Contractual Agreements Vs Joint Ventures - Assignment Example

?Table of Contents Sl. No. Particulars Pg. No Introduction 2 2. General Trends in R&D Dependency 3 3 Reasons for the Preference of Contractual Agreements 4 4. Conclusion 12 5. References 14 Introduction: R&D activities in any firm are considered to be a laggard owing to their slow pay-back returns. From around 1960’s, their importance was emphasized towards building a balanced organization by the international high, medium and low tech companies that they have taken the initiative to forego a part of their profits to set up those facilities. To minimize the cost and earn extra benefits, firms try to strategically partner with other firms which can provide such cutting edge. Analysis of such patterns of R&D partnerships in the inter-firms right from early 1960’s is done. Research is done to discover the modes of agreements and their emphasis on R&D during such transformation. Definition of R&D partnership: R&D implies the standard activity of research oriented development wherein techno-scientific knowledge is applied to create newer procedures and products. The crux is that organizations benefit in the long run through R&D efforts and they need to plan for such activities to foster creation of better processes and products. R&D partnerships form a part of diverse relationships which two unrelated companies entertain through acquisitions or mergers. Different kinds of taxonomies got inter-twined in such understandings and they are now inseparable. This entanglement should impact the firm and ensure its technological improvement. The inter-dependency could be charted in any of the following ways of: Licensing & cross licensing: The service providers collect fee for the technological enhancement provided to their partner and sometimes swap knowledge instead of fee for cross-licensing. Second-sourcing ratifies reproduction of already existing products with specifications. Sub-contracting of one firm by the other establishes the customer-supplier relationship usually for long-term contracts. Joint funded R&D programs are usually contractual in nature wherein firms co-operate to perform such activities. Joint ventures combine the interests of two firms on a profit sharing basis. Sometimes firms with specific objectives related to different functions including R&D stipulate guidelines for performance of those functions smoothly. This paper refers to the R&D programs with inter-firm co-operation (IV & V points listed above). The modes could be either contractual or through joint ventures. The basic objective behind these methods is to ensure cost-economization and strategic intent. General trends in R&D dependency: The MERIT-CATI list which surveys the trend of R&D dependency establishes the following results: 1960s witnessed a relatively low number of such collaborations with a gradual increase towards the end from 10 a year to 30 a year. 1970’s continued the 30 a year trend and graduated to 50 a year partnerships till the middle only to increase three-folds to around 160 a year by the decade end. 1980s are earmarked for 200 and above inter-firm partnerships in the inception and galloping further to 500 a year till its end. The first two years of 1990s slowed down the pace to 350 to 400 alliances a year but later rose to 700 odd partnerships only to set off again to 500 per year till the end. Though, there is a slowdown in the late 90s, the number of partnerships, however, is far higher than the level of partnerships activated in the early 1960s. These alliances are also circular in nature that when they decrease, they tend to increase cyclically. The notable factor is the number of joint venture (JV) collaborations vis-a-vis contractual agreements in such R&D partnerships. In 1960’s when there were meager number of R&D partnerships, most of them were entered through JV’s. Till the mid of 1970’s around 70% of the total agreements were done through the JV route and 30% of them were through contracts. However, in the early 80’s this range slowed down to 40% giving bigger hand to contractual agreements to the tune of 60% and then only. In 1990’s only 10% agreements were through joint ventures while 90% partnerships were because of contracts. (Hagedoorn, 2001). Thus, one can understand that there is an increased demand for contractual agreements in R&D partnerships the reasons for which are enumerated in this paper: The basic reasoning for the dominance of Contractual agreements could be the organizational motives like flexibility and profitability. However, on a broader prospective, the following reasons could be enumerated: Enforceability of contracts Decline in monitoring and transaction costs due to international associations Possibility of innovation and flexibility due to contracts which can enable the firm to tackle competition and set up its own standards. (Narula, 1999). A comprehensive study is being organized in this paper to explore the other possible reasons behind such a shift to have a better understanding of the modalities involved in such preference. Reasons for the preference of Contractual Agreements to Joint Ventures: With more and more high-tech industries getting involved in the contractual agreements, specialized R&D firms started being more careful in their performance. This was the key to better enforceability of contracts as against Joint Ventures where, both the parties would invest and no one firm would be ready to be subdued by the other in its own form. Information and Communications Technology (ICT) the radical alteration agent of all business processes galloped from mid 1970s and extended its web world-wide by the advent of 80’s. One can describe this period as an epochal in the B2B transactions. 