CUHK Business School Research Looks at the Risk of Establishing Strategic Corporate Alliances During Periods of Market Uncertainty
Whenever there is great uncertainty in the market, it is not uncommon for firms to seek out a business partner to leverage on each other’s strengths to develop new business opportunities as well as to help shoulder risks. A case in point is the famous AOL Time Warner alliance, which was billed as the ultimate combination of an online service provider with a media conglomerate, amidst the massive upheaval that occurred just as global use of the internet took off in the early 2000s’.
The deal, which was finally unwound in 2018, is widely considered the worst merger of all time.
There have also been a few success stories. The Spotify-Uber alliance gave users personalised music experience during their car rides has been said to be a win-win for both companies, at a time when Spotify was facing criticism that it failed to compensate its artists fairly. Another famous successful alliance is the partnership between Starbucks and Barnes & Noble, which allows customers to enjoy the former company’s coffee when they visit the latter’s book stores, helping the bricks-and-mortar book seller to fend off online rivals that have since become dominant in the industry.
So why do some firms that try to be stronger and perform better during difficult times by establishing alliances fail to achieve their goals? A recent research study reveals that forming alliances may not make the companies stronger together, especially when the market condition is volatile.
While prior research focused on how alliance strategies improves company performance and innovation, Ribuga Kang, Assistant Professor in the Department of Management at The Chinese University of Hong Kong (CUHK) Business School and her co-author Prof. JungYun Han at National Taiwan University looked at the impact of market uncertainty on innovation of firms involved in alliances in their latest research study Market Uncertainty, Innovation of Firms in Alliance and Alliance Partner Characteristics. In the study, Prof. Kang and Prof. Han analysed 115 firms in alliances in the pharmaceutical and biotechnical industries in the U.S. between 1990 and 2015.
According to Prof. Kang and her co-author, there are four reasons for why market uncertainty hinders innovation of companies in alliances.
First of all, partner firms may be reluctant to commit effort or resources during turbulent times because they would be more interested in protecting their own companies during these periods. Also, companies may need to renegotiate agreements due to the changing environment, which is likely to cause confrontation and conflict. Consequently, the trust and willingness to share between companies would be significantly undermined.
Secondly, a hostile business environment may lead to increased difficulty in communication between companies. As being innovative relies on the integration of knowledge and resources from companies in an alliance, the increased difficulty in communication would hinder efforts in creating new ideas.
Thirdly, companies with alliance partners may tend to overly depend on their partners instead of searching for new ideas elsewhere.
Lastly, when companies in an alliance share their concerns about the uncertainties and challenges amid volatile market conditions, they reinforce the pessimistic forecast about the market and hence would likely develop passive and defensive business strategies that would ultimately lead to low innovation.
“Just because two companies don’t seem to go together at first, doesn’t mean they aren’t a great pair. For firms seeking alliances, they should aim to form partnerships that can create synergy and be win-win to both parties,” Prof. Kang says.
However, the study points out that there are two conditions that would help companies in alliances to mitigate the negative effect of market uncertainty on innovation. According to the study, when companies choose to partner with other firms from a different industry and a different nation, it would help them to develop diverse and useful new knowledge.
Prof. Kang explains that there are three advantages for having a partner firm in a different industry. Firstly, the partner firm would be able to supply brand new ideas and knowledge given their different industry backgrounds. Secondly, if a company has a partner firm in a different industry, the partner will provide fresh perspectives to the other firm and make it less likely that a firm would follow tired old market practices. Thirdly, if the two companies in an alliance are from different industries, they would not be in direct competition. Therefore, they would be more willing to exchange knowledge, which would result in increased innovation.
Having a partner company in another country, according to Prof. Kang, also has three benefits. The first benefit is that the foreign partner would be able to bring in non-localised knowledge and new ideas. Secondly, such a cross-border alliance provides an opportunity to learn a new mindset, different business practices and organisational cultures. Lastly, companies would be able to rely on their foreign partners for their resources and networks to broaden the business opportunities in other markets.
Innovation Quantity Vs Quality
Interestingly, the researchers found that forming alliances with companies in different industries and in different countries can influence innovation in various ways. In particular, different types of alliances have different effects on the quantity of innovation and whether the innovation generated created value by uncovering an unmet customer need or offering a new solution.
To measure the effect on innovation quantity, the research team examined the number of patents filed by a company. For the effect of the latter type of innovation, called exploratory innovation (as opposed to exploitative innovation, which focuses on meeting an already exposed customer need) the researchers looked at the number of new patents filed in different categories. The two types of patents are counted in a four-year period after a firm formed an alliance.
According to the results, forming an alliance with a partner in a different country increases the number of patents, even when the market condition is uncertain. On the other hand, having a partner firm in a different industry can increase the firm’s exploratory innovation during volatile times.
“We think that new knowledge, such as different organisational styles or cultural differences, brought by a foreign partner firm can help a firm file more patents,” Prof. Kang explains. “However, if a company wants to be really innovative, that means expanding its own boundaries, then it must get a partner firm in a different industry to get new ideas and expertise beyond its own existing knowledge stock.”
Although forming alliances is an effective business strategy for companies to pursue mutual benefits, Prof. Kang and her co-author urge companies to pay attention to the risks and challenges that market uncertainty may bring to business alliances because these risks can often outweigh the benefits.
For managers, the researchers suggest them to have a deep understanding of the impacts and risks that their firms face in a difficult business environment. This is important because if managers fail to fully understand the uncertainty they face (and considering that during poor economic conditions, a partner firm would have heightened interest to protect their own interests) an alliance would be unable to achieve meaningful innovative goals.
Based on their findings, Prof. Kang and her co-author advise managers to choose carefully an alliance partner which will allow them to best utilise each other’s expertise to develop innovative products. They also encourage managers to leave their comfort zone in finding partner firms and avoid forming alliances with firms that are close to home or with firms in the same industry, especially in highly uncertain and competitive market conditions.