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The Strategic Logic of Alliance

Alliances have become an increasingly important – and complex - part of corporate strategy. According to one estimate, approximately 30% of global revenues in 2010 were a direct result of alliances – up from 2% in 1980. As more and more companies shift their attention to growth after a period of consolidation and restructuring, it’s likely that the upward swing in alliances will continue.

To create successful alliances, however, a company must understand when alliances make strategic sense – and how to manage them for business results. Alliances can be extremely useful in situations of great uncertainty and in markets with growth opportunities that a company either cannot or does not want to pursue on its own. But the advantages of shared risk are often offset by unclear governance and lack of genuine commitment; for that reason, alliances must be managed carefully.

Now what are alliances exactly? Alliances are collaborations in which 2 or more companies jointly invest in an activity, sharing in the risk and potential returns but remaining independent economic agents. Some alliances – for example, joint ventures – involve the creation of a new legal entity. As a young general manager, I was send to Romania to set up a publishing firm. When my employer Sanoma, one of the largest magazine publishers in Europe, made the decision to set-up a publishing company in Romania, they invited Hearst to join them. The main reason was direct access to some renowned Hearst licenses like Cosmopolitan, Harpers Bazaar or Esquire. But most alliances are simply contractual relationships of longer duration and greater complexity than traditional customer-supplier relationships.

One of the main reasons to engage in an alliance, as opposed to a conventional merger or acquisition, is to share risk and limit the resources a company must commit to the venture in question. Risk can take many forms. One is the financial risk associated with the high costs of the investment required to pursue a particular opportunity. An alliance can be a way to spread – and sometimes even lower – those costs. The multicarrier alliances in the airline industry, for example, allow companies to take advantage of the network effects made possible by a global system of hubs that any single company would find prohibitive to build on its own. Companies also commonly use alliances to manage the risks associated with emerging markets (China!).

Finally, companies in industries going through a major technological or business discontinuity are increasingly turning to alliances to manage the risks associated with uncertainty. The telecommunications industry, for example, has been going through a profound transformation brought about by the convergence of telecommunications, information technology and consumer electronics. The huge investments needed to create national coverage might invoke companies to consider a strategic alliance with a third partner. As this last example suggests, alliances are a way to maximize flexibility. Through an alliance, two (or more) companies can quickly combine complementary assets and attack a business opportunity together.

However, alliances are less effective when the partner’s assets overlap considerably and when there is economic value to be gained through consolidation and cost cutting. Because the partners in an alliance remain independent, no one partner can control the others completely – and, therefore, decide who will suffer the consequences of tough decisions about reducing costs or consolidating operations.

In many respects, implementing an alliance is similar to conducting a merger or an acquisition. A company needs to put a structured process in place to define the explicit role of alliances in its strategy, identify appropriate partners, build the right kind of relationship, and manage that relationship over time. Philips Electronics, for example, uses a simple matrix to divide its alliances into four groups on the basis of the amount of synergy among the partners and the potential long-term value of the alliance to Philips. Business alliances are largely operational or tactical, usually focussing on logistics and purchasing. Strategic alliances usually focus on developing a new product, service, or business. Relationship alliances are partnerships that are long lasting or span multiple divisions. Finally, the company identifies every year 10 alliances that are particularly important to its strategic goals. Each of these formally designated corporate alliances is sponsored by a member of the Philips board.

Considering the high growth levels in some industries and the increasing level of competitiveness, alliances might be a good alternative to M&A for companies that either want to engage in new businesses, or want to strengthen their competitive position on the home market by partnering with a third partner who has certain additional competences and/or resources. The challenge for owners/managers is how to cope with the level of uncertainty in terms of governance and control that are intrinsically part of alliances.

This article was written by Peter Jansen.

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