Alliance alternative

Any company that's hedging mergers and acquisitions risks with pre-acquisition alliances will probably find virtue in maxims like "try before you buy" and "date before you marry."

They're easy things to believe in; if executed properly, preceding an acquisition with an alliance can lead to increases in post-acquisition returns. And in volatile sectors such as technology, where the threat of making the wrong bet is heightened, this can be a lifesaver.

However, after decades of well-meaning mantras, surveys and multiple research articles applying everything from game theory to behavioral science, building alliances sometimes seems grounded in little more than instinct. Few companies get it right consistently. In fact, a recent study in the Harvard Business Review suggests alliances fail 60% to 70% of the time.

Somewhat paradoxically, the number of corporate alliances continues to rise by as much as 25% every year and now accounts for nearly a third of many firms' revenues and value.

Much of this increase boils down to companies' attempts to introduce more "open" business models. This model, typically implemented to supercharge growth, calls for organizations to become more collaborative with other companies to spark innovation and generate value.

Tech-sector giants such as IBM Corp. and Nokia Oyj demonstrate how newfound know-how gathered from networks beyond a firm's four walls can result in improved products and services. Here, alliances increase access to otherwise scarce skills, resources, physical assets, technologies and markets. This, in turn, can help exploit economies of scale, reduce operations costs and lessen the risks associated with acquisitions.

But undertainty often plagues this strategy. Striking a balance between risk and opportunity seems easiest on paper, and the danger of entering restrictive, overly complex or unproductive relationships is a justifiable concern. Moreover, the threat of opportunistic behavior often looms large in the formation of alliances between firms that try to take more than they're willing to give. Subtle shifts in objective, from mutual goals to competitive advantages, add instability to relationships that are at once competitive and collaborative.

Extreme cases, like the well-documented alliances between U.S. and Japanese automotive firms during the 1980s, can end in a learning race where each member tries to learn as much as possible from the other before terminating the collaboration without regard for the mutual goals on which it was built.

Companies can mitigate these risks by assessing the relational quality of a potential ally. Trustworthiness, based on previous experiences, often determines the outcome of these relationships. Ideally, those looking to establish network alliances should have convergent strategic goals and divergent competitive goals. The trick is to overcome the risks of exposing proprietary knowledge with balanced, open interactions. For these reasons, companies need to act on four criteria when forming alliances.

First, the motivations and objectives behind an alliance should be completely transparent. Second, an appropriate governance mechanism is critical. Firms should be aware of the "mutual hostage" effect of equity-based structures, which can stabilize an alliance. More informal structures, on the other hand, can enhance collaboration, boost productivity and render formal governance structures unnecessary. Third, developing trust between network partners can offset the risk of opportunism and help reduce transaction costs. Finally, alliance firms should have comparable learning capacities to avoid imbalances that can lead to competitive disadvantage. Collectively, these considerations build confidence between alliance firms, ease conflict resolution throughout a relationship and allow collaborative scope to grow as relationships mature.

While such open network alliances remain ripe with possibility, getting them right and making them work is a challenge in the real world. Companies trying to ease acquisition risks with open alliances are well aware of the vulnerabilities that hamper progress. Close attention at the formation stage can help eliminate structural uncertainties and make the open road a smooth one.

Scott Wilson is a senior manager in Deloitte Research, Deloitte Services LP. Doug Tuttle is a principal in Deloitte Consulting LLP and the leader of its U.S. alliances program.