1. Vertical and Horizontal Alliances James Oldroyd Kellogg Graduate School of Management Northwestern University j-oldroyd@northwestern.edu 801-422-7888 650 TNRB

2. 1 Alliances- How far have we come? “Alliances are mere transitional devices and because of this they are destined to fail” Michael Porter “Many so-called alliances between Western companies and their Asian rivals are little more than sophisticated outsourcing arrangements -- the traffic is almost entirely one way” Hamel, Doz, and Prahalad “Avoid alliances like the plague.” Reich and Mankin

3. 2 Alliances Growing as a Source of Revenue Alliances as a Percentage of Revenue for Top 1,000 U.S. Public Corporations Source: Columbia University, European Trade Commission, Studies by BA&H, AC.1983-1987, 1988-1993, 1994-1996, 1999

4. 3 Total business conducted through alliances 20% 30% 40% 0% 10% 20% 30% 40% 50% 2000 20052010 Source: EIU Global Executive Survey Andersen Consulting, Warren Company 3-5% 1990

5. 4 Alliances- How far have we come? “If you think you can go it alone in today’s global economy, you are highly mistaken” (Jack Welch, CEO of GE) “Microsoft can’t make it alone, but together anything is possible.” (Bill Gates, Chairman of Microsoft) “Our approach is to develop long term relationships with companies that offer a unique advantage with General Motors. The Alliance Strategy is our major thrust.” (John F. Smith, Jr., Chairman & CE of General Motors)

6. 5 Corporate Evolution and Alliances Moving from Managing a Portfolio of Products... To Managing a Portfolio of Businesses... To Managing a Portfolio of Relationships

7. 6 Alliances vs. Acquisitions: Stock Market Response to Announcements Average Stock Market Gains (Average over 10 day window following announcement).84 percent Percent Stock Market Gains Following Announcements (in percentages) 0 percent Alliances*Acquisitions** (Acquirers) * Source: Dyer, Kale & Singh, 2001 ** Source: Bradley, Desai, & Kim, 1988

8. 7 OUR STOCK ROSE FIVE POINTS ON THE ANNOUNCEMENT IN TODAY’S NEWS, OUR COMPANY HAS DECIDED TO BUY ANOTHER DYING COMPANY IN A BUSINESS WE DON’T FULLY UNDERSTAND. WHY DOES OUR STOCK GO UP EVERY TIME WE DO SOMETHING BONEHEADED? I LIKE TO THINK OF IT AS OUR COMPETITIVE ADVANTAGE.

9. 8 THE STATUS OF OUR STRATEGIC ALLIANCE IS “DOOMED.” OUR PONDEROUS AND INEFFICIENT MANAGEMENT SYTLE CAUSED THEIR BEST PEOPLE TO QUIT AND CREATE A COMPETING COMPANY. WE MUST FIND A WAY TO DESTROY THAT NEW COMPANY. I’LL SEE IF THEY’RE INTERESTED IN A STRATEGIC ALLIANCE.

10. 9 Strategic Alliances Benefits: Speed (vs. acquisition or greenfield) Access to key complementary assets Removal of potential competitor Maintain incentives for partner management Drawbacks: Lack of control; must share decision making Potential spillover of knowledge and capabilities Organizational clashes may impede ability to collaborate

11. INTERNAL FOCUS TOTAL SYSTEM ECONOMICS 30% 20% 50% 0% 20% 40% 60% 80% 100% CUSTOMER ECONOMICS MY ECONOMICS SUPPLIER ECONOMICS MY ECONOMICS HISTORICAL VISIONPARTNERSHIP VISION

12. CREATING VALUE BY FOCUSING ON THE SYSTEM VALUE TO CUSTOMER VALUE TO CUSTOMER VALUE TO SUPPLIER VALUE TO SUPPLIER TRADITIONAL RELATIONSHIP STRATEGIC PARTNERSHIP

13. EXPANDING THE PIE Leverage the full resources of suppliers to create value for the end customer Develop partnerships with key suppliers to optimize the system (lower total systems costs)

14. LEVERAGING THE RESOURCES OF PARTNERS Top 35 Affiliated Suppliers (5-6,000 Engineers) Toyota Engineering (7,000 Engineers) Remaining 250 Tier I Suppliers (10-15,000 Engineers Toyota can leverage its value creation resources by 5-15x by involving suppliers in the Extended Enterprise

