Introduction
There is notably an important trend in how organizations relate in the 21st century. The business world, especially in the international market is characterized by strategic alliances.
These alliances are in a bid to attain different organizational objectives, which may include lower costs in production, higher market penetration, acquisition of knowledge, gain in tactics used in a certain line of business, or acquisition of resources such as brands, patents, copyrights and production technology.
Many companies prefer to outsource different activities instead of internalizing them. These activities are non-core; hence this leaves these companies to concentrate on the core part of being in business. All this leads to higher profits in most cases, or at least, it is the motive of majority of the alliances.
The following paper looks at the two major theories that contribute to the understanding of strategic alliances concept: the transaction based approach and the resource based approach. The two theories are analyzed in detail in a bid to elaborate their explanation being the rationale of such strategic operations. Their assumptions will also be explained to ascertain any limitations.
Formation of Strategic Alliances
Transaction Cost Approach
The above theory is directed towards minimization of costs involved in transaction of various assets. These costs may include expenditures during preparation and execution of contracts, taking care of accrued claims from legal slams or enhancing working environments.
This approach outlines that strategic alliances will be formed when costs of a certain operation will be lower than when a firm internalizes the cost to its individual hierarchical structure. Transaction approach gives reasons for justification of alliances as a way to avoid spot market arrangements. Efficiency is the number one concern when there is a choice among hierarchy and market (Krugman, 2009).
When production costs do not vary among firms, costs of performing transactions are the differentiating factors. A transaction between two or more firms will need huge specialized investments, and lack of certainty in unforeseen contingencies makes an agreement incomplete, paving way for opportunistic behavior. Thus, market plans will be replaced by administrative hierarchies to reduce the costs of transacting.
This cooperative relation mitigates risks attributed to bilateral contracts between separate persons as well as avoiding reduced efficiency brought about by shirking and troubles of bureaucratic systems present in hierarchical firms. This means that cooperative arrangements are better governance strategies in trade because there is a reduction in intermediate transaction costs (Tallman and Fladmoe, 2002).
Transaction cost can be divided into two: Ex-ante costs of preparing agreements and negotiating the same; and ex-post costs which happen after the agreement is realized. These include enforcing the contract and monitoring it. There may be losses that persons may incur due to poor choices in the mode of governance.
This implies that the formation of new corporate entities, owned jointly, and acquisition of minority shareholding is appropriate. Therefore, transaction cost approach aims at increasing performance by reducing transaction costs; more hierarchical arrangements are preferred when transaction costs are high.
Cooperative arrangements may be contractual; this does not involve any equity rights. Examples would be combined research activities or joint sale and marketing programmers. Cooperative arrangements may also involve equity relations; this means sharing of ownership of a venture.
Transaction Cost Minimization in Equity Arrangements
The main differences between an equity arrangement and contractual arrangements are the joint shareholding, ex-ante commitment of assets, and use of a specialized unit in control of operations. Joint ownership reduces the probability of occurrence of opportunistic behavior. This is because opportunistic actions would lead to overall reduction in the value of an investment, which both parties have interest in.
Therefore, such actions are not likely. However, an opportunistic partner may decide to act this way since he can capture all the benefits and only lose by his or her value in the shareholding. This can lead to moral hazard which can be prevented by ensuring that the costs of such behavior is higher than the personal benefits associated with such; moral hazard protection can be said to be partial (Hyder, & Abraha, 2003).
The second advantage in equity relation is that parties must value ex-ante the assets they contribute towards a business venture. The value of this is used in determination of the proportion of ownership in the venture. Partners are induced to subsequently commit to making claims based on the value contributed.
In case of dissolution, proportion of value contributed will be equal to the proportion of resources received as had been put in commitment. This perspective is however not applicable when contributions are made as the venture is in progress or the initial values contributed cannot be actualized because of inadequate information or unverifiable values.
The last advantage is that there is greater efficiency attributed to residual right of control being done jointly by partners. This is through the specialized administrative personnel.
Through the board of directors, which partners are represented, they can be able to oversee management’s decisions, decisions of fellow partners, and scrutinize financial information. The board of directors is also in a better position to solving professional conflicts among partners in case of contingencies that are not expected.
Choice of governance must also consider the costs of equity arrangements over contractual ones, and not just the benefits above. These costs should be weighed in relation to benefits so that the most efficient governance method is established. The cost of equity arrangements includes costs of formulation and negotiation of agreements.
It is also costly and cumbersome to set up a new organization. There are also costs of changing the organizational structure of the parent corporation. The second level of costs is of high costs of termination of such projects. The third disadvantage is that with equities, there may be waste of time in handling a sudden contingency since there is need to consult fellow partners.
This might lead to time wastage that will lead to more severe losses. Williamson (1996) concurs that joint venture is better off than contractual agreement when the investments involve huge transactions which necessitate support from the partners and when monitoring of partners is hard.
Usefulness of Transaction Cost Analysis
If the interaction level is very high and asset specificity is also high, vertical integration will established. Transaction cost theory is important because of its contribution in the analysis and explanation of knowledge transfer within strategic alliances.
