Determinants influencing the survival rate of joint ventures

CONTENTS

FIGURES

TABLES

ABBREVIATIONS

1 INTRODUCTION

2 THE JOINT VENTURE

2.1 WHAT IS A JOINT VENTURE?
2.2 DIFFERENT FORMS OF JOINT VENTURES
2.3 GOALS AND MOTIVES OF THE FORMATION
2.4 NEGATIVE EFFECTS FOR THE JOINT VENTURE PARENTS

3 HOW TO MEASURE JOINT VENTURE SURVIVAL
3.1 DIFFERENT METHODS IN THE LITERATURE
3.2 PROBLEM OF CLASSIFICATION

4 VARIABLES INFLUENCING THE SURVIVAL RATE OF JOINT VENTURES
4.1 INTERNAL FACTORS
4.1.1 Differences in equity ownership
4.1.2 Cultural distance
4.1.2.1 National culture differences
4.1.2.2 Corporate culture differences
4.1.3 Direct competition between the parents
4.1.4 Differences in size
4.1.5 Complementarity of partners ’ resource contribution
4.1.6 Economic linkages
4.1.7 Trust
4.1.8 Partners ’ joint venture experience
4.1.9 Organizational learning
4.1.10 Diversification strategy
4.2 EXTERNAL FACTORS
4.2.1 Risk and uncertainty in the host country
4.2.2 Currency fluctuation
4.2.3 Number of partners

5 SURVIVAL RATE FIGURES IN THE LITERATURE

6 NEGATIVE EFFECTS OF A DISSOLUTION

7 CONCLUSION

APPENDIX

REFERENCES

Figures

Figure 1: Equity control and IJV performance

Figure 2: Effect of equity on mortality risk

Figure 3: Annual termination rate

Tables

Table 1: Annual variation in the termination rate of IJVs

Table 2: Summary of empirical studies on IJV stability

Abbreviations

illustration not visible in this excerpt

1 Introduction

Nowadays the world seems to be moving closer together and markets are becoming increasingly global. Firms take part in this globalization process and become international. A joint venture, particularly a cross-border joint venture, presents companies a promising oppor- tunity to expand into new markets. Joint ventures can help firms to broaden their geographical market participation, to acquire new knowledge, to create economies of scale and scope and, most importantly, reduce risks.

The number of newly formed joint ventures is growing worldwide at an increasing pace. Yan (1998) discovered that the rate of alliance formation in the U.S. has been growing at an annual rate of more than 25 percent since 1985. A lot of the joint ventures endure for a long time but many do not. Kogut (1989) discovered a termination rate of international joint ventures of about 70%. There must be several reasons why they are vulnerable to instability and why so many fail.

The aim of this thesis is to discuss which determinants have an impact on the survival of joint ventures. Guidelines are presented regarding aspects that need to be considered if a company wants to form strategic alliances with other firms. There are internal and external factors that influence the survival of joint ventures. Experts believe that some factors are controversial as they can influence the stability in a positive as well as in a negative way. No clear consensus is found yet. Therefore I describe their positive as well as their negative impacts on the longevity of a jointly owned entity.

In Chapter 2 of this thesis I introduce the broad subject ‘joint venture’ by explaining general information. I first define the term (see Chapter 2.1) and identify different forms of joint ventures (see Chapter 2.2). Then I go on and point out why companies are interested in participating in a venture and why they benefit from it (see Chapter 2.3) but also, why it can be unfavourable (see Chapter 2.4).

The following section (Chapter 3) deals with the measures of survival used in the lit- erature.

Subsequently, I describe internal (see Chapter 4.1) and external (see Chapter 4.2) de- terminants which influence the survival rate of joint ventures. In this section I discuss the in- fluence of differences in ownership structures (see Chapter 4.1.1), of cultural distances be- tween partners (see Chapter 4.1.2), of direct competition (see Chapter 4.1.3) as well as of several other aspects.

In Chapter 5 I illustrate results of the preceding chapter by showing figures of termina- tion rates and instability of different studies. As they all revealed different data on termination or survival rates, I summarize the average figures and note some of them in greater detail.

This is followed in Chapter 6 by a discussion of negative outcomes that can occur due to a joint venture termination.

