The Joint Venture Operating Model Blueprint

   

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87161815 architectural plans and ruler_black_and_white_smallPERHAPS NO OTHER aspect of joint ventures has caused so much trouble as an ill-defined, outdated, or inappropriate
operating model.

In a general sense, an operating model is a high-level architecture of the organization – how the various structures, systems, processes, and people within the enterprise relate to each other to deliver the strategy. In JVs, the operating model is defined by the venture’s overall level of independence from – or dependence on – its shareholders (Exhibit 1). Some joint ventures, like Dow Corning, Aera Energy, and Sony Ericsson, are highly independent. Others, including most upstream oil, gas and mining JVs, are operated by one partner.

Exhibit 1: Range Of Joint Venture Operating Models 

Range of JV Operating Models
Source: Water Street Partners
Click to Enlarge

Yet our analysis of 40 JVs, combined with dozens of discussions around the world, suggest that many JV operating models are ill-defined or out-of-kilter. In some cases, there are enormous cost synergies available by moving the model closer to one share-holder. In other cases, greater venture independence is needed to enable innovation, marketplace nimbleness, and entrepreneurship – or free up the JV from conflicts with the parent companies. But sometimes, what is most called for is simply clarity on what the operating model actually is. All too often, different people have different interpretations of the intended operating model, and such differences – even if subtle – put an enormous strain on venture management and the health of the partnership.

Addressing these issues is an urgent task for many JV Boards.

The purpose of this memo is: (i) to explain what we mean by operating model, including the architecture that underlies the high-level concepts; (ii) to illustrate the nature of the problems. If unmanaged, these problems will become more prevalent as regulation and market forces drive an increase in interdependent-style JVs, especially in emerging markets and the natural resource sector.

THE ARCHITECTURE OF OPERATING MODELS

While it is useful to think in terms of five high-level operating models (single partner operated, one-partner oriented, interdependent, quasi-independent, and independent), an operating model is in fact a multi-dimensional concept. It encompasses 10-20 key design choices related to the venture’s autonomy: strategy and scope; governance and decision making; talent and organization; and financial and commercial arrangements (Exhibit 2). These ultimately build up into an overall model.


Exhibit 2: Key Elements Within a JV Operating Model

Key Elements Within A JV Operating Model
Source: Water Street Partners
Click to Enlarge

A well-defined operating model provides clarity on fundamental questions: Is the JV expected to replicate all or some of the processes of the parent companies? Is the JV required to use the parent companies’ core technology and purchasing scale, or does it have freedom to source from third parties or build on its own if management deems it better for the JV? Will the JV depend on parent company secondees – and if so, for how long, at what level, and under what incentive and reporting model?1

Where a venture lands on these dimensions will inform all sorts of next-level decisions related to the JV’s business system configuration, committee structures, delegations matrix, conflicts of interest policies, reporting relationships, review processes, shared service pricing and other terms, and choice of technology. In contrast, a failure to clarify the operating model – at least at a moderate level of detail – will lead the shareholders, the board, and management into a world characterized by a series of seemingly low-level skirmishes that, collectively, create a serious drain on management time and trust (not to mention sub-optimizing the economic value from
the venture).

Ideally, the operating model is defined prior to deal close. A powerful way to do this is to develop what we call an Operating Model Blueprint. Typically a 10-20 page document, the Blueprint outlines the shareholders core beliefs about the operating model and how the venture will operate vis-à-vis the shareholders', maps out the level of independence on each of the key design dimensions, provides supporting analyses and assumptions for these decisions, and outlines a process for monitoring and adjusting elements of the operating model in the future. Conceptually, the Operating Model Blueprint is similar to an Initial Business Plan: developed prior to deal close, it informs and is informed by the drafting of the legal agreements. And like the Initial Business Plan, it is developed by business people rather than attorneys, and will evolve as the venture’s needs and market conditions change.

Done well, the process for developing an Operating Model Blueprint will include a set of crisply-articulated options within each of the 15-20 key design dimensions. For example, in a large cross-border industrial JV that planned to buy $20-30M in administrative services from its shareholders in the first three years, the integration team defined 3 options for how the shareholders could approach the shared service model (Exhibit 3). By framing the choices at this level of detail – and prior to launching the JV – the shareholders preempted future debates about fundamental philosophy and intent.

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   The specifics of these questions – and the range of available answers – will vary across JVs based on the deal concept and industry content. For example, in a four-partner financial services payments processing technology JV, the high-level operating model choices were best defined as a range between “captive” and “independent,” with captive meaning that the JV was entirely oriented to serve the needs of its four owners, whereas independent meant that the JV should behave as an independent business that not only served and satisfied its four owners, but also the broader market of potential bank customers. Similarly, in an upstream oil and gas JV, it was a given that one partner would be the “operator”; the operating model choices were therefore best defined based on the level, nature and location of the non-operating partners’ involvement. In this case, the high-level choices were arrayed from “financial investor” to “pseudo-operator”, with different flavors in between.