Collaboration as a strategic tool in a downturn period

As an epigram often attributed to Vladimir Lenin goes, “There are decades where nothing happens, and there are weeks where decades happen.” In 2020 we have lived through a ridiculous number of those weeks. Yet periods of disruption can be rich in opportunity. A strategic examination of your current joint ventures and partnerships and the thoughtful creation of new ones can strengthen your position as you come out of the crisis and help you tap opportunities for growth during the coming rebound.

Downturn and partnership in recent years.

Companies will need every tool they’ve got to survive the downturn and rev up their businesses as the economy rights itself. They’ll have to rewire operations, reallocate resources, and in some cases reinvent business models.

At many firms, joint ventures and partnerships will play an outsize role in those efforts, both as a vehicle for sharing costs and reducing capital needs during the crisis and as a way to position themselves for growth once it ends. After all, in industries experiencing great pressure—like automotive, retail, and upstream oil and gas—joint ventures are quite common. GM and Volkswagen, for example, each have several dozen, and JVs account for almost 80% of the upstream production of the largest international oil and gas companies. At these and other energy businesses, joint ventures are also key to managing the transition from fossil fuels to renewables. More than 50% of the largest assets in offshore wind and solar are structured as joint ventures—and such investments are a critical way for companies like Royal Dutch Shell, BP, Total, and Equinor to share risks, build capabilities, and meet ambitious targets to reduce greenhouse gas emissions.

In health care and life sciences, joint ventures and partnerships are crucial to innovation: More than two-thirds of new health insurance products in the United States are built on cobranded or JV offerings, while life sciences companies depend on such ventures to accelerate time to market and broaden distribution of lifesaving products. In March 2020, for instance, Pfizer and BioNTech announced they were teaming up to bring out a Covid-19 vaccine. Other partnerships aimed at developing Covid vaccines have been announced by Sanofi and GSK, and by Hoth Therapeutics, Voltron Therapeutics, and Mass General Hospital.

JVs now drive a material share of companies’ profits as well. In 2019 Airbus, Celanese, Engie, Vodafone, and Volkswagen relied on noncontrolled JVs for more than 20% of their earnings, while at Coca-Cola, GM, and many others that figure was above 10%.

Moving forward, we expect the impact of JVs and partnerships to remain significant and, in some sectors and geographies, to increase. We recently analyzed trends related to joint ventures across the past 35 years. Our analysis showed that in most industries, terminations of them didn’t always increase during downturns—and often fell. Use of JVs also tended to rise on the eve of a recovery. This may be partly due to the time it takes to negotiate a restructuring or an exit, as well as corporate management’s tendency to look first to wholly owned operations when cutting costs. In addition, JVs’ returns on assets have been climbing recently—and are higher than those of wholly owned companies in the same industries. That means the number of terminations during this economic dip is likely to be even lower. Meanwhile, our analysis also showed that new joint venture and partnership transactions tend to increase during a downturn and to accelerate during a recovery, because they allow companies to get off to a much quicker start than organic growth does and are less risky than M&A.

During this period of retrenchment firms might stabilize their existing joint ventures by raising cash, cutting operating costs, reducing capital spending, managing risk, and restructuring. These are commonsense moves for the most part, but they require sustained focus; JVs are hard to restructure even in the best of times, owing to differing owner-company agendas, politicized processes, and general inertia. However, a crisis can serve as a catalyst for change. In addition, we’ll look at how companies might enter into new, “counterdownturn” JVs and partnerships, both to manage the challenging economic environment and to tap into growth opportunities in capital-light ways. But How?

According to Harvard Business Teview there are many ways:

Shoring Up Existing JVs.

Joint ventures are facing many of the same financial challenges—severe revenue shortfalls from fractured supply chains, curtailed operations, evaporating market demand, and frozen credit markets—as their owners and wholly owned peers. These new economic realities require both short- and long-term responses.

