The build-borrow-or-buy framework guiding corporate strategy
To use the framework, four questions must be answered.
- Relevancy. How relevant are a firm’s existing internal resources to solving the resource gap? Highly relevant resources are the ones the firm should continue to build through internal development. Resources are relevant if they are both similar to those the firm needs to develop, and superior to those of competitors in the targeted area.
- Tradability. How tradable are targeted resources that may be available externally? Tradable resources mean a firm is able to source the resource externally through a contract that allows for the transfer of ownership or use of the resource. A highly tradable resource should be borrowed.
- Closeness. How close do you need to be to the external resource partner? Since mergers and acquisitions are often complex and costly strategic options, only if extreme closeness is required should M&A be considered.
- Integration. How well can you integrate the targeted firm, if you decide you want to acquire the resource partner?
Strategic alliances
Looking at the borrow option, strategic alliances come in many forms, from small contracts to large joint ventures. However, it only counts as strategic if it has the potential to affect a firm’s competitive advantage.
The use of alliances has recently increased, as a result of many reasons.
Alliances can enable faster achievement of goals at lower costs, join complementary parts of the firm’s value chain, and allow firms to circumvent legal repercussions of the US or EU agencies. It can also help firms achieve or sustain competitive advantage when their resources are valuable, rare, costly to imitate, and organized to capture value (VRIO).
The relational view of competitive advantage also states that critical resources and capabilities are frequently embedded in strategic alliances that span firm boundaries, encouraging alliances.
Several reasons firms enter into strategic alliances
- To strengthen their competitive position. Strategic alliances can be used to change the
industry structure in their favor, or can set new industry standards. - Alliances also allow entry into new markets. Firms can enter new product/service markets
or geographic markets. Alliances are often motivated by the desire to enter new markets, that neither company can enter alone. Some foreign governments may also require foreign firms to have local joint venture partners (e.g. China). This could mean the foreign firm can benefit from local expertise/contracts, but it also risks losing some of its proprietary know-how. - A third reason is that alliances can hedge against uncertainty. In dynamic markets, strategic alliances can limit exposure to the uncertainty of markets. Larger companies can also invest in small startups that can disrupt markets, before being disrupted themselves. Key to this is the real-options perspective.
- A fourth benefit is access to critical complementary assets. The commercialization of products requires complementary assets such as marketing. Complementary assets are also needed to complete the value chain from upstream to downstream. However, building downstream assets is usually time-consuming and expensive. Strategic alliances allow firms to match skills to resources, and also allow division of labour for more efficiency, so companies can specialize in what they are good at and outsource other value chain activities to partners.
- Lastly, alliances allow firms to learn new capabilities. They can learn from partners, or from competitors. When collaborating firms are competitors, it is called co-optation. This can also cause learning races, which is when both partners are motivated to form an alliance for learning. However, the firm that learns faster is incentivized to leave the alliance or decrease sharing.
Types of alliances
- Non-equity alliance
- Equity alliance
- Joint ventures
Types of alliances: non-equity alliance
The first type is the non-equity alliance.
This is the most common type of alliance, governed by a contract. All vertical strategic alliances are non-equity alliances, which connect different parts of the industry value chain.
Non-equity alliances tend to share explicit knowledge or knowledge that is codified (e.g. patents).
There are three different forms of non-equity alliances. These are:
- supply agreements,
- distribution agreements, and
- licensing agreements.
The benefit of non-equity alliances is that they are contractual, making them easy to initiate and terminate. The disadvantages, however, are that they can be temporary in nature and can produce weak ties between partners. They can also create a lack of trust and commitment.
Types of alliances: equity alliance
The second type is the equity alliance.
This is when at least one partner takes partial ownership of another partner. These are less common because they require larger investments. However, they usually signal stronger commitments.
They also allow for the sharing of tacit knowledge, or knowledge that cannot be codified. Tacit knowledge is the knowledge that can only be acquired by participating in a process. Frequent exchanges of personnel also transfer tacit knowledge.
A type of equity alliance is the corporate venture capital investment. This is an equity investment by an established firm in an entrepreneurial venture, which allows access to new, potentially disruptive technologies. Equity alliances produce stronger ties and greater trust, and are often a stepping stone to full integration.
