In March, Corporate Partner Fred Marcusa gave an interview to Lily Robertson, Senior Content Associate with Argyle Executive Forum, as part of the forum’s ongoing “Argyle Conversation” feature. Marcusa discussed joint ventures and strategic alliances, including the ways organizations are using these strategies to solve business problems. The interview, pasted below, was originally published and can also be found on the Argyle Executive Forum site here.
Q: Since you work extensively with cross-border deals, what do you see as the key drivers for global expansion? And what changes are on the horizon in 2012 regarding M&A activity?
A: The main drivers of strategic alliances are the ongoing efforts of most businesses to reduce costs and increase sales. Many alliances are done to increase revenue in new geographies and these are most evident in ventures to sell into the BRIC countries—Brazil, Russia, India, and China. Efforts to reduce expenses are dependent on finding lower-cost sourcing, rather than geography, per se. An example is the recently announced GM and Peugeot collaboration on joint and more efficient purchasing, which would reduce costs. In addition to those two generic drivers, there are sometimes political elements involved. Businesses sometimes look for the most stable place to invest, which to many increasingly is the United States. We’re hearing more from people in Asia and the Middle East thinking of coming to the U.S. I think there will be increasing policy and political ramifications from that, particularly with investment in U.S. technology companies with national security implications.
A big driver of strategic alliances historically has been the need to manage currency fluctuations. We represent companies that sell in dollars but produce and pay bills in some other currency. The ability to hedge currency exposure impacts the decision of whether to sell only in the currency in which you produce. This is often not possible, for example, with products such as aircraft, priced traditionally on world markets in dollars. Especially with the financial uncertainty in Europe, currency problems are going to continue. There likely will be changes in the value of the euro in relation to the dollar. If the value of the euro drops, it could reduce pressure to come to the U.S. to produce in dollars, rather than euros. Businesses fighting multi-front battles to keep costs down, increase market share, and reduce the impact of currency shifts have several reasons to consider strategic alliances in different places to achieve different ends.
Going forward into 2012, I think there will be a continuation of what we saw in 2011. However, with possible changes in governments in Europe and the United States, it’s hard to gauge what the net political and financial impact will be. For example, elections in Germany and France could change governments there. In recent times, no leader from a stalling economy has been able to win re-election in Europe. Obviously, we also have an election here in the United States, the outcome of which is not now known. There are many moving pieces at the moment, and we would expect them to create both opportunities and risks. People who do joint ventures thrive on that uncertainty.
Q: What is your take on the different value proposition of strategic alliances versus joint ventures? How does one decide the best strategy to take and the amount of risk to accept?
A: A normal M&A transaction involves one of a limited number of structures: a merger or a purchase of assets or stock. Because a strategic alliance or joint venture is designed to solve a particular business problem, the structures and timing are much more varied and dependent on the problem being solved. In general terms, a strategic alliance is a business relationship based on contracts. No new entity is created. A joint venture usually involves similar contracts, but a new jointly-owned entity is created. There is tension for the participants in a joint venture between their two roles: (1) as contract providers of products or services and (2) as equity owners of the venture. A strategic alliance is often conceived to be on a shorter and sometimes trial basis — a trial marriage of sorts. It may be formed for a specific project or teaming together on a big contract. The alliance may also reflect an attempt to see if an unproven theory works. For example, can costs together be reduced? Is it possible to have commercial success in a particular market with a particular approach? In any event, a joint venture, by its nature, involves setting up a new company with its own bureaucracy.
In general, it’s difficult to know which structure makes the most sense until you analyze the business problems proposed to be solved and the risks each party can accept. The aim of a joint venture or strategic alliance is to maximize benefits and reduce risks. This may require reliance on a partner for a critical element of the business. For example, a technology venture may require one party to transfer a significant technology to its partner. Thus, there is an element of trust required for both parties. Common questions normally include: have both parties gone in with realistic expectations? Are those expectations being met? What does a party do if they’re not? One of the key issues for me in structuring and drafting a venture is whether to follow the lawyer’s normal rule of trying to anticipate everything that can happen and providing explicit solutions for each scenario. This is the customary approach, particularly where two parties could end up in deadlock because of something neither foresaw or perhaps did foresee. It could be a change in one or both of the companies’ managements or priorities or one of the companies being unable to contribute the resources both expected it would. Whatever the reason, most people feel nervous about going into a venture without an elaborate deadlock-breaking/dispute-resolution provision.