85% of revenues of e-business were recorded through this transformation. It had dual advantage of reaping cost efficiencies due to automation of processes and earning extra profits also. Even the long term strategies were rolled up under this technology to have beneficial implications for the firms. There were, some arguments against this technological advancement quoting increased investment and process difficulties. However, within a decade, owing to its financial advantages, process standardization, flexibility and customizability, organizations started embracing technological advancement. Thus, the monitoring and transactional costs started to decline for the firms who have entered into contracts with specialized firms for R&D purposes. (Ackroyd, S., Batt. R., Thompson. P, & Tolbert P., 2005). Investing for technological progression was a tedious task that too through joint ventures wherein the two firms had to invest for the R&D expenditure. Basically, the technology user was not interested to forego his capital and wait for years. So, firms started searching for specialized firms in the technological field whose business was to provide the required R&D knowhow to them. The simple technique was to get involved with those specialized agents and learn the best practices. Thus, they can strategize their future actions and set up their own niche standards after tackling competition. Thus, planned deals and structured activities were on the rise wherein agreements were based on: Directions of business strategy by: Identifying the mission of partnering organizations, Quantify the targets to be achieved and communicate them and Conduct a SWOT analysis to assess the competition. Purpose for such alliances like facilitating R&D requirements, cross-licensing etc. The supposed goals relating to non-financial and financial achievements during such alliance. As already mentioned, in the 1960’s & start of 70’s there was more emphasis on Joint Ventures owing to the long gestation periods involved in such alliances and the necessity of continued support from both the parties for such period of time. However, with the initiation of technology driven processes, the process cycles have been shortened drastically. As such, non-equity based contractual agreements (which are mainly non-equity based) were preferred as against equity based joint ventures. A study of the features enumerated as advantages and disadvantages of JV’s and contracts, in this context, would be more useful to understand the pragmatic shift: Joint Ventures – Advantages: Permits a handy working atmosphere & explores newer opportunities of mergers if possible. Pre-empts the possible threat of competition and develop strategies to overcome. Disadvantages: Strategies and tactics are not possible unless planned earlier. Equity investments may be a burden to the client. Contracts – Advantages: Potential of easy initiation It explores opportunities of mergers if the parties are interested. Disadvantages: They cannot exercise ultimate control. There may be paucity in the levels of commitment owing to the various deadlines to be met by the contractors. Here, the exercise of control and commitment are not a point of worry to the organizations that have withstood the tides of time and established their niche in the market. So, they only need to look in for flexibility and innovativeness in their partners. These partners may not have that financial viability to invest in joint ventures. But, given their performance track record, big firms enter into contracts with them and that is the reason why, there is more incidence of contractual agreements in the R&D partnering. Contracts are very handy because they stipulate the revenue division methodologies, individual party’s responsibility, term of alliance and requirements relating to confidentiality. They are also easy to set up as they do not require any business entity to be established for legal considerations. They last for less than 3 years and so the contracting parties may decide whether the partnership was advantageous or not within that short period of time and take decisions accordingly. They can be undertaken even by parties which have hardly any knowledge about the other party and still avoid the risk of handshake agreements. The capital requirements for the purpose could be consequently met as per the situations and thus without any possibility of conflict. Thus, contracts are preferred by most R&D seeking firms. (Pamphilis. D, 2012) Other than simplicity of processes, contracts also are favored for their instance of technological advancement. If we take the case of Operations Management (OM) in Production, it is the most important process that is responsible for transformation of inputs into marketable outputs. A lot of diversification takes in its functional areas and thus, it requires meticulous information systems to support the current competition. One such area is the logistics department which has to order, purchase and synthesize inbound and outbound activities (similar to a value chain) with utmost cost effectiveness. Earlier, in the OM department the following activities were inevitable: Negotiations had to be done with the suppliers, Order, receive and inspect the materials Transfer them to the warehouses and maintain them so that they do not turn out to be obsolete. The worn away materials had to be disposed of time and again, thus incurring losses. A diagrammatical representation is shown here for better understanding: (Meredith. J.R., 1992). Later at the time of requisition by the purchase department, they were transferred. After the technological advancement, the Information Communication