15. 14 THE VALUE OF A NETWORK CHANGES AS MEMBERSHIP INCREASES Connections:0315 Directions:0630 As the number of nodes in a network increases arithmetically, the value of the network increases exponentially (n 2 growth). Small improvement efforts that ripple through the network can dramatically increase the value for all members. Single Firm 3-Firm Network 6-Firm Network

16. Toyota’s Supplier – Customer Interface Surface Contact vs. Multiple-Point Contact (Correct) CustomerSupplier Point Contact (Wrong) Top Execu- tives R & D Manufacturing Top Execu- tives Quality Assurance Quality Control Purchasing R & D Manufacturing Quality Assurance Quality Control Sales

17. CREATING EFFECTIVE PARTNERSHIPS Build supplier trust Use new processes of supplier selection and evaluation Create multiple functional interfaces to facilitate system learning Make dedicated/customized investments

18. 17

19. 18 Multi Functional Interface Risks: Your Employees can be Bought by Competition Customer Contact Changes Benefits: Clear Accountability No Redundancy Risks: Multiple Sales People with Competing Priorities High Coordination Costs Unable to Bring it All Together for the Customer Benefits: Relationships are “Sticky” Relationships cut across multiple dimensions Your FirmCustomer’s Firm Individual owns the process Organization owns the process Your FirmCustomer’s Firm Coordinated by an Account Manager

20. THE FUTURE…. Supply chain management will become increasingly important for competitive advantage Teams of companies will increasingly compete with other teams (extended enterprise); lean teams will win Leveraging the full resources of the extended team will be critical Leading companies will increasingly use partnerships--though not with all suppliers

21. 20 Horizontal Alliances

22. 21 Deals-off WallStreet Journal Sep 27, 2001 Coca-Cola Co. and Procter & Gamble Co. said they abandoned plans to create a $4.2 billion joint venture combining their juice and snack businesses, in a move that analysts say is good for Coke but leaves P&G to deal with two underperforming brands on its own. The joint announcement comes nearly two months after the two sides signaled they were discussing paring back the deal to a "partnership" focusing on research and development of new juice products. P&G had also hoped to include the distribution of its Pringles potato chips on Coke trucks. Instead, the two companies said they now will "independently pursue opportunities to grow their respective businesses."

23. 22 In the News – Cokes New Focus Coca-Cola and P&G agreed in September to abandon their idea of a joint venture to market Minute Maid juices and P&G's Sunny Delight and Pringles. The deal would have combined a fast-growing Coke business with two declining P&G brands. In the process, Coca-Cola came to a realization it might have made earlier: that Minute Maid could play a key role in the Atlanta company's drive to expand beyond carbonated soft drinks. It is part of an effort to more effectively integrate Minute Maid and other Coca-Cola noncarbonated businesses into a global distribution system that has long focused on soft drinks, according to Steven Heyer, a Coca- Cola president who oversees noncarbonated beverages and marketing. A top priority, Mr. Heyer says, is to create global brands out of existing products. Among Minute Maid's recent offensives: a new orange juice. Primarily a producer of orange juice that is mixed from concentrate, Minute Maid threw in the towel earlier this year to Tropicana and other makers of freshly squeezed and processed juice by introducing Simply Orange, a new "not from concentrate" juice. Minute Maid set its new product apart from competitors with its package, an attractive clear-plastic carafe.

24. 23 Wallstreet Journal June 3, 2002 CINCINNATI -- After nearly becoming joint-venture partners last year, Procter & Gamble Co. and Coca-Cola Co. are fighting over the lucrative business of adding calcium to orange juice. P&G filed a patent-infringement suit against Coke on Friday, alleging that the Atlanta beverage company wrongfully used a technology it licenses exclusively to Coke's main rival. In a complaint filed in U.S. District Court in Cincinnati, P&G claimed that Coke's Minute Maid Premium Calcium Original and Premium Calcium Home-Squeezed Style orange juices are using a calcium-fortification technology that P&G developed and licenses exclusively to the Tropicana juice unit of PepsiCo Inc. Alleging "severe and irreparable" damage, the Cincinnati consumer-products company said it is seeking an injunction to stop the alleged violation of its patent, which it received in 1988. P&G also said it is seeking monetary damages and interest. A Minute Maid spokesman called the suit "totally without merit" and said Minute Maid has produced calcium-fortified juice since 1987 under a technology it developed itself, has held a patent on that technology since 1989 and hasn't changed its process for adding calcium.

