GOVERNANCE MECHANISMS

Risk Types and Inter-Firm Alliance Structures

T.K. Das & B.S. Teng

1996

Iacopo Quarone

13/05/2010

Introduction

Various typologies of inter-firm alliances classifiable in two governance structures:

•EQUITY alliances: transfer or creation of equity ownership(i.e.: direct investment or joint venture)

•NON-EQUITY alliances: none equity transfer (i.e.: all kinds of contractual arrangements)

Introduction

Transaction costs theory as the traditional underlying rationale for determing the choice:•i.f. alliances as an intermediate of market and hierarchy forms

•i.f. allaiances as a way to manage oppurtunistic behaviours

Weakness:

•Does NOT take in account governance costs which can make the overall impact of costs on i.f. alliances unknown

Introduction

An integrated risk perspective as a newer and easier accounting for the choice between equity and non-equity allainces.

RISK, from a managerial viewpoint, is defined as the negative outcome variance.

Relational risk and performance risk in inter-firm allainces

The distinctive feature of i.f. alliances is the dependence on cooperation among partners (only partially overlapping goals).

In addition to the risk inherent of achieving the stategic goals of alliance, firms have to face the risks regarding a partner’s future behaviour.

Relational risk in inter-firm allainces

Relation risk addresses the possibility and the consequence that partners may NOT work toward the mutual interests and may NOT co-operate in the manner specified in the alliance agreement or as expected.

Opportunistic behaviours: all partners, given a chance, would tend to maximize their own interest at the cost of the other partners.

Relational risk: an example

The dissipation of the firm-specific advantage: very often a technogly transfer agreement could be just a cover for secretly capturing other partner’s know how.

From this viewpoint, having co-operative relationship with others imposes additional relational risk which inpacts on partner’s perception of risk

“The more difficult it is to protect one’s proprietary know how, the higher will be the relational risk perceived by the partners”

Performance risk in inter-firm allainces

Performance risk addresses the possibility that the objectives of an i.f. alliance may not be sucessfully achieved although all partners co-operate fully.

It embraces all kinds of hazard that can either lead with the failure of an i.f. alliance or to an increase in the magnitude of loss from an allinaces (such as commmercial, technological, corporate and international risk)

Entering into i.f. alliances is one of the main way to share this kind of risk.

Performance risk: some example

The most riskfull activities for firms are R&D and international business.

R&D activities contribuite to a high level of performance risk becouse it is costly, time-consuming and uncertain

International business because cross-border alliances are related to a new set of environmental, industry and firm-specific risks (i.e. a different legal system, market structure, customs,….)

Performance risk will be perceived as higher in i.f. allinaces with a shared R&D component or international alliances, as compared to other kinds of alliances.

Equity alliances and non-equity alliances

When firms have to decide b/w equity or non-equity alliances, they would naturally prefer the structure that minimizes the sum of relational risk and performance risk.

This decision has crucial implications on every aspect of the alliances such as organization structure, operation process, control mechanism and so on.

Equity allainces: pros

Since equity alliances involve the creation of new entity, or ownership transfer of existing entities, they are more like hierarchy and so the impact of relational risk is less strong than in other governace strurctures.

Why?

• Transactions take place in a more formalized way

• Aligned interests, monolithic control and diminished performance ambiguity

Equity allainces: consWhen it comes to controlling performance risk, equity alliances are NOT the answer becouse of their higher degree of performance risk.

Why?

•The special investment required in the joint task is a non-recoverable cost and so makes the price of the eventual failure greater

•High governance costs to manage the more complex decision making process

Equity allainces: pros and cons

Pulling togheter pros and cons, the result is the following:

“Inter-firm alliances are more likely to be equity based when relational risk, rather than performance risk, is perceived as the dominant threat to the alliance”.

Non.Equity allainces: prosNon-equities alliances are more like market-based contracts rather than hierarchies and their main characteristics are a lack of control and strategic flexibility.

Just for that characteristic, this kind of alliance is better able to face performance risk becouse:

• the level of commitment (money, time, resources) is comparatively limited

•Partners can quite easily decide to get out of the alliance

Non-Equity allainces: cons

Beyond the specifics identified by the contract ex-ante, non-equity alliances rely too heavily on the goodwill and voluntary co-operation from indipendent firms.

The lack of shared ownership makes it difficult to align the interests of the partners, to control their behaviour and to distribute performance outcomes.

Non-Equity allainces: pros and cons

Pulling togheter pros and cons, the result is the following:

“Inter-firm alliances are more likely to be non-equity based when performance risk, rather than relational risk, is perceived as the dominant threat to the alliances”.

Conclusion

The joint value created by pooling the partners togheter in a stategic alliances may be able to overcome the cost and even the possible losses of an inter-firm alliance.

Alliances may be formed also if there are high level of both tipes of risk, becouse is the relative levels of relational risk and performance risk that determine the choice b/w the governance mechansim of the alliance.