Managing Partner Relations in Joint Ventures

Between 1991 and 2001, the average number of joint-venture deals announced each year increased dramatically from 1,000 to 7,000. As that trend seems to be continuing, executives are clearly setting great store in these temporary partnerships as a way of achieving both short-term and longer-term goals.

Are they getting all they hope for? The answer is murky. While it has been argued that 50% to 60% of joint ventures fail, the definition of success and failure is blurred.1 Joint ventures last an average of six years and are then terminated for any number of reasons. Sometimes success is clear, as the partners have achieved the strategic and financial goals they sought when they began the venture. In other cases, the competitive environment has evolved so that the partnership no longer makes sense for one of the companies, and it sells its stake to the other partner (85% of joint ventures end with the acquisition of the venture by one of the original partners). In China, for instance, joint ventures were once the only way for foreign companies to gain access to that market; when the law changed to permit wholly owned subsidiaries, companies began to terminate joint ventures in order to fully consolidate operations and gain efficiencies. Although not all terminations have such neat explanations, joint ventures are increasingly viewed as strategic options to be exercised in due course. And achieving financial success in the limited window of existence is an ever challenging task.

Often at the root of difficulties within a venture are poor partner relations. Although partner-relationship management has been widely discussed by academics and practitioners, it does not seem to be well practiced.2 In order to maximize a joint venture’s potential over the course of its life, companies must pay more attention to the impact of partner relations on the performance of their offspring. Too often, a negative cycle develops in which poor partner relations lead to poor performance, which in turn puts the partner relations under greater pressure. In ventures where, for example, communication between the partners is primarily limited to formal board meetings, the joint-venture general manager will struggle to respond quickly to differences of interests when hit by an unexpected event like the loss of a major customer, the loss of market share or a general business recession.

Having worked with executives from joint ventures and their parents, I have identified five minefields that can explode and damage the relationships in an otherwise fruitful operation. (See “About the Research.”) Since joint ventures are here to stay —they are still sometimes the only way for a company to enter a new market or to gain access to key technology or people —managers must learn to avoid the minefields if they are to realize the full potential of these strategic partnerships.

Minefield #1: Unclear Partner Roles

During negotiations between two potential partners, a lack of clarity about how closely the two sides intend to work together is a common problem. Some ventures require the active participation of both parents to be successful, while others do not. In a venture that has a clear majority owner, the minority partner may be contributing money, a brand name or rights to a technology and have no interest in being consulted on day-to-day decisions. In such cases, information flows primarily between the majority owner and the joint-venture management team. A willingly passive partner is the key to the success of a majority-minority venture. Matters are more complicated in a venture structured to be 50-50 or when the minority partner wishes to participate actively in the decision making.

In 50-50 joint ventures, the companies expect to make roughly the same effort. But the key to a 50-50 operation is bringing together unique skill sets, so defining what constitutes an equal contribution of work can be tricky. The parents of a proposed partnership must articulate their assumptions and involve key people (who will continue to play a role in the venture) during the negotiations to define the contributions they will make and the benefits they expect.

In 1990, General Mills Inc. wanted to expand its business beyond North America but did not want to build an operation from the ground up, and Nestlé S.A. wanted to diversify into cereals, a growing business. The two companies established a 50-50 joint venture known as Cereal Partners Worldwide (CPW) and clearly defined what each partner was to contribute. General Mills provided its expertise in making cereal, and Nestlé added its brand recognition and distribution network in Europe and Asia.

The strategy worked. Since forming, CPW has expanded operations to 75 markets and captured 21% of the international cold-cereal business. Keys to this success included the upfront definition of the joint intent and the involvement of key executives from both sides early in the negotiation process. In addition, the venture’s negotiators were able to check with top management to remove many of the ambiguities (such as the definition of “cereals” in this case) that are frequently associated with unclear intentions.

Minefield #2: Unequal Sharing of Risks and Benefits

An important issue to resolve before finalizing any deal is how the value generated by the venture will be distributed between the parents. When the reward earned by one company is perceived as being out of line with the risks it is absorbing — possibly as a result of opportunistic behavior on the part of managers during the initial negotiations — an alliance becomes ripe for early dissolution.

Ensuring an equitable risk-benefit ratio is crucial to the longer-term health of the alliance. If such a ratio is to be clearly visible to the participants, another problem must be avoided: nontransparent payoffs to parents. Nontransparent payoffs occur when one parent is, for example, selling components to the venture and does not disclose to the other the margins generated through those sales. The lack of transparency means that one partner cannot be sure when, how and to what extent the other is profiting. Nontransparent payoffs are a source of distrust especially when the joint venture is suffering losses. One side often suspects that the other is profiting at the expense of the venture.