I end my thesis with a conclusion (see Chapter 7), summing up the most important findings and present implications including which factors should be further researched and predicting what the likely future of joint ventures will be.

2 The joint venture

Initially, I discuss some general information about joint ventures and the motives for their creation as well as some explanations why firms sometimes refuse to become involved in this most intensive form of cooperation.

2.1 What is a joint venture?

When companies want to expand into a new business area or a new market they have different options to do this for example, an acquisition, supply contracts or licensing. However, interestingly companies predominantly prefer the joint venture.

Joint ventures have become a popular and effective strategy for companies for interna- tionalisation. There has been a rapid increase of international joint ventures in recent years. Yan (1998) found that the number of international cooperative arrangements formed in the 1980s exceeded the total number of international alliances created in all prior years combined.

“A joint venture occurs when two or more firms pool a portion of their resources within a common legal organization” (Kogut, 1988, p. 319) to pursue certain strategic objectives. These firms create a legally and economically new organizational entity distinct from their parent ones (cf. Beamish & Inkpen, 1995). This entity can be horizontally- or verticallyrelated to either (or both) joint venture parents but can also be an unrelated entity (cf. Harrigan, 1988). In other words, a joint venture is a means of performing activities in combination with one or more firms instead of autonomously.

In addition to domestic forms of joint venture, international joint ventures are very common. “International joint ventures are ventures in which the sponsoring partners cooperate across national as well as cultural boundaries” (Yan, 1998, p. 775). They are often formed between one or more firms from a developed country and a partner from a developing country and located in this emerging country. The foreign partner, from the developed country, provides the joint venture with upstream resources such as funding, brand and production technology. In return the local partner provides downstream resources such as familiarity with the local market, access to distribution channels, personnel, knowledge of local regulations and preferential access to the State authorities (cf. Meschi, 2005).

The joint ventures can be categorized into groups according to the purpose they should serve. These different forms will be explained in the following section.

2.2 Different forms of joint ventures

Most of the classifications usually distinguish two major types of joint venture. These types are different in the specific motive for which they are established. One type is an addi tive (Garrette & Dussauge, 1995) or scale joint venture (Hennart, 1988) whose aim is to achieve economies of scale and scope; the other type is a complementary (Garrette & Dussauge, 1995) or link (Hennart, 1988) joint venture that involves partners who want to combine distinctive but complementary competencies within a joint project. Another type is the Trojan Horse type, in which the partners engage in a learning race in order to acquire the other ones’ competencies as quickly as possible (Hamel et al., 1989).

A further way to discern joint venture is by the ownership structure which reflects dif- ferent partner nationalities and partner affiliation. The former involves the country of origin of the parent firms and the later is defined in terms of whether the joint venture equity is related between the partners. With this classification we can distinguish four ownership structures: intra-firm joint ventures, which are those joint ventures formed between affiliated home- country based firms; cross-national domestic joint ventures, which are established by unaffili- ated home-country based firms; traditional international joint ventures, which are developed between home-country based and host-country based (local) firms; and finally tri-national in- ternational joint ventures, which are formed between home-country and third-country based firms (cf. Makino & Beamish, 1998).

This thesis is primarily concerned with the traditional joint venture as this is the form empirical research predominantly focuses on.

2.3 Goals and motives of the formation

In this section I outline the main reasons why companies form joint ventures. The ra- tionales give an explanation as to why this kind of cooperation is such a popular form of stra- tegic alliance.

“The primary historic function of joint ventures is to enter emerging countries that are considered difficult to get into, for geopolitical, regulation-related or cultural reasons” (Meschi et al., 2003, p. 3). This is based on the fact that the market entrance of foreign firms into some countries (mostly emerging countries) is often hampered by political restrictions. Due to these local regulations that restrict foreign direct investment the joint venture is the only way to access the market (cf. Meschi, 2005).

Although this mode of entry is imposed by the local government the access of a for- eign company through an international joint venture has several advantages, compared to en- tering through a wholly owned subsidiary. The international joint venture allows the firm to share the costs and the risks of foreign entry and to use the local partner’s knowledge of the local institutional framework, local consumer tastes, and business practices (cf. Barkema & Vermeulen, 1997).

Additionally, it is often the case that serving of foreign markets through exports is impeded by high tariffs and non-tariff barriers, therefore a joint venture as entry mode is an effective method to avoid such costs (cf. Li, 1995).

