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The Role of Alliances in Corporate Strategy

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REPORT

Since its founding in 1963, The Boston Consulting Group has focusedon helping clients achieve competitive advantage. Our firm believes thatbest practices or benchmarks are rarely enough to create lasting valueand that positive change requires new insight into economics, markets,and organizational dynamics. We consider every assignment a unique setof opportunities and constraints for which no standard solution will beadequate. BCG has 59 offices in 36 countries and serves companies inall industries and markets. For further information, please visit our Website at www.bcg.com.


KEES COOLS

ALEXANDER ROOS

N O V E M B E R 2 0 0 5

www.bcg.com

© The Boston Consulting Group, Inc. 2005. All rights reserved.

For information or permission to reprint, please contact BCG at:E-mail: [email protected]: +1 617 973 1339, attention BCG/PermissionsMail: BCG/Permissions

The Boston Consulting Group, Inc.Exchange PlaceBoston, MA 02109USA

2 BCG REPORT2

3The Role of Alliances in Corporate Strategy

Table of Contents

Note to the Reader 4

Acknowledgments 5

Preface 6

The Strategic Logic of Alliances 7

Defining Alliances 7

When Alliances Make Strategic Sense 8

Case Study: Using Alliances as a Tool for Growth in the Telecommunications Industry 10

How Alliances Form and Perform 11

Recent Trends in Alliance Formation 11

Analyzing Alliance Performance 15

Case Study: Assessing the Diminishing Returns of Alliances in the Airline Industry 18

A Structured Process for Managing Alliances 20

Align the Alliance Strategy with the Growth Strategy 20

Conduct a Rigorous Partner Search 21

Negotiate the Deal 21

Manage the Alliance 22

Evaluate Alliance Performance 22

Adopt a Portfolio Approach to Alliances 22

Case Study: Managing Alliances in the Pharmaceutical Industry 24

The CEO Alliance Checklist 26

Note to the Reader

4 BCG REPORT

The Corporate Finance and Strategy practice of The Boston Consulting Group is a global network of expertshelping clients design, implement, and maintain superior strategies for long-term value creation. The prac-tice works in close cooperation with BCG’s industry experts and employs a variety of state-of-the-art method-ologies in portfolio management, value management, mergers and acquisitions, and postmerger integration.For further information, please contact the individuals listed below.

The Americas

Gerry HansellBCG Chicago+1 312 993 [email protected]

Jeffrey KotzenBCG New York+1 212 446 [email protected]

Walter PiacsekBCG São Paulo+55 11 3046 [email protected]

J. PuckettBCG Dallas+1 214 849 [email protected]

Peter StangerBCG Toronto+1 416 955 [email protected]

Alan WiseBCG Atlanta+1 404 877 [email protected]

Europe

Kees CoolsBCG Amsterdam+31 35 548 [email protected]

Alexander Roos BCG Berlin+49 30 28 87 [email protected]

Stefan DabBCG Brussels+32 2 289 02 [email protected]

Peter DamischBCG Zürich+41 44 388 86 [email protected]

Stephan DertnigBCG Moscow+7 095 258 34 [email protected]

Lars FæsteBCG Copenhagen+45 77 32 34 [email protected]

Juan GonzálezBCG Madrid+34 91 520 61 [email protected]

Jérôme HervéBCG Paris+33 1 40 17 10 [email protected]

Stuart KingBCG London+44 207 753 [email protected]

Tom LewisBCG Milan+39 0 2 65 59 [email protected]

Daniel StelterBCG Berlin+49 30 28 87 [email protected]

Peter StrüvenBCG Munich+49 89 23 17 [email protected]

Asia-Pacific

Andrew ClarkBCG Jakarta+62 21 526 [email protected]

Nicholas GlenningBCG Melbourne+61 3 9656 [email protected]

Hubert HsuBCG Hong Kong+852 2506 [email protected]

Hiroshi KannoBCG Tokyo+81 3 5211 [email protected]

Holger MichaelisBCG Beijing+86 10 6567 [email protected]

David PitmanBCG Sydney+61 2 9323 [email protected]

Byung Nam RheeBCG Seoul+822 399 [email protected]

Harsh VardhanBCG Mumbai+91 22 2283 [email protected]

Acknowledgments


This research report is a product of the Corporate Finance and Strategy practice of The Boston ConsultingGroup. Kees Cools is an executive adviser in BCG’s Amsterdam office and global leader of the practice’sresearch and marketing activities. Alexander Roos is a manager in BCG’s Berlin office and coleader of thepractice’s global merger-and-acquisitions team.

The authors would like to acknowledge the contributions of BCG’s global experts in corporate finance andstrategy, as well as the industry experts who made contributions to the case studies in this report:

David Dean, senior vice president and director in BCG’s Munich office and global leader of the firm’sTechnology and Communications practice

Juan González, vice president and director in BCG’s Madrid office and leader of the firm’s Technology andCommunications practice in Europe

Simon Goodall, vice president and director in BCG’s Los Angeles office and coleader of the firm’s biophar-maceutical R&D business

Gerry Hansell, senior vice president and director in BCG’s Chicago office and leader of the firm’s CorporateFinance and Strategy practice in the Americas

Martin Koehler, senior vice president and director in BCG’s Munich office and member of the global man-agement committee of the firm’s Travel and Tourism practice

Heino Meerkatt, vice president and director in BCG’s Munich office and leader of the firm’s CorporateFinance and Strategy practice in Europe

Yutaka Mizukoshi, vice president and director in BCG’s Nagoya office and leader of the firm’s Technologyand Communications practice in the Asia-Pacific region

David Pitman, vice president and director in BCG’s Sydney office and leader of the firm’s Corporate Financeand Strategy practice in the Asia-Pacific region

Daniel Stelter, senior vice president and director in BCG’s Berlin office and global leader of the firm’sCorporate Finance and Strategy practice

Peter Tollman, senior vice president and director in BCG’s Boston office and coleader of the firm’s bio-pharmaceutical R&D business

The authors would also like to thank Jens Kengelbach, a consultant in BCG’s Chicago office; Mindel van deLaar, an analyst in the firm’s Amsterdam office; Remco van Zanten, a consultant in the Amsterdam office;and Hans le Grand, a former topic specialist in the Amsterdam office, all of whom contributed to theresearch described in this report.

Finally, the authors would like to thank members of the editorial and production teams, including KatherineAndrews, Gary Callahan, Elyse Friedman, Kim Friedman, and Robert Howard.

Preface

6 BCG REPORT

Alliances have become an increasingly important—and complex—part of corporate strategy. The lasttwo decades of the twentieth century witnessedexplosive growth in corporate partnering. Accord-ing to one estimate, approximately 35 percent ofglobal corporate revenues in 2002 were a directresult of alliances—up from only 2 percent in 1980.1

Clearly, alliances have become an integral part ofthe corporate-finance and corporate-developmenttool kit.

The economic downturn following the bursting ofthe Internet bubble of the late 1990s caused thenumber of new alliances created worldwide eachyear to decline precipitously. Nevertheless, alliancesremain central to competitive advantage in key sec-tors of the global economy, such as telecommunica-tions and pharmaceuticals. As more and more com-panies shift their attention to growth after a periodof consolidation and restructuring, it’s likely thatthe upward swing in alliances will resume again.This is a trend that has already begun in someregions of the world.

In order to create successful alliances, however, acompany must know when an alliance is appropri-ate and when it is not. One of the main reasons toengage in alliances—as opposed to mergers andacquisitions (M&A)—is to share risk and limit theresources a company must commit to the venture inquestion. Alliances can be extremely useful in situ-ations of high uncertainty and in markets withgrowth opportunities that a company either cannotor does not want to pursue on its own.