Efforts to reduce working capital, cut costs, tap additional credit lines, and take advantage of government subsidies and relief programs are already well under way in most joint ventures. To help pull off these near-term interventions, their boards will need to get far more involved than usual. Under normal conditions, joint ventures’ board directors spend an average of 5% to 10% of their time on governance. But during economic storms, an effective board can be the factor that determines whether a JV thrives, stagnates, or dies an untimely death. Working with managers, directors are convening special board and committee meetings and fast-tracking decisions.

JV partners, boards, and management teams will also need to evaluate opportunities to more fundamentally reset their businesses. Because of their shared ownership, joint ventures can use restructuring tools that aren’t available to wholly owned businesses. These approaches may benefit a venture, its parents, or both. They come in various forms.

Raising capital in unconventional ways.

Some joint ventures will have opportunities to secure low- or interest-free loans or capital from their cash-rich owners—such as state-owned companies, sovereign wealth funds, private equity firms, and multinationals with strong balance sheets. In exchange, those owners might get additional interest in the venture, preferred returns, or increased control. In 2015, when Russian automobile sales collapsed amid wider economic problems, Ford Sollers, a 50:50 joint venture between Ford and Sollers PJSC, received additional funding from Ford, which in return got preferred shares that gave it majority voting rights.

To free up cash, improve future liquidity, or open up new markets, joint ventures may also want to bring in new owners, such as PE firms, pension funds, other financial institutions, or strategic industry partners. Earnouts for the current owners could be pegged to the future performance of the business to make adding more owners attractive. Many investors, like PE firms, can bring in capabilities that give ventures a boost, including a better understanding of value creation, a sharp focus on cost reduction and talent management, governance discipline, M&A experience, and a portfolio that can double as an ecosystem of customers, suppliers, or partners.

Structuring creative commercial arrangements with suppliers, customers, lenders, and other business partners is another option for JV owners. In the past we’ve seen an ownership interest or option sold to a major supplier or customer in exchange for better commercial terms, including cash advances. If one of the owners is a major supplier to the JV, the parties might renegotiate their agreement (to, say, narrow the band of prices). Similarly, a joint venture might negotiate with a lender to convert debt to equity, making the creditor a direct owner.

Reducing costs through synergies and new operating models.

While JVs can cut costs on their own, much greater savings may come from consolidating or otherwise optimizing activities and assets with their owners. Ventures and owners might make joint purchases, integrate their supply chains, or combine some infrastructure, logistics, warehouses, or other operating assets. In 2003, Vodafone entered an agreement with SFR, its French mobile-telecommunications JV with Vivendi, to collaborate to improve economies of scale in operational areas like the development and rollout of new offerings and procurement, especially of technology.

Joint ventures might also save money by insourcing certain functions (such as legal, HR, IT, or finance) currently being provided by an owner. Our analysis has shown that although owner companies rarely profit from providing administrative services to joint ventures, their cost structures are often 10% to 30% higher than those of the JVs or of third-party providers they might contract with. Conversely, a joint venture that lacks scale might benefit from outsourcing certain functions to an owner or a third party.

In some cases cost cutting may lead to more-fundamental changes to the operating model. Those that reduce operating expenses or increase strategic and financial flexibility are especially popular during downturns. A lower-cost partner in a joint venture or a third party might become the controlling partner or operator, which can open up synergies with that organization. In our view many joint ventures should aggressively pursue this option, which allows greater nimbleness and offers more potential for performance improvement than do JV models in which control is shared by the partners and the joint venture’s management doesn’t have much authority.

In response to the Asian financial crisis in the late 1990s, BASF and Mitsubishi creatively restructured their equally owned and controlled joint venture in Japan, Mitsubishi Chemical BASF. It was split into two joint ventures, one focused on dispersants and the other on foam products—the business’s two core segments. Each was placed under the operational leadership of the parent best positioned to strengthen it—with BASF responsible for the dispersants venture, and Mitsubishi responsible for the foam products one.

Regearing financial ratios.