Furthermore, an international joint venture offers the participating firms the opportunity to draw upon knowledge and capabilities that would be very difficult for them to obtain on their own (cf. Park & Ungson, 1997). Along with other benefits this can help firms to share costs, improve their capabilities, seek more radical innovations by integrating knowledge from different areas of science and technology, and generate common platforms for products and services (cf. Sirmon & Lane, 2004).

A joint venture provides the parents with opportunities to create economies of scale and critical mass, and to facilitate effective resource sharing which all helps to reduce costs (cf. Park & Ungson, 1997).

All these reasons make the joint venture a beneficial way of gaining access into a new business area, to share costs and to reduce risks. However, there are several disadvantages which arise from such cooperation. In the following paragraph I point out negative effects for the parties involved in a joint venture.

2.4 Negative effects for the joint venture parents

The above mentioned motives for the formation of a joint venture and the resulting benefits are numerous but in spite of these advantages there are several adverse effects of a joint venture for the partners. For example, involuntary loss of potential revenues, uncompen- sated transfers of technology, operational difficulties and problems, disagreements, and anxie- ties over the loss of proprietary information (cf. Park & Ungson, 1997). These anxieties occur due to the fact that partners have frequent access to the assets contributed by one another since the joint venture is created. Such access can offer one partner greater opportunities to gradually acquire and appropriate the other’s key firm-specific assets and may cause unde- sired leaks and uses of replicable firm-specific assets (cf. Lu & Hébert, 2005). Herewith the parents run the risk of creating a future competitor (cf. Gomes-Casseres, 1987). Therefore, firms should be careful and think accurately about these consequences before signing the con- tract for a jointly owned entity.

Having explained the basic information about joint ventures as well as its advantages and disadvantages for the involved partners I will now approach to the topic of this thesis by describing how scholars investigate into the survival and performance of joint venture.

3 How to measure joint venture survival

Duration and survival rate were the first measurements of the success of joint ventures, and they are still predominant in research literature. They are used to evaluate performance and stability of the joint ventures (cf. Meschi et al., 2003). Survival can be defined as the con- tinued presence of the joint venture in the host country and failure as its exit (cf. Li, 1995).

Although the measurements of survival are frequently used in joint venture studies there is no consistent measure.

In the following section I outline the different measurements that are used in the litera- ture.

3.1 Different methods in the literature

After investigating several studies whose topics were the longevity and success of in- ternational joint ventures, I found that the scope of measurement differs among studies. In some studies (Franko, 1971; Beamish, 1988; Blodgett, 1992) joint venture survival has been measured in terms of ‘instability’ which can be defined as changes in the division of owner- ship between partners or as major inter-partner renegotiations of a prior contract. In most studies (Gomes-Casseres, 1987; Harrigan, 1988; Kogut, 1988, 1989) joint venture survival has been measured by different forms of termination. These forms can be either sell-offs, dis- solutions or acquisitions. After measuring the number of terminations in a sample, a joint ven- ture’s termination rate can be calculated. The termination rate is defined as the ratio of the number of terminated cases to the number of newly formed joint ventures for an investigated period of time (cf. Makino & Beamish, 1998).

Research has conceptualized and operationalized international joint venture instability into an outcome-oriented approach and a process-oriented approach. The former characterizes instability as termination of joint ventures through various avenues and the latter defines in- stability as major reorganizations or contractual renegotiations (cf. Yan & Zeng, 1999).

Franko (1971) considered three categories of instability: firstly, the foreign firm in- creased its ownership to more than 95%, thus converting it to a wholly-owned subsidiary; secondly, the foreign firm increased its equity holding from a minority or 50% - 50% split to a majority under 95%; and thirdly, the venture was liquidated completely by mutual consent, i.e. its operation was halted and its assets were sold or scrapped.

Studies often use the event-history analysis to examine the effect of internal and external factors influencing the longevity of joint ventures on the exit rate.

“An event history is a longitudinal record of events occurring among a sample of firms. A central concept in event-history analysis is the risk set, defined as the set of firms at risk of a given event (e.g., entry, exit) at a given point in time” (Allison, 1984, cited in Li, 1995, p. 339).

