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Alliance Structures
STRATEGIC ALLIANCE PRACTICE
Discussion draft
July 1995
CONFIDENTIAL/INTERNAL ONLY
DC-ZXE070/950726DHR.1
ALLIANCE STRUCTURES
The purpose of this document is to help CSTs understand the full range of alliance structures that are available to clients, and provide frameworks for selecting among alliance, M&A, and arms-length contractual options.
This draft document has been developed as part of a broader, ongoing practice effort on negotiating and structuring alliances. The document has four sections:
1. Typology of alliance structures
2. Frameworks for selecting structures
3. Alliance structures: definitions and examples
4. Illustrative structures.
DC-ZXE070/950726DHR.1
ScopeWhat is in the alliance?
GovernanceHow can we manage it effectively?
Legal/financialWhat should be the ownership and financial arrangements?
Focus of this document: types of alliance structures
MgmtBoard composi-tion
Valuation and ownershipshares
Capitaliza-tion and financing
Type of alliance
Exit provisions
SkillsGeographiesProducts Assets/activities
Roles of parents, JV Board, JV CEO
This document focuses on clarifying types of alliances; for a broader perspective on developing alliance structures, see “Core Beliefs – Designing Successful Alliance StrategiesÝ or “Best Practices and End Products – Developing Successful Alliances,Ý or contact David Ernst (DC) or Trond Riiber Knudsen (OL) for results from a current practice project
Focus of this document
1. TYPOLOGY OF ALLIANCE STRUCTURES
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What is a strategic alliance?
Elements Comments
Joint contributions Each partner contributes capabilities, e.g., skills, access to markets, assets
Influence without full ownership
Partners are able to influence assets without full ownership
Shared control, ownership, risk, and reward
Parents share control and/or ownership of business system, leading to shared risks or rewards
Exclusivity There is typically some degree of exclusivity
Temporary Strategic alliances are typically intermediate strategic vehicles
DC-ZXE070/950726DHR.1
Strategic alliance: a definition
Intermediate strategic vehicle involving substantial shared risk, cost, or reward without full control, and with a significant degree of exclusivity
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Not all corporate relationships are strategic alliances
Acquisitions
Mergers
Joint ventures
Partial equity investments• One-way minority stakes• Cross-equity stakes
Contractual agreements(parent-to-parent)
Corporate relationships
No
Rarely
Yes
Only if combined with JV or contractual alliance
May be alliances, depends on level of shared risk, reward, exclusivity
Are they strategic alliances?
DC-ZXE070/950726DHR.1
“Partial acquisition” JV – one parent takes substantial stake in other company (often contributing cash and skills or technology) while a new “JVÝ entity is created
One-way or two-way minority investments with JV or contractual alliancesMinority investments – without JV or contractual alliance
Startups in which both parents contribute assets, technology, people, other capabilities
Formation of JV in which parents contribute ongoing business, significant assets, capabilities
Formation of “shell” JV – small management or marketing/sales company which uses other business elements that remain with parents
Mergers in which a single combined entity retains ownership and control after the deal
Broad types of alliances are
based on ownership, contributionsStrategic alliances
CORPORATE RELATIONSHIPS
Acquisitions
Mergers
Minority equity investments between parents
Contractual agreements
Mergers in which both parents retain significant ownership and control, e.g., merger of business units, held as 50-50 JV after the deal*
Contractual alliances with substantial shared risk/reward
or exclusivity**• R&D partnerships• Exclusive licensing• Strategic outsourcing
• Franchise• Production swap• Co-production
• Exclusive supply• Exclusive distribution• Co-branding• Joint bidding
• Long-term purchase agreement
• Buying cooperatives
Arms-length agreements withoutsubstantial shared risk/reward or exclusivity**
* Debatable, these are mergers at BU level; JV at parent level
** Specific terms of each contractual agreement determine whether they are strategic alliances. Contractual alliances
are often referred to as joint ventures; in our definition a joint venture must include the creation of a separate entity.