25. Contractual Agreements Equity Arrangements Traditional NontraditionalNo New Firm Creation of EntityDissolution Contracts Contractsof Entity Arm’s-length Joint Research Minority NonsubsidiaryJV Mergers and Buy/Sell Equity JVsSubsidiaries Acquisitions Contracts Investmentsof MNCs Franchising Joint Product Equity Fifty-fifty Development Swaps Joint Ventures Licensing Long-term Unequal Sourcing Equity Agreements Joint Ventures Cross- Joint Manufacturing licensing Joint Marketing Shared Distribution/ Service Standard Setting/ Research Consortia Strategic Alliances Based on: Yoshino and Rangan, 1995 The Scope of Inter-corporate Linkages

26. Why Seek a Partner? Reduce Risks Size or Uncertainty Associated with Project Preempt Competitors Flexibility/Option Value Gain Efficiency Economies of Scale and/or Scope Speed to Market Access Complementary Skills New market entry; synergy-sensitive skills Learning Acquire New Skills Gain Market Knowledge and Experience Monitor Competition Politics Sensitive Industries Regulations Market Access 1 2 3 4 5

27. Objectives of Horizontal Alliances Reduce Risks E.g., Oil Drilling JVs (spread risk and cost of drilling) Gain Efficiency E.g.., McDonalds and Disney (share advertising costs) Learning (Development & Innovation) E.g.,; Autobody and Composites Consortiums (GM, Ford, Chrysler); Fuji-Xerox Access Complementary Skills E.g., Apple-Sony partnership to develop Powerbook; Politics E.g.,: Otis-Tianjin JV in China (Otis allowed to enter China) Coordination Costs Management Time Redundant Structures Communication Programs Control Systems Loss of Competitive Position Leakage of Knowledge Reduced Flexibility Create a Potential Competitor Exposure Loss of Bargaining Power with Others Lower Market Valuation due to Loss of Control Premium Benefits Costs

28. 27 Challenges for Horizontal Alliances Leveraging each partner’s resources while protecting proprietary know-how; many horizontal alliances are inherently learning races. Building trust with potential competitors; simultaneously cooperating and competing (Co- opetition) Less ability to “control” partner decisions (relative to supplier alliances). 1 2 3

29. 28 Favorable Conditions for Horizontal Alliances The partner’s strategic goals converge while their competitive goals diverge. (e.g., Philips and Du Pont collaborate to mfg. compact disks; neither invades the other’s market) The size, market power, and skills/resources of partners is modest compared with industry leaders; an attempt to catch up. (e.g., Japanese chipmakers collaborate to develop chips; U.S. automakers collaborate on autobody and battery technology). Each partner believes it can learn from the other and at the same time limit access to proprietary skills (e.g., Xerox and Fuji alliance; Xerox gets access to Japanese market and technology in Japan; Fuji participates in copier business; Fuji believes it can protect film business while Xerox believes it can protect worldwide copier business)

30. 29 The Logic for Joint Ventures Alliance objective is characterized by a high degree of uncertainty, such as R&D alliances (need incentives to bring best technology) Desire to create a “new culture” (resources, processes, values) that fit the new opportunity. Desire to limit liability of parent companies. Superior way to measure alliance performance (separate P&L)

31. 30 Identify Partners with : Strategic Fit: Compatible resources, assets, and capabilities Cultural Fit: Compatible cultures and work processes Establish clear performance objectives & monitor performance for the alliance and requirements for each partner; make technology transfer dependent on meeting performance requirements Develop plan to learn from partners Invest in absorbing key skills/technology from partners while protecting protect proprietary knowledge/skills as much as possible. Use appropriate “governance” mechanisms Build trust and align the incentives of partnering firms (e.g., joint stock ownership is superior to legal contracts for eliciting knowledge transfer). Create a “Strategic Alliance” function in your firm Assign responsibility to acquire and codify knowledge with regard to effective alliance management practices. Keys to Horizontal Alliance Success

