Lateral Capital Management, LLC

Joint Ventures: Eleven Keys to Success

Beginning in the mid-1980s, “partnering” was adopted by big companies as a core strategy for entering new markets on fast timing. It was designed to reduce working capital, increase business focus and better meet the needs of global customers. In recent years, this approach has taken a turn to engage Early Stage companies (ESCs) as partners. The idea is that big companies can often get the value of new thinking from smaller companies without buying them. This is often attractive to ESCs because it preserves their lives as independent entities. The question is how to “do this right.”

What Are JVs? – Basically, JVs are partnerships of various descriptions, including manufacturing alliances, licenses, resellers, contract business management and (for the purpose of this material) companies that share ownership. Especially in non-U.S. markets, companies combined in special purpose JVs to enter new countries more efficiently. Broadly, JVs have become an industry standard approach, but the results have been at best uneven. This list of “Keys to Success” highlights some of the most frequent areas of conflict and concern.

  • Ensure that the Joint Venture has a unique, sustainable reason for being. JVs are painful to negotiate and even harder to manage. So, the reason to adopt one has to be more than save on distribution costs, lower overhead costs or enter new markets more quickly. These benefits are real, but they are typically exhausted after Year-2, putting the Joint Venture into the same “what do we do now” position the member companies were experiencing in the first place. Sustainable reasons for Joint Ventures do exist, but the parent companies have to be brutally honest about why they are choosing such an inherently unstable model. The short-term synergies will be real, but they are often just enough to pay for the huge, often hidden costs of starting up the JV. Experience is that while synergies drive the initial headlines, the true long-term business purpose is far more important.

Here are three examples of JV objectives we have seen which led to strong long-term business models:

  • Long-Term Competitive Advantage with Customers – Merging branded product manufacturing with private label operations at one set of plants can save costs via increased plant utilization. This type of alliance will deliver even more leverage if it offers co-production/packing/selling/distribution of private label and branded products to the same retailers. For example, retailers who display combined pallets of private label and branded canned goods shipped directly to their stores from one plant, will have a significant cost advantage.
  • Expanded Leverage of World Class Product Technology – Manufacturing Joint Ventures will deliver significant advantages in joint packaging/manufacturing/distribution of products. But the real value of the JV will not be realized until unique technology contributed by both companies is reapplied across the combined product line. For example, high rate manufacturing skills from one partner will be much more effective if combined with superior product technology from the other.
  • Products expanded from One Distribution Channel Into Another – For example, if software designed for industrial applications can be adapted to the small and medium business segment (SMB), the user base for the core programming can be greatly expanded. If one partner brings the product and another the distribution expertise, a great JV can be born.

Importantly, the “sustainable reason for being” needs to be expressed succinctly and publicly, so there’s no going back. (“Burn the rafts.”) After the JV is launched, it cannot afford to re-explore or “further define” its reason for being. Everyone has to “get it” the first time. This means that whatever is said publicly about the business purpose needs to be expressed in compelling terms: Distinctive, easily understandable reasoning that says exactly how the JV can produce a business result that neither parent can achieve alone. It should be so simple and obvious that it can be used in press releases, with financial analysts and prospective employees. The difference between a good reason for being and a muddy one can make all the difference in being successful.

  • Plan for the end at the beginning. JVs are not destined to be forever structures. Before entering this type of partnership, both parties need to know how they will get out. Will one party buy the other? On what timing and on what terms? Will the JV become its own public vehicle of some kind? How and when? The parties need to talk about these eventualities openly and construct their contract with a clear “end in mind.” Otherwise, both parties become very tentative about the relationship, always playing out “what if” scenarios as a way of never really committing to the JV’s success. One other point: assume the exit arrangements become broadly known to employees, customers and suppliers. They are impossible to keep secret, and a general public understanding is much better than endless speculation.
  • Be certain the parents agree on financial goals for the Joint Venture. While this sounds obvious, parent companies frequently make different assumptions about what the JV should accomplish, how that will be measured and over what time schedule results should be expected. Capital appetites are also frequently mismatched with one party assuring the other of their willingness to invest, only to starve the JV later with a change of heart because of unrelated internal needs. Sound advice: Agree on cash flow objectives, investment hurdle rates and capital approval criteria in advance.

Once the goals are translated into annual targets, set clear forecast peg dates and hold the JV management to the numbers. Parent companies should treat the JV like any other operating unit, expecting it to hit shipment/share/profit targets, according to a set schedule. Financial staff in both parents should act as the key day-to-day liaison to the JV so that the results are anticipated in time to adjust spending if the results miss expectations.