Joint ventures
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Each structure has distinct features
Control None/limited Shared None Unified control (but few true mergers of equals)
Acquiror gains full control
Ownership None Shared ownership of JV entity
Typically 10-20% Unified Complete
Influence of parents
Can be substantial Substantial(one JV)
Some, may receive Board seats
Depends on power balance
Complete
Pooling of assets
No Yes, for assets in JV No Yes Yes
Legal relationship
Contract New corporate or partnership entity created
None except minority shareholder rights
Single entity Single entity
Governance, dividend policy
Not an issue Must be determined in advance
Per minority shareholder rights
Typically determined in advance
Acquiror decides
Capital expenditure/ cash outlay
None except per contract
Partners typically share capex for startup, continuing operations
Cost of minority stake Capex of both companies combined
Cash outlay include premium, full capex to both companies
Valuation/premium
None No premium; partner with lesser value must compensate for value gap or accept <50% ownership
None No premium Substantial premium
* Without associated JV or contractual alliance
Feature
Contractual alliances
Joint ventures Minority stakes*
Mergers Acquisitions
DC-ZXE070/950726DHR.1
Startups in which both parents create a new business by contributing assets, technology, people, other capabilities
Formation of JV in which parents contribute ongoing business, significant assets, capabilities
Formation of “shell” JV – small management or marketing/sales company that uses other business elements that remain with parents
Many structuring options within each type of alliance
Example: JV structures
OPTIONS FOR STRUCTURING JVS
Ownership
“Mechanics”
Majority/minority (typically in range of 20/80 to 80/20)
50/50
3-party, usually 2 large, even shareholders, 1 small (e.g., 49/49/2%)
Mergers in which both parents retain significant ownership and control, e.g., merger of business units, held as 50-50 JV after the deal
“Partial acquisition” JV – one parent takes substantial stake in other company (often contributing cash and skills or technology) while a new “JV” entity is created
Partnership
CorporationLegal form (U.S.)
GeneralLimitedCSLimited liability corporation
Scope
Business systemFullPartialLimitedUnlimited
ExistingNewLimited scopeAll products
Geographic
Products/technologies
Governance
Financial flows
Other elements
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Many important, sensitive governance choices
GOVERNANCE
Board
Who
Roleof parents
Staffingof JV
Other governance elements
ILLUSTRATIVE
How many
Balance
Voting
All insiders
Insiders plus outsiders
Even number, parents equally represented (with conflict resolution mechanisms)
Odd number
Majority vote – all issues
Veto power or supra-majority voting on key issues
Specific issues delegated to each partner
One parent has majority
Parents have equal numbers,
tiebreaker vote held by outsider
JV highly independent, treated as autonomous unit by both parents
JV treated as division of one parent
CEO
Other key
appointments
Insider
OutsiderAppointed by one parent
Selected by both parents
Determined by JV CEO with approval of Board
Specific spots (e.g., CFO) reserved for parent selection
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Choice of structures depends on objectives and business environment
Contractual alliances
Joint ventures Minority stakes
Mergers Acquisitions
2. FRAMEWORKS FOR SELECTING STRUCTURES
• Desire for full control
• Core business, geography
• Difference in partner size, strength
• Need for scale
• Predictable environment
• Need for integration
• Business not yet fully concentrated
• “Monolith” is winning model
• Desire to influence rather than own
• New business or geography
• Similar partner size/strength
• Need for complementary capabilities
• Unpredictable environment
• Need to bridge multiple businesses, technologies
• “Web” is winning model
Use M&AUse JV/contractual alliance
Corporate relationships
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Objective drives choice of specific alliance type
Objective Specific alliance type
PRELIMINARY
Combine complementary resources
Enter new markets/channels JV, franchising, co-branding, out-licensing, co-production, distribution
Create new business JV, othersAccess specific products,assets, functions
JV, in-licensing co-production, franchise
Develop technology jointly JV or parent-to-parent R&D partnerships
LearnTechnology JV, licensing, R&D partnerships
Skills JV; minority stake; R&D partnerships
Manage rivalryDevelop industry standards R&D partnerships
Rationalize capacity Production swap, co-production, JV; minority equity interests, joint bidding, merger of units as JV, M&A
Position to acquire or sell
Acquire JV or minority stake in parent, depending on desired scope of acquisition/divestitureSell
Improve effective- ness of vertical relationships
“Lock up” supply source/ customers