and Technology (ICT) would perform major of these functions. The department of purchase can undertake the task of placing orders through the interchange of electronic data. Technologies such as scanners and audio speakers can perform activities related to inspection and supervision. Large warehouses maintain robots to perform the inventory arrival, dispatch and maintenance activities. Thus, the activities which were considered to be tedious and time consuming are now delegated to ICT. The work done is standard, dependable and also on time while incurring the least monitoring and transactional costs. So, there is no fear of mistakes being rolled out which could occur due to human fallacy. This is what is called Computer Aided Manufacturing (CAM). Now, if the organization is facing financial crunch or if its investment activities earn more interest, it can outsource this material maintenance function by entering into a contract with a small firm. Entering into equity based joint ventures would only be an impediment to the organization’s financial returns which can dent its profitability in the future. This is in addition to the extra burden of maintaining the purchase department, which it would have avoided, had it gone for a contract. Further, there is also a risk of experienced personnel learning the advanced technology and leaving the organization to set up their own business. Thus, many organizations are selecting the contractual agreement route as against joint ventures. Some examples illustrated below will help understand the concept in a better manner: Example of CAM: Stone Container Corporation, the Lipton’s packaging materials supplier has gone in for a contract with the parent company to establish system of interchange of electronic data. As a result, Lipton’s Information systems experienced a major shift from mainframes to a mini-computer with client’s server as a base. This reduced the amount of investment by Lipton on information systems. In addition to this financial benefit, the collaboration could stand up to: Schedules of delivery which were tighter than the previous ones Maintain consistency levels of production Smoothening the demand and supply peaks and valleys all through the year. Needless to say, Lipton could maintain its image of quality through CAM. Example of CAE: A Business to Business virtual order model service was created by Fed Ex where it integrates catalogs of web designs of companies in a virtual order. The customers could select the required product and order for it. Immediately, Fed ex would intimate the seller of the order and ensure safe transactions for both the seller and buyer. In addition, it would also provide services like dispatching invoices, procuring confirmation, after sales repairs etc. The buyers and sellers who are connected through the virtual order are implicitly bound by the Fed Ex’s contract. Thus, it undertakes more than 1000 contracts per month. (Turban. E, Lean. E & Wetherbe. J, 2001). A pictorial representation of this process is presented below: Order through Order through Internet Internet Delivery of products or service Software shipping Labels Shipping (Anon., 1998). This kind of simplicity is only possible in the case of contractual agreements. One more interesting fact to be noted is the involvement of financial constraints in case of joint ventures. As companies need to arrange for financial means to enter into joint ventures, there could be every possibility that their numbers tend to dwindle in competition to the contracts which they can undertake even to perform their daily activities. The same point is reiterated in the MERIT CATI survey results as follows: The complex nature of R&D partnerships, would force anyone to expect that the high-tech industries would overpower other medium and low-tech sectors. However, it did not occur till mid-80’s when there were high number of such partnerships. 60’s only witnessed a range of 20-40% of partnerships in the high-tech while the same range improved to 35-50% in 1970’s. Commensurately, the medium-tech industries share declined to 40-20% in the 70’s. The low-tech were always dormant with only 20%-10% between 60’s and 80’s and further down to 5% in 90’s. As high-tech industries overpowered the R&D partnerships, they have preferred more of contractual understandings to keep up with the pace of rapid changes in technology. Further to these contractual natured high-tech partnerships, emphasis was laid to find out the sectors in which such alliances flourished and the results could be enumerated as: Above average preference is seen in IT and pharmaceutical contractual R&D relationships. Joint ventures have declined in the medical and instrumental technology owing to their R&D intensive nature. The same is true with consumer electronics. In these fields, if Joint Ventures are entered into with long gestation periods, the resulting products may be outdated, non-viable financially and even sometimes face unforeseen obstacles due to technical obsolescence. (Anon. 2012) Joint ventures have been dominating the non-high tech industries like electrical engineering, automotive, food and metal products because extreme end R&D possibilities are not viable in these fields till date. Thus, we understand that contracts are taken up to undertake R&D intensive projects as against joint ventures, and then high-tech industries have started to dictate their command in most important sectors through contractual agreements. Credit of R&D tax: One more underlying reason of the companies to prefer contractual agreements as against ventures is the fear of incidence of tax on R&D efforts. Since 1981, more than 38 industrialized countries have been offering R&D tax