Joint Ventures: The benefits and perils - why some are successful and others fail

Contents

Intro - What is a joint venture?

Why do firms venture?

Entering foreign markets

Reasons to venture become competitive advantages - the benefits

Problems and common reasons to fail - the perils

Designing ventures that work

Conclusion

References

Intro - What is a joint venture?

Over the last decade, we were able to witness rapidly growing companies, some of them seeking for partnerships to take advantage of positive synergy effects to gain in size or to enter new foreign markets. The topic of this essay should be why firms seek to venture, what the benefits of venturing are and why some firms fail after the venture, what are the downsides of this concept?

The concept of the joint venture was developed in the United States. First, we need to make a distinction between purely contractual, non-equity joint ventures, on the one hand, and equity or corporate joint ventures, on the other.

The regular form of joint venture is a company that is founded out of equity provided from two other entities. This venture is similar to a business partnership but limited to a specific project or purpose.^[1] The equity joint venture manifests the founding firms' willingness to cooperate by providing each a certain percentage of the common capital stock as illustrated in the graphic below (in this case with each partner providing half of the capital stock).There are countless ways to build up an equity joint venture with each partner providing only a certain percentage of the common capital stock (e.g. 70/30%, 90/10%, 51/49% and so forth). The firms gain control over the founded joint venture and share revenues, expenses and assets in equal proportion to their respective contributions to the venture's registered capital. Differing arrangements are possible.

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The above-mentioned equity joint venture^[2] shall be seen as the regular case of venturing.

Another case of JV, as an irregular form, is the purely contractual or cooperative joint venture. This juridical form was first introduced in China and dilutes the venture concept unnecessarily^[3]. The contractual JV is just a special case of partnership and is very similar to a usual business partnership with only a contract between the two entities enclosed^[4]. The Cooperative joint venture differs from the "real" joint venture in several aspects: First, the venturers do not create a new legal entity. Second, the share of revenues and the composition of the management board do not depend on the proportion of capital contributed. However, these rules only apply to Chinese markets (which are nonetheless worth mentioning since China became the world's biggest recipient of foreign investment (including joint venture) in 2003)^[5].

To further differentiate the definition of joint ventures, there are three distinguishing factors according to which the ventures can be categorized, namely concept, region and function. As stated above, the most important differentiation is made between an equity JV and a contractual JV. Further, one has to differentiate between purely domestic (two firms from one country venture), or international (companies from at least two countries) ventures.

Also, we can categorize the newly founded companies according to their purpose such as research and development, marketing tasks or production issues.

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In the juridical view, several international distinctions in the definition of a joint venture are being made. Therefore, the international regulation and transnational juridical controllability is problematic. As international lawyers assess the situation in the European Union as being "failed", joint ventures remain a fleeting concept, which is regulated by the laws of respective contracts and the law of companies of the region and/or country wherein the joint venture company has been set up. In general, joint ventures are subject to all-embracing anti-monopoly principles, competition laws, technological norms and so forth.^[6]

What is most important and most commonly incorrectly understood is that the term joint venture refers only to the purpose of the entity and not the particular legal type of entity. It is possible to call several forms of entities "joint venture" such as a limited liability enterprise (German GmbH) or other juridical corporate forms. The legal type of entity that best suits the needs of the business depends on a vast number of criteria including tax and tort liability.^[7] Most importantly, the joint venture is set up to be a separate legal entity and therefore accounts for its own liability (except for invested capital).

Whereas the contractual equity joint venture is often merely a special case of a partnership, an equity joint venture is similar to a usual business partnership with two differences: a partnership generally involves an ongoing, long-term, infinite business relationship which can cover several topics and segments, whereas an equity-based joint venture very often comprises a single business activity.

Also, the time frame of the concept is to be considered. A distinction therefore is to be made between putting together resources for an infinite time or a bounded time frame: The first case is merely a business partnership and not to be considered an equity joint venture (even if another legal entity is founded and provided with equity). In the second case, a particular time- or purpose-framed entity, the company is being terminated once the purpose of the entity is fulfilled (for example carrying out a particular project). In such a case the joint venture is more correctly referred to as a Special Purpose Company which serves the purpose of providing the basis for a consortium (or similar cooperation agreement). As a non-permanent structure, the joint venture can be dissolved when the aims of the original venture have been met or not met. As soon as either or both parties develop new goals or no longer agree with the joint venture aims, the time frame for the joint venture has expired, legal or financial issues or evolving market conditions mean that joint venture is no longer appropriate or relevant. In such cases the Joint Venture Company may become dissolved or terminated - all in accordance with the Articles of Association and other legal terms that may be in place.^[8]

Why do firms venture?

Entering foreign markets

The most common case for venturing is that two firms belong to different countries and different market situations and strive for some business that - for very different reasons - they are not able to achieve on their own. The creation of a joint venture company is more or less the "vehicle" on the two enterprises' ways to business success. In this essay, I will focus on the situation of two firms from two different countries seeking to venture in order to enter into new markets or to penetrate markets one firm is already engaged in. In recent economic developments, conquering new foreign markets like the world largest markets, i.e. China and India, which gained vastly in buying power over the last decades becomes more and more promising and mostly necessary for companies from industrialized countries in order to strengthen the firm's selling power in the future. This often tends to be a decision on the future strategic alignment of the company as well.

In a globalized world, those decisions may involve entering into foreign markets, often a "terra incognita" or unknown territory. One firm has to decide on the degree to which it wants produce and provide goods in the home market or abroad.

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Let us look at a quick example: Swabia's hidden Champion "Spezialmaschinen Hauber" has a 50-year tradition in producing machines in a very specialized segment. The firm sees its products able to compete against others and wants to sell its products in foreign markets, in this case in India. Now, the CEO of the firm has to decide which strategic path the firm shall choose, specifically how much of the value-added chain it wants to set up in India and how much capital it wants to deploy abroad. Do they want to export goods (with all trade tariffs in mind), license their products to another producer in India, build up a franchise or subsidiary branch and produce abroad, create a project-based joint venture with an Indian partner to share assets and revenues, manifest a strategic alliance, which means finding a foreign partner to pursue an agreed goal while remaining independent companies or concentrate on a foreign direct investment (FDI), which means acquiring more than 10 percent of equity in an existing company abroad to secure lasting management interest?

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All of the above-mentioned forms and possibilities to enter foreign markets are of course afflicted with their own risks and benefits. These risks mainly depend on the degree of legal commitment and the degree of trust you need to have in a potential foreign partner. While it is much easier to exit franchising, licensing and exporting agreements, strategic alliances and foreign direct investments are much more difficult to dissolve.^[9]

[...]

^[1] Zecchini (1990), p.51

^[2] Joint venture may further be referred to as "JV"

^[3] Trost (2011), interview

^[4] In this essay, I will only relate to equity joint venture since the contractual joint venture is a merely special case joint venture.

^[5] United Nations Conference on Trade and Development (2004), p.5

^[6] cf. Mallat (2009),p.1

^[7] cf. Mallat (2009),p.1

^[8] cf. Boitout et al. (2006), p.2

^[9] Cf. Meffert et al. (2008), p. 291