Minority equity, e.g., Keiretsu (effectiveness is questionable); supply contract, long-term purchase agreements
Improve supplier/manufacturer/ customer linkages
Supply contracts, strategic outsourcing, buying cooperatives, long-term purchase agreements, minority equity (effectiveness is questionable)
Gain scaleLeverage existing capabilities with complementary partners
Licensing, co-branding, distribution JV, others
Consolidate for synergy M&A, JV combining specific functions
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Environmental conditionsContractual
alliance JVMinority
stake Merger Acquisition
Uncertainty (e.g., regulatory, political)
Need to bridge multiple businesses or technologies
Business already global/highly concentrated (few acquisition targets)
Target business is small part of partners) total business
Large difference in size with potential partners
Differing perceptions of importance of target business to partners core businesses
* Acquisition of target business unit
** JV may be appropriate as step toward acquisition
*** Minority stake taken by larger company in smaller company
Business environmentaffects choice of vehicle
Highly appropriate
Neutral
Inappropriate
*
**
FOR DISCUSSION
**
***
DC-ZXE070/950726DHR.1
Structures offer different levels of influence, ownership, risk-sharing
Inc
rea
sin
g i
nfl
ue
nc
e
One-off arms-length transactions
NO SHARED RESOURCES, OR EQUITY; LIMITED SHARED RISK
Shared resources, no equity Cross-equity investments
Shared equity Owned equity
Franchises
Production swap
Co-production
Long-term pur- chase agreement
Buying cooperatives
Joint bidding agreement
Exclusive supply contract
Strategic outsourcing
Co-branding
Exclusive distribution
Exclusive licensing
R&D partnerships or consortia
Increasing ownership and shared outcome
Keiretsu
JVs
Merger of units as JV
Acquisitions
Minority stakes with operating alliance
Minority stakes – financial only
PRELIMINARY
INFLUENCE ASSETS WITHOUT OWNING THEM; SHARE RISK
Full mergers
Strategic alliances
OWN ASSETS ABSORB FULL RISK
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Alliance selection driven by need
to share or divide business elements
MarketingTechnology development
Product development
Sourcing ManufacturingSales and distribution
Sharing business elements
Buying cooperatives
Manufacturing JV Co-marketing
Bidding consortia
Research and development consortia
<Text> Co-branding
Dividing business elements
Research and development consortia, each partner specializing (e.g., airframes)
Long-term purchase agreements
Strategic outsourcing
Co-production; production swaps
Exclusive sales and distribution licenses
Technology licensing Exclusive supply contract
Technology/ manufacturing licenses
Joint ventures
Joint ventures
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Choice of structure influenced by need for integration, need for flexibility
Ne
ed
fo
r in
teg
rati
on
M&A
Need for flexibility
PRELIMINARY
High
Low
Low High
JVs
R&D partnerships
Exclusive licensing Exclusive distribution Strategic outsourcing Exclusive supply
Co-brandingOther long-term nonequity agreements
One-off arms- length transactions
Strategic alliances
DC-ZXE070/950726DHR.1
TAX/LEGAL FACTORS
General partnership
Limited partnership “C” corporation “S” corporation*
Limited liability company
Pass-through** taxation?
Yes (most taxes passed through to each venturer)
Yes No, double taxation on dividends
Yes Possible, depending on structure
Subject to franchise taxes?
No No Yes Yes Yes
Is flexible allocation of revenues, deductions between partners permitted?
Yes Yes No No Yes
Flexibility in exit strategies?
No; venture may terminate for tax purposes if >50% interest transferred within a 12-month period
Yes (merger, consolidation, tax-free reorganization, etc.)
Yes No
Are shareholders liable for debts, liabilities of alliance?
Yes, personal liability of each venturer for all debts, liabilities
No (limited partners not liable)
No No No
* Shareholders must be individuals, estates, trusts; “SÝ corporations cannot be members
of an affiliated group, therefore not relevant to large corporations
** Taxes apply only to corporate owners on distribution of dividends
Note: McKinsey does not provide tax advice; clients should consult their own tax advisors
Choice of specific JV structure should take tax, legal factors into account (U.S.)
PRELIMINARY/
INTERNAL ONLY
DC-ZXE070/950726DHR.1
Corporation ownership*
Partnership<20% 20-50% >50%
Can assets, revenues be consolidated (for accounting purposes)?
No No Yes Typically based on proportion of ownership, but can be allocated based on other methods
How is net income reported?
As minority interest, using equity method
Using equity method
100% of net income reported; carve-outs reported as negative minority interest
Typically based on proportion of ownership but can be allocated based on other methods
* Test is based on control, not ownership percentage
Note: McKinsey does not provide tax advice; clients should consult their own tax advisors
Ownership share of JV affects financial impact on parents (U.S.)
