Article Creating Profit Through Alliances


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Article about different competitive strategies and how these relate to basic types of alliances. An introduction to the book Creating Profit Through Alliances

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Article Creating Profit Through Alliances

  1. 1. Alliance expertsCreating profit through alliancesHow collaborative business models can contribute to competitive advantageAlfred GriffioenAbstract:Companies need to develop and adopt new productsand business models in order to differentiatethemselves from their competitors and to outperformthem. This article discusses three strategies fordifferentiation and shows how alliances can be auseful sourcing mechanism. The three strategies areelaborated and combined with various basic forms ofalliances.IntroductionFor most companies, making profit, or shareholder value, will be an importantobjective or at least an important precondition. How profit is created at a companylevel is described in basic micro-economic theory. A distinction can be madebetween doing business in competition or as a (de facto) monopolist.In a situation with competitors where everyone sells more or less the same product,your pricing strategy has to be responsive to what others are doing. For if yourprices are higher than those of your competitor, everyone will go to him, and if yourprices are lower you may be depriving yourself of income, and the competitor mightalso lower his prices. The price multiplied by the numbers sold is your turnover,and after deducting your costs you are left with a (small) profit, as demonstrated inthe first diagram of Figure 1. This typically applies to raw materials such as pig ironand diesel, objects such as lighters and cotton wool, and services provided byhairdressers, Chinese restaurants and cleaning companies. monopoly   with price in competition price monopoly price skimming  the  market demand curve demand curve demand  curve price of the profit profit competitor profit costs costs costs numbers numbers numbers sold sold soldFigure 1. The effect of the demand curve with competition and in a monopolyIf you are selling a unique product, or if you know of another way to ensurecustomers choose you instead of your competitor, you will have a kind ofmonopoly. In that case, you are free to determine at which price you wish to sellyour product. That price comes with a certain demand, which is how you canoptimize your profits (second diagram). If you start off with a higher price and thenslowly bring it down, you can make an even bigger profit. This is known asskimming the market (third diagram). Apple sold the first iPhone for approximately300 dollars, and then dropped the price.Alfred Griffioen – Creating profit through alliances 1
  2. 2. Alliance expertsThe opportunities for differentiation can be found by evaluating the needs andcompetences of the companies in your value chain, or rather, the value networkaround you. This requires thorough analysis and proper market knowledge. On thebasis of a needs analysis, you can identify entirely different ways of servicing yourdirect customers or their customers. Alternatively, by integrating activities from oneof your suppliers, customers or the other suppliers of your customers, you canadapt your business model.Three strategies for differentiationOnce you know where in the value chain you can serve your customers better thanyour competitors, then you need to devise how to do this. There are two modelsoften referred to that give direction on how to get your customer value propositionto stand out: Porters model1 on product differentiation, cost leadership and focusstrategy, and Treacy & Wiersemas model2 on product leadership, operationalexcellence and customer intimacy.If you have more products, the Boston Consulting Group portfolio matrix offersguidance on how to direct the cash flows in your company: depending on marketgrowth and market share, one should invest or divest in certain activities. Althoughcorporate finance has changed significantly over the last decade (see below), themodel is widely used because of its conceptual simplicity and the clear answers itprovides.However, Porter’s strategies were first published in 1980, and Treacy & Wiersemaintroduced their model in 1995. The BCG portfolio matrix was first used in 1959.Since then the world has changed considerably, and some of these changes haveaffected the validity of these models.If there is one development that has dominated how consumers and companies dobusiness in the last decade, it is the ever-growing availability of information,facilitated by the internet. Consumers, purchasing companies and governmentalinstitutions have increasingly better knowledge of the market and can compareproducts from several companies. A few mouse clicks and phone calls is all it takesto fulfil their needs with suppliers from all over the world. Internet search and evenonline auctions are steadily replacing the relationship-based purchasing process3.Thanks to this availability of information, it is also easier for small innovativecompanies to offer their services and to compete with larger players. This leads tofaster product rationalisation. Through the faster distribution of technology, thenumber of competitors for a certain product increases while prices decline. A goodexample is offered by two comparable products: the video recorder and the DVDplayer, as shown in Figure 2. The video recorder was developed in a time wheninformation exchange was slow. It took competitors a long time to develop acomparable product. With the DVD player this was already different.These developments force companies offering products and services to concentrateon those activities where they can offer real ‘value for money’. Distribution channelscan only add value by presenting relevant combinations of products or serviceswithin the right sales concept.Alfred Griffioen – Creating profit through alliances 2