The second component is the hazard (or exit) rate. This hazard rate is defined as “the prob- ability that an individual would experience an event in an interval from time t to t+s, given that the individual is at risk from time t” (Allison, 1984, cited in Meschi et al., 2003, p. 11). With this rate it is possible to derive a model of the duration or longevity of joint ventures.

Among those definitions we must bear in mind that termination or dissolution does not always imply instability and failure. Alternatively, it can signify a successful completion of the partnership or be pre-agreed by the partners at the founding (cf. Yan, 1998).

3.2 Problem of classification

It is often the case that the terms duration, stability and success are all used as synonyms for survival. Therefore a clear-cut differentiation of these expressions is impossible. Even if scholars used different operationalizations in their studies they investigated into the same area of interest. Thus, I regard these terms uniformly in my thesis so that stability can be equated with survival and vice versa.

4 Variables influencing the survival rate of joint ventures

I now come to the main part of this thesis and discuss factors which influence the lon- gevity of joint ventures. There is a long list of studies which deal with this topic. I examined a large quantity and filtered the most important and much discussed determinants. For some of these factors, the experts disagree on whether they influence the survival of the venture in a positive or a negative way. We must keep in mind that they researched in different areas and had different samples. So it is not unexpected that they achieved varying results. As we will see, the nationality of the joint venture’s partners is decisive to the success and the longevity of the relationship. But there are numerous other determinants which have an impact on the survival of a venture.

In the first part of this section I discuss internal factors, i.e. factors that can be influenced by the partners of the venture or inhere the partners. Subsequently, external factors will be discussed, to show that there are determinants that act upon the venture and therefore influence the stability of it, but which cannot be influenced by the venture itself.

4.1 Internal factors

The list of internal determinants influencing the survival rate of joint ventures is long and scholars continue to find new factors which can extend this list. I discuss each point in greater detail and explain that the factors are sometimes connected as they influence each other.

4.1.1 Differences in equity ownership

There has been a lot of research on the relationship between equity control and joint venture survival. However, no clear consensus on this issue exists. Some researchers reported a positive relationship (Killing, 1983) between ownership control and duration of joint ven- tures while others reported a negative relationship (Blodgett, 1992). The ones who advocate the dominant share position argue that equity is a measure of control and dominance in a joint venture. This implies that the more absolute control on party exercises the less potential for conflict exists as decisions can be made easily by the major partner and hence the venture re- mains stable. However, the ones who reported a negative relationship argue that the more the ownership is equally shared the less the instability will be as such arrangements allow for maximum involvement of both partners.

In this paragraph I present an overview of the impact that different apportionments of ownership between the partners can have on the longevity of a joint venture.

According to Blodgett (1992) joint ventures are more unstable when partners start out with uneven shares of equity. She hypothesis that “a joint venture that assigns majority (> 51%) - minority (< 49%) equity positions to the partner will have a higher hazard rate than one that divides ownership more equally (49% - 51% or 51% - 49%)” (Blodgett, 1992, p. 478). In contradiction to this, Killing (1983) argues that precisely dominance of one partner lends stability to a joint venture. Further to this, Killing says he does not believe a firm should enter a shared management venture unless it is absolutely necessary. It should only be estab- lished when it is abundantly clear that the extra benefit of having two parents managerially involved will more than offset the extra difficulty which will result. In his study he came to the clear result that dominant parent ventures significantly outperform shared management ventures. Killing states that due to the different equity shares the dominant partner has more power to make decisions and thus dictate terms. Thereby, there will not be long negotiations and dissonance about managerial decisions between the partners. He holds that the more the venture can be run as if it has only one parent, so virtually as if it were a wholly owned sub- sidiary, the simpler will be the management task.

However, Blodgett (1992) disagrees with Killing’s contention and believes that the minority shareholder feels to be left out in this constellation and therefore will renegotiate the ownership terms. This renegotiation leads to instability and constant tension between both sides. Joint ventures with slightly unequal ownership shares (51% - 49% or 49% - 51%) will show the tendency of renegotiation to a lesser degree. Joint ventures with a 50% - 50% divi- sion of equity will experience the lowest incidence of renegotiation because the roughly equal bargaining power of the partners puts pressure on both sides to make accommodations to the partnership. In her survey she found that the 50% - 50% shared-management arrangements have a greater chance for long life than the dominant-partner joint ventures.

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