Since the 1970s, firms have increasingly turned to strategic alliances as a way to orga- nize complex business transactions collectively without sacrificing autonomy. Alli- ances may be horizontal, involving collaboration between two firms in the same industry, as when Sina (China’s main Internet portal) and Yahoo partnered to offer auction services in China. They may be vertical, such as when Moroccan tile manu- facturer Le Mosaiste teamed up with Los Angeles interior designer Vinh Diep to create computer-aided design renderings of Le Mosaiste’s mosaic tiles in “real-world” living spaces. Or they may involve firms that are neither in the same industry nor
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related through the vertical chain, as when Toys “ R ” Us and McDonald’s of Japan allied to build Toys “ R ” Us stores in Japan that would include a McDonald’s restaurant (see Example 4.5).
A joint venture is a particular type of strategic alliance in which two or more firms create, and jointly own, a new independent organization. The new organization may be staffed and operated by employees of one or more parent firms, or it may be staffed
EXAMPLE 4.5 TOYS “ R ” US ENTERS JAPAN
In the 1980s, Toys “ R ” Us, the leading toy retailer in the United States, was eager to enter the Japanese market. Japan’s Large-Scale
Retail Store Law required that Toys “ R ” Us be approved by Japan’s Ministry of International Trade and Industry (MITI) before building its stores. This law, which protected Japan’s politi- cally powerful small merchants, made it difficult even for Japanese retailers, such as supermarket operator Daiei, to open large-scale establish- ments. Toys “ R ” Us concluded that it had to find a local partner. It chose a partner that already had considerable experience bringing an iconic American retailing brand name to Japan: McDonald’s.
Toys “ R ” Us formed an alliance with McDonald’s-Japan to help it navigate the politi- cally charged entry process. McDonald’s-Japan’s president, Den Fujita, was politically well con- nected and understood the ordeal Toys “ R ” Us faced, having built McDonald’s-Japan into the largest fast-food operator in the country. He also had a remarkable knowledge of Japanese real estate. “If you name a city,” he bragged, “I can see the post office, train station, everything.” In 1990, Toys “ R ” Us and McDonald’s-Japan formed an alliance in which McDonald’s took a 20 percent stake in the Toys “ R ” Us Japanese unit, Toys “ R ” Us Japan. As part of the alliance, 9 of the 11 Toys “ R ” Us stores would have a McDonald’s restaurant on the premises.
This transaction was a good candidate for an alliance both because it pertained to a small and specific element of both companies’ overall business and because it had elements that strongly argued for both “buying” and “mak- ing.” Toys “ R ” Us needed to obtain McDonald’s political know-how, site selection expertise, and business connections to enter the Japanese
market. It would have been extremely costly, perhaps even impossible, for Toys “ R ” Us to have developed this know-how on its own. These considerations argued for Toys “ R ” Us “buying” the political and site selection services from the market rather than “making” them itself.
By taking a stake in the success of Toy’s “ R ” Us’s Japanese venture—through both its 20 percent ownership of the venture and the colo- cation of the Toys “ R ” Us stores and McDonald’s restaurants—McDonald’s faced hard-edged incentives to carry out its part of the bargain. For example, McDonald’s-Japan estimated that a McDonald’s restaurant located inside a Toys “ R ” Us store would generate three times more customers than a stand-alone restaurant would. The potential payoff from this venture gave McDonald’s-Japan a strong incentive to work hard on behalf of Toys “ R ” Us. The alliance enabled Toys “ R ” Us to obtain the political services and site selection know-how it needed without having to make costly investments of its own. The alliance also avoided the difficult incentive problems that might have arisen had Toys “ R ” Us relied on traditional market con- tracting to obtain the services and know-how it needed.
Today, there are about 170 Toys “ R ” Us and Babies “ R ” Us stores situated on all three major islands of Japan, as well as two distribution cen- ters. McDonald’s also remains strong in Japan, although it recently closed over 400 poorly performing stores (leaving over 3,000 still in operation). But the McDonald’s/ Toys “ R ” Us affiliation came to an end in 2008 when McDonald’s sold its stake in the joint venture to Toys “ R ” Us following a legal dispute over busi- ness consulting services that McDonald’s was supposed to provide to Toys “ R ” Us.
independently of either. Examples of joint ventures include Sony and Samsung’s S-LCD, which manufactures LCD panels for televisions; NEC Lenovo Japan Group, which develops low-cost PCs for the Japanese market; and Cemex and Ready Mix, which share cement production and distribution.