But the very characteristics that make alliancesattractive also put strict limits on their usefulness.Alliances are more appropriate for some businessgoals (for example, participating in incrementalrevenue enhancement) than for others (forinstance, achieving economic synergies through

cost cutting). And the advantages of shared risk areoften offset by unclear governance and a lack ofgenuine commitment. It’s important for a companyto understand when alliances make strategicsense—and how to recognize and react when theybegin to deliver diminishing returns.

Alliances are also notoriously difficult to manage. Inmany respects, implementing an alliance is similar toconducting a merger or an acquisition. A companyneeds to put a structured process in place in order todefine the explicit role of alliances in its strategy,identify appropriate partners, structure the rightkind of relationship, and manage the relationshipover time. But alliances also differ significantly fromM&A. In many cases, a company needs to establishclear criteria for exit—before entering into a partner-ship. And it must be prepared to monitor the rela-tionship continuously and interact effectively with itspartners in order to achieve its goals.

The Role of Alliances in Corporate Strategy distills les-sons about alliance strategy and managementdrawn from recent client work and research by theCorporate Finance and Strategy practice of TheBoston Consulting Group. The report

• describes the situations in which companiesshould pursue an alliance strategy instead of astrategy based on M&A

• presents research on recent trends in alliance for-mation and performance

• defines a structured six-step process for managingalliances

• analyzes the role of alliances in three key indus-tries: telecommunications, airlines, and pharma-ceuticals

• introduces BCG’s ten-point CEO alliance checklist

1. Marloes Borker, Ard-Pieter de Man, and Paul Weeda, “Embedding Alliance Competence: Alliance Offices,” in Fostering Execution, ed. H. van der Zee andH. Strikwerda (De Meern, Netherlands: Nolan Norton & Co., 2004), p. 84.

The Strategic Logic of Alliances


To understand the growing importance of alliancesand the management challenges they present, con-sider the following three examples:

In February 1999, the Japanese mobile-telephonecarrier NTT DoCoMo launched its i-mode service formobile access to the Internet. Within a brief three-year period, the company was able to establish i-mode as the dominant industry standard in Japan,attracting 30 million subscribers and penetrating 45 percent of the Japanese market for cellularphones. What accounted for i-mode’s rapid growth?A key factor was thatinstead of developing itsown content, DoCoMoformed alliances with awide range of contentproviders. These partner-ships allowed the com-pany to quickly assemblea critical mass of rich con-tent and services that made i-mode immediatelyattractive to Japanese consumers.

In the 1990s, the airline industry witnessed thedevelopment of a handful of global multicarrieralliances. These alliances provided airlines with ahighly effective means of skirting legal and regula-tory barriers to consolidation and capturing incre-mental revenue. By 2004, the three major airlinealliances accounted for roughly half of the globalpassenger market and more than half of global rev-enue. However, the alliance structure has proved tobe considerably less effective when it comes to elim-inating overcapacity and realizing synergiesthrough aggressive cost cutting. For this reason, thenext phase in the industry’s evolution is likely tohappen through M&A rather than through allianceformation.

With patent expirations increasing and the existingstock of blockbuster drugs leveling off, the globalpharmaceutical industry needs to find new ways tofill its diminishing pipelines. One important waycompanies are addressing this challenge is bylicensing new compounds developed by smallbiotech companies. Alliance deals involving bigpharmaceutical and small biotech companies are

growing in value by more than 20 percent per yearand penetrating into earlier and earlier stages ofdrug development. (For in-depth examinations ofthese three examples, see the case studies on pages10, 18, and 24.)

Clearly, alliances have become an integral part ofthe corporate-finance and corporate-developmenttool kit. Although the number of new alliances cre-ated each year has recently declined, alliancesremain central to competitive advantage in key sec-tors of the global economy, such as telecommunica-

tions and pharmaceuti-cals. As more and more companies shift their at-tention to growth after aperiod of consolidationand restructuring, it’slikely that the upwardswing in alliances willresume again. This trend

has already begun in the Americas.

In order to create successful alliances, however, acompany must understand how alliances differfrom other forms of corporate control and recog-nize when they make strategic sense—and whenthey do not.

Defining Alliances

Alliances represent a distinctive type of corporatecontrol. Although in many respects they pose man-agerial challenges that are similar to those of otherforms of corporate control, alliances also presentdistinctive characteristics that need to be con-sidered.

Business relationships between companies can runthe spectrum from a simple, short-term transac-tional relationship (for example, between a corpo-rate customer and its supplier) to a full-fledgedacquisition in which one company takes full owner-ship of another. (See Exhibit 1, page 8.) A transac-tional relationship allows one company to influenceand, to some degree, direct the actions of anothercompany. But it is a relatively light form of control,restricted to terms stipulated in a contract and gen-

Alliances remain central to competitive

advantage in key sectors of

the global economy.

erally limited in scope and duration. At the sametime, the allocation of business risk between buyerand seller tends to be highly asymmetric, depend-ing on which party has the preponderant marketpower. In an acquisition, by contrast, the acquirerexpends resources to gain complete controlthrough ownership of the assets and capabilities ofthe acquired company. But the acquirer alsoassumes full responsibility for any risks those as-sets incur.

Alliances fall in the middle of this spectrum. Theyare interfirm collaborations in which two or morecompanies jointly invest in an activity over a num-ber of years, sharing in the risks and potentialreturns but remaining independent economicagents. In the case of one form of alliance—thejoint venture—an alliance involves the creation of anew legal entity, and the time frame is generallylong term.2

But most alliances are simply contractual relation-ships of greater complexity than traditional cus-tomer-supplier relationships. (For example, someinvolve an exchange of equity.) Although alliancestend to last longer than a typical buyer-suppliercontract, they also usually have a clear endpoint,whether it be a specific point in time or a thresholddefined in terms of invested costs or expectedreturns.

When Alliances Make Strategic Sense

Alliances can be an extremely effective way toembrace new strategic opportunities, pursue newsources of growth, and contribute to the upside ofthe business. They are particularly useful in situa-tions of high uncertainty and in markets withgrowth opportunities that a company either can-not or does not want to pursue on its own. One ofthe main reasons to engage in an alliance (asopposed to M&A) is to share risk and limit theresources a company must commit to the venturein question.

Risk can take many different forms. One is thefinancial risk associated with the high costs of theinvestment that is required to pursue a particularopportunity. An alliance can be a way to spread—and sometimes even lower—those costs. The multi-carrier alliances in the airline industry, for exam-ple, allow companies to take advantage of thenetwork effects made possible by a global system ofhubs that any single company would find financiallyprohibitive to build on its own. Similarly, in theautomotive industry, companies have engaged injoint research in certain base technologies in orderto take advantage of economies of scale unavailableto any single partner.

Companies also commonly use alliances to managethe risks associated with emerging geographic mar-kets. This trend has been exacerbated by legal andregulatory provisions in some countries thatrequire global companies to create joint ventures as

8 BCG REPORT

Risk and control

Duration

Entity formation (legal status)

Acquisition Contract MergerJointventure

Nonequityalliance

Equityalliance

SharedAsymmetric

Short term

No new legal entity formed

Medium to long term

New legal entityformed Legal status of old entities changed

Permanent

Alliance PurchaseTransaction

Total (by owner)

E X H I B I T 1

THE SPECTRUM OF CORPORATE CONTROL RANGES FROM SHORT-TERM TRANSACTIONAL RELATIONSHIPS TO FULL-FLEDGED ACQUISITIONS

SOURCE: BCG analysis.

2. According to one estimate, only one of five joint ventures lasts morethan six years. See Bruce Kogut, “A Study of the Life Cycle of JointVentures,” in Cooperative Strategies in International Business, ed. Farok J.Contractor and Peter Lorange (Lexington, MA: D.C. Heath, 1988), pp. 169–85.