Joint venture boards might also consider authorizing or compelling management to increase external borrowing, especially if the entity is underleveraged, as JVs tend to be. Conversely, if a venture has excess cash, the board might seek to repatriate it to fund other, pressing corporate needs. During the 2008 financial crisis, the board of a large liquefied-natural-gas JV found that it had almost $500 million in cash on hand—enough to cover six months of operating costs. The board immediately approved a $300 million dividend, giving the owners cash to weather the storm elsewhere in their businesses.

Assisting owners through buyouts and other means.

Downturns tend to expose strategy and performance differences among partners. While the data doesn’t suggest they cause buyouts to spike, inevitably there will be some buyouts and sellouts, and some JVs will be terminated or liquidated.

In the current environment, routine decisions about budgets and capital expenditures may become deadlocked, triggering buy-sell options in about a third of joint venture contracts. In other cases the potential synergies will be greater if a single partner has full ownership, and the one for whom the JV is more core—or already more integrated—will buy out the other partners. Or one owner might acquire and integrate parts of the joint venture or sell out to a third party. After the 2008–2009 financial crisis forced the Canadian company Nortel to file for bankruptcy protection, for example, it sold its controlling stake in a high-performing Korean joint venture with LG to Ericsson. Alternatively, all the owners might sell the venture to a consortium of financial investors.

Creating New Joint Ventures and Partnerships.

New JVs and partnerships can also help companies navigate the economic crisis. They can be used to raise cash, secure cost synergies, or pursue lower-risk and more-capital-efficient growth. When funding is tight, such benefits make joint ventures and partnerships a popular alternative to mergers and acquisitions or organic investments. Our analysis shows that JVs and partnerships tend to increase in the late stages of a downturn, signaling a recovery and outpacing M&A. Right after the 1990–1992 and 2001–2002 downturns, for instance, the number of new joint ventures and partnership transactions was 20% above normal levels.

Partial divestments.

For companies that need more liquidity, a joint venture can be a good alternative to a full divestiture. One approach is to use it as the first step in a planned exit: A seller puts a noncore business into a joint venture with a potential buyer and negotiates to sell the full business over time, typically within three to five years. This kind of deal is especially worthwhile for sellers when prospective buyers don’t recognize the full potential of the business or its assets or may not be able to buy or operate the business on day one. IBM used this staged-exit structure when it sold its personal computer business to Lenovo, and so did Lanxess when it folded its specialty plastics business into a joint venture with Ineos, in 2007. In that case, Lanxess received one payment when the joint venture was set up and a second after two years, when it fully exited the JV. The second payment was based on the performance of the business—a useful method when it’s difficult to arrive at a valuation.

Another approach is to sell a partial interest in a business unit to a third party, effectively converting the business into a joint venture. Dow Chemical famously pursued such a game-changing structure in 2008, when it tried to sell key elements of its commodity-chemical business to Kuwait’s state-owned Petrochemicals Industry Company to raise cash and reduce exposure to the cyclical commodity-chemical business. But it was left at the altar when the Kuwaiti parliament rejected the deal at the last minute. During the Asian financial crisis, Doosan agreed to sell a 50% interest in its Oriental Brewery unit to the global player Interbrew to raise cash. The deal gave Oriental Brewery access to new technologies, marketing networks, and cost management capabilities that lifted its performance. In a similar move, from 2008 to 2010, Chesapeake Energy raised more than $8 billion by selling a partial interest in its U.S. shale gas assets to BP, Equinor, Total, and others.

A creative third alternative is an asset sale with a leaseback. Through such deals, companies typically divest certain (noncore) assets but tie them to a joint venture. For instance, as part of an aggressive corporate restructuring program it ran from 2005 to 2007, Sony sold its chip-manufacturing facilities to Toshiba for more than $800 million; those assets were then leased back to a new joint venture between the companies, which produced chips for the PlayStation and other Sony consumer electronics.

Business consolidations.