Alliances and joint ventures fall somewhere between arm’s-length market trans- actions and full vertical integration. As in arm’s-length market transactions, the par- ties to the alliance remain independent. However, an alliance typically involves more cooperation, coordination, and information sharing than would occur in an arm’s- length transaction. Kenichi Ohmae has likened a strategic alliance to a marriage: “There may be no formal contract. . . . There are few, if any, rigidly binding provi- sions. It is a loose, evolving kind of relationship.”10 Like a marriage, the participants in an alliance rely on norms of trust and reciprocity rather than on contracts to govern their relationship, and they resolve disputes through negotiation rather than through litigation.
What kinds of business transactions should be organized through alliances? The most natural candidates for alliances are transactions for which, using the framework in Chapter 3, there are compelling reasons to both make and buy. Specifically, trans- actions that are natural candidates for alliances have all or most of the following features:
1. The transaction involves impediments to comprehensive contracting. For exam- ple, the transacting parties know that as their relationship unfolds, they will need to perform a complex set of activities. But because of uncertainty and the parties’ bounded rationality, the parties cannot write a contract that specifies how deci- sions about these activities are supposed to be made.
2. The transaction is complex, not routine. Standard commercial and contract law could not easily “fill the gaps” of incomplete contracts.
3. The transaction involves the creation of relationship-specific assets by both par- ties in the relationship, and each party to the transaction could hold up the other.
4. It is excessively costly for one party to develop all of the necessary expertise to carry out all of the activities itself. This might be due to indivisibilities or the presence of an experience curve.
5. The market opportunity that creates the need for the transaction is either transi- tory, or it is uncertain that it will continue on an ongoing basis. This makes it impractical for the independent parties to merge or even commit themselves to a long-term contract.
6. The transaction or market opportunity occurs in a contracting or regulatory environment with unique features that require a local partner who has access to relationships in that environment. For example, the strong role that the Chinese government plays in regulating foreign investment requires that nearly all foreign ventures in China are joint ventures with Chinese partners.
Although alliances can combine the best features of making and buying, they can also suffer from the drawbacks of both making and buying. For example, just as tra- ditional market transactions involve a risk of leaking private information, indepen- dent firms that collaborate through alliances also risk losing control over proprietary information. The risk of information leakage can often be more severe in an alliance than in a traditional market transaction because the conditions that tend to make an alliance desirable (complex, ambiguous transactions that do not lend themselves to comprehensive contracting) often force the parties to exchange a considerable amount of closely held information.
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In addition, although the loose, evolving governance structure of an alliance can help the parties adapt to unforeseen events, it may also compromise coordination between the firms. Unlike an “inside-the-firm” transaction, in an alliance there are often no formal mechanisms for making decisions or resolving disputes expeditiously. The “footprints” of this are delay and lack of focus, problems that plagued the highly publicized alliances between IBM and Apple in the early 1990s. These alliances were supposed to develop a new operating system, a multimedia software language, and the PowerPC. Instead, by 1994 IBM’s senior management had become so frustrated in its protracted negotiations with Apple over the operating system for the PowerPC that it concluded it would have been better off acquiring Apple rather than dealing with it through an alliance.
Finally, just as agency costs can arise within departments of firms that are not subject to market discipline, alliances can also suffer from agency and influence costs. Agency costs in alliances can arise because the fruits of the alliance’s efforts are split between two or more firms. This can give rise to a free-rider problem. Each firm in the alliance is insufficiently vigilant in monitoring the alliance’s activities because neither firm captures the full benefit of such vigilance. Firms that repeatedly engage in alliances may be less prone to free ride, lest they establish a reputation that pre- cludes them from finding future partners. Influence costs can arise because the absence of a formal hierarchy and administrative system within an alliance can encourage employees to engage in influence activity, such as lobbying, to augment their resources and enhance their status.