  3. 3. Alliance expertsA second important development in the last decade is the increased transparency offinancial markets. In the twentieth century, the main objective of practically everycompany was growth. Growth provided economies of scale, made a lucrativeposition as market leader possible, and above all: growth and the associatedinvestments were a logical way to reinvest profits. The BCG portfolio matrix isbased on these assumptions. Price (€) 1500 Video recorders DVD-players 1000 500 0 4Figure 2. Price development of video recorders and DVD playersAs the financial sector globalised as well, it became easier to reinvest profits fromone company into another if that company had a better performance or lower riskprofile. In recent years and under the influence of large private investors,transparency has increased, moving the investment decision from a company levelto an activity level. The added value of a holding company or corporate head officeis now debated more frequently.Both developments make the resources available in a company less relevant.Knowledge can be obtained more easily, relevant components and partners can befound all over the world, and financial resources can be obtained more easily for agood idea. Active investors can choose in which company to invest and whichcapabilities to combine. This allows small but specialised organisations with highadded value activities to lead the new economy, instead of large corporations.Given that the availability of information has continued to increase, pay-back timesof new products have shortened and the globalisation of financial markets hasrerouted cash flows, the question arises: how to make a profit in such a transparentworld? We can look at the strategies suggested by Porter and Treacy & Wiersemaand evaluate them for their current validity.Focusing on your customer, described by Treacy and Wiersema as customerintimacy, is a strategy seen from the company. Of the three, it is actually the mostmarket-oriented type of strategy. However, with the growing diversity of companiesand brands, the perspective from the customer becomes more important: howrelevant is the company for its customers? If a company has multiple brands, theanalysis should be performed per brand (Figure 3).Alfred Griffioen – Creating profit through alliances 3
  4. 4. Alliance experts The three strategies of The three directions of What happened in the Michael Porter (1980) Treacy & Wiersema (1995) internet age? Current validity Focus strategy: targeting on a niche Customer intimacy: having a complete of f ering f or specif ic customer groupsFigure 3. Development of differentiation on customer focus There are many suppliers with a broad of f ering. Customers can choose ü Customer relevance: being seen as relevant by your customer groupProduct differentiation alone is not good enough anymore, as product choice hasincreased enormously and the differences between product variants are becomingsmaller. Product leadership, in the sense of continuously being at the cutting edgeof technology and creating a really unique and hard to copy product, remains avalid strategy (Figure 4). The three strategies of The three directions of What happened in the Michael Porter (1980) Treacy & Wiersema (1995) internet age? Current validity ü Product leadership: The enormous diversity of Product dif ferentiation: (Continuously) having continuously introducing new products makes it hard to having a better product unique products products stand outFigure 4. Development of differentiation on productStrategies for cost leadership or operational excellence can easily be copied asmuch more information about companies and their suppliers is available thanbefore. The globalisation of financial markets has caused that, if scale is called for,funds can be arranged to buy this scale. In the short term, creating cost advantagesis a prerequisite for many companies and can be a logical goal to pursue and asufficient reason for entering into an alliance. Only as an overall strategy it will beless sustainable and less profitable than being relevant to your customer or havinga unique product (Figure 5). The three strategies of The three directions of What happened in the Michael Porter (1980) Treacy & Wiersema (1995) internet age? Current validity Cost leadership: having the lowest costs Operational excellence: having the lowest total costs, including costs of your clientFigure 5. Development of differentiation on costs Cost advantage is easily copied or leveled down. Scale can be bought û No sustainable strategyAlliances as sourcing mechanismIt is important for companies to focus on the areas in which they truly deliver value-for-money. If you can convert competences into value for the customer, and you cando so at relatively low costs, then youre better off keeping these competencesunder your own roof. But if the competences deliver value for the customers butonly against high costs, and someone else can do so more efficiently, then it makessense to seek partners. This is illustrated by the value-engineering model (Figure 6): • Components of your product or service with a low customer value and low costs (for instance the transport packaging) can best be purchased.Alfred Griffioen – Creating profit through alliances 4