In the case of MobiNil, a joint venture formed in 1998 between Motorola, France Telecom and Orascom to run a mobile phone license in Egypt, each partner received and contributed differently. France Telecom Group received a management fee (for example, 2% of revenues) and dividends based on profits for running the operations, while Orascom Telecom (the locally based partner in Cairo) received only dividends and Motorola Inc. obtained an 18.6% stake for contributing equipment to the venture. France Telecom and Orascom came to believe that Motorola was unduly benefiting from the deal because although it did not have to carry the risk of operations, it earned an undisclosed amount of income from the margins on the base stations sold to the business. In 2001, France Telecom and Orascom bought out Motorola and replaced it with Nokia Corp. as equipment supplier; by 2002, the joint venture consisted of only the two remaining original partners.

Equity in the relationship should not be mistaken for equivalence of earnings. In an equitable relationship one parent may contribute more for a certain period of time, in the expectation that the other will contribute more in future years, yet the exact nature of the benefit may be different. The more the parents perceive that the right balance of contributions and rewards exists, the better joint-venture performance will be.

The joint-venture managers of Ericsson Hewlett-Packard Telecommunications (EHPT) worked to ensure that each partner had an accurate understanding of its contributions to the venture. Originally a 60-40 operation (Telefon AB L.M. Ericsson was the majority owner), the venture focused first on the development of network-management platforms and later on solutions for tele-com operators. At board meetings, contributions by each side were made explicit, and once a year those efforts were matched up against dividend payouts. The process ensured that both parents were aware of the risk-benefit ratio. Between 1998 and 2001, the year the venture was closed down, the joint venture expanded considerably and had an average growth rate of 10% annually.

Simply put, in higher-performing joint ventures, each parent believes the financial return is fair, considering what each is contributing. So that suspicions of unfairness don’t arise later, managers leading the negotiations should not always put the “deal” ahead of all other interests. Once the negotiating managers walk away, the deal has to be implemented. It won’t work if trust is breached as a result of deal making that takes advantage of one side’s weakness or mistakes.

Minefield #3: Mistrust of the Joint-Venture Manager

Once the deal is signed, the organization’s board of directors meets for the first time and has its first contacts with the joint-venture manager and his or her team. Distrust between either of the partners and the venture’s chief executive can seriously hamper the latter’s ability to make decisions and thus can limit the new company’s competitiveness. It is important to establish a high level of trust at the outset so that the joint-venture manager has the freedom to make decisions that are in the venture’s best interests.

In 1995, Leica Microsystems AG and the Carl Zeiss Group established a joint venture, called LEO Electron Microscopy Ltd., whose purpose was to become a key player in the electron-microscope business. But the venture’s CEO, a Leica employee before heading up the venture, received only a three-year contract (which contained an option making it possible to replace him after two years). That should have been a clear signal that his decisions would need continual approval from the parents. The executive ran into trouble when he tried to carry out plans that would benefit the joint venture but were controversial at Zeiss. In one case, he wanted to establish new supply channels in the Czech Republic in order to reduce costs, thereby reducing the venture’s dependence on Zeiss for the supply of raw materials. After a Zeiss board member became annoyed over the search for external suppliers, an agreement was worked out in which the joint venture would continue to be supplied through Zeiss but at lower costs.

But the general problem, lack of trust in the executive on the part of Zeiss, did not go away. In a second incident, the venture’s CEO wanted to directly license a component for the manufacture of electron microscopes from a third party. Zeiss, however, thought it had exclusive rights to buy from the third party. The Zeiss board member of the joint venture heard about the licensing agreement and as a result used his influence to remove the venture’s CEO from his position. Had the executive earned the trust of the board by working with the Zeiss board members informally before making decisions that were to Zeiss’s disadvantage, that would not have happened. The venture was dissolved in 2001 when Zeiss bought Leica’s shares.

Of course, when the chief executive is from one of the parents — as is often the case — he will have to go to extraordinary lengths to show the other parent that he can be fair. The joint-venture CEO should spend time with executives from both sides that have business links to the venture but are not part of the board. In formal meetings, the joint-venture manager has to lay out his strategy, show how the new organization will have a positive impact on the parent’s business, and demonstrate sensitivity to the issues that are particularly important to that parent. Informal meetings are also useful, as the relationships that form may lead to the venture executive getting the benefit of the doubt in times of potential conflict.

But the responsibility for making things run smoothly is not solely the venture leader’s. When the new operation’s manager has a time-bound contract, the implicit message is “We do not really trust your decision making.” And the original architects of the joint venture are responsible for aligning the two sides at the outset and selecting a general manager who can earn people’s trust.

Minefield #4: The Inevitable Crisis

If a joint venture gets off to a successful start, it will settle into a normal pattern of operation and stable relationships. Effective day-to-day routines will be established, and life will be somewhat predictable. The test of the joint venture will invariably come, however, when something out of the ordinary happens. The most difficult events are those that have the potential to pit the parents against each other.