9

a condition for direct foreign investment. Take theexample of China. Although the Chinese economyis increasingly open to foreign investment, thereare still many situations in which multinationalcompanies are obliged to take on a Chinese partner(and, in some cases, a majority partner) before theymay invest in the country.3

Finally, companies in industries going through amajor technological or business discontinuity areincreasingly turning to alliances to manage the risksassociated with uncertainty. In situations in whichthe future evolution of an industry is highly uncer-tain, alliances can be a way to combine capabilitiesand explore new market opportunities—withoutcommitting too many resources before the futureshape of the industry becomes clear. The telecom-munications industry, for example, is currentlygoing through a profound transformation broughtabout by the convergence of telecommunications,information technology, and consumer electronics,and by the parallel deconstruction of the valuechain of traditional telecommunications. As compa-nies in the industry try to cope with the implica-tions of these changes, a number have turned tostrategic alliances to test new business models andmarket opportunities.

An alliance can also be an effective way for two (ormore) companies to combine complementaryassets and attack a business opportunity together.For example, big pharmaceutical companies areincreasingly entering into licensing partnershipswith small biotech firms. Through these alliances,the pharmaceutical companies are able to stocktheir new-drug pipelines relatively cheaply, and thesmall biotech companies get access to the largefirms’ formidable global marketing and sales capa-bilities.

However, alliances are less effective when the part-ners’ assets overlap considerably and when there iseconomic value to be gained through consolidationand cost cutting. Because the partners in analliance remain independent, no one partner isable to control the others completely—and, there-fore, to decide who will suffer the pain of toughdecisions about reducing costs or consolidatingoperations. In the airline industry, for example,multicarrier alliances have been effective at gener-ating new sources of revenue through such mecha-nisms as code sharing. But they have been less suc-cessful at consolidating alliance members’ IToperations. In this respect, M&A is a much bettermechanism for cutting costs than alliances are. (SeeExhibit 2 for a summary of the differences betweenalliances and M&A.)


3. For further information on requirements for multinational investmentsin China, see http://www.fdi.gov.cn/main/indexen.htm.

Synergies

Control

Resources

Risk anduncertainty

Regulations

Reciprocal Modular or sequential

High

Full ownership

Unambiguous corporate governance

Low

Flexibility and quick implementation

One or multiple partners

Benefits from network effects

Cultural fit important

“Hard” and therefore easy to value

High redundancy

High potential for economies of scale

“Soft” and therefore difficult to value

Low redundancy

Low potential for cost cutting

Low

No barriers to consolidation

High Requires a portfolio approach

Desirable in situations where M&A is impossible for legal or regulatory reasons

M&A Alliances

E X H I B I T 2

M&A AND ALLIANCES DIFFER ON SEVERAL DIMENSIONS


10 BCG REPORT

For an example of a telecommunications companythat has effectively used alliances as a means ofgrowth under conditions of high uncertainty, con-sider how the Japanese mobile-phone carrier NTTDoCoMo established its i-mode mobile Internetservice as the dominant standard in Japan.

Since the launch of i-mode in February 1999,DoCoMo has attracted more than 44 million cus-tomers to the service, representing nearly 60 per-cent of the Japanese mobile Internet market. Inestablishing i-mode as the dominant standard formobile data communications in Japan, DoCoMo pur-sued a classic orchestrator strategy, in whichalliances were at the center of its plans for growth.

Rapid Launch. Well before launching i-mode,DoCoMo created a series of partnerships with con-tent providers. Through these alliances, the com-pany was able to assemble a critical mass of richcontent and services that made i-mode immediatelyattractive to consumers. Only three years afterlaunching i-mode, DoCoMo had 30 million sub-scribers and had penetrated 45 percent of theJapanese market for cellular phones.

Participation in i-mode has distinctive benefits foralliance partners. DoCoMo’s content partnersoccupy pride of place on the standard menu on all i-mode handsets. They also benefit from i-mode’sinnovative microbilling system, which allowsDoCoMo to charge users small fees for each sitethey visit and transfer a portion of those fees to therelevant content providers after collecting a 9 per-cent commission. Finally, i-mode partners benefitfrom DoCoMo’s extensive research into how sub-scribers use the system, which in turn has informedhow the partners design their Web sites for easyviewing and use on mobile devices.

Global Expansion. DoCoMo has also used alliancesto fuel its global expansion outside Japan—a criticalcomponent of its strategy that takes advantage ofeconomies of scale in the production of mobilephones built to the i-mode standard. The companyhas agreed to license the i-mode service to 13 oper-ators outside Japan. For example, it has establishedpartnerships with local telecom operators in nineEuropean countries (including Telefónica in Spain,

C A S E S T U D Y : U S I N G A L L I A N C E S A S A T O O L F O R G R O W T H I N T H E T E L E C O M M U N I C A T I O N S I N D U S T R Y

Wind in Italy, and KPN in the Netherlands) in orderto create a Europewide i-mode network. Withapproximately 4 million subscribers outside Japan,i-mode is not as dominant globally as it is in itshome country. Nevertheless, i-mode remains com-petitive with other Europewide networks such asVodafone live! and Orange World.

Adjacent Businesses. In recent years, there hasbeen a slowdown in sales growth in the mobile tele-com business, forcing DoCoMo to move into adja-cent businesses in order to sustain its growth.Alliances have played a central role in this develop-ment. In early 2004, DoCoMo created a joint ven-ture with Sony to incorporate that company’s FeliCa“contactless” smart-card technology as a standardin all i-mode handsets. The technology makes it pos-sible to store existing credit-card and bank-card dataand functionality on an individual’s cell phone—ineffect, creating a mobile wallet for electronic cashpayments. Currently, the i-mode FeliCa service canbe used at 20,000 outlets such as conveniencestores and movie theaters and in more than 1,000vending machines in Japan. DoCoMo estimates thatthe technology will be available on approximately 10 million phones by 2006.

In order to leverage i-mode’s new possibilities as afinancial portal, DoCoMo recently announced that it isentering the credit card business through a joint ven-ture with Sumitomo Mitsui Card, the second-largestcredit-card company in Japan. By joining withSumitomo, DoCoMo will get a bigger share of thetransaction fees—not to mention the profits from anyinterest payments customers make. What’s more, byamortizing the costs of customer acquisition across i-mode’s already enormous customer base, the com-pany hopes to use i-mode as a powerful platform forthe delivery of a wide range of financial services.

However, as DoCoMo moves farther away from itscore business in telecommunications, it is unclearwhether the alliance strategy that served the com-pany so well in the creation of i-mode will continueto be appropriate. Can DoCoMo establish a prof-itable business model through close cooperationwith Sumitomo? Or will it need to establish a greaterdegree of control?

11

How Alliances Form and Perform

As part of our examination of the role of alliancesin corporate strategy, BCG recently analyzed trendsin the establishment of business alliances worldwidebetween 1988 and 2004.4 To understand the relativeimportance of alliances as a preferred form of insti-tutional collaboration, we also compared thesetrends with those for M&A. And we disaggregatedour global sample to look at trends by region and byindustry.

Finally, in order to understand what kind ofalliances are most successful, we studied the impactof alliance announce-ments on the stock priceof 233 alliance partnersthat participated in 103alliances in the UnitedStates and Europe.

Recent Trends in AllianceFormation

After rising substantially from 1988 to 1995, thenumber of alliances created each year declined inthe late 1990s and dropped significantly after 2000.This decrease reflects the shift of many companiesfrom focusing primarily on growth to focusingmore on consolidation and restructuring.

And although the number of mergers and acquisi-tions created each year has also declined substan-tially from its peak in 2000, the number has begunto rebound in the last few years. The number ofalliances, by contrast, has not. (See Exhibit 3, page 12.)5

From the late 1980s to the mid-1990s, the share ofalliances, including joint ventures, created eachyear as a percentage of total interfirm collabora-tions, including M&A, also grew—from 12 percentin 1988 to 34 percent in 1994. However, since 1994,that percentage has decreased more than fourfold:by 2004, alliances represented only 8 percent of

new interfirm collaborations. (See Exhibit 4, page 12.)

