Joint ventures are powerful ways to create value for involved parties.

What is a joint venture?

A joint venture (JV) is a newly created legal entity (i.e., business) formed between two or more parties to engage in economic activity together. The parties generally agree to create the new entity by contributing equity, and sharing in the revenues, expenses, and control of the enterprise. Equity contributions can come in any percentage combinations – either of equal value or differing ownership values.

Water Street Partners also views consortia (also called "cooperative agreements"; typically formed for a specific project (e.g., building of the Chunnel)) and other complex partnerships (e.g., syndicates, marketing alliances, joint development alliances) as variations on the joint venture, as many of the challenges of forming and managing JVs also apply to these partnerships.

Water Street Partners' research estimates that assets in material joint ventures – any joint venture or partnership accounting for 10 percent or more of a parent company’s total assets, invested capital, costs or revenues, or that is expected to account for 10 percent of the profit and loss of the corporation, or smaller joint ventures that are strategically important or carry disproportionate risks – exceeds $2 trillion.

Assets in material joint ventures of public companies

With that much value at stake, how do JV's perform?

JV performance is mixed. Our research across the years shows:

• Announcing a new JV had a negative effect on the shareprice of almost half the parent companies involved
• About half of JVs failed to perform against the financial and strategic expectations set by one of the parent companies
• About half of JVs perform worse than similarly sized, wholy owned business units of the parent companies

JV mixed performance

What is hard about creating and operating a joint venture?

JVs are inherently different from full mergers, acquisitions and wholly-owned business units:

• Owners are separate companies – each with its own distinct (and changing) interests, constraints, and processes
• Owners often have direct, numerous and complex commercial relationships with the venture – e.g., as input supplier, off-take buyers
• Owners provide ongoing operational resources, services, skills and support to the venture (e.g., sales support, customer financing, advanced design engineering expertise, administrative services such as legal, finance)
• Staff are at least partially drawn from the separate owners – and will likely return to those owners

These features create a set of incremental challenges for board members and managers.

JV challenges

1. Strategy – Separate owners are prone to diverging views on business prospects and evolution, different investment / risk appetites, dividend policies, prioritization of non-financial needs
2. Governance – Shared decision making (among potentially conflicted / competitive shareholders) is required. JV Board has additional roles not needed in corporate Boards – e.g., managing conflicts between owners, securing resources from the owners, monitoring transfer prices/parent transactions, managing career path of management team
3. Organization – Reliance on secondees / rotational staff creates conflicting incentives and approaches. Partial ownership structure makes it much harder to attract top owner company talent into venture. Venture culture often uncomfortable mixture of multiple owners – with limited incentives to integrate due to reliance on rotational staff and non-permanent nature of many JVs.
4. Financial Arrangements – Complexity of economic flows (direct earnings, royalty payments, pricing) make it very hard to understand total venture economics / true P&L. JV owners routinely have conflicting / non-aligned incentives in the business

Given the inherent challenges of joint ventures, why do companies choose to pursue them?

Joint ventures can create significant value to their owners. Key uses of joint ventures and alliances include:

• Building a new business – useful when risks are high, skills are incomplete, or speed is essential. Examples:
  • Microsoft and NBC created a JV (MSNBC) to compete in cable and internet-based broadcasting
  • Philips and Sony used an alliance to pool their patents to develop the compact disc and licensed it as an open standard
• Accessing new markets – allows company to remain focused on core business while reaching a large number of new customers in new geographies (particularly in emerging markets or where foreign ownership is not permitted), or new product and customer segments. Examples:
  • Starbucks has used joint ventures to enter new geographies (China, Chile), and create new products (JV with PepsiCo to develop coffee beverages and Dreyer’s Ice Cream to sell a coffee ice cream line)
  • Dow Chemical used the EQUATE JV to enter the Kuwait petrochemical market
• Accessing skills and learning – enables companies to gain skills and learning that they can use to build future competitive advantage. Examples:
  • Samsung uses JVs to access various skills and technology platforms
  • Eli Lilly and ICOS formed a JV to develop and sell Cialis, where ICOS provided the IP for the drug and Eli Lilly contributed cash to the JV
• Gaining scale – similar to traditional mergers and acquisitions, allows companies to consolidate overlapping businesses, reduce costs, and increase scale. Companies may choose a JV vsacquisition because acquisition premiums are often high, most JVs are tax free and companies don’t have to relinquish control of their business. Examples:
  • First Data Corporation forming JVs with several banks to gain scale in credit card processing