Two events at Ericsson Hewlett-Packard Telecommunications led to conflicts that required renegotiations. One emerged at the April 1994 board meeting. Briefly, HP wanted to use a platform that it had developed internally as the basis for the joint venture’s core product (a network-management platform for telecom operators), while Ericsson felt that the HP standard did not have sufficient functionality to serve as a basis for public telecommunication customers; it wanted to continue the joint development of the product in the new venture. A year later, at the April 1995 board meeting, HP made the case that it should be allowed to sell EHPT products through its own sales organization, but Ericsson had been designated as the sole sales channel for the joint venture.

In both cases, compromises were reached. The key was the involvement of two of the original architects, both of whom were also on the board of the joint venture. The two executives resolved the difficulties that came up in 1994 and 1995 by aligning their respective organizational interests with the joint venture’s interest. They started by posing the question, Why are we pursuing the joint venture? For HP, the answer was increased access to telecommunication operators; for Ericsson, it was to provide a standardized high-quality network-management product. Both board members worked with the joint-venture manager on a business plan that was aligned with the goals of the parent organizations.

Having two board members, one from each parent, serve as problem solvers is ideal; it’s even better if they are the original architects of the venture. On the flip side, sometimes a manager from the joint venture can create the inevitable crisis, as the EHPT example also illustrates.

After the venture began, Hewlett-Packard appointed an alliance manager, an HP employee who was responsible for the interface between the joint venture and HP. That manager, however, became a bottleneck for information sharing. The joint venture’s engineers needed to share information directly with HP engineers if the common EHPT platform was to be a technical success; more specifically, engineers from EHPT needed proprietary information about an R&D project within HP to work effectively. But HP’s alliance manager blocked direct contacts with HP engineers because she was afraid that such interactions would lead to an unwarranted transfer of intellectual property to Ericsson employees. She would not allow for direct contact until she got HP management approval, a process that took nine months —during which no work on developing the product was done.

An alliance manager should facilitate the sharing of information within the joint venture, which in part requires negotiating with the parent about what is and isn’t proprietary. At the very least, someone in this position should help ensure that the joint venture doesn’t founder over conflicts about shared knowledge.

Minefield #5: No Exit Mechanisms

When conflicts escalate beyond a certain threshold, and the parties no longer feel they can work with each other, it is vital to have a formal exit mechanism in place so that costly and time-consuming litigation can be avoided.

In the EHPT joint venture, the venture’s business model came under scrutiny at a January 2000 board meeting. The question was whether in the future EHPT should focus on developing the network-management platform as well as providing network-management solutions or focus only on the latter. The venture had a contractual agreement in place that dealt with such deadlock situations, so the conflict was manageable (the platform business was transferred back into Ericsson). The board’s discussion led to a reassessment of the venture’s ownership structure; Ericsson increased its stake from 60% to 81%. By September 2001, Ericsson had amicably acquired the remaining 19% from HP. The focus had changed, and it made sense to bring the venture to a close.

Needless to say, if the venture is ending on a high note in which both parents have achieved what they wanted, the exit is not difficult to arrange. But if the venture is ending after years of poor performance, with one parent no longer able to absorb the losses, the exit negotiations are likely to be acrimonious.

When the Swissair Group decided in April 2001 to pull out of AOM/Air Liberté, the French airline group went into bankruptcy. Swissair had no explicit exit clauses and owned 49.5% of the group. This led to tough separation talks that included the French government, which did not want to let Swissair out of the venture. In July 2001, a French tribunal ruled against the breakup of the airline group, instead approving a takeover bid led by a former pilot from the Air France Group. Swissair was obliged to provide $174 million to give the airline a fresh start.

In order to avoid a similar scenario, it is important to include deadlock provisions in the original agreement that make it possible for the various partners to exercise buy-sell options at a predetermined valuation price. (EHPT had such provisions, which facilitated the smooth conclusion of that venture.) Crafting exit clauses by thinking about worst-case scenarios has only recently become a commonly accepted practice. Explicitly discussing and formalizing procedures in case of escalating conflicts would be a useful extension of the ideas behind formal deadlock provisions and exit clauses.

Given the short life span of joint ventures, it is surprising that many founders of joint ventures do not seem to have paid enough attention to managing partner relations. Traditionally, the negotiating managers see the potential of a joint venture as “the sky’s the limit,” while underestimating the amount of partner coordination that is necessary after the deal is signed. To avoid having to exit a venture that is by one measure or another a failure, the parents need to step around the minefields. They must establish effective working relations by creating forums of joint coordination that can ensure parental alignment of strategies. And the key is thinking through all the issues during the heady period of negotiations, not after the ink is dry and the day-to-day work has yet to begin. When misalignment does become obvious, however, the parties need to have considered the circumstances in which exercising their strategic options —whether by divesting their interest in the venture or acquiring the other company’s stake — makes sense.