Investment Entry through Equity Joint Venture

Joint-venture entry takes place when an international company shares in the ownership of an enterprise in a target country with local private or public interests. Most commonly, an international company agrees to share capital and other resources with a single local company in a common endeavor. Depending on the equity share of the international company, joint ventures may be classified as majority, minority, or 50-50 ventures. They may be started from scratch or by the foreign partner’s acquisition of a partial ownership interest in an existing local company.

An international company has less control over a joint venture than over a sole venture, particularly when it has only a minority equity posi­tion. With a sole venture, full control enables a company to carry out its own strategy in the target country and gain all the profits. It also facilitates parent company management by bringing the venture into common finan-cial and other reporting systems, allows better protection of industrial property, encourages transactions between the parent and the venture, and eases the integration of the venture with the parent’s operations in other countries. In contrast, a joint venture can frustrate a foreign partner’s strategy when the local partner’s interests conflict with his own. At the very least, the foreign partner needs to accommodate the fundamental interestsof the local partner if the joint venture is to survive. Why, then, should a manufacturer choose a joint-venture entry?

1. Reasons for Joint-Venture Entry

The most common reason for joint-venture entry is the prohibition or discouragement of sole-venture entry by governments in developing coun­tries. The same reason pertains to Communist countries, in which sole ventures are never allowed (furthermore, only Yugoslavia, Hungary, Roma­nia, Poland, and China encourage joint ventures¹’). Thus joint ventures may be the only feasible form of investment entry in developing and Communist countries. In general, therefore, joint ventures represent a second best in-vestment entry strategy for manufacturers, a strategy dictated by govern­ment rather than business policy. For most manufacturers that want to invest abroad, the first-best entry strategy remains the sole venture.²⁰

Although joint ventures are commonly a response to host government policies, they can also bring positive benefits to the foreign partner through the local partner’s contributions: local capital (which reduces both the investment and the risk exposure of the foreign partner); knowledge of the host country environment and business practices; personal contacts with local suppliers, customers, banks, and government officials; management, production, and marketing skills; local prestige; and other resources. In most instances, the key contribution is the local partner’s knowledge of the local environment and his skills in dealing with it. It is why some compa­nies have chosen joint-venture entry in Japan even when a sole-venture option was open to them. It is also why joint-venture entry may appeal to companies with little experience in operating on their own abroad. The local partner’s contributions, when combined with the foreign partner’s (especially technology and related skills), can sometimes exploit a target market more effectively than a sole venture. It would be a mistake, there­fore, for international managers to pick a local partner simply to satisfy the host government and thereby ignore the contributions that a partner can bring to the joint venture.

2. Picking the Right Partner

The most critical decision in joint-venture entry is the choice of the local partner. For that reason, joint ventures are often compared to marriages. And like marriages, joint ventures frequently end in divorce when one or both partners conclude they can benefit by breaking their association. Once a company has decided on a joint-venture entry for a target country, its managers must initiate a search/evaluation process very much like that for acquiring a foreign company: (1) drawing up a joint-venture profile that specifies the desired features of a candidate, (2) identifying/screening candi­dates, and (3) negotiating the joint-venture agreement. The accompanying checklist is offered to assist managers in screening and negotiating joint ventures.

Managers should start by defining what they want the joint venture to accomplish in the target country/market over the strategic planning period and how the joint venture will fit into their company’s overall international business strategy.

Managers also need to know the objectives and strategy of the prospec­tive local partner. It would be rash to assume that the two partners would have the same or compatible interests in the joint venture. What is called for is an open, thorough discussion between the two parties about the purpose of the joint venture and how it will be attained. Agreement on these fundamental issues can be formalized in a memorandum of agreement signed by both parties, but mutual trust and understanding are the true foundation of a successful joint venture.

