Interview with a Joint Venture expert

With all of the Joint Ventures (JV) occurring in the lithium industry, we thought it would be helpful to delve into the topic and provide a framework with which to understand them.  In this post, we interview Professor Benjamin Cole of Fordham University, who has direct experience with JVs both as a practitioner and an academic.

 

Biography: Benjamin M. Cole, PhD, holds the William J. Loschert Endowed Chair in Entrepreneurship and serves as Director of the Full-time Cohort MBA and Professional MBA programs at the Gabelli School of Business at Fordham University; he earned his PhD and MBA at the University of Michigan’s Ross School of Business. Dr. Cole uses both domestic and international settings to investigate how social factors—such as status, legitimacy, logics and media framings—influence technological innovation, regulatory oversight and economic exchanges. His awards at Fordham include the Gladys and Henry Crown Award for Faculty Excellence (2015), the Stanley Fuchs Award (2015); the Dean’s Award for Teaching Excellence (2016, 2013, 2009); and the Dean’s Awards for Excellence in Research (2015).

 

The Lithium Spot- Can you explain your background and a little bit on how long you’ve studied JV’s and other similar strategic alliances for?  

Ben Cole- I am the William J. Loschert Endowed Chair in Entrepreneurship and serve as Director of the Full-time Cohort MBA and Professional MBA programs at the Gabelli School of Business at Fordham University. I hold both an MBA and PhD from the University of Michigan’s Ross School of Business. I’ve been a close observer of JVs since spending several years in Tokyo working for Toyota, who is involved with numerous technological and production JVs around the world. As a scholar, my work in alliances and JVs looks at the symbolic nature of announcements of both initiation and dissolution of such tie-ups.

TLS- What are the major benefits of a Joint Venture?  

BC- Joint ventures allow firms to quickly access capabilities, products and markets that would otherwise take time and money to achieve. They represent a ‘short-cut’ to building their firm or serving customers, but as with all ‘short-cuts’ there are downsides to them. In particular, you are connecting your firm to someone that you don’t control and who most likely have different interests than you. That means that there is room from opportunism in everything from transfer pricing to asymmetric gains, such as your counterparty learning more from you than you learning from them.

TLS- Many investors are wondering where the next joint venture will come from, what should they look for?  What are some telltale signs of a JV that might be needed for a business?  

BC- JVs come in many flavors. The first type is a firm has a product ready to sell but doesn’t have access to a desired market. That could be a lack of presence in a geographic market (such as lacking a local distributor), or it could be that certain hurdles haven’t been overcome in order to be able to access the market. As an example of the latter, a small biotech company may have an amazing drug, but cannot legally sell it to customers until it is approved by the FDA, which the small firm has no experience in tackling. In that case, the biotech company would seek out a partner with a track-record of going through the clinical trial process. These types of JVs are very common in the pharmaceutical industry. Naturally, this type of JV can be viewed from the perspective of the firm who can facilitate access, someone who has an amazing distribution system, but lacks products to sell through that distribution system. In short, the two firms in this first type of JV have complementary assets to each other.

The second type is a firm that wants to build new capabilities or technology, but developing those things alone would take too much capital or too much time. There can be quite a learning curve when entering a new technology space. In this case, the firm will go out to find a partner who has the other piece of the puzzle. Those firms work together to build something new together.

In the Lithium space, which is fundamentally an extraction business that then sells the product in B2B markets, both types of JVs are possible. Large producers may have already locked in key B2B buyers via contracts, and so the only way smaller producers can access those buyers is through supply arrangements to the large producers. In terms of the second type, a producer who uses the brine-based method may be interested in working with someone who uses the Spodumene processing method.

TLS- What are the downside risks of a JV that investors should be aware of when investing in a JV?  

BC- As I said before, joint ventures are ‘short cuts’ to accessing markets or capabilities or products. But that also opens up some downside risk for the counterparties. First, research shows that firms engage in ‘learning races’ with each other in JVs and alliances. In other words, once the relationship officially begins and the firms begin sharing knowledge with each other, one side of the JV may try to gain as much information as possible. And once they have what they want, they could pull out of the JV or allow it collapse. The most common way to do this is to move employees into the JV, and then once they have an understanding of things, move them back to the headquarters, bringing back the knowledge they have gleaned from the counterparty. That’s a real risk. Once they get what they want, they don’t need you anymore and can toss you aside like a paper cup.

The second big risk of JVs is transfer pricing. This is the price paid for technology or services provided by one of the counterparties to the JV itself. So if the JV needs a particular technology, the focal firm does not just donate it to the JV (usually). Rather, the focal firm usually licenses the technology for a fee. This seems pretty innocuous, doesn’t it? Firms license technology all the time. But remember, with a JV the partners are sharing the profits of the JV. If the licensing fee is too high, then costs would be high, driving profits to zero. Then there is nothing to share! But remember: one of the firms just got all those licensing fees, so they essentially ‘stole’ all the profits from the JV through transfer pricing, leaving nothing for their partner. That’s a real danger of JVs where the partners do not have equal stakes. The partner that has greater control may be able to authorize out-of-control licensing fees to siphon away any profits that the JV might otherwise have made.

TLS- On the flip side, what are telltale signs that a JV is working out well and is on its way to success?  

