Working Paper: European Strategic Alliances: Partners, Motives and Problems

Working Paper: European Strategic Alliances: Partners, Motives and Problems

Author: Dr. Colin J Butler

Assistant Professor

College of Business and Economics

UAE University

Tel: 00971506180174

E-mail:

Abstract: This working paper reports on on-going research on the strategic alliance activity of defence manufacturing firms in 5 European countries: UK, France, Germany, Sweden and Czech Republic. Strategic alliances are being used to share costs and risks in defence manufacturing and the research aims to analyse firms approaches to alliance formation. The main problems experienced by the firms in the sample are similar to problems found in other studies. The motives are market and technology-driven. European partners are popular as well as partner sin the US. This differs from previous research on the industry which found that the US, being the largest market, was the most popular country for alliance formation.

Introduction

The two main challenges for firms in the globalized market have been the increase in costs for achieving competitive advantage and the need to deliver products and services around the world to many more countries in order to achieve a return on this advantage.

Firms may, in the first instance, be capable of accessing new markets, previously considered too distant or too costly, by themselves. However, the risk associated with pursuing such strategies alone can be too great. Thus, firms adopt co-operative strategies to achieve competitive advantage and reduce risk. The benefits are lower as they are generally shared with other co-operating parties but the costs and overall risk to survival are also lower. Firms can, however, increase market share without exposing the entire business to unforeseen and potentially calamitous conditions. Essentially, only parts of the firm are exposed in any one area of alliance formation. Thus, if one part of the business finds itself under attack by environmental changes, the rest of the business is protected. The attraction of strategic alliances is the ability of a firm to add value to its products, achieve a return on investment and at the same time, circumvent over-exposure to risk.

Interpretation of Strategic Alliance ‘Family’

Not all authors agree on what is a strategic alliance and what it is not. Some form of co-operation is a pre-requisite and certainly the alliance must be differentiated from a merger or an acquisition; alliance partners must remain separate in other areas. Yoshino and Rangan (1995:5) state that there are three necessary characteristics: the two firms remain independent subsequent to the alliance; partners share benefits and control of the alliance.

Harbison and Peckar (1998) maintain that alliances are used because mergers and acquisitions are too expensive. They also maintain that competitive advantage comes from using partnerships to fill critical capability gaps. Joint ventures are an area of contention between alliance authors with some interpreting this form of management as a strategic alliance whilst others reject them. The main difference between JVs and other forms of alliance is the establishment of a new entity and alliance theorists differ over whether this excludes the structure from the alliance class.

In essence, strategic alliances are agreements between two or more firms to cooperate with each other in some way for varying lengths of time. The degree of cooperation falls within a broad range of parameters from informal exchanging of knowledge to more formal agreements, such as joint ventures. Similarly, the structure and duration are variable depending on the type of strategic alliance formed. Osborn and Hagedoorn (1997) view on alliances is that “each is unique but they often share similar properties”.

Harrigan (1988:4) states that, where the competitive setting is volatile and the aim is price cutting, a joint venture is less likely and that "joint ventures restrict the sponsoring firm's abilities to enjoy the close co-ordination they seek in global strategies".

Harbison and Pekar (1998:81) stated that "the structure chosen determines what types and amounts of knowledge or information are transferred". Equity based alliances tend to lock in firms and are less flexible. They also point out that "more critical to the alliance than competitive success over the long-term, the creative contribution and technological resources and shared information are the firm's contribution to an alliance".

Firm Motives for Alliance Formation

Motivation for strategic alliance formation may differ from industry to industry. The motives (see Fig.A for detailed list) must fit into the overall strategic plan because alliance formation could become a strait jacket to future expansion. For example, in alliances where the motive is to seek economies of scale, the exit costs tend to be very high (Doz and Prahalad 1998).