32. 31 Strategic Fit Organization/Cultural Fit High Low High Optimal Strategic Alliance Solution Compatibility but few Synergies Good Commercial Compatibility but Organizational Integration Difficult No Redeeming Value HOWEVER, Remember that it is the differences between the organizations that drive the formation of the alliance The Importance of Strategic and Cultural Fit

33. The New Environment

34. 33 The economics of business are changing Unprecedented visibility, quantity, quality and immediacy of information Information costs are rapidly falling Information asymmetries are disappearing Markets (and in particular, prices and inventories) are becoming more transparent Intellectual property is increasingly difficult to protect Information and transaction costs are disappearing Global boundaries falling Opening of regulated markets Fewer impediments to cross-border business Single currency zones Countries are competing with one another, offering aggressive incentives to attract companies Fading cultural and language barriers Speed is driving value more than ever Increased growth and earnings pressure, shorter CEO tenures Slowness is equated with unnecessary cost Unnecessary cost are more visible and unacceptable The rapid pace of technology change has infected everything

35. 34 Implications Information and transaction costs are disappearing Global boundaries falling Speed is driving value more than ever Good Bad Customers have perfect clarity of problems. Must deliver real value better than competitors. Can’t protect information Harness savings with suppliers & squeeze costs out of the supply chain. Know customers intimately Opportunities for new markets and globalization of production, sales and service Focus on core business and provide best in class solutions. Use alliance to create complete customer solutions Become obsolescent rapidly. No long term success Company Implications Good Bad Good Bad Increased competition, increasingly complex production, sales and service

36. 35 Services New Ventures Services AlliancePartners Competitors Collaboration Suppliers Customers IPO New Ventures Core Business Focus Facets of Alliances Self Correction Kn ow led ge SEPARATION INTEGRATION Source: Booz Allen and Hamilton

37. 36 These changes are restructuring industries and affecting how value is captured Every crack of the value chain is infiltrated Value chains are broken up, each link eliminated and/or optimized Rapid adaptation is essential to survival Each transaction exposed to the scrutiny of consumers and competition Business forced to operate more globally than ever before SourcingDistribution Outsourced to low cost provider Monolith Inc. New companies appear “instantly” High value added step retained

38. 37 The Alliance Organization is greater than the sum of its parts The Alliance Organization focuses on what it does best It pushes all other activities outside its boundaries THE SCOPE BECOMES LESS AND LESS... The organization accesses capabilities throughout the alliances It may build, buy, borrow or lease depending on the circumstances The network is greater than the sum of its parts YET THE ORGANIZATION ACHIEVES MORE AND MORE

39. 38 The Alliance Organization organizes around and builds network equity The Alliance Organization must manage its network equity: the value of the firm’s network of relationships with its customers, suppliers, alliance partners, and competitors Companies have built great expertise and elaborate processes for managing physical assets (manufacturing facilities, products, retail locations) The challenge is to shift to managing network relationships and treating these as assets Companies must also shift from functional organization structures to relationship based structures Many companies now have a new organization called business development that creates, broadens, and deepens network equity over time

40. 39 Networks are competing with each other, for example, in the airline industry COMPETITION

41. 40 Credit cards and e-commerce COMPETITION 23,000 Financial Institutions 21,000 Financial institutions

42. 41 Governments COMPETITION Argentina Bolivia Brazil Chile Paraguay Uruguay Italy Luxembour g Netherlands Portugal Spain Sweden United Kingdom of Great Britain and Northern Ireland Austria Belgium Denmark Finland France Germany Greece Ireland Mexico US Canada Cambodia Indonesia Laos Malaysia Myanmar Philippines Singapore Thailand Viet Nam

43. 42 Powerful economic forces are driving disaggregation Insourced Decentralized HR Services Insourced HR Shared Services Outsourced HR Shared Services Typically 30-40% Cost Differential Bypass Shared Services and Leapfrog to Outsourcing Higher People & Technology Investment Transaction Cost Comparisons Typical Large Company (50,000 Employees) Outsourcer (1,000,000 Plus Employees) Cost Per Employee CONCEPTUAL Source: Booz·Allen & Hamilton

44. 43 Frequency of Alliances 19801980 1998 1998 Percent of revenues from core business Source: Dr. Peter Pekar, Jr.