Checklist for Joint-Venture Entry

1. Purpose of Joint Venture
   1. Objectives/strategy of foreign partner.
   2. Objectives/strategy of local partner.
   3. Reconciliation of objectives.
2. Contributions of Each Partner
   1. Knowledge of local environment.
   2. Personal contacts with local suppliers, customers, and so on.
   3. Influence with host government.
   4. Local prestige.
   5. Existing facilities.
   6. Capital
   7. Management/production/marketing skills.
   8. Technical skills and industrial property.
   9. Other
3. Role of Host Government
   1. Laws/regulations/policies.
   2. Administrative flexibility.
   3. Interest in this joint venture.
   4. Requirements for approval.
4. Ownership Shares
   1. Majority (foreign partner).
   2. Minority (foreign partner).
   3. 50-50.
   4. Other arrangements.
5. Capital Structure
   1. Legal character of venture.
   2. Equity capital.
   3. Loan capital (local and foreign).
   4. Future increase in equity capital.
   5. Limits on transfer of shares.
6. Management
   1. Appointment/composition of board of directors.
   2. Appointment/authority of executive officers.
   3. Expatriate staff.
   4. Organization
7. Production
   1. Planning/construction of facilities.
   2. Supply/installation of machinery and equipment.
   3. Operations
   4. Quality control.
   5. R&D.
   6. Training
8. Finance
   1. Accounting/control system.
   2. Working capital.
   3. Capital expenditures.
   4. Dividends
   5. Pricing of products provided by partners.
   6. Borrowing and loan guarantees by partners.
   7. Taxation
9. Marketing
   1. Product lines, trademarks, and trade names.
   2. Target market(s) and sales potentials.
   3. Distribution channels.
   4. Promotion
   5. Pricing
   6. Organization
10. Agreement
    1. Company law in host country.
    2. Articles and bylaws of incorporation.
    3. Contractual arrangements (licensing, technical assistance, management, and so on).
    4. Settlement of disputes.

Each partner enters a joint venture to gain the skills and resources possessed by the other partner. Hence the contributions of the international company to a joint venture depend on both its own capabilities and those of the local partner, as well as on the joint venture’s purpose and scope. Usually, the key contribution of the international partner is technology or products, while that of the local partner is the knowledge and skills to manage the venture in the host country. When a joint venture must be approved by the host government (as is true in developing countries), the partners’ respective contributions—particularly the ownership share of the foreign partner—may also be influenced by public policy.

Apart from settling the question of ownership shares, managers need to resolve many other issues in negotiations: the allocation of responsibilities in management, production, finance, and marketing; day-to-day operations; and planning for the future. Frequent problem areas of joint ventures in­clude profit reporting, dividend policy, capital expansion, the pricing of inputs sourced from either parent, and executive compensation. If these issues are not resolved by the partners during negotiations, they will almost certainly return to haunt them at a later time.²²

Negotiations end in written agreements that determine the legal and substantive nature of the joint venture (articles of incorporation, bylaws, memorandum of agreement, and so on) and in written agreements (such as licenses, technical-assistance contracts, and management contracts) concern­ing the provision of industrial property or services by one or both partners to the joint venture.

3. The Question of Control

The most common criticism of joint ventures by international companies is the loss or dilution of management control. As noted earlier, the impor­tance of control to a company ultimately depends on its strategy. Control for the sake of control is hardly a satisfactory policy. Instead, managers should decide how much control is needed to accomplish their objectives in the target country. A follow-on question is how they should obtain the desired control.

The most direct way to gain control over a joint venture is through majority ownership. But when majority ownership is ruled out by govern­ment policy, control may still be exercised in other ways by the minority partner. This is most evident when the joint venture is critically dependent on a continuing flow of technical assistance from the foreign partner. By holding the power of life or death over the joint venture, the minority partner can easily exert a dominant influence on its policies and operations.

The minority partner can also exercise control through bylaws that grant it certain rights (for example, the selection of key executives) or through a management contract. Another control device is the issuance of voting and nonvoting stock shares, with a majority of the latter held by the foreign partner. The minority partner’s interest may also be protected by holding veto rights over key decisions in the joint venture, such as dividend declarations or new capital investments.

Enough has been said to indicate that an international company can exercise a substantial degree of control over a joint venture even when the company is a minority partner. Managers should recognize that a minority position need not mean a lack of control, and that they can negotiate good joint-venture agreements as a minority partner. For that reason, it would be shortsighted for managers to insist on full or majority ownership at the cost of losing the only opportunity to enter an attractive target country as an investor.

Source: Root Franklin R. (1998), Entry Strategies for International Markets, Jossey-Bass; 2nd edition.