Fig.A Sample of Strategic Motivation for Alliance Formation (non-defence industry specific)

Technology Development

Share R & D costs

Exchange of Complementary Technology

Exchange of Patents

Market Power

Maintain Market Position

Produce at Lowest Cost Location

Reduce Competition

Market Development

Facilitates International Expansion

Faster Entry to Market

Gain Presence in New Market

Conform to Foreign Government Policy

Resource Specialization

Concentrate on Higher Margin Business

Economies of Scale

Faster Payback on Investment

Large Project

Spread Risk of Large Project

Product Diversification

Source : Adapted from Glaister,K.W. and Buckley,P.J. "Strategic Motives for International Alliance Formation" in Journal of Management Studies May 1996 p.320

It is increasingly likely, in most exporting firms, that some form of strategic alliance will be used as a stepping stone in any overall management development strategy. Not all planning, however, is directed at these emerging markets. Traditional markets must also be developed in the strategic planning process. The primary motive may not necessarily always be the local market share itself, but may be other alternative inducements, such as the transfer of knowledge, the acquisition of finance or knowledge skills that the initiating firm lacks.

Technology and Costs

The need for change is fundamentally being driven by the mounting need to cut costs. Strategic alliances such as collaboration have helped by sharing development costs and securing longer production runs. One of the effects has been for firms to attempt market stabilisation behaviour by the formation of pre-competitive collaboration in weapons and defence equipment research (Mussington 1994). However, in terms of industrial consolidation, it has done little to help (Weston 1999).

Mussington’s (1994:14) arguments on costs suggest that "the importance of the profit motive of the necessity of amortising high fixed costs of research and development over large production runs and perceived desire to maintain firm autonomy all create potential conflicts between state interests and those of the defence sector". Anthony et al. (1991) indicate that costs have compelled the production of many products which apply the technology developed.

Rising costs are mostly due to the increased sophistication of weapons systems, sophistication gained mainly by the installation of more electronic subsystems. The percentage costs devoted to R+D for a combat aircraft have doubled in 25 years. The costs of military aircraft increase by a factor of 4 every 10 years (Blunden 1989). Martin and Hartley (1995:22) suggest a cost figure range of between 10 and 20 per cent for shared production work with the low figure applicable to advanced nations and the higher figure applying to less advanced figures.

Due to rising costs buyers are seeking less costly ways of achieving a share of the industrial benefits associated with the purchase of foreign defence equipment. This has led to the growth of off-sets. Purchasers of defence equipment tend to have a preference for the indigenous development and production of such goods because it is believed that this form of procurement generates new technologies (which might spill over into civil industry), provides jobs, improves the balance of payments and offers security of supply (Martin and Hartley 1995)

The cost issue is forcing firms to assess what type of equipment to manufacture in the short-term. With the guarantee of regular and lucrative work removed, firms can no longer afford to manufacture across several sectoral lines. The loss of a single contract may compel the firm to exit that particular sector altogether because there may not be another contract which they could win for several years.

On a sectoral investigation, Mayer (1993:166) added that “the decline in combat aircraft production poses severe challenges”. The reason is that “airframe manufacturers lose both the incentive to invest in important technologies.....re-entry into the aircraft business is thus nearly impossible for firms who have gone any length of time without production contracts”. One solution has been to allow “teaming” where several contractors work on one program. the problem with this is that contractors may not offer their best designs if the are working so closely with competitors. Recent tendering competition have also illustrated the trend towards consortia with several firms submitting a bid as a team[1].

There are three main advantages to collaboration. The first is that collaboration enables participating countries to move into technological areas formerly beyond their national reach. The second advantage is that they should result in lower unit costs and the third advantage is that the benefits can be spread to the sub-contractor. The innate desire to protect national interests drives governments under threat to feel the need always to move into a higher division of technology in weapons procurement. Thus, alliances assist the spread of technology and, arguably, the proliferation of local arms races (Draper 1990).

Another form of co-operation, licensed production, has helped foster development of defence industries in what were previously pure importers of military equipment, such as Brazil, South Korea, India and Taiwan. This policy not only allows the licensee to gain access to the markets but also helps to stabilise regions. Off-sets are another form of co-operation. Off-sets are, however, more likely to be used by larger firms only (Martin and Hartley 1995).

Methodology

The literature on strategic alliances identified motives for successful alliance formation as well as causes for problems. These theoretical axioms supposed that usual free-market commercial industry practices were in existence. The model was unproven, however, in conditions where the free-market commercial practices were not in operation to the same degree. There was no evidence to suggest that the model could be applied to industries that operated within certain environments. The defence industry was one of those environments being, as it is for example, excluded from the Treaty of Rome governing the European Union's Single European Market. Defence industries globally hold a high strategic value in the views of governments and, therefore, command a lot of attention when there are changes, or potential changes, being executed. The alliance model derived from a range of other industries may not, inevitably, be appropriate or wholly applicable to defence manufacturing. Alliance theory, therefore, needs to be investigated under conditions governed by high degrees of political constraints and unusual market conditions, such as monopsony and complex financial arrangements. A large-scale survey was used to collect the data.