  • Set clear, comprehensive boundaries from the start. JVs need to be carefully defined in terms of four kinds of boundaries:
  • Product Lines – Which products from the two parents are considered part of the JV? Is this defined by brand (e.g., anything and everything sold under the name Dell, Nestle or NewCo software) or by specific types of product under that brand? Does that include all product forms and all sizes? All distribution channels, including direct to consumer/Amazon? What about private label, OEM or industrial customers? What about new products developed in other markets by either of the parents: Does the JV have an automatic right to introduce these as new products in the JV geography or distribution channel? To import them from other markets? Or do they have to negotiate “Importation” with the parents? On what terms? Most favored nation?
  • Technology – Who owns the technology the JV will use? Patents are easily assigned or licensed to the JV for specific purposes, but what about Trade Secrets or proprietary-making processes? How are these boundaries defined, and how are technical differences of opinion to be adjudicated, without making what the parties “can’t disclose” part of the JV agreement? What happens to new technology developed in the JV? Who owns that?
  • Types of Customers – Can the JV sell to anybody in the JV geography? How about to customers who will sell JV products into non-JV areas, perhaps competing with products sold elsewhere by one of the parents? (Depending on the item, remember that products will typically “transship” across Europe or the U.S. anytime the price differential market-to-market exceeds about $1,500.00 per truck (40,000 lbs.)) or about $6,000 per container (18,000 kg). What about types of customers? Does either parent want to reserve a trade channel for some reason – peanuts to airlines, for example – which one parent might want to sell globally, using a worldwide sales agreement?
  • Geography – To what area will the JV be confined? Is this an economically discreet area, with (for example) a common currency, similar political history or common ethnicity? How many trade barriers are there between sectors of the JV area? Is this JV likely to be distracted by those barriers? Do both parents really want to do business there for the long-term, or is one area much more important than the other? Is the JV of equal value to each parent in each part of the intended geographies, or is Country B included only to convince one of the parents to go into Country A? How will the JV handle geographies which one of the partners is forbidden from selling in – or just doesn’t like? What if a despot takes over the county and requires “baksheesh” to do business?

As an example of how important boundaries can be, consider the simple issue of cross-border shipments. If products sold by either parent outside the JV geography are resold by distributors in the JV area, the JV will rightfully complain about “parallel imports” that undermine the JV’s pricing and distribution plans. This can be the natural reaction of one parent’s non-JV sales force, trying to make their quota by selling to gray market distributors at special “export prices.” Or it can be purely inadvertent: It is impossible to control where distributors sell or at what price. For the JV, the result is the same in terms of chaos, finger pointing and de-motivation. The solution to this is to acknowledge the issue up front and put an economic value on the likely impact on the JV. Alternately, the JV area can be expanded so that all relevant products in a trading area (typically, this winds up being an entire region) are put “in” to the JV.

Similar solutions exist for almost every “boundary” issue. If they can’t be defined in advance and put down in the agreement, don’t proceed. There is only one chance to get this right, and that is when the JV is formed. If you don’t do it up front, issues will arise almost immediately.

  • Agree on a truly independent CEO, and then be prepared to have him/her build an independent business. The reason you enter a Joint Venture/ Alliance is because both parties believe that the combined entity can succeed better/faster than either party alone. You have to live to this standard externally, but also internally. Neither party can harbor a secret desire to “control” the Joint Venture by staffing it with “one of their own” or trying to influence former employees of either parent in their new Joint Venture roles. In a 50/50 JV, not necessarily a bad idea, alternating positions under the CEO is an effective tool: If the CEO comes from Company A, Company B provides/picks the Chief Financial Officer, Company A the Chief Marketing Officer, etc.

The initial question the CEO must address is: “Just how independent are we?” Alternating key positions from the parents results in a great cultural melting pot. But it also means the JV management will take a long time to jell into an independent organization. As one JV CEO put it: “The various company representatives tended to look after their parents’ property rather than the JV’s combined brands and assets. The parent’s culture remained so strong in the minds of their former employees that it took a major effort to overcome their bias.” If the JV concludes that time is of the essence, agree to let one parent “run the show” – picking the best candidates for each position with the requisite business experience. Then use the “alternating key assignments approach” as a guideline rather than a policy. The JV Board can still provide the overall direction and establish targets for the new management team, but you will have everyone doing it one way.

  • Recognize that the JV will eventually build a company culture foreign to both parents. The parents may not like what they see, but if they want the Joint Venture to succeed, they have to support the JV as NewCo, not the company represented by the cultural evolution of the parents.