PRELIMINARY/
INTERNAL ONLY
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Tax issues Liability Consolidation
• Partnership – normally the most tax-efficient structure; no intercompany dividend taxes
• Corporate structure – dividends taxed
– 80% exclusion of dividends from taxes if ownership is >50-80%
– 70% exclusion from dividends if ownership is 20-50%
• JV partners may face unlimited liability if partnership structure used
• Corporate structure limits liability of each partner in JV
• For accounting purposes, control is required (voting rights, board representation)
• For tax purposes consolidation occurs at 80% ownership
Summary: tax, financial issues (U.S.)PRELIMINARY/
INTERNAL ONLY
Note: McKinsey does not provide tax advice; clients should consult their own tax advisors
DC-ZXE070/950726DHR.1
Type of alliance Definition Example
CONTRACTUAL ALLIANCES
• Franchise agreement
A license agreement which includes the right to conduct business using the name, logos, and trademarks of the franchiser
McDonalds
• Production swap agreement
A contractual agreement between two or more entities producing similar products wherein each agrees to specialize in a certain product which is then exchanged for equivalent value of other products; this type of cooperation is often used to reduce transport costs
Oil, commodities
• Long-term purchase agreement
Agreements spanning several years, typically committing supplier to meet specific design or delivery standards and committing buyer to minimal levels of purchases; may involve shared investment
Coors and Anchor Glass have a 10-year partnership to make glass bottles. Coors contributes staff and equipment. Anchor will invest $54 million to modernize a plant and increase capacity by a third.
• Buying cooperative Several companies pool purchasing to increase bargaining power with suppliers
Bell Atlantic, Nynex, and Pacific Telesis say they will pool their orders for roughly $800 million in set-top boxes to reduce costs of the devices
• Exclusive supply contract
A contractual agreement between two or more entities binding each in an exclusive supplier/customer relationship for given products in given markets
Sony will use IMAX as its exclusive supplier of the IMAX giant-screen movie systems in NY, Berlin, and San Francisco. Sony will build the theaters, produce IMAX format movies, purchase IMAX projection technology and pay IMAX a percentage of box office receipts.
Alliance structures
3. ALLIANCE STRUCTURES: DEFINITIONS AND EXAMPLES
DC-ZXE070/950726DHR.1
Type of alliance Definition Example
Joint bidding agreement
• A contractual association of independent entities formed for bidding on one or more contract opportunities
• Successful contract bids may be subdivided among participants or delegated to one of the entities for completion on behalf of the consortium
• The agreement is a strategic alliance if it provides for an ongoing commercial relationship after the project is subdivided
• TNT Express Worldwide and Schenker International will jointly bid for logistics business in Asia and North America. Schenker deals in large freight and cargo; TNT deals in overnight small package delivery.
• Offshore drilling consortia are another example
Strategic outsourcing
A long-term agreement whereby one company transfers to another, and purchases, a service or product formerly made internally
EDS reportedly signed a 10-year, $800 million agreement to manage Lucas Industries internal information services
Co-branding Two or more entities combine brands for one or more products
Blockbuster and Visa jointly issue credit card
Exclusive licensing agreement
A contractual agreement between two or more entities granting one entity exclusive access to and use of technology or intellectual property developed by the other, usually coupled with authorization to produce, distribute, or service products
Schering-Plough has access to Fareston (breast cancer treatment) produced by Orion, in return for an undisclosed upfront fee plus milestone payments
Alliance structures (continued)
DC-ZXE070/950726DHR.1
Type of alliance Definition Example
Exclusive distribution agreement
Agreement under which one company gains the right to distribute (and possibly manufacture) a product using the technology, patent, or brand owned by another company
Budweiser beer is distributed by Antarctica in Brazil on an exclusive basis. Anheuser-Busch also bought a 10% stake in Antarctica for $105 million with an option to increase to 35%.
R&D partnership agreement
A contractual agreement between two or more entities wherein each agrees to fund a specified type of research in return for mutual benefit from the end products; the technology developed can be licensed to one or both of the participants, or an outsider
GE (U.S.) and IHI Heavy (Japan) have a $400 million alliance to co-develop a jet engine for use in 80-seat planes; GE will fund 75% of development costs, IHI will fund 25%
Consortia • A combination of three or more entities in which all parties work together toward a common goal, without creating a formal JV entity
• Consortia participants typically share risk (while reducing risk for each participant), benefit from different skill sets of the partners, and gain benefits of scale
