Chapter 6: FACTORS AFFECTING SUCCESS OR FAILURE

CHAPTER 6

Factors Affecting Success or Failure

NUMEROUS STUDIES HAVE BEEN MADE regarding why international JVs get into trouble. Each JV is, of course, unique, and it is therefore difficult to draw sweeping generalizations from these studies. Nevertheless, it is useful to understand some of the more common problems that tend to arise. In each case, the parties need to consider appropriate changes in JV operations and/or the overall business strategy of the JV. Recognition of early warning signs is important because failure to deal with a specific problem may doom later attempts to reach a solution through one of the formal dispute resolution procedures described in Chapter 16.

Poor Pre-Formation Planning

Many problems that might arise during the operation of a JV are in fact created by pre-formation planning that is inadequate and, perhaps, too hasty. For example, a distribution relationship might fail if a product was inappropriate for the target market, or the parties failed to assess correctly the competitive factors in the market. Before you leap into a JV, consider the following: ■ Pay careful attention to country and market analysis, due diligence investigation, and entity selection and formation. This is time well spent, even if the timeline for becoming operational must be extended a bit. ■ Take assertive steps to guard against communication failures, which may occur due to language, cultural, or geographic constraints. ■ Reach a consensus on the fundamental objectives of the JV. Often, discussions during formation and negotiation unduly emphasize methods and procedures, without clarifying or expanding on the overall objective. As a result, the JV is less able to adjust if another method is needed to accomplish its prime objective.

Unexpectedly Poor Financial Performance

Nothing can strain a relationship between two parties more than unexpectedly poor financial performance by the JV, whether in poor sales, cost overruns, or otherwise. Poor financial performance can result from such factors as inadequate preformation planning, failure to approach the market with sufficient management flexibility and efficiency, and unanticipated changes in the country’s situation. Although business risks cannot be completely eliminated, factors that might adversely influence the JV’s financial performance can be identified and monitored. These factors should be reviewed before finalizing formation of the JV and periodically during its operation so that adjustments can be made if problems are found.

Management Problems

One of the biggest challenges for parties to an international JV is the effective coordination of managers drawn from diverse countries, cultures, and educational backgrounds. Managerial styles reflect the expectations of workers and their tolerance for confrontation, factors that also differ among countries. The fact that many JVs fall apart over misunderstandings about leadership strategies is not surprising. Successful management requires compromise, respect and understanding of the differences, and integration of the strengths of both styles to overcome the weaker points. EXAMPLE: A number of JVs between US and Japanese partners reached a crisis point when US managers, who prefer strong direction from upper management, clashed with Japanese executives, who prefer to rely on consensus built from within the organization. Adding to the strain was the fact that Japanese management philosophy tends toward a less formal organizational structure. A byproduct of this was that Japanese managers relied more on verbal communications without keeping the extensive written memoranda and informational reports that US executives tended to expect.

INAPPROPRIATE MANAGEMENT STRUCTURE Contrasts in management style can be magnified if the management structure selected is inappropriate for the JV’s activities. Many parties, particularly those with little or no experience with JVs, insist on a shared management system to protect themselves from what they perceive as an attempt by the other party to extract an unfair advantage from the relationship. As a result, daily operational decisions that are best made quickly must instead be approved by a committee, making rapid movement by the JV more difficult, and increasing the possibility that the parties will become embroiled in disputes over matters that are immaterial to the JV’s success. For this reason, the parties should consider letting one assume control over daily operations while reserving joint approvals for major issues. A cumbersome management structure can increase the costs associated with operating the JV, particularly if the partners work in different languages and decisions must be frequently reviewed by home office personnel in disparate locations. Delegation of daily decisions to on-site personnel is therefore not only time and labor efficient, but can save significant costs, as well. EXAMPLE: Early JVs between United States and Japanese companies struggled under high costs for translating company documents and sending constant communications from the JV in Japan to the US headquarters. Time differences placed significant strains on personnel, particularly in the US, where managers had to be available during business hours for Japan. Many of these problems could have been avoided if the US companies had delegated more authority to on-site personnel in Japan.

