta, and Frank J. Franzak (2009), Successful strategic alliances with international partners: key issues for small- to medium-sized enterprises, International Journal of Business Innovation & Research, 3(3), 232-251.

Yan, Amin, and Yadong Luo. International Joint Ventures: Theory and Practice. New York: M.E. Sharpe, Inc. 2000.

Dacin, M.T., M.A. Hitt and E. Levitas (1997), ‘Selecting partners for successful international alliances: Examination of us and Korean firms’, Journal of World of World Business, 32(1), 3-16.

 

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