The decreasing percentage of alliances has beendriven by an especially sharp falloff in joint ven-tures. Although new joint ventures as a percentageof all alliances grew from 42 percent in 1988 to 62percent in 1995, they dropped to a mere 10 percentin 2004. (See Exhibit 5, page 13.)

This trend may reflect the organizational costs ofjoint ventures (for example, the costs of the more

stringent legal require-ments associated with jointventures and the risks asso-ciated with sharing propri-etary knowledge) andtheir relatively high failurerate.6 In effect, companiesmay be deciding that jointventures represent the

“worst of both worlds”—providing neither the com-plete control of full-fledged M&A nor the flexibilityof contract-based alliances.

So does the declining percentage of alliances meanthat alliances are becoming less important? Notnecessarily. A look at the regional breakdown ofalliance formation helps explain why. Exhibit 6, onpage 13, shows the trends in alliance formation forthree major regions of the world: the Americas,Europe, and Asia-Pacific.

Two trends are immediately apparent. The first isthat the Americas region, where the vast majority ofalliances are located, has experienced a consider-able rebound in alliance formation from the mostrecent low in 2001. Although the overall trend lineis not yet clear, it seems that alliances in theAmericas have resumed their growth path.

The second trend is that the Asia-Pacific region,which missed out on the alliance boom of the early


Does the declining percentage of alliances mean that alliances are

becoming less important? Not necessarily.

4. Our data source was the Thomson Financial Strategic Alliance and Joint Ventures database.

5. However, preliminary data for 2005 suggest that this trend may be changing. As of October 2005, the rate of alliance creation had exceeded that of 2004by 15 percent. Assuming that this rate continues, we estimate that the total number of deals in 2005 will surpass that of 2004—the first year-to-year increasesince 2000.

6. See John Hagedoorn, “Interfirm R&D Partnerships: An Overview of Major Trends and Patterns Since 1960,” Research Policy 31 (2002), pp. 477–92.

12 BCG REPORT

M&A Alliances

Annual formation of alliances and M&A, 1988–2004Number of deals

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

1988 1990 1992 1994 1996 1998 2000 2002 2004

E X H I B I T 3

ALTHOUGH THE NUMBER OF MERGERS AND ACQUISITIONS HAS REBOUNDED IN RECENT YEARS, THE NUMBER OFALLIANCES CONTINUES TO DROP

SOURCES: Thomson Financial; BCG analysis.

Joint ventures Other alliances M&A

Relative formation of joint ventures, other alliances, and M&A, 1988–2004

%

0

20

40

60

80

100

84

11

1988

88

7

5

90

73

1990

77

13

10

72

15

13

1992

71

20

9

67

19

14

1994

66

17

17

69

12

19

1996

83

8

9

81

10

9

1998

84

11

5 5

2000

84

12

4

86

11

3

2002

89

92

90

91

2004

92

71

E X H I B I T 4

BY 2004, ALLIANCES REPRESENTED ONLY 8 PERCENT OF NEW INTERFIRM COLLABORATIONS



Joint ventures Other alliances

%

0

20

40

60

80

100

1988 1990 1992 1994 1996 1998 2000 2002 2004

5865

56 54

6757

4938

47 51

67 71 7481 78

90 90

4235

44 46

3343

5162

53 49

33 29 2619 22

10 10

Relative formation of joint ventures and strategic alliances, 1988–2004

E X H I B I T 5

A SHARP DECLINE IN JOINT VENTURES HAS CONTRIBUTED TO THE DROP IN ALLIANCES


Asia-PacificEuropeThe Americas

Number of deals

01988 1990 1992 1994 1996 1998 2000 2002 2004

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000Formation of alliances by region, 1988–2004

E X H I B I T 6

AN EXAMINATION OF ALLIANCE FORMATION BY REGION SHOWS THAT ALLIANCES ARE STILL IMPORTANT


NOTE: Excludes all alliances located in Africa and the Middle East and those that involve companies from multiple regions.

14 BCG REPORT

1990s, experienced considerable growth in alliancesstarting in the mid-1990s. Although annual forma-tion rates in the Asia-Pacific region have not yetreturned to their 2002 peak, alliances are muchmore important in that region today than they wereten years ago. This trend may be a reflection of thegrowing internationalization of R&D and the risingnumber of strategic R&D alliances among globalcompanies and local Chinese companies, universi-ties, and governments.7

In addition to variations across regions, there areconsiderable differences in alliance formation byindustry. This finding makes sense given thatalliances are most likely to be found in industrialsectors that are either growing rapidly or facingconsiderable uncertainty (and, therefore, increasedrisk). Exhibit 7 shows alliance formation by indus-

7. For more information on R&D alliances in China, see Jiatao Li and JingZhong, “Explaining the Growth of International R&D Alliances in China,”Managerial and Decision Economics 24 (2003), pp. 101–15.

Formation of alliances by sector, 1988–2004

Relative formation of alliances by sector, 1988–2004

Number of deals

%

0

20

40

60

80

100

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

1988 1990 1992 1994 1996 1998 2000 2002 2004

1988 1990 1992 1994 1996 1998 2000 2002 2004

9,000

Industrial goods

Financial services

Business services

Technology and communications Other

Health care

Consumer goods

E X H I B I T 7

ALLIANCES ARE MOST LIKELY TO BE FOUND IN INDUSTRIES THAT ARE GROWING RAPIDLY OR FACING CONSIDERABLE UNCERTAINTY


NOTE: Alliances lacking SIC codes have been excluded from the analysis.

15

try sector—by the number of alliances and by thepercentage of total alliances created each year.

Three trends stand out. First, the degree to which asingle sector, technology and communications,dominates alliance formation is striking. In 2000,alliances in this sector represented 51 percent of allthe alliances created that year. And even thoughthere has been a significant decline in alliances inthe sector since then, they still represented 33 per-cent of all alliances created in 2004. Most likely, thisfinding reflects the high levels of uncertainty in the fast-changing technology-and-communications sector.

Second, there has been a long-term decline (bothrelative and absolute) in alliances in more tradi-tional industrial sectors, such as industrial goodsand consumer goods. Alliances in these two sectorsaccounted for 40 percent of all alliances created in1988 but only 19 percent in 2004.

Third, recent years have seen a rapid increase inalliances in the business services sector. Suchalliances represented an almost negligible 1 per-cent of total alliances in 1988 but a full 27 per-cent in 2004. It is likely that this increase representsthe proliferation of outsourcing agreements inrecent years.

Analyzing Alliance Performance

To understand what kind of alliances are most suc-cessful, we analyzed 103 alliances in the UnitedStates and Europe involving some 233 partners.These alliances were announced between July 1999and January 2001—the most recent period of majoralliance activity.

We divided this sample into groups on the basis ofwhether the participants were competitors or non-competitors and on the relative breadth and depthof the alliance itself. (See Exhibit 8 for an illustra-tive matrix.) This categorization yielded four broadalliance types:

• Expertise alliances bring together noncompetitorsin order to share specific expertise and capabili-ties. Examples include outsourcing agreementsfor information technology and the licensing ofnew drug compounds in the biopharmaceuticalindustry.

• New-business alliances are partnerships in whichcompanies that traditionally have not been com-petitors join together to enter a new business ormarket. Examples include Microsoft andEricsson’s alliance to create Web-enabled mobiletelephones and NTT DoCoMo’s recent alliancewith the Japanese credit-card company SumitomoMitsui Card.

• Cooperative alliances group competitors in a jointeffort to attain critical mass in an activity in orderto take advantage of economies of scale or net-work effects. Examples include purchasingalliances in the mobile communications sectorand joint R&D on selected base technologies inthe automotive industry.

• M&A-like alliances are partnerships in which com-petitors may desire total integration but are pre-vented from pursuing it—either by regulatoryobstacles or by unfavorable conditions in thestock market. Examples include the airline indus-try’s multicarrier alliances.