Strategy Problems

For many JVs, the problem is not the execution of the JV’s business strategy, but rather the strategy itself. During formation, the parties should try to anticipate strategy changes and allow for flexibility within the JV’s operations so as to avoid at least some of the following strategy pitfalls:

■ FAILURE TO ANTICIPATE PROBLEMS A JV’s initial strategy may be faulty if the parties did not lay their plans with careful analysis. For example, a distribution JV may fail if the parties did not expect to adapt their product for sale in the local market.

■ FAILURE TO ADAPT TO CHANGING MARKET CONDITIONS A business strategy should always reflect market conditions, which means that it must be revised periodically as those conditions change. For example, if a distribution JV is paying substantial costs for importing goods produced in another country with higher labor costs, the parties might revise their strategy and decide to expand the activities of the JV to include manufacturing operations as a way of reducing costs.

■ FAILURE TO GRAB NEW OPPORTUNITIES A business should be encouraged not limited by strategy decisions. Strategy decisions that impose, for example, unreasonable limitations on product lines or targeted customers, tend to work against the JV.

■ FAILURE TO FOLLOW A PARTNER’S ALTERED POSITION Strategy changes are sometimes a function of revised objectives within one of the JV participants.

The other party might resist such changes, and at the least they should be open to negotiation. Consider a situation where one party decides that the JV is no longer merely a manufacturing opportunity, but also has potential for marketing the product in the host country and elsewhere. That party might shift the mix of the personnel that it assigns to the JV to include marketing experts and general managers with experience in operating a multifunctional marketing and manufacturing subunit.

Improper Choice of JV Format

In some cases, the JV format is inappropriate for the particular product or service that is being exploited in the collaboration. As a general rule, a JV works fairly well for a standardized product, such as chemicals, drugs, plastics, and automobiles. On the other hand, construction of a dam or a steel mill does not lend itself to establishment of a separate enterprise, but rather is best accomplished through a network of contractual relationships covering various activities, each of which is coordinated through a single owner-manager.

Inappropriate Performance Milestones

Even if JV participants appear to agree on the fundamental objectives of the relationship, confusion often occurs if assets are transferred to the JV over time, particularly if one party transfers technology or other intangible property. A fairly common phenomenon is that the other JV partner fails to recognize the value of acquiring knowledge and process experience, which can be used in a diverse set of product and market areas. In such cases, performance should not be measured by revenues or market share, but instead by performance milestones that measure how well the local operation has been able to absorb and exploit the relevant know-how and other intangibles. Properly used, these milestones may uncover problems arising from the unwillingness or inability of one party to actually transfer its technology and other intangible rights through the JV.

Personnel Problems

As with any business, personnel problems can significantly harm the viability of a

JV, resulting in poor performance and ultimately in high personnel turnover. The range of possible problems is quite broad, and may stem from poor training, low benefits, difficult work conditions, and difficulties with managers. To the extent possible, JV parties should try to anticipate these problems during the formation stage.

In particular, they should address these basic personnel concerns: ■ What will the personnel policies be in view of the contrasting management styles of the parties? Personnel problems may actually be a byproduct of some of the differences in management styles. For example, while Japanese workers may value job security and the intangible comforts of sharing in management decisions, US employees may not be satisfied with those perks if they have to sacrifice performance-based incentives, which are more commonly used in the US. ■ What mechanisms will be used for performance reviews? Countries tend to use different systems for performance reviews, which may create uncertainty and stress for workers who may not receive the guidance and feedback they expect. ■ How will directors, officers, and managers of the JV be selected? Nepotism can be a cause for controversy. Substantial conflict can arise if a foreign party imposes professional criteria for selection of executives and key managers of the JV, while the local owners want to give influential posts to their relatives. ■ What will be the timeline for phasing out foreign staff in favor of national management, and what is the compliance period under national laws?

Disagreements can arise when local partners, or the local government, hasten the replacement of foreign staff by nationals more rapidly than the foreign partner feels is warranted by the training and experience of the local employees.

Conflicting Objectives

As a JV grows, the possibility increases that one or both of the parties will begin to have business objectives that conflict with the ongoing operation of the

JV. Periodic review of the JV’s performance and the business objectives of each of the JV participants should be conducted to ensure that both parties remain committed to the JV. Common scenarios to watch out for include the following: ■ One party becomes interested in developing business relationships outside the JV. ■ The JV is considering selling its products into markets where one of the JV parties is already active, either on its own or through another agent or distributor. ■ One party may develop, and wish to independently exploit, new products that may compete with or replace the products made by the JV. ■ One participant may simply lose interest in the project, perhaps because of a revised focus of the company independent of the JV’s success or failure.