• Consortia can be used to share activities (e.g., R&D consortia), or divide activities (e.g., aircraft and jet engine consortia)
Airbus
Alliance structures (continued)
DC-ZXE070/950726DHR.1
Type of alliance Definition Example
EQUITY ALLIANCES
• Keiretsu Sets of companies linked together by minority equity stakes and semi-exclusive supply arrangements
Toyota, Koyo Seiko, others
• Minority equity stake with operating agreements
Minority investment of one company in another, with other agreements creating shared risks or rewards
Boehringer Ingleheim invested $28 million for an 8% stake and provided a $40 million credit line to ISIS, a biotech company; the two companies are conducting joint research on cell adhesion, and Boehringer has option to raise its stake to 15%
• Joint venture • A contractual agreement between two or more entities creating a new equity-based entity to carry on an economic activity
• Ownership, control, and decision making are shared and both (or all) partners typically contribute to the operating entity
Siemens and Swatch have created a JV to jointly develop mobile phones to be sold under the Swatch name
• Merger of units as joint venture
JV where two (or more) parents merge overlapping assets and capabilities into a single entity, but neither parent cedes control, e.g., merging business units where each parent holds 50% interest
Rhone-Poulenc, Hoechst merged their South American polyester and nylon fiber businesses into Fairway Filamentos, to be headquartered in Brazil
Alliance structures (continued)
DC-ZXE070/950726DHR.1
Stand-alone joint venture INTERNAL ONLY
EastCo
NewCo
• 50/50 joint venture
• Private-label merchandise sold via new channels to existing customers of WestCo and EastCo
– Multimedia marketing
– International expansion
PeopleProductsCustomersOperationsCapital
WestCo
PeopleProducts
CustomersOperations
Capital
Pros• Equal ownership• NewCo able to
develop own identity• Performance easy to
measure
Cons• Potential conflict over
transfer pricing for services provided by parent
• Potential conflict with core parent businesses in new geographies, unless geographic scope limited
4. ILLUSTRATIVE STRUCTURES
JV Board(WestCo/EastCo)
Oversight
Sanofi/Sterling alliance structurePartial merger/JV plus development partnership
* Japan excluded
100%
Joint clinical development(project-based)
Elf Acquitaine(49% French government)
Sanofi(discovery)
100%
100%
Territory A JV(Europe, Asia*, Africa)
51% Sanofi/
49% Sterling managed by Sanofi
Local subsidiaries
Local subsidiaries
100%
Territory B JV(Americas, Australia)
51% Sterling/
49% Sanofi managed by Sterling
Drugs sold through worldwide Sanofi/Winthrop joint production, distribution, marketing
Kodak
Sterling Drug(discovery)
CONFIDENTIAL/
INTERNAL ONLY
CONFIDENTIAL/
INTERNAL ONLYSterling/Sanofi alliance
Guiding principles…
• Maximize synergies (e.g., capture full merger effect at country level)
• Create indifference to which products are sold post deal
• Ensure that each partner receives fair value
– “Existing” product profits shared based on ingoing contributions
– “New” product profits and synergies shared 50/50
• Optimize tax/financial effects of alliance
• “Equal” control over combined activities
• Retain control of basic research
• Create a manageable structure
…drove structure
Separate upstream research; joint product development, separate JVs for manufacturing, marketing, sales, distribution
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x x (Subsidiary A)
50/50 JV created by merger
of two metal mining subsidiaries
NewCo International
JV
NewCo board
BrazilCo(parent)
SAFCo(parent)
NewCo Brazil
NewCo South Africa
BrazilCo(Subsidiary B)
SAFCo(Subsidiary B)
Supply ofadministrative
servicesat cost
(Subsidiary A)
Transfer of all assets,
employees and activities;
subsidiary then
terminated
Equity of Brazmine,investments
Equity of SAFmine, investments
Dividends Dividends
CONFIDENTIAL
INTERNAL ONLY
100% equity 100% equity
Supply ofadministrative servicesat cost
DC-ZXE070/950726DHR.1
JV plus minority stake –
P&C Insurance Co. and fund management firm
CONFIDENTIAL
INTERNAL ONLY
Brinson Partners(Fund mgmt firm)
Before After
YFM(P&C Co)
Brinson JapanYFM investment subsidiary
Brinson Partners
YFM
YasudaKasai Brinson (YKB)(P&C fund mgmt JV)
YKB Chicago
YKB London
100% 100% 60% 40%
15%
100%
Minority acquisition
Strategic needs
P&C Co• Enhance investment-
management capability• Enter Japanese pension fund
management
Fund mgmt firm• Enter Japanese pension fund
management• Realize capital gain from sales
of shares (for partners)Source: FAC Practice
DC-ZXE070/950726DHR.1
Japanese/foreign JV structures where
ownership has shifted to foreign partner
CONFIDENTIAL
INTERNAL ONLY
Joint venture
Post-joint venture
Comments
Pfizer – TaitoYokogawa – Hewlett-Packard BOC – Osaka Sanso
J/V
F J
50% 50%
J/V
F J
49% 51%
J/V
F J
50.5% 49.5%
F(Jsub)
F J
100%
J/V
F J
75% 25%
J(sub)
F J
100%
F gradually increased share and finally acquired
J acquired 840,000 shares of HP itself
• BOC provided special gas technology to Osaka
• BOC initially acquired 15% of J and increased its ownership to 42%
42%
Source: FAC Practice