To measure the impact of these four types ofalliances on value creation, we analyzed theirannouncement effect—the impact of the announce-ment of the alliance on the share prices of the par-ticipating companies. Calculating announcementeffects is a common analytical tool in evaluating the success of M&A. Typically, researchers measurethe movement in share price of the acquiring


Noncompetitors

Competitors

Partnership type

Narrow Broad

Alliance scope

Cooperative alliances M&A-like alliances

New-business alliances Expertise alliances

E X H I B I T 8

ALLIANCES CAN BE GROUPED INTO FOUR TYPES


company from a few days (or weeks) before to a fewdays (or weeks) after the announcement of thedeal.8 Although a growing body of recent financeresearch suggests that a deal’s announcement effectis not a strong predictor of long-term value creation,it remains a useful technique to assess the differencesin the potential for value creation among differenttypes of deals. Therefore, we have used it to com-pare the performance of our four types of alliances.

Exhibit 9 shows the outcome of our analysis. The xaxis portrays the percentage of sample companiesthat participated in each of our four alliance cate-gories (the wider the column, the higher the per-centage). The y axis divides our sample into threeroughly equal groups. Those companies withannouncement effects greater than 4 percent arewinners. Those with effects between 4 and –1 per-

cent are neutral. Those with announcement effectsless than –1 percent are losers.

As the exhibit demonstrates, the majority of com-panies in our sample—53 percent—participated innew-business alliances. This finding makes sensebecause alliances are most useful for seekinggrowth, and the period in question (July 1999 toJanuary 2001) was the height of the Internet boom.Relatively few companies—only 8 percent—formedM&A-like alliances, reflecting the fact that suchalliances are pursued only in situations in whichregulatory or other obstacles make alliances aninferior alternative to genuine M&A.

Although new-business alliances were the most com-mon, they did not receive the most favorable marketreaction. Thirty-four percent of the companies thatentered into such alliances were in the loser category,and another 38 percent were in the neutral category.By contrast, 67 percent of the companies that formedexpertise alliances were in the winner category.

16 BCG REPORT

8. To calculate the announcement effect of an alliance, we measured thechange in share price of all participating companies from three daysbefore to two days after the announcement and compared that figure withthe industry average.

LoserNeutralWinner

Market reaction to alliance announcements, July 1999–January 2001Announcement effect by category(%)1

0

25

50

75

100

28

38

34

32

26

42

22

27

42

31

67

11

12

Expertise alliances

New-businessalliances

53

Cooperativealliances

8Alliance type (%)2 27

M&A-likealliances

E X H I B I T 9

AN ANALYSIS OF THE MARKET REACTION TO ALLIANCES REVEALS DIFFERENCES IN THE POTENTIAL FOR VALUE CREATION

SOURCES: Datastream; BCG analysis.

NOTE: The sample consists of 233 companies that participated in 103 alliances announced between July 1999 and January 2001.1Percentage of firms in each alliance type by performance category.2Percentage of total sample by alliance type.

M&A-like alliances were the most likely to be losers: afull 42 percent fell into this category. Again, this find-ing makes sense because most of these alliances arecreated in response to unavoidable regulatory orother restraints. But this is not to say that M&A-likealliances are not appropriate in certain circum-stances.

Companies engaging in expertise alliances were notonly the most likely to be winners. The size of themedian announcement effect for this group wasalso significantly larger than those of companiespursuing other types of alliances. Expertise al-liances had a median announcement effect of 7.7percent—nearly six times that of the next-best cate-gory (new-business alliances). And cooperativealliances on average had a negligible announce-ment effect. (See Exhibit 10.)


7.7

1.30.1

0.7

Median announcement effects of sample firms by alliance type%

0

2

4

6

8

10

n=19n=64n=123n=27

Expertisealliances

New-businessalliances

Cooperativealliances

M&A-likealliances

E X H I B I T 1 0

EXPERTISE ALLIANCES CREATED THE MOST VALUE

SOURCES: Datastream; BCG analysis.

NOTE: The sample consists of 233 companies that participated in 103

alliances announced between July 1999 and January 2001.

18 BCG REPORT

In the 1990s, the airline industry saw the develop-ment of a handful of global multicarrier alliances. By2004, the three largest—Star Alliance, Oneworld,and SkyTeam—accounted for roughly 49 percent ofthe global passenger market and about 58 percentof global revenue.

These alliances were formed in response to certaincharacteristics of the global airline industry: the highdegree of fragmentation, coupled with severe regula-tory and cultural barriers that have made it difficultto consolidate the industry through M&A. In such an environment, alliances have allowed the industryto take some useful steps on the road to consolida-tion. But there are many signs that these alliancesare now producing diminishing returns. It’s likelythat the future of consolidation in the airline indus-try will take place through M&A rather thanalliances.

The Economics of Airline Alliances. Multicarrier air-line alliances were a response to the financial crisisin the airline industry.1 Like many other capital-intensive industries, the airline industry struggles toearn a return on its cost of capital. As a result, theindustry has historically underperformed the market.The total shareholder return of most companies isconsistently in the bottom quartile of the stock mar-ket as a whole.

A major factor in this poor economic performance isthe high fragmentation of the industry and theresulting excess capacity. For example, 21 Europeancarriers divide approximately 45 percent of thetransatlantic passenger traffic between WesternEurope and the United States—whereas only 6 U.S.carriers provide 51 percent (and carriers from otherregions of the world provide the rest). It’s likely thatas few as 3 long-haul carriers (or closely integratedgroups of carriers) will survive in each of the threemajor regions of the globe.

From a purely economic point of view, there aremajor benefits to consolidation in the industry.Operational synergies can provide opportunities forcost rationalization. Network synergies can both

C A S E S T U D Y : A S S E S S I N G T H E D I M I N I S H I N G R E T U R N S O F A L L I A N C E S I N T H E A I R L I N E I N D U S T R Y

reduce costs and improve asset utilization. Andconsolidation can improve carriers’ competitivepositions by providing a platform for growth.Despite the powerful economic logic of consolida-tion, however, there have been strong regulatoryand cultural barriers to M&A. The commitment ofindividual countries to subsidize their national car-riers, strict international air rights that cause anacquired company to lose highly coveted landingrights at foreign airports, and strong labor unionswith powerful seniority privileges have all made itextremely difficult to consolidate the industrythrough M&A. So airlines have pursued globalalliances as an alternative.

The Advantages—and Limits—of Airline Alliances.Multicarrier alliances provide direct benefits toconsumers in the form of increased frequency offlights, better connectivity among destinations, andconsolidated frequent-flyer programs. As a result,the alliances have been extremely effective atenhancing revenue. Consider one example: approx-imately two-thirds of Lufthansa’s transatlantic pas-senger traffic originates from feeder flights of theairline’s Star Alliance partner, United. According toone estimate, Lufthansa’s participation in StarAlliance was responsible for an estimated $250 million in incremental annual profitsbetween 1999 and 2001.

But most of the extra revenue that resulted fromimproved connectivity has been harvested. Mostmajor airlines have already joined one of the threemajor alliances, and many consumers have alreadybeen locked into one of the alliances through well-designed frequent-flyer programs. The next phase ofconsolidation will require long-overdue cost cutting.The airline alliances have tried to tackle thesetougher cost synergies, but the alliance structurehas proved singularly ineffective. Take the exampleof the rationalization and consolidation of IT net-works. The current IT landscape in the airline indus-try is extremely fragmented and anachronistic, andthere are powerful advantages to economies ofscale. Every individual airline would benefit from an

1. For a more detailed analysis of the economic condition of the global airline industry, see Unfriendly Skies: The Outlook for the Global Airline Industry,BCG Focus, January 2002.


alliancewide (or even industrywide) solution. Andyet, IT consolidation has made relatively littleprogress over the past decade, despite the undis-puted potential. The same is true for joint procure-ment, whether of expensive items such as aircraftand spare parts or of daily expendables such as foodand fuel.