It elaborates the importance of knowledge transfer, helps in identifying a partner’s resource provisions and elaborates deeply the cost-benefit analysis necessary in selection of governance criteria. In international trade, coordination expenditures can be significantly reduced with organization of overseas alliances as a way to extend hierarchical structures and increase scale and scope of knowledge.
A perfect example would be the Renault-Nissan alliance. Renault was still recovering from its failure in merger with Volvo in 1995. It had never entered the global market and had a bad public image. Nissan was in bad financial state with a debt of $20 billion. Car production had reduced by 600,000 units.
Their capacity was therefore underutilized by 47%. Renault was strong in Europe and Latin America while Nissan had great engineering powerhouses and good market dominance in Japan, North America and Asia. Five years later, Renault’s investment in Nissan had grown from USD 5.4 billion to USD 18.4 billion.
Renault increased its stake in Nissan from 36.6% to 44.4%. Nissan’s profit of 7.6 billion and 11% operating profit margin was a record high in the industry. This is because ii reduced its transaction cost by using the underutilized potential of Nissan manufacturing plants (Wathne, & Heide, 2000).
Limitations/ Assumptions of Transaction Cost Approach
This theory explains only the importance of reduction of transaction costs and ignores the other pros of strategic alliances, which may be increased competitiveness and increased values of firms. Transaction cost is also argued to be biased only to transaction cost in elaborating rationale of knowledge alliance.
The alliance involving transfer of know-how often end up increasing costs, but in the long run increases profitability. This theory has limitations of making assumptions that individuals and organizations are culturally restrictive. This is not actually the case since alliance like Suzuki-Marti and Renault-Nissan brought about huge acceptance of external culture’s goods.
There is also an assumption in this theory that individuals are strictly profit motivated and will act in an opportunistic manner while being rational. There is lack of trust between parties. This may be the dominant case in western countries. However, in East Asia, there is a move towards greater trust and dependency between organizations’ collaborations even when the number of those in cooperation is small.
Resource Based Approach
This is quite different from the rationale in the transaction cost logic. This is because the resource based approach puts more emphasis on maximization of value of a firm through bringing together, or pooling, and using valuable resources.
Firms are therefore trying to establish the optimal resource boundary where the value of their resources is higher than any other combination of their resources. Here, integrating resources can be done regardless whether the two parties are in the same industry (Heiman, & Nickerson, 2002).
A firm is said to have a competitive advantage when it performs a strategy to increase its values, while its rivals are not simultaneously implementing such strategy. This is because they may not be in possession of such resources. Resources of valuable firms are rare, cannot be perfectly imitated, and have no perfect substitutes (Brown and Hogendorn, 2000).
Therefore, there is need for trade and strategies of accumulating resources. According to Pavlovich and Akoorie (2003), trading in the spot market to obtain such resources is mostly not possible because some resources are not completely tradable because of their highly attached relationship with their firm.
This necessitates strategies that may include strategic alliances. Therefore, this theory sees strategic alliances as methods used by firms to access resources of other firms, which they will be better off with in terms of competitive advantage.
The main reason that firms engage in strategic alliances is to attain resources which they would otherwise not get through the market or mergers and acquisition. The combined resources should bring about higher returns. This was a strategy used by Suzuki when it decided to leave the highly competed market by other major Japanese automobile manufacturers and venture into a new market, India.
Its new joint venture with Marti Ltd had numerous challenges, especially because of brands like Tata motors. Gaining market knowledge from Marti made it establish itself as India’s “people’s car.” Marti Suzuki India Ltd has 4000 employees and it is looking forward to build new factory this year with a capacity of 300,000 cars per year because of its anticipated demand increase (Foss, 2010).
The resource based approach gives two reasons why firms have interests in alliances. These are:
Acquiring Resources of Other Firms
Firms enter into strategic alliances to increase their competitive advantage by gaining resources owned or possessed by another firm. Multinational corporate organizations may enter into a local market by forming an alliance with a local firm.
They therefore get access to local resources and knowledge of this market by these new international joint ventures. Firms can also bring together technological know-how of several companies to invent new methods of production or new products.
Strategic alliances are more advantageous than mergers and acquisitions. This is because at times, not all resources of a targeted firm may be valuable to a strategizing firm. However, with acquisitions, the parent company buys all the resources of the target firm whether they are important to them or not. There are also cases in which needed resources are not separable from the non-desired ones.
Therefore, with acquisition, the non-desired assets may not be disposed. Alliances will help a firm use the needed resources as they bypass the non-desired resources. However, when the two types of resources are separable, firms will prefer acquisition (Sividas and Dwyer, 2000)
Retaining Resources
In times where a firm is not untiring its resources and may need them in future, strategic alliances come in hand. A good example would be human resource employed by a research company. When they are in excess, instead of the firm laying them off, they may opt to out-source them to other companies which have research in progress then get them back when need arises.
They will therefore save on having to pay them while they are in excess or cost of training new personal after there is need for new tasks which would require similar trained personnel as those sent off. This is therefore another advantage over acquisitions and mergers.