Over a long time, I have concluded that in some cases it may be best, even for the person who feels he will have the weaker position, to say nothing in documents about deadlock. I have observed that, often in life, the less defined the risk, the more frightening it is. For example, most people who go to a doctor are terrified if he says, “You may have a major problem. Let me check on it.” On the other hand, if one goes and gets a horrible diagnosis, but it’s conclusive, people tend to accommodate to that situation. In ventures where there hasn’t been a specific outcome articulated in the event of a problem, people are fearful of a horrible outcome and they tend to work around the problem. It’s like a world with no divorce. If there’s no divorce and you have to get along, you tend to find a way to do so. This approach is not appropriate in all situations, of course. It does represent a viewpoint which I recognize is different from many people’s.
Q: A partnership mentality seems important for managing the risks and potential pitfalls. Is that something many people miss when entering these types of relationships?
A: Anyone who does something involving risk believes that he can overcome the risk — otherwise, he wouldn’t do it. A venture is normally done based on the belief that, factoring in known risks, it will generate acceptable returns. Generally people doing ventures accept risks they understand. However, part of what’s attractive about a venture (including a strategic alliance) is that it helps a company deal with risks it doesn’t understand as well as its partner may.
M&A professionals are accustomed to two-dimensional deals, acquiring something in a traditional transaction. This is much different than structuring and managing a venture as an ongoing-relationship. The nature of a joint venture or strategic alliance is much more complex and subtle than an acquisition. Transaction skills are necessary but not sufficient. At least equally important is an understanding of the business. Few people, even with considerable M&A skills, can do strategic alliances quickly. Doing a lot of these transactions, of course, helps you understand what you don’t know and apply what you do more effectively.
Q: What are some hallmarks of a successful joint venture or strategic alliance? Do they differ based on transaction type?
A: Consider the analogy of the difference between being married and living together for a long time. Both scenarios last as long as they work. There are a few things that make an endeavor successful, whether it’s a strategic alliance or a formal joint venture. The first is success in meeting expectations, however those are defined. People who are getting what they want tend to be less philosophical and analytical than those who aren’t. Going into these transactions requires an act of faith. But what justifies that act of faith? I believe that each party must have “skin in the game.” To me, this means ideally that they both have a lot to gain from the venture’s success and a lot to lose from its failure. People are probably more often attracted by potential gains than fear of loss, but in my experience, the opportunity costs of not doing something drive many ventures, especially in motivating an appropriate sense of commitment, patience, and time scale for the venture. Everyone thinks they can do something the first time in a lot less time than it actually takes. If you attempt to change the lock on your door, it could take four hours, but the second time you do it, it may only take one hour. Most people underestimate the difference between a prospective venture and others they have done. As a result it becomes very difficult to avoid the anxiety when you think you’re going to do something in six months and it takes much longer. When you see failure for six months, it’s difficult to know whether it’s truly evidence of failure or just a prelude to success.
Q: Do you think it’s possible to plan in advance for those periods of failure, or is it more important to adapt to changes as they come?
A: Every venture is done to solve a particular business problem. Most people working on a venture have some understanding of the business problem and the likelihood of solving it with a specific venture structure over time. For example, suppose one company has a great product but a small marketing organization in the partner’s home country. It’s possible to plan the likelihood of the partner’s successfully distributing the product and how that will produce an acceptable result over a defined period of time. If one company lacks technology and contracts to use its partner’s technology, it may well be able to anticipate the potential output of the plan, including costs.
One important planning factor involves the contracts each party will enter as a result of the venture, such as supply or service contracts. In analyzing the outcome of the venture, the contracts that guarantee the inputs are critical. The output in those types of ventures where the market is uncertain are much harder to predict. If it’s a cost-saving venture, a supply contract to guarantee the desired costs and output is often possible. Determining the number of units of a product which can be sold in a new market is often harder.
Q: What general red flags exist in terms of entering into these types of partnerships?
A: A threshold red flag is a venture being negotiated by people who aren’t sensitive to the business and cultural issues and problems of both partners. The chance of getting it right with only M&A professionals involved is lower. You must have people who understand the specific business problems that are the basis and rationale of the venture. If the underlying business problem is the need to obtain a raw material, then the supplier of that material has to understand the need of the other party to have it in a particular form in a timely manner. If the business problem of one partner is low-cost production at a high-quality level, the supplier obviously needs to understand the quality needs of the other partner as well. Each partner must be able to put itself in the position of the other partner and say, “What is the partner looking for from the venture? Can we realistically provide it and, if so, how?” If you have people who only look at what they’re going to get out of it, rather than what both parties expect, the likelihood of success of a venture is a lot lower.