There are at least four major reasons why the airlinealliances have failed to further consolidate theindustry:

• Asymmetric Benefits. Revenue synergies owing toincreased connectivity are an incremental additionto an existing asset base. By contrast, achievingcost synergies such as consolidated IT platformsrequires up-front investments. But the benefits ofthese investments are asymmetric and unpre-dictable. There is no guarantee that the airlinethat invests the most will receive the greatest ben-efits. This uncertainty causes companies to hesi-tate to invest.

• Irreversible Commitments. Because cost synergiesrequire big investments, they also make a com-pany’s commitment to the alliance irreversible.Once a company has invested millions of dollars ina new alliancewide IT system, it is highly unlikelyto leave the alliance and walk away from thatinvestment. But this irreversibility undermines asignificant part of the logic of a strategicalliance—its flexibility—and is another reasonwhy companies shy away from making the neces-sary investment.

• Eroding Option Value. The more engaged an air-line is in an alliance, the less freedom of choiceexecutives have to determine the destiny of thecompany. Put another way, the potential opera-tional value of alliances in terms of lower costs isoutweighed by the enormous option value—espe-cially for smaller carriers—of remaining indepen-

dent. In the long term, these players are unlikelyto survive the ongoing consolidation of the indus-try. And yet, seen from the perspective of share-holder value, it is better for these players to retaintheir independence today in order to positionthemselves for acquisition in the future than tocede their independence to an alliance withoutgiving stockholders the benefit of an actual sale.Too much reliance on alliances can dilute thisstrategic option value. As a result, participantswithhold further commitment and investment, andthe alliance enters a phase of paralysis.

• Cumbersome Decision Making. The effectivenessof multicarrier airline alliances has been limitedby overly complex organization and decisionmaking. In many respects, an airline alliance islike a mini United Nations in which every airlinehas an equal vote, irrespective of size or degreeof importance to the alliance. It is striking that,to the degree that the alliances have made stepsin consolidating their operations, the agreementshave usually been bilateral—involving only twomembers—rather than agreements that involveall members of the alliance.

For all these reasons, although the major airlinealliances have been an important step in the evolu-tion of the industry, they will play a diminishing rolein the future. Competitive dynamics in the industryare rapidly moving toward the endgame. Many lead-ing airlines are scaling back their commitments toalliances. The ongoing consolidation of the industryis more likely to happen through mergers—despitethe barriers to M&A. Signs of this trend include therecent mergers of KLM Royal Dutch Airlines and AirFrance, Lufthansa and Swiss International Air Lines,and US Airways and America West Airlines.Ultimately, the multicarrier airline alliances may endup being a temporary—and inferior—substitute forfull-fledged M&A.

Alliances are notoriously difficult to manage. Inmany respects, implementing an alliance is similarto conducting a merger or an acquisition. Acompany needs to put a structured process inplace in order to define the explicit role ofalliances in its strategy, identify appropriate part-ners, structure the right kind of relationship, andmanage that relationship over time. But alliancesalso differ significantly from M&A—and need tobe managed differently. There are six key steps.(See Exhibit 11.)

Align the Alliance Strategy with the Growth Strategy

Alliances are primarily a way to grow. Therefore, acompany’s alliance strategy must be grounded in its

long-term corporate strategy for growth. Amongthe questions senior executives need to ask are thefollowing:

• What are the prospects for organic growth in thecore business?

• Are there more attractive growth paths outsidethe core business?

• How risky are these options?

• Where do alliances make more sense than full-fledged M&A?

• What companies are potential partners, and whatis the appropriate time frame for the alliance?

A Structured Process for Managing Alliances

20 BCG REPORT

1

2

3

4

5

6

Align the alliance strategy

Conduct a partner search

Negotiate the deal

Manage the alliance

Evaluate performance

Adopt a portfolio approach

Define the alliance strategy

Determine the optimaldeal structure Assess needs

Screen on the basis of financial and strategic fit

Select on the basis of alliance experience and cultural fit

Define governance and the exit strategy

Design the alliance organization

Monitor on the basis of business criteria

Identify gaps betweengoals and results

Continue, relaunch, or exit

Learn fromexperience

Enter with a strategic plan in place

Close the deal orstop negotiating

Establish analliance office

Define alliance segments

Continuously reshapethe portfolio

E X H I B I T 1 1

A STRUCTURED ALLIANCE PROCESS HAS SIX KEY STEPS



It’s also important to be clear about exactly whattype of alliance makes sense, given the company’sgrowth strategy, because different types of allianceshave different success rates.

Conduct a Rigorous Partner Search

When a company has a clear sense of how alliancesfit into its growth strategy, it is in a position to iden-tify potential partners and structure the right kindof alliance. In M&A, successful acquisitive compa-nies conduct rigorous searches for the right part-ner, comprehensive duediligence, and what wecall high-definition valua-tion.9 Alliances require anequally rigorous process.But that process must alsoaddress the distinctivefeatures of alliances.

For example, many alliances, especially in R&D or in emerging technologies and markets, arebased on tacit knowledge. Participants sense thatby combining the capabilities of their companies,they will be able to take advantage of an opportu-nity. However, it is often very difficult to definejust how large that opportunity is. In order to takeadvantage of the opportunity, partners need todefine clearly how they intend to appropriate thevalue of the alliance—for example, by applying forpatents or investing in new joint R&D.10 Amongthe questions executives need to ask are thefollowing:

• Have we identified the full range of potentialalliance partners?

• What is the strategic and financial fit with eachcandidate?

• Can the cultures of the two companies worktogether?

• Have we quantified the value we want to get fromthe alliance?

Negotiate the Deal

Once a potential alliance partner is identified, thecompanies must make sure that they address keyaspects of the alliance during the negotiationprocess. One area to focus on is governance. In anacquisition, it’s clear who governs the new com-pany: the acquirer. In an alliance, by contrast, gov-ernance often remains ambiguous. There are alwaysquestions about the relative weight of the invest-ment of each of the partners and, therefore, thebest way for revenues from the alliance to be

shared. If a company isn’tcareful, this ambiguity canlead to a vicious cycle inwhich the ambiguityabout contribution andrevenue sharing causespartners to become hesi-

tant about investing and making a genuine commit-ment to the alliance.

It’s imperative when entering into an alliance toaddress this classic “free rider” problem by defininggovernance mechanisms as explicitly as possible.Issues such as access to financial information, crite-ria and metrics for evaluating performance, and theprocess for resolving disagreements among thepartners should all be made explicit in the alliancecontract.

In the past, some alliance experts argued that focus-ing too much on control can undermine the devel-opment of trust, and it is trust on which effectivecooperation in alliances depends. But recentresearch suggests that as long as control mecha-nisms focus on business criteria that define theactual costs and benefits of the alliance, rather thanon social norms of behavior, such mechanisms actu-ally increase rather than diminish trust amongalliance partners.11

The negotiation period is also the time to establishclear requirements for exit—for example, throughthe formulation of an explicit stop-loss agreement.

9. For a more detailed discussion of high-definition valuation, see Growing Through Acquisitions: The Successful Value Creation Record of Acquisitive GrowthStrategies, BCG Report, May 2004.

10. See Katila Riita and Paul Y. Mang, “Exploiting Technological Opportunities: The Timing of Collaborations,” Research Policy 32 (2003), pp. 317–32.

11. See Angela L. Coletti, Karen L. Sedatole, and Kristy L. Towry, “The Effect of Control Systems on Trust and Cooperation in Collaborative Environments,”The Accounting Review 80, no. 2 (2005), pp. 477–500. For the importance of the negotiation process in alliances, especially as a mechanism for building trust,see Robert J. Mockler, “Multinational Strategic Alliances: A Manager’s Perspective,” Strategic Change 6 (1997), pp. 391–405. See also Robert J. Mockler andMarc E. Gartenfeld, “Using Multinational Strategic Alliance Negotiations to Help Ensure Alliance Success: An Entrepreneurial Orientation,” StrategicChange 10 (2001), pp. 215–21.

