In strategic alliances, there are two types of risks: relational risk and performance risk.
Relational risk is the type of risk that concerns regulations governing firms’ behaviors and relations in a partnership. Trust forms the foundation of strategic alliances. Firms build trust to reduce relational risks, set up control to measure and reduce those risks.
Performance risk is the type of risk that concerns firms failing to achieve their goals even when the alliance itself is fully operational. Synergy is at the center of reducing performance risk. Because of synergy, partners can distribute performance risk among partners.
Relational Risk 1: Loss of Financial Resource Control
Firms put in financial resources, but do not trust the partnership.
For alliances operating with this type of risk, the investing firm may want to control the relationship and make sure that the invested resources are used appropriately.
To control the relationship, firms may rely on either a hierarchical organizational structure (joint venture) or their people in the partners’ board of directors (equity alliance). These are two solutions firms can use to overrule the strategic decisions made by their partners, thus reduce the risk.
Relational Risk 2: Leak of Technological Resources
Firms provide technological resources but do not trust the goodwill of the partners.
Facing such a situation, the firm will mostly concern with protecting its technology. The firm must learn how to cooperate without giving tacit knowledge, unique capabilities, and in turn, core competencies. Unintended transfers of important skills and proprietary technology may occur at any time.
Thus, protecting technology becomes the firms’ orientation.
One of the solutions is that a firm can rely on the protection of the patent system. This system will ensure the firms’ exclusive usage of specific technology for a period since informal transference of patented technology and knowledge is impossible. Thus, a firm should let its partners access only patented technologies which the partners cannot freely copy or apply on their own.
When the relational risk is high, firms should only expose their patented technology and knowledge. In case they need to transfer unpatented knowledge, the firms should attempt to reduce the transparency of the technology, limit the scope of the agreement, and follow the incremental approach. Generally, giving incremental pieces of technology is always better than signing a wholesale agreement.
Relational Risk 3: Opportunistic Behaviors
Firms are not concerned with performance pitfalls but guard against opportunistic behavior and cheating.
This usually happens because of either a failed contract or a false perception of the firms’ trustworthiness. In such a situation, insufficient trust between the partners may threaten the partnership.
Even though the alliances may provide profits in short-term, in the long run, the result would be a disadvantage for the firm having a better starting point, leaving it with no clear competitive advantage in the marketplace.
The solution for this type of risk is to build a stable relationship with the partners. Firms should be embedded deeply in an alliance so that they will be less likely to behave opportunistically.
Building trust is an important aspect of building and maintaining strategic alliances. Many partnerships have failed because the lack of trust between partners leads to issues impossible to solve since trust directly links to communication and mutual understanding.
Without trust, conflicts between partners will build up over time. Firms start disagreeing on business philosophies, established goals, objectives, and controls. These problems may eventually lead firms to perform unsatisfactorily and even result in business failure.
The ways to build a stable relationship are (1) extending the duration of the alliance, since the level of embeddedness positively correlates with the alliance length, (2) formalizing the relationship as much as possible, because formalization leads to better control, and (3) entering an equity alliance with investment from both partners, as this type of collaboration increases the embeddedness of partners.
Relationship Risk 4: Loss of Managerial Control
Firms allocate managerial resources to the alliance but will try to acquire managerial authority.
Dealing with this risk type, the firm would want to ensure it makes final decisions on managerial issues.
The solution for the firm in this situation is to retain managerial authority. There are several ways the firm can retain this type of authority. First, the firm must try to put its people in the key positions of the alliance, such as the board of directors and executive committee. Secondly, the firm must keep its key personnel from being recruited by the partners.
Performance Risk 1: Non-Profitable Investment
Firms trust their partners but worry about the performance of the alliance.
In this situation, the investing partner mostly focuses on its profitability. The firms’ invested equity becomes a burden that increases the likelihood for the firm to actively seek viable solutions.
To handle this type of risk, the investing firm may specify exit provisions in the alliance contract to ensure that its investment can be as recoverable as possible. The exit clauses should state that one partner has the obligation to sell, and the investing firm has the right to purchase back the equity in case the alliance must be terminated.
Performance Risk 2: Low Technological Utility
Firms trust their partners but are concerned about the riskiness of the venture.
The firm owning the technology would mainly concern with enhancing the usefulness of its technology so that the venture can succeed.
Usefulness, or utility, of technological resources would mean (1) the objective utility of the technology itself, or (2) the usefulness to the firm itself, usually in terms of economic returns.
Thus, one of the solutions to control this type of risk is to increase the output of technology. The second solution to control this type of risk is to license the technology to as many partners as possible.
Extensive licensing can help firms to reach early standardization of product design, while at the same time collect royalties quickly.
Performance Risk 3: Business Environmental Changes
Firms can build trust with partners but worry about the prospects of the products.
Facing this type of risk, firms are not certain about the market, its trends, and related events.
Constant changes in the business environment may threaten the continuation of the alliance. The changes in the external and internal environment may affect business strategies, making the assumptions upon which the alliance strategy is based become no longer valid. Alliances may not be able to produce expected outputs without agreement modifications.
The solution for firms finding themselves in such a situation is to be flexible and responsive to changes in the market. Flexibility, in this context, means being in a position for an easy withdrawal. Firms should not dedicate resources explicitly to the alliance.
To achieve such levels of flexibility, the firm should aim for recurrent contracts. This means to repeat short-term agreements based on prior performance of the alliance. With recurrent contracts, the firm can experience with the alliances, using alternative methods if necessary.
Firms can use recurrent contracts in licensing, buyer-supplier relationships, and manufacturer-dealer relationships.
Performance Risk 4: Inefficient Management
Firms have a stable relationship with partners but are concerned about managerial efficiency.
Firms in an alliance have trust in each other in this situation, so the orientation is on how to best exploit the managerial competence of each firm, rather than protect itself from the others.
To exploit managerial competencies, each firm should have competent alliance managers. Thus, the firm must ensure to assign the best people to the job. Due to the nature of the strategic alliance, firms sometimes are not willing to contribute to the best of their people.
Another important aspect of exploiting managerial competencies is to keep the managers long enough in the venture. This will help them develop effective managerial skills. Short tenure usually hurts managers because valuable assets do take some time to grow.
Resources
Further Reading
Related Concepts
References
- Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2016). Strategic Management: Concepts: Competitiveness and Globalization (12th ed.). Cengage Learning.
- Hill, C. W. L., & Jones, G. R. (2011). Essentials of Strategic Management (Available Titles CourseMate) (3rd ed.). Cengage Learning.
- Wheelen, T. L. (2021). Strategic Management and Business Policy: Toward Global Sustainability 13th (thirteenth) edition Text Only. Prentice-Hall.
- Resource and Risk Management in the Strategic Alliance Making Process. (1998). Journal of Management. Published.