Joint Venture Creation Rationale

Joint Venture Creation Rationale

The reality of global competition today is that only few companies possess all of the competitive advantages that will enable them to compete successfully. Also, for a variety of reasons, doing business in developing countries is considered riskier. As a result, firms are now seeking to complement their strengths through alliances/partnerships with other firms even, when possible, in LDCs.

Many multinationals have gained access to foreign markets via the formation of international joint ventures. A joint venture may be defined as “a common project between legally and commercially independent companies in which the parties jointly bear the responsibility for management and financial risk” (Miller et al., 1993). Such joint ventures are usually formed to achieve synergies through combining complementary partners (Kogut, 1988). Local partners, especially those from developing countries, benefit from the technological know-how, management skills and capital brought in by their foreign partner(s) (Kim, 1996). On the other hand, multinationals depend on local partners’ knowledge and networks in the host country to minimize risks and increase returns. International joint ventures allow partners to share information, resources and risks, thus creating synergistic effects.

For example, Miller et al. (1993) acknowledge the possible contribution of a local partner enterprise to the joint venture by way of its familiarity with the domestic market; the knowledge of government bureaucracies and regulations; and an understanding of local labour markets. On the other hand, the foreign partner could be expected to offer advanced process and product technologies, management know-how and access to foreign markets.

4.3.1. Access to Local Capital

There is an inverse relationship between the intensity of initial investment and the level of risk inherent in a country. Firms are unwilling to inject a substantial amount of funds into a country/project where the returns/benefits are uncertain. Furthermore, the sheer size of a project (in terms of capital intensity) may entail that a firm, especially an inexperienced one, is unable to undertake the project on a sole basis.

Hence, entering a foreign market via a joint venture may allow the investing firm to limit its financial exposure^[1] while at the same time gaining experience in a new market. Nevertheless, the risk sharing function is deemed more important in research intensive industries where successive generations of technology tend to cost much more to develop while at the same time life cycles are shrinking  (Friedmann et al., 1979).

4.3.2. Minimise Risks of Establishing in a New Environment/Different Country

There are unfamiliar territories in which the rules of the game are likely to be dissimilar from those of developed economies. The challenge to a foreign investor is how to adapt its investment strategies to those economies in order to succeed under the peculiar conditions of diverse political and economic systems. In less developed countries (LDCs), in which requirements for adaptation and information are greater, the appropriateness of an MNE forming a joint venture agreement is reinforced (Beamish and Banks, 1987).

Closely connected with capital savings, is the reduction in business risk. By sinking less capital into a venture and diversifying investment between industries and countries, the investing company obviously gains an element of protection. Also, the entrepreneurial skills and experience of local partners permit easier adaptation to the potential dangers of investing in a new business environment with a different culture and legal background. For example, Killing (1983) and Beamish (1984) found that the primary skill required by the multinational partner from the local firm was its knowledge of the local economy, politics and culture^[2].

There is also hope that having a local partner may engender more favourable treatment from the government. The success of a joint venture may be affected by the positive actions which the government may take. Governments’ attitudes with regards to issues such as tax burdens/exemptions; repatriation of profits/capital may be very important.

Nevertheless, using an international joint venture as the preferred mode of entry also entails unique risks owing to the potential problems of cooperating with a partner from a different national culture (Brown et al., 1989). Socio-cultural distance significantly influences intercultural business operations (Agarwal, 1994; Chan, 1996; Hofstede, 1980). For example, Kogut and Singh (1988b) found that the greater the socio-cultural gap between the investing firm and the local partner, the more likely will the firm use a joint venture as the mode of entry.