If a company isn’tcareful, ambiguity

about governance canlead to a vicious cycle.

A merger is like a marriage—ideally, it lasts forever.Not so with an alliance. Although some alliances (inparticular, joint ventures) do last for a number ofyears, one of the great advantages of alliances isthat they are temporary. Companies have the flexi-bility to readjust or end an alliance when competi-tive circumstances shift.

Before entering into an alliance, however, it’sextremely important for a company to have a clearexit strategy already in place. This strategy shouldspecify explicit criteria and trigger points for exit,as well as explicit agreements with partners aboutwhen and how to end the alliance. Executivesshould be asking questions such as

• What are our triggers for exit?

• What are the responsibilities of the two partiesshould either decide to end the alliance?

• Are there any continuing obligations after exit—for example, access to brands or ongoing sourc-ing agreements?

• How should assets, personnel, and brands be val-ued and priced?

Manage the Alliance

Once a company agrees to an alliance, it must makesure to manage it carefully. In M&A, postmergerintegration (PMI) is critical to realizing the value ofa deal. PMI can make or break a merger and oftendifferentiates experienced, successful acquirersfrom those that are less successful. But whereas PMIis a highly focused activity with a clear beginningand end, alliances need to be managed continu-ously throughout the life of the partnership.Among the questions executives need to ask are thefollowing:

• Are management processes aligned with the com-pany’s alliance strategy?

• Are managerial accountabilities for the perfor-mance of the alliance clearly defined?

• How will alliance performance be monitored over time?

Evaluate Alliance Performance

Once an acquisition is fully integrated, the optionof divestiture is no longer on the table. In analliance, by contrast, the possibility of liquidation isalways on the table and should never be forgotten.A company needs to evaluate alliance performanceregularly to determine whether or not the allianceis meeting its strategic objectives. For example,executives need to ask the following questions:

• Is the alliance meeting its strategic and finan-cial goals?

• Has anything happened in the competitive envi-ronment to challenge the strategic logic of thealliance?

• Should the alliance continue full speed ahead oris it time to exit?

Adopt a Portfolio Approach to Alliances

Of course, at any single moment in time, most com-panies will be conducting not one or two alliancesbut many. According to one estimate, most largecompanies have at least 30 and some have morethan 100.12 Therefore, a company must also put aprocess in place for actively managing its entireportfolio of alliances, weeding out the valuedestroyers, and nurturing the successful partner-ships over time. By taking a portfolio approach toalliances, a company further protects itself from thefailure of any single initiative and positions itself totake advantage of those high-risk initiatives that suc-cessfully deliver above-average returns.

One effective approach to managing the allianceportfolio is to create a dedicated alliance office.Consider, for example, the approach taken by RoyalPhilips Electronics.13 The company uses a simplematrix to divide its alliances into four groups on thebasis of the amount of synergy between the partnersand the potential long-term value of the alliance toPhilips. (See Exhibit 12.) Business alliances arelargely operational or tactical, usually focusing onlogistics or purchasing. Strategic alliances usuallyfocus on creating a new product, service, or busi-ness. Relationship alliances are partnerships that are

22 BCG REPORT

12. Marloes Borker, Ard-Pieter de Man, and Paul Weeda, “Embedding Alliance Competence: Alliance Offices,” in Fostering Execution, ed. H. van der Zee andH. Strikwerda (De Meern, Netherlands: Nolan Norton & Co., 2004), pp. 84–92.

13. The authors would like to thank John Bell, head of the corporate alliance office at Royal Philips Electronics, for his assistance with this section.

long lasting or span multiple divisions. Finally, everyyear the company identifies ten alliances that areparticularly important to its strategic goals. Each ofthese formally designated corporate alliances is spon-sored by a member of the Philips board. The list ofcorporate alliances is revised yearly.

Business and strategic alliances are managed bythe Philips business units that formed the partner-ships in the first place. For these alliances, thealliance office typically functions as a competencecenter. For example, it makes sure that each prod-uct division adopts an appropriate alliance strat-egy; supports the alliance process; identifies bestpractices in alliance management and communi-cates them to the product divisions; and, in somecases, conducts postmortems after the alliance hasbeen concluded. Once a partnership is elevated tothe status of a relationship or corporate alliance, itis managed directly by the alliance office itself. Inparticular, each corporate alliance has a dedicatedalliance manager who is responsible for overseeingall of the dealings between the partner andPhilips.

This approach has the advantage of focusing seniormanagement’s attention on the most critical of thecompany’s alliances at any given moment. And theexistence of a dedicated alliance office has helpedPhilips establish throughout the organization thedistinctive managerial competencies necessary tomanage alliances.


Low

High

Synergy

Low HighLong-term value

Relationship alliances Corporate alliances

Business alliances Strategic alliances

E X H I B I T 1 2

ROYAL PHILIPS ELECTRONICS MANAGES ITS ALLIANCE PORTFOLIO USING A SEGMENTATION MATRIX

SOURCES: John Bell, Royal Philips Electronics; BCG analysis.

24 BCG REPORT

The global biopharmaceutical industry has, for sometime, faced a significant R&D productivity challenge.In the 1990s, industry revenues grew on the back ofa surge in the stock of blockbuster drugs. But withpatent expirations increasing, the stock of block-busters is set to level off in the current decade. Toavoid a sharp decline in revenue growth, big phar-maceutical companies will need to find new ways toboost their diminishing pipelines.

One important way companies have been addressingthis productivity challenge is by licensing new com-pounds developed by small biotech companies.1

Small biotechs (defined as all biotech companiesexcept for the ten largest) currently account for lessthan 10 percent of the industry’s cash, market cap-italization, and R&D spending. And yet, these firmsare responsible for two-thirds of the worldwide clin-ical pipeline of biopharmaceuticals.

Given the powerful economic logic for collaborationbetween big pharmaceutical companies, which pro-vide resources and know-how, and small biotechcompanies, which furnish clinical candidates, itshould be no surprise that deal making in the indus-try is growing in value at more than 20 percent peryear and penetrating into earlier and earlier stages ofdrug development.

But as licensing has become critical to R&D produc-tivity, it has also become immensely competitive. Theworldwide clinical pipeline of biopharmaceuticals cur-rently boasts more than 2,500 compounds. Butnearly 1,000 of these compounds are alreadylicensed. And the rate of deal making is growing rap-idly at approximately 10 percent per year, while thetotal pipeline is increasing slowly at around just 2 per-cent per year. What’s more, only about 30 percent ofthe remaining unlicensed compounds would passeven a cursory licensing triage, the rest being unsuit-able, not novel, or of low value. As a result, the stockof licensing candidates is rapidly draining away.

Effective licensing is very much a partnership game.Although, obviously, the amount of money a com-

C A S E S T U D Y : M A N A G I N G A L L I A N C E S I N T H E P H A R M A C E U T I C A L I N D U S T R Y

pany has available for licensing deals is important,paying the most is neither the only way nor neces-sarily the best way to win a deal. A company’s abil-ity to identify and attract the best partners andeffectively manage its alliances will be critical tofuture competitive success. Five steps are key.2

Establish clear licensing objectives. The first step isto determine precisely how much of the company’sclinical pipeline needs to come from externalsources. What is the likely size of the earnings gapthat licensing must fill? What are the odds thatexisting opportunities (given realistic assumptionsabout the types of projects to target and typical hitrates) can fill those gaps? Is it feasible to expand therange of compounds to target? Or is it more appro-priate to revise earnings guidance? When defining itslicensing objectives, a company should make sure todo more than merely set dollar value targets. Lastyear’s licensing may turn into this year’s deep part-nership or acquisition. It’s important for the seniormanagement team to be aligned on how to approachdeals that could evolve further into broader partner-ships or outright acquisitions.