The large-scale survey to identify a population of relationships between firms that fit within the remit of our definitions encountered several difficulties, showed some problems of conducting this research across different countries. The response rates for the first survey are shown in Table I..

Table I Response Rate for Large-Scale Survey

Findings

The most popular usage of strategic alliance is collaboration with 71% of the sample involved in this type of structure. Licensing is used by 69% of firms. The number of firms using in joint ventures is 33%. Table II shows the usage by alliance type.

Table II Alliance Usage

The most represented sector is Land Systems. This includes tanks, armoured vehicles, artillery, other types of wheeled vehicles and engines. Some firms are involved in several sectors.

Table III Industrial Sectors of Firms

Table IV Motives for Strategic Alliance Formation

The majority of firms in the sample are seeking technology development from their cross-border strategic alliances. From the data the firms are using collaboration and licensing to achieve this objective. The low usage of joint ventures suggests that partner firms are reluctant to form a new entity with them and wish to limit interfaces. The other motives include maintaining market power, sharing research and development and diversification. The firms perceive strategic alliances as a beneficial method to achieving these goals. Table C shows the top 10 motives for alliance formation.

Major Problems

The most common problem is control of decision-making. The second most frequent problem is lack of communication between partners. Table V summarises the data on problems.

Table V Major Problems in the Sample’s Strategic Alliances

Partner Selection

Table VI summarises the most popular countries for partner selection

Table VI Main Partners in Strategic Alliance Formation

Discussion

Germany and the USA are the most popular countries for seeking partners.

Collaboration is the structure most firms are involved in and is the preferred structure

of most executives. Collaboration prevails in the high technology sector including the

large platforms incorporating this technology. There is a lot of association between

joint ventures and the use of strategic alliances within the literature corpus but these

findings show that joint ventures are not as popular a form of alliance as seems to be

the case in other industries.

The main reason for the dominance of collaboration is the greater control it affords to

firms. The multi-dimensional nature of the decision-making process in this industry

influences the prevalence of structures. If firms feel that they retain more control in

collaboration and lose it in joint ventures, then this structure keeps a very complex

alliance, from both managerial and political processes more simple. Joint ventures

theory derived from the literature appears not to differ too widely with the data where

JVs are recommended as a vehicle for market access, are used for major investments

and are a legal entity but management organisation does not integrate easily within

the firm’s group.

The main motives for alliance formation are technology development, maintaining

market power, diversification, sharing R+D and exchange technology. This

corroborates the findings in the literature. The rising cost of technology is compelling

firms to seek partners. As one failure to win a major contract (which may only be

offered every ten years) could potentially ruin a business, firms are seeking to lower

risk and cost whilst maintaining market power.

Control of decision-making is the most frequent problem associated with alliances.

Lack of communication is the second most frequent problem experienced by the UK

firms. Whilst the interpretation of control within the literature revolves round

ownership structure, the concept is multi-faceted in the defence industry. When

deliberating over the issue of control firms are faced with not only commercial

decision-making processes such as ownership structure but also degree of integration

within the group.

Lack of trust causes problems but a fear of contact with third parties is low. The lack

of trust may be related to the problems over control or lack of communication.

However, the confidence that the major European partners do not make contact with

third parties is important for restricting technology transfer. The popularity of

Germany and the USA may be related to these problems.

The most popular countries for alliance partnerships are Germany and USA. The USA

is the largest market and this finding is not a surprise. The difference between the

levels of participation between Germany and the two other leading European

countries, the UK and France, is surprising. This may be because of the large

representation in the land systems sector rather than the electronic and information

sectors such as air systems and C4I.

This research bore out the importance of control of decision-making in the defence

Industry. It confirmed the similarity of alliance problems such as

communication and cultural differences. It identified the leading motives for alliance

formation and the most popular countries for seeking partners.

The applicability of contemporary strategic alliance theory to the defence industry

closely mirrors other industries when the uniquely political nature of this industry is

not factored in. Executives in the industry are effectively managers of a business

similar to managers in all industries. When these managers are allowed to operate

their business in a commercial environment, the evidence provided by the data