credit to the firms involving in such activities. However, these bills are fairly unpredictable. They would or would not be passed for the next financial year depending on the ruling party’s decision. The companies are therefore not able to guess whether such credit would be available even in future. So they are less interested in performing R&D activities in lieu of the risk involved as to the acceptance of the outcome. The less risky way would be to contract the function out to experienced firms which would perform their activity for a fee. (Anon., 2011) Conclusion: Thus, we can conclude that there is a growing consensus to enter into contractual agreements rather than setting up R&D joint ventures due to the following reasons: 1. Contracts can be entered into easily without requiring any establishment of separate legal entity. They are also easily enforceable as against Joint Ventures. 2. Contracts only require a fee which is quite inexpensive as against the capital which would have to be invested in case of in house team or joint venture efforts. The declining monitoring and transactional costs also payback more returns. 3. The partnering firms can get along with experienced partners for R&D and invent flexibility in the processes to tackle competition and set up their own standards. 4. With the advent of technology, product cycles have lower gestation periods because of which, they can be implemented even in short term contracts. 5. Contracts are less risky given their recurring nature to the partners who have already performed such contracts even in the past. Joint Ventures on the other hand are new to both the partnering firms and as such, there is less possibility of flexibility and innovativeness in such activities. 6. Decisions of contractual agreements can be taken keeping in view the track record of the partner. There is no need to do extensive research about the partnering firm. 7. Technological advancement is rampant in contractual agreements as specialists who have performed these tasks many times get involved. 8. By outsourcing for contracts, firms can earn financial returns on investments which otherwise they would have had to deploy into R&D activities. Further, they also can avoid the extra burden of activities which their partners would take care of. 9. The risk of highly experienced personnel leaving the organization and becoming a competitor is not at all possible if contractual agreements are taken up. There is also no need to incur huge expenditure on training the staff. 10. Technical advancements such as CAD, CAM, JIT etc are all possible due to contracts and less possible due to Joint Ventures within a short period of time. In those fields if Joint Ventures are entered into with long gestation periods, the resulting products may be outdated, non-viable financially and even sometimes face unforeseen obstacles due to technical obsolescence. 11. Financial constraints are not usually posed in contracts while the vice-versa is the case with Joint Ventures. Hence, firms think twice before entering into JV’s as against contracts. 12. Joint Ventures are preferred in industries which technically have long gestation periods like electrical engineering, automotive, metal and food products etc. because of non-availability of viable short term R&D solutions till date. 13. Non-assurance of extending the R&D tax credit even in future. Nevertheless, the truth that Joint Ventures provide the technical expertise for any firm to gain the competitive edge is not negated any time. So, firms usually employ R&D ventures individually in the primary activities which are important for their existence and plan to outsource other activities to various contracts thereby increasing the number of contractual agreements to Joint Ventures. Book References: Ackroyd, S., Batt. R., Thompson. P, & Tolbert P., 2005, The Oxford Handbook of Work and Organization, U.K: Oxford University Press. Meredith. J.R., 1992, The Management of Operations, 4th Ed., New York: John Wiley & Sons Inc. in ed: Turban. E., Lean. E., & Wetherbe. J., 2001. Information Technology for Management. Transaction Processing, Innovative Functional Systems & Integration. John Wiley & Sons. U.K. Ch. 8. Pamphilis, D., 2012, Mergers, Acquisitions & Other Restructuring Activities – Integrated Approach to Process, Tools, Cases and Solutions. Ch. 14, New York: Academic Press. Turban. E., Lean. E., & Wetherbe. J., 2001, Information Technology for Management. Transaction Processing, Innovative Functional Systems & Integration. Ch. 8, New York: John Wiley & Sons. Internet References: What is the Research & Development Tax Credit., 2011, IPC.org, Illinois, 30th Jan, 2012, Available at: http://www.ipc.org/ContentPage.aspx?pageid=What-is-the-Research-and-Development-Tax-Credit Research & Development., 2012, American Heritage Dictionary, USA, 30th Jan., 2012, Available at: http://www.answers.com/topic/research-and-development Hagedoorn, 2001, Interfirm R&D Partnership – An Overview of Major Trends & Patterns Since 1960, Proceeding from an NSF Workshop, Arlington, 30th Jan, 2012, Available at: http://www.nsf.gov/statistics/nsf01336/p1s3.htm. Narula. R. 1999. R&D Collaboration by SMEs, Ch.22, Pg. 544, In ed: Farok J. C. 2002. Co-operative Strategies and Alliances. R&D Collaboration by SME’s. Some Analytical Issues and Evidence. 30th Jan., 2012., Available at: http://books.google.co.in/books?id=M6XYQFgWR0cC&pg=PA517&lpg=PA517&dq=interfirm+R%26D+from+joint+ventures+to+contractual+agreements&source=bl&ots=XkAZcTfqw9&sig=H5bKTa6CsRmtwOQML9ssZW4YkdQ&hl=en&sa=X&ei=bo4iT5bNOsXqrAeNgbnECA&ved=0CEMQ6AEwAw#v=onepage&q=interfirm%20R%26D%20from%20joint%20ventures%20to%20contractual%20agreements&f=false Read More