  5. 5. Alliance experts • Components with a high customer value but relatively low costs for you should certainly be developed and supplied by your own company. For example, right now it would not make sense for Apple to have the user interface of their iPods and iPhones developed by a third party. • Components with a low customer value and high costs for you had better be left out of your product or service. As an example: a ten-year warranty on a watch which most customers will tire of in five years and replace with a new one. • For components with a high customer value and high costs for you, it is worthwhile looking at another company: this party may have a better understanding of the customers need, or be able to produce or distribute the component more cheaply, and can thus deliver more value-for-money. Value for the customer Use as high selling point Outsource low Procure Remove low high CostsFigure 6. What activities to perform in-house and which to have another party perform?If you decide to outsource part of your activities, and especially those required tocreate components for your product or to deliver high-value service to the customerat low costs to yourself, there are various options: • Outsourcing these activities to parties that possess the right competences in a regular way. But then the question is, can your competitors not do the same, or have they not already done so? • Taking over a company that has the right market position or the right products, or possibly to enter into a merger. But then the question is, why have your investors not already taken their money from your firm and invested it in the other party? • Entering into an alliance with such a firm, and partly combining your people and resources, sharing your knowledge, and approaching your clients with a broader offer.The option you choose depends on a number of preconditions that occur in anymarket: • The time available to bring a new product to market. • The extent of investment and whether a firm can afford it. • The acceptable measure of risk.Alfred Griffioen – Creating profit through alliances 5
  6. 6. Alliance expertsDirect investment in development activities or broader marketing, as a base option,requires a lot of time, certainly if it calls for new competences. Procuring thesecompetences will expedite the process, but captures part of your profit due tooverhead and your suppliers profit margin. The risk of investing in a client groupthat barely responds or in a product that fails to succeed remains entirely with yourown company.A take-over or merger directly guarantees access to an existing customer base or anexisting unique product portfolio, but often also implies investing in overlappingpeople and resources or non-strategic activities. Given the market preconditions, analliance with a complementary party is therefore preferable. Competences are madeavailable immediately, the investment sum is often limited, and the risk of the jointactivity is shared.The best collaboration results from both parties contributing unique elements, suchas: • geographic spread • contributing market or product knowledge • eliminating risks • arranging the financing.The essence of a partnership is that it is to both parties benefit. It is important todetermine the extent to which your contribution is unique and not easily copied,otherwise the collaboration will soon lose value.A partnership also has its drawbacks: it means making your company partlydependent on the performance and continuity of your partner company. Thisdemands careful partner selection, mutual trust and a solid contract. Additionally,you need to share the revenue of the collaboration. The task is thus to jointlyincrease the size of the cake, rather than obtaining a larger piece of the cake.The purpose of an alliance is often not connected to the legal design. Distributionalliances, joint R&D and shared investments, for example, can be arranged eithercontractually or as a new legal entity (a joint venture). Each companys preference,the variety of legal forms and tax structures in a country can influence this choice.Realisation of your strategy through alliancesIn the first part of this article we discussed three strategies for differentiation. Inthe second part we introduced alliances as a way to obtain the resources andcompetences necessary to pursue such a strategy. In this third part these strategiesare elaborated and coupled with various forms of alliances.Customer relevanceThe term customer relevance pertains to the access a company has to offer itsproducts and services to its target group. After all, any target group, whether itconsists of consumers or people with purchasing responsibility within a company,are exposed to so much information and so many opinions and offers, that theyhave built up a highly effective filter in response.Alfred Griffioen – Creating profit through alliances 6