Define a strategy for where to focus. Once thefinancial boundaries of the licensing partnershipchallenge have been set, it’s also important todevelop a clear strategic focus for the kind of dealsto pursue. Most companies will choose to emphasizethose therapeutic areas and modalities in whichthey already have internal expertise. This approachensures that the company has the requisite capabil-ities both for evaluating potential projects and fortaking them forward once they are licensed. Thechoice of where to focus in drug development, how-ever, is more complicated. It depends partly on thecompany’s appetite for risk and also on its attitudetoward different types of deal structures. Earlier-stage deals, for example, are better suited to proj-ects that involve deeper collaboration or shared con-trol. One final criterion is financial: any strategyshould include an agreed minimum for expectedpeak sales.

1. For a more comprehensive account of how biopharmaceutical companies can address the R&D productivity challenge, see Rising to the ProductivityChallenge: A Strategic Framework for Biopharma, BCG Focus, July 2004.

2. For a more detailed treatment of biopharmaceutical licensing, see The Gentle Art of Licensing: Rising to the Productivity Challenge in Biopharma R&D,BCG Focus, July 2004.


Manage the partnership message. Once a companyknows what kind of deals it is looking for, the nextstep is to communicate a clear and consistent mes-sage to potential partners about the advantages ofallying with one particular company as opposed toanother. There is a lot that a licenser can do toshape the perceptions of potential partners. And yet,unclear messages are all too common, eitherbecause the company’s general licensing strategy isitself unclear or because the company undervaluesor mishandles the art of communication.

It’s largely a matter of balance: send too vague orfaint-hearted a message, and potential partners willsuspect a lack of commitment; come across toostrong, and they will be on their guard. An effectivemessage needs to both resonate with potential tar-get partners and be consistent with a company’soverall image and intent. By viewing licensing effortsas being in part a branding exercise, a company canbetter grasp the requirements for success—namely,defining clearly and simply a promise of value thatmeets the needs of potential partners and then reli-ably and consistently following through on thatpromise. Such follow-through requires efforts frommore than just the licensing or business develop-ment functions because perceptions are shaped byinteractions with the entire company.

Develop internal processes. To deliver on its strat-egy and image promises, a pharmaceutical companyalso needs to put a set of processes in place forlicensing—from candidate identification and screen-ing, through negotiation, to execution and manage-ment. Take a simple example: emphasizing a com-pany’s “responsiveness” to potential partners

doesn’t mean much if there is no process in place forensuring that inquiries are handled promptly.Establishing and managing effective processes forlicensing are challenges because so many functionsare involved and need to be consulted. Experts fromR&D, commercial, and manufacturing all need toassess a potential project for validity and attractive-ness. To reduce the burden on these functions, thosewithin licensing must have the requisite knowledgeto triage opportunities appropriately.

Anticipate organizational tradeoffs. There is nosingle best-practice organization design for manag-ing licensing. As with most organization-designchoices, different models necessarily entail differ-ent tradeoffs. It is important to be aware of thetradeoffs inherent in the model chosen and to putmechanisms in place to address the issues thatarise. For example, should licensing and even M&Aactivities report to a single head? Or should eachdistinct activity report to its own group head? Splitreporting—with technology licensing reporting todiscovery, clinical licensing reporting to develop-ment, and M&A reporting to corporate—allows forbetter coordination of each group with its keystakeholders. But single reporting facilitates coor-dination among these groups. Depending on acompany’s specific situation, one model may bedemonstrably better than another. A company thatseldom contemplates technology licensing, forinstance, shouldn’t have a separate technology-licensing group. But even when the structuralchoice is clear, it’s important to think through theresulting tradeoffs and develop mechanisms to off-set them.

In conclusion, we offer a ten-point CEO alliancechecklist that captures the key arguments and rec-ommendations of this report in a concise, easy-to-use format. These principles represent a usefulstarting point for any company’s alliance strategy.

1. Don’t get left behind. Despite the recent decline inalliance formation, alliances are here to stay.They are a permanent part of the corporate-finance and corporate-development tool kit,and they are particularly important in industriesthat are facing uncertainty, discontinuity, orrapid growth.

2. Understand the differences between alliances andM&A. Alliances represent a distinctive form ofcorporate control. Understand when they makesense strategically and when they do not. Avoidusing alliances as a substitute for M&A.

3. Align your alliance strategy with your corporate strat-egy. In particular, know the role of alliances inyour growth strategy.

4. Pay attention to option value. Alliances are a way tokeep options open in order to participate ingrowth opportunities that otherwise wouldn’tbe possible. Think of them as “options” on thefuture.

5. Don’t be afraid to fail. By spreading the risks offailure among multiple partners, alliances allowa company to limit its downside exposure.

What’s more, because no one company takes onthe full investment in any individual alliance,each partner is able to invest a fixed amount ofresources in a broad array of high-risk ventures.

6. Take a portfolio approach. Actively manage youralliance portfolio. Over time, weed out the val-ue destroyers and nurture the successful part-nerships.

7. Develop a structured alliance process. Be as system-atic in partner selection and negotiation as youwould be in the pursuit of a merger or an acqui-sition. And continuously monitor alliance per-formance on the basis of explicit criteria forperformance.

8. Pay attention to governance. Ambiguous gover-nance undermines commitment. Make sure thatgovernance mechanisms are clear. Address thefree-rider problem and manage it carefully dur-ing the lifetime of the alliance.

9. Have a clear exit strategy. Most alliances don’t lastforever. Make exit criteria explicit in advanceand know when to take your losses.

10. Develop a dedicated alliance function. Once a com-pany has an active portfolio of alliances, it’simportant to establish a strong capability inalliance management. The alliance office modelis an effective way to embed this capabilitythroughout your organization.

The CEO Alliance Checklist

26 BCG REPORT

The Boston Consulting Group publishes other reports and articles on corporate finance that may be of inter-

est to senior executives. Recent examples include:

Balancing Act: Implementing an Integrated Strategy for Value Creation

The 2005 Value Creators report, November 2005

ÒIntegrating Value and Risk in Portfolio StrategyÓ

Opportunities for Action in Corporate Finance and Strategy, July 2005

ÒThe Dilemma of the Successful CEOÓ

BCG Perspectives, May 2005

ÒWinning Merger Approval from the European CommissionÓ

Opportunities for Action in Corporate Finance and Strategy, March 2005

The Next Frontier: Building an Integrated Strategy for Value Creation

The 2004 Value Creators report, December 2004

ÒThe Right Way to DivestÓ

Opportunities for Action in Corporate Finance and Strategy, November 2004

Growing Through Acquisitions: The Successful Value Creation Record

of Acquisitive Growth Strategies

A report by The Boston Consulting Group, May 2004

ÒNew Rules for European AntitrustÓ

Opportunities for Action in Corporate Finance and Strategy, May 2004

Back to Fundamentals: Value Creators Report 2003

A report by The Boston Consulting Group, December 2003

Winning Through Mergers in Lean Times: The Hidden Power of Mergers

and Acquisitions in Periods of Below-Average Economic Growth

A report by The Boston Consulting Group, July 2003

ÒThinking Differently About DividendsÓ

BCG Perspectives, April 2003

ÒManaging Through the Lean YearsÓ

BCG Perspectives, February 2003

ÒTaking Deflation SeriouslyÓ

BCG Perspectives, January 2003

Succeed in Uncertain Times: A Global Study of How TodayÕs Top Corporations

Can Generate Value Tomorrow

Value Creators report 2002, November 2002

ÒNew Directions in Value ManagementÓ

BCG Perspectives, November 2002

ÒMaking Sure ÔIndependentÕ DoesnÕt Mean ÔIgnorantÕÓ

BCG Perspectives, October 2002

ÒTreating Investors Like CustomersÓ

BCG Perspectives, June 2002

For a complete list of BCG publications and information about how to

obtain copies, please visit our Web site at www.bcg.com.

To receive future publications in electronic form about this topic or others,

please visit our subscription Web site at www.bcg.com/subscribe.

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BCG

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