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Joint Ventures - Perfect Partners?

by Geoff Gravil

Much has been written about how joint ventures are good vehicles for fostering corporate growth, particularly in overseas markets. In some countries it is the only way of gaining access to a market. A host government may discourage, or even prohibit, a totally owned foreign company operating within its country in order to encourage domestic development. Many companies see joint ventures as a means of rapidly expanding geographically by using other companies' resources. By 'tapping' into existing skills, knowledge and finance, as well as accessing existing customer groups, it is possible for a firm to develop its foreign business more swiftly and cheaply than if it has to rely solely on its own resources and efforts. However, despite these benefits, there can be difficulties in operating within joint ventures, particularly those involving foreign firms where language, business culture and even different perspectives on business ethics can generate misunderstanding and even mistrust between the partners. It is advisable to clarify any potential for conflict as early as possible and this might be better addressed at the initial contract stage.

Problems which can arise from joint ventures.

  • There may be fundamental disagreements with the partners having different objectives. One partner (often the newer and more local party) may be more concerned with growing the business from its own geographic base and may be wanting to see the profits re-invested back into the enterprise. The older partner (often having sought a foreign partner so as to access new markets) may be more concerned with repatriating profits to distribute to its own shareholders.
  • The local partner may be hoping to generate exports into other geographical areas. This may not be in the interests of the more established partner, who may already have export business in those targeted areas, and is not willing to share this market with the new partner.
  • There may also be concerns over transfer pricing arrangements. The established partner may be transferring expertise, technology and components to the newer local partner. It is probable that this partner will be looking to charge the highest price possible. Any profit will belong 100% to that partner. However the local partner will prefer a low transfer price charge. This will enhance the profitability of the joint venture, benefiting both partners. There is obviously room for disagreement here.
  • It is also possible that cultural differences in management between the two partners may disrupt smooth working relationships. Attitudes towards equal opportunities, commercial practice, short and long-term planning are a few among many issues where disagreements may occur. It is important that any differences should be reconciled as smoothly and as swiftly as feasible.
  • Joint ventures benefit where synergies can be created. This is most prevalent where the knowledge, expertise and resources of the partners are complementary. There is a danger that the partners may have strengths in the same areas but possess the same weaknesses. However it is fair to comment that joint ventures between foreign partners do not generally suffer from this difficulty. The local partner usually provides marketing knowledge along with an existing customer base whereas the other partner brings technological expertise and know-how to the partnership.
  • Another difficulty which can occur with joint ventures is the problem of ensuring smooth co-ordination and control. This results when there is no clear pattern for decision making and stems from a lack of overall leadership. Any partnership must allocate responsibilities for decision-making so as to ensure that the venture does not suffer from management paralysis.
  • Another issue where disagreements may occur is how profits are to be allocated and distributed. This has already been touched upon in discussing transfer payments and the re-investment of funds. It is an avoidable problem if initial agreements have been made but all too frequently many small to medium-sized joint ventures have disagreements over this issue which only helps to destroy trust between the partners.
  • It is also important to clarify who the partners are within the joint venture. Difficulties can arise if one party chooses to use sub-contractors. This can have a detrimental impact on areas such as quality, service and even delivery, and again destroy the trust and harmony between the partners.

Many of these issues which can so easily become contentious may be avoided if the contract between potential partners was carefully drawn up. There is the obvious danger, as with the pre-nuptial contracts now so popular with Hollywood film stars, that the contract destroys romance, or in the case of a joint venture - the flexibility and entrepreneurial spirit. A contract should not be seen as a constraining influence but as a guiding light.

Issues which should be addressed within a contract
The following are areas which should be made clear in the contract between the partners. Careful preparation here can save innumerable problems and disagreements later.

  1. There should be a clear indication as to the parties to the joint venture. This should minimise the risk of lower quality suppliers being brought into the chain as a result of uncontrolled sub-contracting.
  2. There also needs to be a clear specification of the purpose of the joint venture. This ought to clarify the duties of and expectations from each of the partners. This might minimise conflicts of interest and avoid accusations of greed or short-termism being levelled at one of the partners. Issue concerning transfer pricing and the supply of components or expertise would be addressed in this clause of the contract.
  3. There should be an unambiguous definition of territories to be covered by the joint venture. This should prevent arguments as to whether the newer local partner has the right to export joint venture products which might compete in markets, already served by the longer-established partner.
  4. There should, within the contract, be a precise statement as to the merchandise and product areas to be covered within the joint venture. The older company may not be willing to share technology over its whole product range, whereas the newer local partner may be expecting much broader co-operation. The scope of the agreement must be clear to all parties.
  5. There should also be an agreement as to how profits are to be shared, what proportion should be ploughed back into the company, and how much should be re-patriated. This appears to be obvious but unfortunately this issue can create more conflict and animosity than one might imagine.
  6. There should also be also some time-scale attached to the contract. No party would want to be locked into a lengthy agreement, particularly if the joint venture was not working well.
  7. It might also be advisable to set out in contractual format how costs are to be shared. There are many costs which could be disputed promotional material, R&D, administration. It may be necessary to itemise these costs and to allocate responsibility for their payment.
  8. There is a danger that where two companies come together as in a joint venture there will be a lack of overall leadership. It is probably sensible that one of the partners should be invested with the responsibility for decision-making so that there is no paralysis brought about by an inadequate command and reporting structure.
  9. Finally there should be some agreement as to arbitration if a dispute between the partners cannot be amicably resolved.

Conclusion
Joint ventures can be viewed from both technical and emotional perspectives. On the technical side there is the joint contribution of product technology, corporate expertise and market knowledge. It is relatively easy to ensure that these factors are complied with in contractual terms. It is less easy to legislate for the emotional aspects. This is more concerned with cultural issues, trust, style of management and expectations of each partner. These factors are more intangible. However if there is less cause for disagreement with the more quantitative aspects, considered above, because of contractual clarity then the less precise and more qualitative areas may become less contentious.

Many companies see joint ventures as a first step before acquiring a company. With the development of a smooth and harmonious relationship between the partners this could be a preliminary stage before an agreed and beneficial acquisition strategy.