Synergies from this kind of joint venture can be substantial. There is a range of options here. At the narrower end of the spectrum, companies (especially those in the natural resources sector) consolidate a set of adjacent assets into a single joint venture to align all the parties’ incentives better and save money on infrastructure. Extending that logic more broadly to an entire region, country, or business unit, companies can consolidate similar operations with those of an industry peer or competitor to capture additional scale or cost synergies. In 2009 Morgan Stanley and Citibank consolidated their retail brokerage and wealth management businesses into a 51:49 joint venture in which Citibank also received an up-front cash payment of $2.7 billion. In a similar vein, in 2013 Bertelsmann and Pearson combined their trade-book publishing businesses, which were facing headwinds, into a 53:47 joint venture, Penguin Random House.

Companies might also team up with industry peers to consolidate back-office, sales, or purchasing functions into joint ventures and realize greater economies of scale. The big three U.S. automakers have done this in forming global purchasing joint ventures. Oil and gas companies have also pursued purchasing cooperatives, logistics pooling, shared maintenance and inventory management ventures, and other collaborative structures. So have telecom companies. For instance, Deutsche Telekom and France Télécom-Orange formed BuyIn, a purchasing joint venture in which the companies pooled procurement activities in an effort to save more than a billion dollars annually.

Partnerships for capital-light growth.

Companies looking for growth but seeking lower investment risk can consider a range of transaction structures. Some firms may enter global strategic partnerships with cash-rich players—including state-owned companies, sovereign wealth funds, or PE firms—to identify and develop a portfolio of opportunities within a sector or a market. The global oil corporation BP, the European chemicals maker Borealis, the Brazilian state-owned oil company Petrobras, and the French automaker Renault are among the dozens of companies that have pursued such arrangements over the years.

Alternatively, companies might acquire a partial stake in troubled business units of their peers operating in attractive markets. In 2003 the French oil giant Total took a 50% position in Samsung Chemicals through its chemicals unit Atofina, creating Samsung Atofina, to which it transferred technology, operating capabilities, and marketing expertise that jump-started the business’s growth. In some cases firms might jointly acquire third parties, as competitors Votorantim and Suzano did when they bought majority voting control in the Brazilian pulp and paper maker Ripasa during a market downturn. That transaction was structured to maintain the market independence of the two owners, converting Ripasa into a jointly controlled production unit. The agreement also provided the purchasers with the option to acquire additional preferred and common stock of Ripasa within six years.

A similar strategy is to invest in or partner with innovative suppliers and technology companies. Toyota’s investments and deep partnerships with core parts suppliers in the 1990s were credited with compressing the time necessary to go from concept to production, reducing manufacturing costs, and lowering defects. Similarly, in the 1990s, Samsung Electronics developed a program that nurtured suppliers with financial support and help building their technical capabilities, which led to technology improvements, savings on materials, and shorter order lead times.

Today power, chemical, mining, and petroleum companies could set up similar deals, making minority investments in clean-tech, renewable energy, recycling, or autonomous vehicle firms and agreeing to pilot those firms’ technologies in their operations. Such arrangements would allow large incumbents with lower PE ratios to participate in firms with much higher growth prospects and valuations and to speed up their transition to a carbonless future.

Yet another approach is to team up with industry peers and adjacent players to create and commercialize new products. Within the chemical sector, companies have been forming consortia and small partnerships to establish standards for, develop, and sell new sustainable technologies. Similar patterns will play out in other sectors; partnerships are especially valuable in disruptive markets and on technology frontiers. Many of these will start as simple nonequity collaborations with an option to convert to a full-scale joint venture once certain technology or financial milestones are passed, as a way to hedge bets and reduce up-front investments.

More:

• David Ernst, Your Alliances Are Too Stable.

by Alessio De Filippis, Founder and Cheif Executive Officer @ Libentium.

Founder and Partner of Libentium, developing projects mainly focused on Marketing and Sales innovations for different type of organizations (Multinationals, SMEs, - Start-ups).

Cross-industry experience: Media, TLC, Oil & Gas, Leisure & Travel, Biotech, ICT