Article Creating Profit Through Alliances

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Alfred Griffioen – Creating profit through alliances 1

Creating profit through alliances How collaborative business models can contribute to competitive advantage Alfred Griffioen Abstract: Companies need to develop and adopt new products and business models in order to differentiate themselves from their competitors and to outperform them. This article discusses three strategies for differentiation and shows how alliances can be a useful sourcing mechanism. The three strategies are elaborated and combined with various basic forms of alliances. Introduction For most companies, making profit, or shareholder value, will be an important objective or at least an important precondition. How profit is created at a company level is described in basic micro-economic theory. A distinction can be made between 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 your prices are higher than those of your competitor, everyone will go to him, and if your prices are lower you may be depriving yourself of income, and the competitor might also 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 in the first diagram of Figure 1. This typically applies to raw materials such as pig iron and diesel, objects such as lighters and cotton wool, and services provided by hairdressers, Chinese restaurants and cleaning companies.

Figure 1. The effect of the demand curve with competition and in a monopoly

If you are selling a unique product, or if you know of another way to ensure customers choose you instead of your competitor, you will have a kind of monopoly. In that case, you are free to determine at which price you wish to sell your product. That price comes with a certain demand, which is how you can optimize your profits (second diagram). If you start off with a higher price and then slowly bring it down, you can make an even bigger profit. This is known as skimming the market (third diagram). Apple sold the first iPhone for approximately 300 dollars, and then dropped the price.

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The opportunities for differentiation can be found by evaluating the needs and competences of the companies in your value chain, or rather, the value network around you. This requires thorough analysis and proper market knowledge. On the basis of a needs analysis, you can identify entirely different ways of servicing your direct customers or their customers. Alternatively, by integrating activities from one of your suppliers, customers or the other suppliers of your customers, you can adapt your business model. Three strategies for differentiation Once you know where in the value chain you can serve your customers better than your competitors, then you need to devise how to do this. There are two models often referred to that give direction on how to get your customer value proposition to stand out: Porter's model1 on product differentiation, cost leadership and focus strategy, and Treacy & Wiersema's model2 on product leadership, operational excellence and customer intimacy. If you have more products, the Boston Consulting Group portfolio matrix offers guidance on how to direct the cash flows in your company: depending on market growth and market share, one should invest or divest in certain activities. Although corporate finance has changed significantly over the last decade (see below), the model is widely used because of its conceptual simplicity and the clear answers it provides. However, Porter’s strategies were first published in 1980, and Treacy & Wiersema introduced 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 have affected the validity of these models. If there is one development that has dominated how consumers and companies do business in the last decade, it is the ever-growing availability of information, facilitated by the internet. Consumers, purchasing companies and governmental institutions have increasingly better knowledge of the market and can compare products from several companies. A few mouse clicks and phone calls is all it takes to fulfil their needs with suppliers from all over the world. Internet search and even online auctions are steadily replacing the relationship-based purchasing process3. Thanks to this availability of information, it is also easier for small innovative companies to offer their services and to compete with larger players. This leads to faster product rationalisation. Through the faster distribution of technology, the number of competitors for a certain product increases while prices decline. A good example is offered by two comparable products: the video recorder and the DVD player, as shown in Figure 2. The video recorder was developed in a time when information exchange was slow. It took competitors a long time to develop a comparable product. With the DVD player this was already different. These developments force companies offering products and services to concentrate on those activities where they can offer real ‘value for money’. Distribution channels can only add value by presenting relevant combinations of products or services within the right sales concept.

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A second important development in the last decade is the increased transparency of financial markets. In the twentieth century, the main objective of practically every company was growth. Growth provided economies of scale, made a lucrative position as market leader possible, and above all: growth and the associated investments were a logical way to reinvest profits. The BCG portfolio matrix is based on these assumptions.

Figure 2. Price development of video recorders and DVD players4

As the financial sector globalised as well, it became easier to reinvest profits from one company into another if that company had a better performance or lower risk profile. In recent years and under the influence of large private investors, transparency has increased, moving the investment decision from a company level to an activity level. The added value of a holding company or corporate head office is 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 be found all over the world, and financial resources can be obtained more easily for a good idea. Active investors can choose in which company to invest and which capabilities to combine. This allows small but specialised organisations with high added value activities to lead the new economy, instead of large corporations. Given that the availability of information has continued to increase, pay-back times of new products have shortened and the globalisation of financial markets has rerouted cash flows, the question arises: how to make a profit in such a transparent world? We can look at the strategies suggested by Porter and Treacy & Wiersema and evaluate them for their current validity. Focusing on your customer, described by Treacy and Wiersema as customer intimacy, is a strategy seen from the company. Of the three, it is actually the most market-oriented type of strategy. However, with the growing diversity of companies and brands, the perspective from the customer becomes more important: how relevant is the company for its customers? If a company has multiple brands, the analysis should be performed per brand (Figure 3).

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Figure 3. Development of differentiation on customer focus

Product differentiation alone is not good enough anymore, as product choice has increased enormously and the differences between product variants are becoming smaller. Product leadership, in the sense of continuously being at the cutting edge of technology and creating a really unique and hard to copy product, remains a valid strategy (Figure 4).