Moreover, the Joint Venture must leave behind those elements of the parent cultures that restricted great success in the first place. The fact the JV behaves differently will cause anxiety inside the parent companies. For example, different compensation policies will be needed to attract and motivate the best people to the more risky Joint Venture work environment, and the parents have to be prepared to explain this in their companies. Remember: If the JV isn’t its own thing and different from both parents, it has much lower chance of succeeding.

  • Invest in an effective JV Board of Directors. Pick Board members who have a range of advisory skills (technical, organizational, etc.), not just “available” executives from the parent companies. Be sure they are rising stars, not just seat fillers. It is important that the Board have a working structure, with committees on compensation, audit and (when appropriate) marketing. Ideally, the Board Chair should be independent of both parent companies, so the parents get a balanced view of how the Joint Venture CEO is performing relative to the expectations. Alternately, if the Board Chair comes from one of the parents, the individual must be given the support to act independently of their parent. When “favoritism” of any kind becomes apparent to the Joint Venture organization, confidence and productivity drop immediately.

The Board needs to take its governance responsibility seriously, observing all the appropriate legal and procedural protocols. Members need to understand how to behave; how to provide valuable counsel to the JV’s CEO, without being “micro-managers”. Board members should expect some periodic conflict with their “day jobs” inside the parent companies, but if they fail to remain loyal to the Joint Venture and its CEO, effectiveness will decline rapidly.

  • Transfer only the best people to the JV. “Middle-of-the-road” performers will fail quickly in the high pressure Joint Venture environment, especially without the support systems of their parent companies. Getting your best to go may be less challenging than you think, given the attractiveness of performance-based compensation and a more entrepreneurial work environment. But in return, they have to commit to the business success and not worry about how or if they can get back to the “mother ship.”

Whether people should be “loaned” to the JV for specific periods of time or given “one-way tickets” is a hotly debated topic. On one hand, if people in the new company believe that success is “optional” in any way, the new CEO will not get the commitment he/she needs to succeed. This would point to one-way assignments: “If the JV fails, or if you fail in the JV, there is no job for you back here.” On the other hand, the JV is necessarily smaller than the parent, providing fewer promotion or training and broadening opportunities. This is very de-motivating for some employees, particularly marketing people, and may suggest that a “porous” wall be set up between the companies, allowing people to move to and then back from the JV.

  • Don’t underestimate the start-up costs. In an effort to “sell the deal,” financial projections are typically too aggressive, especially on start-up costs. In our experience, higher cost items have included office space, house loans in new locations, health care benefits and, most of all, IT systems. Because the JV CEO is rarely on board at the time the economics are put together, this becomes a continuous issue. Since the first year is the time in which the Joint Venture must get the sense that it will succeed, this becomes a needless distraction. If low start-up costs are essential to the JV’ s economic viability, rethink the entire project.
  • Prepare to invest heavily in systems from Day One. Neither company will have the full systems capability to support the JV – in terms of human resources, information technology or accounting. The temptation will be to “save money” by having each parent donate or contract-out these services to the JV. Don’t do this. It helps on the overhead allocation front for the parents, but it causes havoc for the JV. The JV must have a clear mandate and adequate systems staffing to put first-class customer/employee consumer systems in place immediately, even if they have to use outside vendors. They will never get the priority they need from the parents and good systems are essential to knowing where the business is – in terms of benefit costs, market share, manufacturing expense, etc. One insight: these systems typically have to be better than the parents are, because the JV lacks the scale to get away with anything but first-class service to customers.
  • Locate, staff and manage for success. All this will sound obvious, but many JVs fail to see how important it is to get off on the right foot with:
  • Establish one central location for the entire JV staff, with the CEO, under one roof. If they are going to build a powerful culture, you need to have everyone in one place – ideally at a site and city different from either parent.
  • The JV needs all the management functions. Don’t skimp on expertise the JV has to have – like a General Counsel – just because you are going for a lean staff. Take out layers to save overhead, not functions.
  • Design the structure for a minimum of bureaucracy. Don’t impose the reporting systems or “expected communications style” of the parent on the JV. Leave them at home and determine the minimum amount of required paperwork necessary to run the business.

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JVs are not easy to construct or operate. Unless the size of the prize is significant for both parties, or there is some kind of market pressure which suggests JVs are the only viable path to success, think twice about whether to do them. And if you proceed, recognize there is no substitute for having the CEOs of both organizations participate personally in setting up the structure.