45. 44 Dell Case Dell is the #1 PC company Relentless focus on PC business. Reinvestment in core processes. Inventory about 2 days $7.3 billion profit over the last 10 years  Compaq lost the #1 PC company slot  Purchased service business from Digital Tandem Computers, and $100 million investment in a biotech company  Inventory about 60 days  $1.8 billion loss over the last 10 years

46. 45 Leading companies balance tensions between the core business and the new venture... Experienced personnel from core Core Wants... Venture Needs... Tension Leverage core assets Core Assets Human Resources Entrepreneurship, risk taking Rewards New Venture Develops Distinctive Offering From Core Strategic guidance, expertise Leadership New Venture Establishes Separate Assets (including brand) New revenue streams may compete Revenues/Growth New Venture Establishes Separate, Fast Track Decision-Making & Governance Processes Redirection of financial resources Financial Resources New Ventures Sources New Ideas Independently Rapid decision making, tolerance of risk Speed & Flexibility New Venture absorbs All New Ideas And Develops Independently Core business to contribute Idea Sharing Fairness and equity New Venture Develops Similar Or Competing Offering With Core Focus on core business New Venture Leverages Core Assets To Create New Offerings Growth of traditional streams New Venture Follows Core Company Processes And Procedures Continued investment in core New Venture Sources Ideas From Core Business Established policies and procedures Originator Of Idea In Core Involved With Development Of Idea Control of new ideas Protect core assets Keep top talent Source: Booz·Allen & Hamilton

47. 46 Virtually every technology is guaranteed to become a commodity within 18 to 25 months. Once you acknowledge that, the only thing needed to ensure winning form is constant innovation. Naveen Jain founder of InfoSpace Importance of Speed

48. 47 New Economy Organizational Structure  Rite Aid and Drugstore.com  KBkids.com (KB Toys and BrainPlay.com)  Covisint (Autos)  EnergyLeader.com (Mid-Atlantic Utilities)  ForestExpress.com (Paper Products) Hybrids  BarnesandNoble.com  Wal-Mart.com  Nordstrom.com  Land’s End  Office Depot  Walgreen’s  Target.com SeparationIntegration The integration-separation decision need not be an “all or nothing” strategy. Choices exist along a continuum and it is possible to operate more than one model at the same time.

49. 48 …By using key organization design levers such as establishing a separate organization structure (1) “Separate” refers to the establishment of a separate subsidiary or division (2) “Hybrid” refers to the combination of a separate subsidiary or division and embedded new venture efforts (3) “Embedded” refers to new venture creation and/or capture that lies within each business unit or division Source: BA&H Analysis Separate (74%) Total =23 Organization of New Ventures Efforts Hybrid (17%) Embedded (9%)

50. 49 The Network Organization increases collaboration throughout the industry New Ventures Core Business Disintermediation Source: Booz·Allen & Hamilton Customers CompetitorsComplementors Suppliers End Customers

51. 50 ROI for Alliances *top 1,000 public corporations in US Source: Dr. Peter Pekar Jr.

52. 51 Integration through alliances for venture services allows companies to rapidly access capabilities Source: Booz·Allen & Hamilton “Spot-buy” of Services Acquisition Keiretsu Joint Venture Annual or Multi- year Agreement DESIRED LEVEL OF CONTROL/ RISK WILLINGNESS NATURE OF RELATIONSHIP Transactional Permanent LowHigh

53. 52 Building Alliance Capability: Corning vs. H-P Corning (Informal Approach) Alliances (JVs) are central to strategy (50% of revenues) Alliances initiated and driven at business level Alliances receive visibility and senior management support Alliance training incorporated into fabric of day-to-day management systems Simple principle: Can we trust the partner? HP (Formal Approach) A dedicated alliance team In-house alliance training Use of alliance manual and databases Alliance knowledge sharing by HP veterans at Alliance Summits Competitive benchmarking of alliances/practices Source: Kale, Dyer & Singh 2000

54. 53 Suppliers take increasing levels of responsibility for their customers’ success SUPPLIER RESPONSIBILITY LADDER Solutions: On the next rung, a supplier assumes responsibility for the realization of customer benefit, but leaves the ultimate value creation to the customer Arm’s length: On the lowest rung, a supplier sells products and services, but leaves it to customers to apply their own knowledge to assemble what they require and to use it effectively. Bundling: Up one rung, a supplier enables value-added integration. Customers still have to create and capture the end value from the combination. Strategic Partnering: Finally, at the top of the ladder, a supplier actually takes responsibility —in part or in full — for the customer’s success Source: Booz·Allen & Hamilton