Lastly, when investing in companies with new technology, the technology can be treated as a real option, and can be abandoned if not promising. However, downsides of an equity alliance include large investments, lack of flexibility, and the slow speed of benefits obtained from the alliance.
Types of alliances: joint ventures
The last type of alliance is joint ventures.
As mentioned, these are standalone organizations created and jointly owned by two or more parent companies. Partners commit for the long-term by investing equity.
Through joint ventures, firms can exchange both explicit and tacit knowledge through employees. They can also be used to enter foreign markets where the host country requires partnership to access the market. It is the least common type of alliance, but the benefits are strong ties and trust.
The drawbacks are long negotiations, large investments, and if it does not work out, undoing the company can be very expensive. Additionally, firms have to share profits. Partners could also misuse knowledge sharing to take advantage of the alliance.1
Alliance management capability tasks
Alliances could be necessary to compete, but many of them fail. In order for alliances to be successful, a firm has to have alliance management capability, which is the firm’s ability to effectively manage three alliance-related tasks.
- Partner selection and alliance formation. There must be partner compatibility, meaning there is a cultural fit between different firms, and partner commitment, which is the willingness to make necessary resources available and accept short-term sacrifices to ensure long-term rewards.
- Alliance design and governance. Managers must choose the alliance type and appropriate governance mechanisms. Interorganizational trust is very important for alliance success. This is because all contracts are inevitably incomplete, since they cannot fully include all future contingencies. As a result, trust is needed for effective alliance management.
- Post-formation alliance management. This is the ongoing management of the alliance. To create competitive advantage, partnerships should create 3 things: relation-specific investments, knowledge-sharing routines, and interfirm trust. Interfirm trust means that alliance partners will behave in good faith and develop norms of fairness. Interfirm trust is also important in fast decision-making.
Mergers and acquisitions
Mergers are the joining of two independent companies to form a combined entity. They tend to be friendly, with the two companies agreeing to join forces.
Acquisition is the purchase or takeover of one company by another. These can be friendly or unfriendly. A hostile takeover is when the firm does not want to be acquired. With mergers, companies are usually of a similar size, while with acquisitions there is a greater difference in sizes between the companies. One should only acquire a company if this company has tacit knowledge, knowledge that only one company or business unit has. This means that we only should do acquisitions if the resources/capabilities are non-transferable, not easily replaced, based on tacit knowledge, and difficult to provide or create these yourself.
For example, Disney acquired Pixar because of their unique animation skills and their creativity. The merger was a success because of good communication, a clear organizational structure and good collaboration between Disney’s and Pixar’s animation units. Next to this, the creative culture of Pixar was protected, so that it wouldn’t get lost after the merger.
Firms merge for many reasons. Both mergers and acquisitions are horizontal integrations. This is the process of merging with competitors at the same stage of the industry value chain. However, a firm should only horizontally integrate if the target firm is more valuable to have inside the acquiring firm than outside.
The main benefits of horizontal integration are threefold:
- Reduction in competitive intensity:
Integration changes the underlying industry structure in favour of surviving firms. Excess capacity is reduced, and competition decreases. The industry becomes more consolidated, which makes it more profitable. However, often the European Union or the Federal Trade Commission (in the United States) must approve large horizontal integration. - Lower costs:
Horizontal integration can lower costs through economies of scale, enhancing economic value creation. This is especially important in industries with high fixed costs. - Increased differentiation:
Integration can help fill gaps in a firm’s product offering.
There are also reasons why a firm would choose to acquire another firm
- To get access to new markets and distribution channels. In this way, they can overcome entry barriers into markets they are not competing in, and obtain new capabilities or competencies.
- To pre-empt rivals. Firms acquire promising startups to gain access to new capabilities or competencies, but also to prevent rivals from doing so.
M&A and competitive advantage
Mergers and acquisitions do not usually create competitive advantage, as synergies may not materialize.
Additionally, value might be created that goes directly to the shareholders. Other reasons why M&A might not create value include the principal-agent problem, the desire to overcome competitive disadvantage, and the superior acquisition and integration capability.
Regarding principal-agent problems, managers are frequently incentivized to grow a company via acquisitions to build an “empire” that comes with more prestige and pay, rather than focusing on shareholder value.
Larger companies may also create more job security. Another danger is managerial hubris. This is a form of self-delusion, where managers convince themselves that they have superior skills in the face of clear evidence to the contrary.