Divergent Values

Perhaps the most challenging problem for an international JV is that the parties typically have divergent values which impact how they interpret the objectives of the relationship. For example, in JVs between parties from developed countries, there is a certain community not only of tradition but also of scientific, technical, and legal standards, and there is also more experience with responsible business and investment practices and legal supervision. In contrast, these standards typically have not yet been established in the business environment of less developed countries where power and wealth remain concentrated in a small group of companies and individuals, and where workers and consumers are not well protected. On the other hand, companies in the developed world tend to lack appreciation for building an enterprise over a long time to achieve continuous profitability. Instead, they seek to make a quick profit, even if long-term viability of the relationship is compromised.

Perceived Differences in Contributions by Parties

After a JV has been operating for awhile, a foreign party may express discontent with the level of contribution and commitment from the local party. The lack of commitment may be real, as when a local party has realized all the benefits from the initial transfer of technology and is eager to strike out on its own. Alternatively, it might simply be a byproduct of unrealistic initial expectations caused by the foreign party’s inability or failure to make a due diligence investigation. In other cases, one partner might accuse the other of a lack of commitment, such as when a foreign party is unwilling to commit senior managers to the JV and is slow to contribute cutting edge technology.

Financial Difficulties for One Party

One JV partner may, for reasons unrelated to the JV activities, experience financial difficulties that impact the projected growth and stability of the JV. For example, if a party has made a long-term commitment to provide additional funding to the JV, and that source of funding become uncertain, the parties would need to consider whether alternative sources might be available. In many cases, financial difficulties of one partner will trigger the other party’s right to terminate the JV or to buyout the interest of the distressed party.

Local Business and Regulatory Conditions

In some situations, adverse local business and regulatory conditions may doom the JV relationship. Even if the parties do their best to analyze the local economy and to identify any anticipated trends that might impact sales by the JV and local cost factors, the JV may fall victim to an unforeseen recession based on local factors that are beyond the control of the participants. The risk is exacerbated in developing

countries because local policy makers may lack the regulatory tools and experience to manage problems in the economy effectively.

National tax laws and foreign exchange considerations can be regulatory sources of conflict. For example, the foreign party may want the JV to retain surplus and not to remit dividends in order to be free of home country taxes at a given time. However, this goal may directly conflict with the needs of the local partner to take cash out of the JV to fund other activities. Conversely, a foreign party may want to avoid accumulation of profits because of concerns about depreciation of the local currency, while the local party may rightly argue that it doesn’t make sense to fund the JV’s working capital requirements from bank borrowings that carry a heavy interest burden. In either case, having to deal with a partner significantly reduces the degree of flexibility that a party might otherwise have to exploit profit opportunities from tax and currency situations. It is worth considering, however, that undue focus on tax and foreign exchange strategies may be counterproductive and distract attention from the operation of the core business.

Legal and regulatory changes can also impact the risk-adjusted financial return on investment from the JV. For example, changes in local labor or environmental laws, although impacting all businesses in the country, may significantly alter the cost structure for the JV and erase any pricing advantage that the parties may have anticipated from operating in the particular country. Again, the parties need to analyze carefully the political environment when they are planning the JV.

Political Factors

Political factors always play a substantial role in an international JV, particularly when the parties come from countries with different social, cultural, and economic backgrounds. If the local political situation is unstable, the foreign party can expect substantial scrutiny from regulators. Moreover, if the local partner should fall out of favor with the government, as is likely to happen if new regimes take over on a regular basis, the chances for success for the JV are significantly impaired. It is worth noting, however, that unstable political conditions probably would have threatened the foreign party’s investment regardless of the form of its operation, and it remains important for foreign investors to conduct a thorough country analysis before deciding to enter a new market under any strategy.

Local political factors are especially important when one of the parties is the local government, a government agency, or a local company that is controlled by the government. If there are changes in political leadership or public policies regarding foreign investment, the government may begin to push for changes in the original agreement between the parties. These changes could potentially have significant impact on the JV, such as a demand that the JV increase the number of local employees or grant preferences to local suppliers. While this may improve the local economy, it may at the same time adversely impact the overall return on investment for the foreign party. Of course, the government may contemplate more drastic measures, including expropriation.