  7. 7. Alliance expertsBrands are the carriers of customer relevance. This is owing to the various functionsof a brand, of which recognisability is the most important. Users will attributecertain values and features to a brand, partly based on advertisements, and fill inthe rest of the picture with their previous experiences with products and servicesoffered under that brand.A brand is relevant if the fulfilment of its promise connects to actual customerneed. This will happen if their actual need is answered by the promise that yourbrand makes, and how this is fulfilled in products, services, distribution or yourmarketing communications5 (Figure 7). Portfolio Generic management needs Actual Fulfillment of Customer customer your brand promise relevance needs Distribution and Context / communications SituationFigure 7. Customer relevance increases to the extent that brand promise and actual customer needs overlapEvery person has a number of generic needs: security, friendship, relaxation,efficiency and success. Depending on the context or situation you are in, thesegeneric needs are translated into actual needs. Again depending on the situation,one or more of these generic needs will be dominant, complemented by needs thatarise through a customers expectations with respect to a certain situation. Forexample, when spending the night in a hotel you do not expect anyone to enteryour room unasked (privacy), that drinks in the bar are charged to your account(convenience), and that there is wake-up call service (efficiency). At higher-endhotels you will expect a laundry or dry-cleaning service (give me comprehensivesolutions) and personal attention.The other aspect is the brand promise and how this is fulfilled. If you want to have ameal, that need will differ depending on whether youre alone or with your family. Acompanys response to this may lie in the right portfolio management of theproducts and services it offers. It also makes a difference whether youre in town orin an amusement park, and a companys solution here lies in its distributionmanagement. And finally, in this particular case, you do not have this need for ameal at each and every moment. Thus, being relevant means that companies mustpresent you with their offer at the right time. This is a matter of marketingcommunication.Alliances can help achieve relevance for customers more quickly. The value ofalliances can best be quantified by considering the costs your own company wouldhave to make to accomplish a comparable boost in relevance. Five basic forms ofalliances contribute to the customer relevance strategy: distribution agreements,franchising, proposition alignment and referral, collaborative offering and co-branding (Figure 8).Alfred Griffioen – Creating profit through alliances 7
  8. 8. Alliance experts Strategy Purpose  of  the   alliance Basic  form Using the other partys local Distribution agreement presence and service Expanding ones own Franchising perceived presence Customer   Increasing the chance of proposition alignment obtaining leads and referral relevance Expanding ones own market Collaborative offering to larger projects Utilizing the relevance of the Co-branding other partys brandFigure 8. Five basic forms of alliances contributing to customer relevanceThe forms differ in the way the financial arrangements are structured. In adistribution agreement the customer contact is handled by an independentdistributor and the margin is shared. In case of franchising this distributor is boundto several rules regarding the brand name, marketing communications andprocurement, and the franchisee will pay a periodical fee for the franchisorssupport.Proposition alignment and referral is a much looser form of collaboration: theremight even be no financial flows between the partners. In the case of collaborativeoffering the partners need to make formal arrangements: one of them needs to bethe main contractor, or a new legal entity needs to be established.In case of co-branding it might even be that one of the companies is not involved inthe sales and delivery of the products or services, but only lends its brand toemphasise certain aspects of the offering, for which it may receive a fee.Unique productHaving a unique product is an important means of setting yourself apart on themarket and of keeping your competitors at bay. It actually means that you have asmall monopoly. This gives protection for higher pricing strategies, since there areno competitors offering a similar product. Despite the lower demand for higherpriced products, this position is often very profitable.A unique product always has a significant, not easily copied advantage whencompared to competing products. So this is not about a coffeemaker in a newcolour, a camera with a few more megapixels, or a mid-range car with a slightlydifferent design. This is about more than just differentiation. Being different is notgood enough; the point is to be exceptional.Examples of a unique product are the Nespresso coffeemaker, a Harley Davidson,Viagra, music by Elton John or the ‘beyond first class’ private cabins in the latestaircraft operated by Singapore Airlines. To imitate such products would require theright technology, patents, extreme creative efforts, and/or huge investments.Many unique products are therefore protected in one way or another by intellectualproperty rights: patents for technology, copyright for books and music, drawingand model rights for design. These property rights ensure that competitors cannotcopy the product and enjoy the advantage of not having suffered the developmentcosts.Alfred Griffioen – Creating profit through alliances 8