BC- If you recall the two types of JVs that I mentioned before, one can discern whether things have been going well by carefully examining financial reports such as 10-K or 10-Q filings. So if a firm has engaged in a JV to access a particular market, the financial filing should reveal information about sales levels in that market. That type of thing.

It is also important to remember that when things are going well, managers want attention for their success. So it is inevitable that they will make public pronouncements, publish press releases and so forth. I would be much more interested in a firm that announces a new JV, then never announces anything else about it moving into the future. That’s a sign that things may not be going as well as they had hoped. It’s much, much easier to see if things are going well, because managers want to be known for making good decisions.

TLS- What are the risks inherent with companies forming Joint Ventures that are across other countries’ borders?  Example, the JV’s currently formed are worldwide JV’s formed across many countries between them.  

BC-All JVs have certain risks, but cross border ones have even more. Firms often fail to realize just how challenging cultural and language barriers can be to smooth interactions. If you are working with a partner from the same country, the firms may have different managerial accounting systems, but at least you do not need a specialized translator to make sense of the categories. That’s not necessarily true for firms in other countries, who may have ways of quantifying things that are fundamentally different than the way the focal firm might.

On top of that, firms also have both transaction exposure (when money changes hands as customers buy products or the firm or JV buy inputs) and translation exposure (when capital is tied up in property, plant & equipment). Adding in currency fluctuations on top increases the need to do more financial engineering to reduce risk, such as hedging exposure in currency markets.

TLS- Much of our time as investors is spent studying and looking for competitive advantages.  Is there one point or a few points that investors should look for when it comes to competitive advantages within Joint Venture’s?

BC- Well, one thing that we know from research on the subject of JVs is that firms get better at doing them across time. A firm that has no experience in JVs will need to build a new skillset at managing JV relationships at the same time it is trying to pull off the JV. That’s like flying the plane as you build it. In contrast, firms that have had prior JV experience can know what not to do as much as what to do the next time around. That reduces the probability of failure, reduces costs, and so forth. So, one key source of competitive advantage in JVs is building up a skillset in managing them. Firms that are skilled at JVs understand that the managers in charge of JVs are working not only with the counter-party in the other firm, but also with counter-parties within the focal firm itself. Those managers need to maneuver across departments, translating the needs of the JV into language that people inside the focal firm would care about. Remember: Those people are not generally being evaluated as to whether or not they help a particular JV succeed. If they were, then the firm’s leadership is very wise in incorporating that criterion into its assessment process. But, in general, firm leadership is not that attuned to all the complexities that a JV will bring internally to that JV manager. And that means a lot of work for that manager.

TLS- When you see a company with many JV’s (as opposed to equity stakes in partner companies), would you get concerned that they are hiding something?

BC- Not at all. In fact, as I just mentioned, the more JVs the firm does, the better it will be at them. Thus, the trend will be for firms to not stop at one JV if the prior one is successful. What’s interesting is how firms learn to reconfigure their portfolio of relationships as the competitive environment changes. One of my colleagues here at the Gabelli School of Business, Navid Asgari, recently published a paper in the Strategic Management Journal.

Here is a link to the paper:

http://onlinelibrary.wiley.com/doi/10.1002/smj.2554/abstract

Here is a link to Dr. Asgari’s website:

https://www.navidasgari.com/

Dr. Asgari and his co-authors look at how portfolios of relations are reconfigured after a technological discontinuity. This happened, for example, in the drug discovery process in the pharmaceutical industry when combinatorial chemistry and high-throughput screening allowed firms to screen for many, many more drug molecules. Dr. Asgari and his co-authors find both complementarity pressures and substitution pressures on portfolios of relations. Complementarity creates incentives to form alliances for resources that the technological discontinuity reinforces or challenges in order to improve the collective value of co-specialized assets. In contrast, substitution creates incentives to terminate existing alliances, even if their value is otherwise unaffected by the discontinuity, in order to create carrying capacity for new alliances.

TLS- How common would you say that it is to see large, established companies form JV’s with pre-revenue start up companies like we are seeing in the lithium space?

BC- I would say very common. We know from lots of research contexts, ranging from the pharmaceutical industry to F1 racing teams, that large, established players often tap the creative energies of smaller players. This helps keep the larger firm more nimble, and brings in different types of thinking that might otherwise never emerge in a firm with set practices and protocols. In fact, there has been some research on how joint ventures may act as a ‘real option’ play of larger firms. Because the larger firm has created and nurtured a relationship, that firm has a better chance of succeeding in an acquisition attempt of the smaller firm should it decide to go that way.

Example research:

http://pubsonline.informs.org/doi/abs/10.1287/mnsc.37.1.19

http://www.jstor.org/stable/3094305

It is also important to remember that the Lithium industry is an extractive industry. Thus, firms need to be able to control, or have access to, deposits in the ground. Thus, tie-ups allow them to access the mineral rights that are being held by these smaller players. If a firm cannot become more efficient than its current level, then it needs access to new sources of minerals. JVs can provide that in ways that are much faster, much cheaper and much less complicated than an outright acquisition. JVs also allow the larger firm to assess the degree to which an acquisition might be successful, in terms of congruence of corporate culture, quality of employees, quality of deposits and so forth.

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