55. 54 Supply chain collaboration is also important for creating and delivering value to customers Source: Strategy Implementation, J.R. Galbraith & Robert K. Kazanjian, p. 51 & 56 Raw Materials Primary Manufacturer Fabricator Product Producer Consumer Marketer Retail Supply Flow Consumer Weyerhaeuser International Paper Container Corporation Appleton Procter and Gamble

56. 55 Knowledge acquisition Internal (KM initiatives) Technology & process Trust & experience Trust & experience Competitor Facing Alliance Facing Competitiveintelligence Exchanges CRM Customer Facing Supplier Facing

57. 56 Many companies are capturing value from knowledge communities Palm, Inc. benefits from a 100,000-member developer community including an exchange where developers sell services to one another. Users pose questions, developers provide answers, and Palm owns the knowledge exchanged. Covisint links automakers and parts suppliers through a virtual marketplace built around dynamic information sharing. Community participants transact, share data on capacity and demand forecasts, and utilize collaborative workflow and development tools. Analysts predict value of $2,000 to $3,000 per car America Online built a media conglomerate on the strength of its customer chat rooms and community-related services. AOL has more than 28 million customers — five times as many as its nearest competitor — who pay for the opportunity to interact with each other and AOL partners through a wide range of community features. In a recent pilot, selling Time Warner magazines to targeted communities resulted in 800,000 new subscriptions. Source: Booz·Allen & Hamilton

58. 57 Structure is the tip of the iceberg - other levers contribute to aligning behaviors with overall objectives Leadership System Information Conflict Resolution Boundaries Measures Roles & Responsibilities Objectives Organization Structure DECISIO N RIGHTS How Are Key Business Trade-Offs Made? CoordinationMechanisms Incentives Source: Booz·Allen & Hamilton

59. 58 The Old HP Each product unit was responsible for its own profit/loss performance EXECUTIVE COUNCIL CEO CONSULLTING, SECURITY SOFTWARE, UNIX SERVERS INK CARTRIDGES, DIGITAL CAMERAS, HOME PRINTERS HOME PCs, HANDHELDS, LAPTOPS SCANNERES, LASER PRINTERS, PRINTER PAPER Source: BusinessWeek, February 19, 2001, p. 72

60. 59 The New HP  AUTHORITY  RECOMMENDATIONS  IDEAS & INNOVATIONS  PRODUCT & INFORMATION Source: BusinessWeek, February 19, 2001, p. 72 Personnel from the front- and back-end groups collaborate on projects aimed at sniffing out new markets that will create growth. DIGITAL IMAGING Make photos, drawings, and videos as easy to create, store, and send as e-mail. WIRELESS SERVICES Develop wireless technologies that will fuel sales of HP-made devices, ranging from handhelds to servers. COMMERCIAL PRINTING Divert printing jobs form offset presses to Net-linked HP printers. CROSS-COMPANY INITIATIVES CARLY FIORNIA EXECUTIVE COUNCIL Eight top lieutenants, including heads of the four front- and back-end groups. STRATEGY COUNCIL Nine fast-rising managers who advise the executive council on allocation money and people to growth initiatives. CONSUMER SALES $15 billion in annual revenues JOB Sell consumer gear with focus on meeting current-year earnings and revenue goals. Let back end know of must-have products and features COMPUTERS 57% of annual products JOB Focus on future success by making computers that companies and consumers want, with sales input form front end. CORPORATE SALES $34 billion in annual revenues JOB Meet near-term financial targets by selling technology solutions to corporate clients. Keep back-end units abreast of what’s hot. PRINTERS 43% of annual production JOB Build new printing and imaging products to ensure HP’s long-term growth. Track trends with help from front-end units. FRONT END BACK END

61. 60 HP Happier customers Single account team assigned to customers Sales boost Reps will sell all HP products not just division’s Real solutions Able to sell packages Financial flexibility Able to measure total value of customers Overwhelmed with duties Miss the product details Poorer execution Harder frontend to backend management Less accountability No one hot seat Fewer spending controls New lines of command BenefitsRisks Source: BusinessWeek, February 19, 2001, p. 72