  9. 9. Alliance expertsA unique product will not remain unique for ever. Despite the protection of atechnology or model, new technologies can be developed that offer the same orsimilar functionality. Patents expire and music becomes outdated. Changing needsamong consumers and businesses, or new legislation, can cause a productspopularity to decline.The point is therefore to run your organization in such a way that it does notproduce a one-off unique product, but that you can constantly come up withimprovements and innovations. A unique product can result from leading the fieldin certain competences, such as technological know-how, design skills or marketunderstanding. The point is to develop these competences further and to excel inthem, so that you can create unique products time and again.Collaboration is an important means of ensuring that you have the rightcompetences and knowledge in-house. There are basically two types of alliancesthat can result in a unique product: joint R&D and technology licensing (Figure 9). Strategy Purpose  of  the   alliance Basic  form Utilizing the other partys Joint R&D development capacity Unique  product Utilizing the other partys Technology licensing technologyFigure 9. Two basic forms of alliances contributing to the development of unique productsIn case of joint R&D, different competences from the two partner firms are broughttogether, and the risk primarily pertains to the actual development process. Thiscan result in an extensive contract with technology roadmaps and milestones. Alsothe allocation of intellectual property rights needs to be arranged. For technologylicensing, the firms conclude agreements about the use of existing intellectualproperty rights. These kinds of arrangements are often less complex.Cost advantagesEnhancing your customer relevance or developing a unique product yields durablecompetitive advantage. However, alliances can also be used to achieve costadvantages, though these are often easier to copy. Three forms of alliances aregeared to costs: shared investment, reciprocal hiring agreements, and unusualsupplier risk (Figure 10). Strategy Purpose  of  the   alliance Basic  form Achieving scale advantage Shared investment and risk reduction Reciprocal hiring Cost  advantage Limiting ones own staffing agreement Utilizing the other partys Unusual supplier risk cost benefits and experienceFigure 10. Three basic forms of alliances contributing to cost advantagesShared investments could be the purchase of an expensive machine or installation,of which the costs and capacity are shared. It could also be combining part of theactivities in order to create more efficiency, such as PepsiCo and Lipton did for thedistribution of their soft drinks.Alfred Griffioen – Creating profit through alliances 9
  10. 10. Alliance expertsReciprocal hiring agreements are useful where two companies have similarcapabilities but must cope with unpredictable demand. Whenever possible they canhire each other’s staff or production capacity. Code sharing in the airline industry isan example.If a supplier takes over risks that are normally managed by the client in order tooptimise collaboration on a project or specific assignment, this can be regarded asan alliance. A lot of public-private partnerships can be classified as such. The risksharing can be arranged through a bonus-penalty system or in a joint venture typeof collaboration.ConclusionsAlliances can play a significant role in the pursuit of company strategy. The type ofstrategy through which a company seeks to stand out in the market will generallydetermine the most suitable type of alliance.This article took three generic strategies as point of departure. These types arebased on work by Porter and Treacy & Wiersema, but have been elaborated furtherwith a view to the changing circumstances over the past decade; primarily theimmense increase in the accessibility of information and availability of capital.In each case, the principal concern is value creation and the distribution of theadded value of collaboration among the participating partners. Alliances that seekto enhance the relevance of a business for its customers often apply a profit-sharing mechanism based on the additional sales or extra margin. For alliancesdevoted to developing unique products, the principal issue being the ownership ofintellectual property rights. For alliances geared to achieving cost advantages,splitting those advantages is often a simple matter.By analysing collaborative ventures in terms of several basic types, it becomeseasier to establish cost and profit allocation mechanisms. This helps standardisethe process of forging an alliance, thus facilitating companies wishing to pursuethis strategy.For more articles of Alfred Griffioen search on Slideshare or go to www.allianceexperts.com1 Michael E. Porter, Competitive Strategies, 19802 Michael Treacy, Fred Wiersema, Discipline of market leaders, 19953 Andrea Ordaninni, Stefano Micelli, Eleonora di Maria, Failure and success of B-to-B exchange business models: a contingent analysis of their performance, 20044 Bob Hoekstra, Innovation@Philips, Innovative environments, lezing IMR Conference, 20045 Alfred Griffioen, De Strategieversnelling, Pearson, 2009Alfred Griffioen – Creating profit through alliances 10