Figure 4. Development of differentiation on product

Strategies for cost leadership or operational excellence can easily be copied as much more information about companies and their suppliers is available than before. 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 advantages is a prerequisite for many companies and can be a logical goal to pursue and a sufficient reason for entering into an alliance. Only as an overall strategy it will be less sustainable and less profitable than being relevant to your customer or having a unique product (Figure 5).

Figure 5. Development of differentiation on costs

Alliances as sourcing mechanism It 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 can do so at relatively low costs, then you're better off keeping these competences under your own roof. But if the competences deliver value for the customers but only against high costs, and someone else can do so more efficiently, then it makes sense 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.

üThe three strategies ofMichael Porter (1980)

The three directions ofTreacy & Wiersema (1995)

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Focus strategy:targeting on a niche

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üThe three strategies ofMichael Porter (1980)



Product dif ferentiation:having a better product

Product leadership: continuously introducing new

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ûThe three strategies ofMichael Porter (1980)



Cost leadership:having the lowest costs

Operational excellence:having the lowest total costs, including costs of your client

Cost advantage is easily copied or leveled down.

Scale can be boughtNo sustainable strategy

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• 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 customer's need, or be able to produce or distribute the component more cheaply, and can thus deliver more value-for-money.

Figure 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 to create components for your product or to deliver high-value service to the customer at 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 any market:

• 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.

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Direct investment in development activities or broader marketing, as a base option, requires a lot of time, certainly if it calls for new competences. Procuring these competences will expedite the process, but captures part of your profit due to overhead and your supplier's profit margin. The risk of investing in a client group that barely responds or in a product that fails to succeed remains entirely with your own company. A take-over or merger directly guarantees access to an existing customer base or an existing unique product portfolio, but often also implies investing in overlapping people and resources or non-strategic activities. Given the market preconditions, an alliance with a complementary party is therefore preferable. Competences are made available immediately, the investment sum is often limited, and the risk of the joint activity is shared. The best collaboration results from both parties contributing unique elements, such as:

• 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 to determine 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 partly dependent on the performance and continuity of your partner company. This demands careful partner selection, mutual trust and a solid contract. Additionally, you need to share the revenue of the collaboration. The task is thus to jointly increase 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. Distribution alliances, joint R&D and shared investments, for example, can be arranged either contractually or as a new legal entity (a joint venture). Each company's preference, the variety of legal forms and tax structures in a country can influence this choice. Realisation of your strategy through alliances In the first part of this article we discussed three strategies for differentiation. In the second part we introduced alliances as a way to obtain the resources and competences necessary to pursue such a strategy. In this third part these strategies are elaborated and coupled with various forms of alliances. Customer relevance The term 'customer relevance' pertains to the access a company has to offer its products and services to its target group. After all, any target group, whether it consists of consumers or people with purchasing responsibility within a company, are exposed to so much information and so many opinions and offers, that they have built up a highly effective filter in response.

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Brands are the carriers of customer relevance. This is owing to the various functions of a brand, of which recognisability is the most important. Users will attribute certain values and features to a brand, partly based on advertisements, and fill in the rest of the picture with their previous experiences with products and services offered under that brand. A brand is relevant if the fulfilment of its promise connects to actual customer need. This will happen if their actual need is answered by the promise that your brand makes, and how this is fulfilled in products, services, distribution or your marketing communications5 (Figure 7).

Figure 7. Customer relevance increases to the extent that brand promise and actual customer needs overlap

Every person has a number of generic needs: security, friendship, relaxation, efficiency and success. Depending on the context or situation you are in, these generic needs are translated into actual needs. Again depending on the situation, one or more of these generic needs will be dominant, complemented by needs that arise through a customer's expectations with respect to a certain situation. For example, when spending the night in a hotel you do not expect anyone to enter your 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-end hotels you will expect a laundry or dry-cleaning service (give me comprehensive solutions) and personal attention. The other aspect is the brand promise and how this is fulfilled. If you want to have a meal, that need will differ depending on whether you're alone or with your family. A company's response to this may lie in the right portfolio management of the products and services it offers. It also makes a difference whether you're in town or in an amusement park, and a company's solution here lies in its distribution management. And finally, in this particular case, you do not have this need for a meal at each and every moment. Thus, being relevant means that companies must present you with their offer at the right time. This is a matter of marketing communication. Alliances can help achieve relevance for customers more quickly. The value of alliances can best be quantified by considering the costs your own company would have to make to accomplish a comparable boost in relevance. Five basic forms of alliances contribute to the customer relevance strategy: distribution agreements, franchising, proposition alignment and referral, collaborative offering and co-branding (Figure 8).