Certain ventures built solely on political necessity, such as a requirement for a local company to sell a defense product, often can work well, but are risky if the “political” party is not a real commercial partner. These arrangements create tension because one party who needs political support may get what it wants in a more simplistic way than the other party who needs complex workshare. Some types of ventures with simple goals are more likely to be successful than others. I think cost-savings ventures are the most likely to be successful. Ventures to sell into a new market often can be successful. Those that solve political or commercial problems can work more easily if they’re one dimensional, but if they’re multi-dimensional and must be combined with a lot of others things, complex goals are harder to achieve.
If a business makes a widget without a political aspect, it won’t need the same expertise as another partnership with political aspects. Anyone who makes a product that’s politically sensitive, either because of its huge scale or its effect on employment, will need political and technical people to help. Also, in the case of multinational deals, you need cultural translators who understand the world in terms of each of the two countries. No one really understands anyone else’s country, but most people don’t comprehend how much help they need from a cultural translator. When I have clients who are very sophisticated about cultural issues, they have a much better chance of being successful because their cultural sensitivity shapes the reasonableness of their expectations.
Coming full circle, the key to a successful venture is both parties’ having reasonable expectations that can be and are met. What makes an expectation reasonable is that success can be achieved by doing in a normal way things that the venture is capable of doing. It may require input that is political, technological, financial, or marketing-related. The interesting thing for people like me who work in this area is to combine different elements in different ways in various transactions and situations with new ways of thinking to produce better results.
Q: What global trends do you currently see? Do you consider the BRIC countries as emerging markets or are they more developed?
A: Regarding the BRIC countries, each of them has an incredibly dynamic economy with an increasing consumer base. For people trying to find markets to sell many types of products, these are the places. While other places are growing as well, these are large countries where the efforts to put down a stake have been rewarded. The same energy is probably needed to do a complex venture, whether the place is small or large. However, the payoff and opportunities are a lot greater in the larger countries. As an example, selling into New York City is often more profitable than selling into a small town. Selling into India, which has recently modernized certain laws, is very exciting. Brazil is dynamic in a way that is compelling for a lot of industries. The growth of a vibrant consumer economy in China is extraordinary, as Chinese consumers now look to buy imported consumer goods that were only available in the West some years ago. Market growth has raised living standards and wages in many cases. For example, China is no longer the lowest-cost producer in many things, propelling many companies to move production to other places which may have lower costs and perhaps more modern machinery. One of the great successes over the last number of years is the growth in machine tool exports from Europe. These machine tools are helping build industrial bases in a number of different places, which are now providing, through strategic alliances and ventures, low-cost, high-quality subcomponents and products.
Q: Are there any other M&A trends that you want to highlight?
A: Joint ventures and strategic alliances are the reflection of a world that’s becoming more flexible and competitive. As companies recognize they can benefit, this will include almost all industries. The pharmaceutical industry is increasingly dependent on licensing products and buying companies with new products. There is an overall great sense of anxiety about the ability to be competitive in the global world, and people are willing to make more kinds of deals to enable them to be competitive as the world “flattens,” as Tom Friedman says. To stay competitive, many companies need to do things their own resources may not allow. With the use of telecommunication and the internet, it becomes possible to have partnerships which can be better managed remotely and send data in ways that were never possible before. Domestically and internationally, people are doing things that have never been done before, including strategic alliances in services that weren’t previously done. Global competition puts pressure on everyone to lower costs and improve quality. The only way to deal with it, in many cases, is with a strategic alliance or venture.
I believe M&A still has an important role to play, but increasingly, organizations that need to address immediately specific needs of their businesses are not going to do it through traditional M&A as rapidly or effectively as they could through some kind of strategic alliance, which represents a broader contractual relationship enabling them to compete quickly. Let’s suppose you want to solve a problem in a far off place. Sometimes an acquisition is the answer. It would take a while to find one, local laws may inhibit an outright purchase and, in any event, you would need to find management. The alternative would be to enter into a contractual relationship with a party already in place, who can immediately supply some of these other elements more quickly and at a lower risk. I believe the future for ventures is very bright, as more people become more comfortable with them. As that happens, more people will then use them as a way to increase market power and profitability.
Fred Marcusa, a senior Partner in Kaye Scholer’s Corporate Department, practices principally in the areas of domestic and international acquisitions and dispositions. He is widely recognized for providing counsel to senior executives and others contemplating strategic alliances and joint ventures, international commercial transactions, and leveraged buyouts as well as providing advice to senior executives on various matters, including employment agreements. Marcusa has developed a number of innovative techniques for dealing with highly complex commercial, political, and legal issues. At the request of various governmental and corporate institutions, he has written and spoken about various topics in corporate and international law in the U.S., Asia, Latin America, and Europe. He also has extensive involvement in complex and sensitive international negotiations and investigations
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