Strategy

How to Reduce International Joint Venture Risk

Joint ventures with local partners overseas often don't work out as planned. Here's what you need to know to help such arrangements succeed.
Valrie Demont and Soumya SharmaMarch 28, 2016
How to Reduce International Joint Venture Risk

International joint ventures remain one of the principal means for multinational companies to enter a foreign market. According to a recent PricewaterhouseCoopers survey of 1,409 global CEOs in 83 countries, 49% plan to enter into a new joint venture or strategic alliance in 2016.

Valerie Demont

Valérie Demont

Some of the advantages of entering a joint venture with an established local partner include gaining local knowledge, political connections, risk sharing, immediate access to a built-out infrastructure, market share, and brand recognition. Pooling the positive attributes of each party is expected to generate monetary gains for both parties for a long time.

In reality, though, many international joint ventures never realize the parties’ vision. Of those that do, many have a relatively short life span before they are dissolved or end up in litigation.

Danone’s joint ventures in China serve as a notable illustration of failed international joint venture attempts. In 1996, Danone launched a venture with the Wahaha group to manufacture yogurt in China. Hailed as a “showcase” joint venture by Forbes, the business grew into 39 joint venture entities by 2007.

But in 2009, Danone exited all of those ventures following legal battles with Wahaha. Cultural issues coupled with differences in marketing strategy, investment issues, and conflicts of interest were cited as the dominant reasons for the breakdown.

Before that failure was complete, in 2006, Danone had made another attempt to penetrate China’s yogurt business with a different group, Mengniu. However, that new venture failed the following year. In 2013, Danone once again entered into a joint venture arrangement with Mengniu. This time, Danone owns 20% of the venture and Mengniu 80%. Time will tell whether the third time is a charm for Danone in China.

Stories similar to Danone’s saga are occurring around the world.

What Causes Joint Ventures to Fail?

A majority of joint ventures fail simply because the partners are not the “right fit” for each other. They may have different visions of purpose and their roles. The international partner often visualizes itself as a strategic ally, active in making major decisions, while the local partner is unwilling to give up control and management and expects the other to be a passive investor.

Soumya Sharma

Soumya Sharma

Another pitfall is a lack of common vision on the exit strategy from the investment. This becomes acute when one of the partners is a private equity fund looking to monetize its investment in the medium-to-long term. The need to exit and monetize often conflicts with the local partner’s longer-term view of the venture, resulting in deadlock or litigation.

Cultural differences have also severely undermined joint efforts within a joint venture. For example, the scaling back of Beverage Partners Worldwide (BPW), a joint venture between Coca-Cola and Nestlé, from certain geographic markets including the United States, is attributed in part to the incompatibility of their respective organizational cultures.

In other cases, complex regulation around foreign investment has seriously threatened the functionality and enforceability of joint ventures. In response, international parties and their local partners devise structures which on their face keep control in the hands of the local partners to comply with local restrictions, but are designed in effect to shift the control or economics to the international partner. This only makes the foreign partner more vulnerable in case of breach.

In the Danone-Wahaha venture, for example, the parties entered into an IP licensing agreement to facilitate the joint venture’s exclusive use of the Wahaha trademark, which was not compatible with Chinese law. Between 2005 and 2007, Danone discovered that the local partner had set up competing businesses using the Wahaha name, in violation of the license.

To further complicate things, Wahaha publicly expressed its bitterness Danone, portraying the latter as a foreign imperialist and itself as the Chinese victim/hero. Danone, meanwhile, alleged flagrant contractual violations. Ultimately, after years of weak reconciliation attempts, Danone sold its 51% stake in the joint venture to Wahaha in 2009.

In some of the more egregious cases, local partners have used the joint venture to effectively lock in the foreign partner through exclusivity provisions in the contract, or to “steal” the international partner’s intellectual property by siphoning off the joint venture’s business through affiliates.

What Can Be Done?

Due Diligence: In addition to the standard due diligence of the business (legal, accounting, regulatory, and otherwise), extensive due diligence must be performed on the joint venture partner, its family members, other businesses, political affiliations, and business relationships. A comprehensive diligence will enable the foreign partner to assess whether the local partner is the right “fit” with the right ethical and governance background.

This screening also confirms the partner’s ability to deliver what is expected for the joint venture (whether political connectivity, know-how, market knowledge, distribution channels, or otherwise). In emerging markets where the enforceability of contracts and rule of law could be challenging, the only real protection is the absolute trustworthiness, alignment of interests, and shared values of the partners.

Governance and Management of the Joint Venture: Keys to setting the tone are having a clear business model, aligning objectives, structuring the governance, and staffing the joint venture. A well-drafted joint venture contract encapsulating the governance structure, rights, roles, and responsibilities of each party can help bridge the gap and bring parties on the same page. It also helps identify and address areas of conflict early, so that there are no unfortunate surprises later.

Planning for the Exit: An exit strategy must be developed from the outset. Certain contractual rights are important in this regard:

1. Put/call rights: The foreign partner should have a mechanism to exit the joint venture entirely and start afresh. In structuring put/call rights, however, the focus is on:

  • Enforceability — in jurisdictions with foreign investment restrictions, put/call rights may not be enforceable or available.
  • Valuation — if put/call rights are exercised in the midst of an acrimonious dispute between partners in a failed venture, determining fair market value can be a tall order.
  • Events triggering the rights — put/call rights should not be so easily triggered that the joint venture becomes a loose agreement that can be ignored as soon as it is signed. Because the international partner’s key contribution is often technology and know-how, care must be taken so that the put/call right does not become a mechanism for the local partner to seize control of the joint venture after the technology and know-how have been transmitted and before the joint venture scales up production.

2. Exclusivity and Non-Compete Provisions: While appealing to the foreign partner, these provisions can backfire if the joint venture fails by effectively preventing the foreign partner from starting again in the local country. A release from these restrictions may become a bargaining tool in a settlement with the foreign partner.

3. Dispute Resolution: In most cases of disputes between joint venture partners, international arbitration is the preferred dispute-resolution mechanism. However, these arbitration provisions should not preclude the parties from being able to go before the courts to seek injunctive relief, especially where technology or intellectual property are concerned. At the same time, the dispute resolution procedures should be carefully crafted to eliminate instances where local courts can interfere or stay the arbitration proceedings. Mechanisms for enforcement of the arbitration award also need to be carefully analyzed.

Joint ventures are complex and risky. Failure to identify and address the risks and challenges early on can adversely impact the venture’s success. Given that joint ventures are here to stay, it is worthwhile to get the right team of professionals and take certain necessary precautions at the outset to ensure success.

Valérie Demont chairs the U.S.-India Practice Group at Pepper Hamilton LLP and is a partner in the firm’s Corporate and Securities Practice Group. Soumya Sharma is an associate with the Corporate and Securities Practice and a member of the firm’s India Practice Group.