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Figure 8. Five basic forms of alliances contributing to customer relevance

The forms differ in the way the financial arrangements are structured. In a distribution agreement the customer contact is handled by an independent distributor and the margin is shared. In case of franchising this distributor is bound to several rules regarding the brand name, marketing communications and procurement, and the franchisee will pay a periodical fee for the franchisor's support. Proposition alignment and referral is a much looser form of collaboration: there might even be no financial flows between the partners. In the case of collaborative offering the partners need to make formal arrangements: one of them needs to be the 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 in the sales and delivery of the products or services, but only lends its brand to emphasise certain aspects of the offering, for which it may receive a fee. Unique product Having a unique product is an important means of setting yourself apart on the market and of keeping your competitors at bay. It actually means that you have a small monopoly. This gives protection for higher pricing strategies, since there are no competitors offering a similar product. Despite the lower demand for higher priced products, this position is often very profitable. A unique product always has a significant, not easily copied advantage when compared to competing products. So this is not about a coffeemaker in a new colour, a camera with a few more megapixels, or a mid-range car with a slightly different design. This is about more than just 'differentiation'. Being different is not good 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 latest aircraft operated by Singapore Airlines. To imitate such products would require the right technology, patents, extreme creative efforts, and/or huge investments. Many unique products are therefore protected in one way or another by intellectual property rights: patents for technology, copyright for books and music, drawing and model rights for design. These property rights ensure that competitors cannot copy the product and enjoy the advantage of not having suffered the development costs.

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Purpose of the allianceStrategy Basic formUsing the other party's local presence and service Distribution agreement

Expanding one's own perceived presence Franchising

Increasing the chance of obtaining leads

proposition alignment and referral

Expanding one's own market to larger projects Collaborative offering

Utilizing the relevance of the other party's brand Co-branding

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A unique product will not remain unique for ever. Despite the protection of a technology or model, new technologies can be developed that offer the same or similar functionality. Patents expire and music becomes outdated. Changing needs among consumers and businesses, or new legislation, can cause a product's popularity to decline. The point is therefore to run your organization in such a way that it does not produce a one-off unique product, but that you can constantly come up with improvements and innovations. A unique product can result from leading the field in certain competences, such as technological know-how, design skills or market understanding. The point is to develop these competences further and to excel in them, so that you can create unique products time and again. Collaboration is an important means of ensuring that you have the right competences and knowledge in-house. There are basically two types of alliances that can result in a unique product: joint R&D and technology licensing (Figure 9).

Figure 9. Two basic forms of alliances contributing to the development of unique products

In case of joint R&D, different competences from the two partner firms are brought together, and the risk primarily pertains to the actual development process. This can result in an extensive contract with technology roadmaps and milestones. Also the allocation of intellectual property rights needs to be arranged. For technology licensing, the firms conclude agreements about the use of existing intellectual property rights. These kinds of arrangements are often less complex. Cost advantages Enhancing your customer relevance or developing a unique product yields durable competitive advantage. However, alliances can also be used to achieve cost advantages, though these are often easier to copy. Three forms of alliances are geared to costs: shared investment, reciprocal hiring agreements, and unusual supplier risk (Figure 10).

Figure 10. Three basic forms of alliances contributing to cost advantages

Shared 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 the activities in order to create more efficiency, such as PepsiCo and Lipton did for the distribution of their soft drinks.

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Purpose of the allianceStrategy Basic form

Utilizing the other party's development capacity Joint R&D

Utilizing the other party's technology Technology licensing

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Purpose of the allianceStrategy Basic formAchieving scale advantage and risk reduction Shared investment

Limiting one's own staffing Reciprocal hiring agreement

Utilizing the other party's cost benefits and experience Unusual supplier risk

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Reciprocal hiring agreements are useful where two companies have similar capabilities but must cope with unpredictable demand. Whenever possible they can hire each other’s staff or production capacity. Code sharing in the airline industry is an example. If a supplier takes over risks that are normally managed by the client in order to optimise collaboration on a project or specific assignment, this can be regarded as an alliance. A lot of public-private partnerships can be classified as such. The risk sharing can be arranged through a bonus-penalty system or in a joint venture type of collaboration. Conclusions Alliances can play a significant role in the pursuit of company strategy. The type of strategy through which a company seeks to stand out in the market will generally determine the most suitable type of alliance. This article took three generic strategies as point of departure. These types are based on work by Porter and Treacy & Wiersema, but have been elaborated further with a view to the changing circumstances over the past decade; primarily the immense increase in the accessibility of information and availability of capital. In each case, the principal concern is value creation and the distribution of the added value of collaboration among the participating partners. Alliances that seek to enhance the relevance of a business for its customers often apply a profit-sharing mechanism based on the additional sales or extra margin. For alliances devoted to developing unique products, the principal issue being the ownership of intellectual 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 becomes easier to establish cost and profit allocation mechanisms. This helps standardise the process of forging an alliance, thus facilitating companies wishing to pursue this strategy. For more articles of Alfred Griffioen search on Slideshare or go to www.allianceexperts.com 1 Michael E. Porter, Competitive Strategies, 1980 2 Michael Treacy, Fred Wiersema, Discipline of market leaders, 1995 3 Andrea Ordaninni, Stefano Micelli, Eleonora di Maria, Failure and success of B-to-B exchange business models: a contingent analysis of their performance, 2004

4 Bob Hoekstra, Innovation@Philips, Innovative environments, lezing IMR Conference, 2004 5 Alfred Griffioen, De Strategieversnelling, Pearson, 2009

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