A good example to illustrate this is the Rover-Honda Alliance. Rover was in a bad financial position and was having loses. It had poor quality control mechanisms and need to a new product in the lower medium sector. Honda was renowned for its high quality motorcycles.
It needed to penetrate the European market. Therefore, the two companies formed an alliance. Rover would benefit from high quality controls and great reputation of Honda, while Honda would utilize market knowledge and manufacturing resources of Rover which were being underutilized (Reuer, & Arino, 2002).
Resources’ Traits Encouraging Alliance Formation
Characteristics of resources give the possibility of firms entering in a strategic alliance. Possession of a vital resource that a party needs is necessary for any alliance formation. Properties of resources that encourage strategic alliances in the resource based approach are imperfect mobility, imperfect substitutability, and imperfect imitability.
Imperfect mobility arises because of the difficulty or impossibility and high costs of relocating resources from one organization to another. This may be because of the cost to transfer being higher than the benefits of the transfer; an organization’s reputation cannot be traded at all.
Culture of an organization is also not tradable hence to acquire such, strategic alliances are necessary. Knowledge in performing certain business tactics loses its value if transferred from one organization to another. It may also cause complimentary resources to lose value (Shrader, 2001).
Imperfection in imitability and substitutability make it extremely difficult for an organization to get one resource from the other. This is because of casual ambiguity which makes it unclear for management of a firm to know the relationship between certain resources and competitive advantage.
Imperfect imitability may be caused by protection by law of resources like patents and copyrights. Imperfect substitutability may arise because of lack of knowledge to produce homogeneous resources as another firm. This may be because of lack of certain tactics or complexities in production.
Carbaugh (2008) argues that if resources of one firm are easily imitated, substituted or perfectly mobile, there would be no need for any firm to form a strategic alliance with such a firm – no firm would be willing to share its resources which are desirable with such a company.
Strategic alliances would only make the superior company more vulnerable with no mutual gains. The superior firm would lose on some level of control of its organization. Costs of administration would also increase with such an alliance. This therefore means that the superior organization would be worse off.
A firm will only get into a strategic alliance if it cannot efficiently obtain resources it requires through any other means, especially the market, with the exception of strategic alliance. Companies with enormous financial resources are approached for alliances by firms who need financial support. This is because this can be readily obtained in the capital market. There is easy substitutability in this case.
However, if the company in need of financial support wants to engage in a risky business, and therefore the prevailing interest rates are not sustainable with such high levels of risk, it may now opt for an alliance since finances will have become imperfectly mobile and imperfectly substitutable. This was the case with Rover, which was in a poor financial state hence could only do well with support from Honda.
Its financial risks were high hence an alliance was the only way to solve it from collapse. Honda helped Rover, but with a mutual gain in market penetration knowledge resource and use of manufacturing resources previously owned by Rover (Grant, 2002).
Alliance Survival and Resource Alignment
In the resource based view, the critical factor that affects survival of an alliance is existence of resource alignment. Where one organization has needs that are being provided for by another firm, and the other with needs whose provision is possible to the other partner, such alignment sustains an alliance.
If it happens to be a change in the provision of resources, resource requirement by the parties to an alliance, there are higher chances for the termination of the strategic alliance. This means that three should be a fit in the resources of the parties in the alliance for it to exist (Borwn, and Hogendorn, 2000).
Limitations/Assumptions in the Relative Based Approach
Existence of assumptions in this theory causes some factor to be ignored. The main assumption is that only resources that are related and useful to alliance parties should be considered. This means that unreliable resources are not considered.
This ignores that fact that such resources may be important in that the surplus resources may be used as increased value for the alliance which may lead to further beneficial alliances with firms in need of such surplus resources. The surpluses resources may also be used as a tool for risk management incase current resources are lost in a contingency. Surplus resources should not be just viewed as idle resources.
It may be used as a platform for future increased capacity without the need to acquire new resources when need arises. For example, if an alliance leads to existence of surplus manufacturing capacity, this should also be considered and not just the utilized capacity since it gives a firm greater potential for increased production if market trends change causing anticipated excessive demand.
Hill (2005) asserts that excessive financial resources after an alliance should not be ignored since if acts as risk mitigation tool in cases of emergency financial need.
Conclusion
Strategic alliances are a common phenomenon in the current corporate world. It is highly evident in the interracial arena that collaborations are beneficial to firms. It is a deliberate attempt by firms to cooperate via linkages for strategic objectives. Theories explaining the logic behind these interactions include the transaction cost approach, which generally state that firms cooperate in operations to reduce transaction costs.
This theory however does not consider other significant reasons for cooperation such as market penetration. The other theory is the resource based theory; it argues that firms form alliances to mutually share vital resources because of imperfection in resource mobility, imitability, and substitutability.
A limitation of this theory is ignorance of resources that are not related and useful to alliance parties on its formation, but might be vital in the long run, say for risk minimization purposes. It can be concluded that alliances are advisable strategies in the main objective of organizations, which is profit maximization.
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