Is a joint venture right for you?

Successful joint ventures depend on early HR involvement

By Diane Lee, Principal, M&A Engagement Manager, Mercer Human Resource Consulting

In June 2006, Nokia Corporation and Siemens AG announced the combination of their mobile network operations into a 50-50 joint venture (JV) to compete successfully with market leader Ericsson AB. Pending regulatory approval, the new entity, Nokia Siemens Networks, would employ some 60,000 employees, create an estimated 1.5 billion euros in economic synergies within four years, and bring together important technical and market competencies neither company had mastered on its own. That same month, Korean Air entered into a JV with Chinas

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Sinotrans Air Transportation Development Co. to establish cargo operations in the Peoples Republic of China. As Korean Air saw things, the new entity would give it a strategic foothold in Chinas air cargo industry, which was growing at 30 percent per year faster than anywhere else in the world. These cases are two examples of a growing trend by which business leaders are using JVs and alliances to create market leadership positions, increase profitable growth and enter new geographic markets. (For a closer look at joint ventures,

see Sidebar 1 on page 2.) A 2005 survey by KPMG LLP found that 64 percent of U.S. executives planned to increase their use of alliances (a formal relationship rather than a business entity), and 52 percent planned to enter into more JVs (the formation of legal entities) during the next two years. Respondents also expected to increasingly use alliances or JVs in high-growth markets such as China, where partnerships with local companies can help foreign firms gain a toehold in unfamiliar terrain.i (For a comparison of JVs and alliances, see Sidebar 2 on page 4.)

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Key challenges in forming joint ventures

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Forming a joint venture involves a high degree of complexity from three sources:

In general, companies that use JVs as part of their business strategy face three major challenges. First, there are no universal rules on how best to structure and operate a JV; each joint venture has unique qualities. Second, the parent companies must share a vision and agree on a strategy for creating and sustaining value. In the absence of either, the JV is unlikely to succeed. Finally, the parties to the transaction must establish a business start-up with all the functions required for successful operations: an executive team, an HR function, marketing, finance and so forth. This start-up task is challenging and, as well see later, must be accomplished within a compressed time and with a focus on human capital issues.

2 Ambiguity. Substantial critical information is unavailable to the deal makers, often because of regulatory constraints on sharing information before a deal is actually consummated. The use of clean teams can help mitigate this problem, while also streamlining and expediting other aspects of the integration process. (See Sidebar 3 on page 5.)

The number of parties involved. Many people have a say in the outcome during the pre-deal phase: executives of each participating company, executives of the JV itself, and the lawyers and advisors who represent the JV and its participating companies. Absent a decision hierarchy and with so many people in the picture, consensus is challenging.

In addition, a JV partnership should include one more element: a clear intention of what it wants to do three to five years in the future i.e., an exit strategy. Examples of an exit strategy include one partner buying out the other(s), selling its interest to the other(s) or to another party, or exiting the business through an IPO.

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Initial absence of a decision hierarchy. The JV will eventually have a leadership team for making decisions. But between the deals announcement and its close when many critical decisions are needed key posts may remain unfilled. In some cases, the top-tier executives (e.g., the chairman, CEO, CFO, and possibly COO and general counsel) are named, but secondtier positions are generally not filled until near or after closing. In the 2004 Sony-BMG joint venture, for example, the chairman, CEO, COO and CFO were appointed almost immediately long before the official formation of the JV. However, important management positions, notably in business functions and in the 42 countries where Sony-BMG intended to operate, were vacant until just prior to and after the close.

The success factors

JV partnerships should have some crucial elements in place before close to overcome the complexities surrounding their formation: a business strategy that all venture partners support; a hierarchy of effective decision makers; sufficient human, financial and technical resources; and a comprehensive integration plan for strategy implementation.

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4 Total rewards Rewards also pose a challenge to HR. In many cases, the package of compensation, benefits and career opportunities (including training and development) offered to JV employees is less favorable than that offered by their parent companies. Early HR involvement pays dividends As with other business transactions, including mergers and acquisitions, getting the human capital side of the JV right calls for HRs involvement in the pre-close phase, when critical aspects of leadership, staffing and other human resource issues are planned. Early involvement, however, doesnt always happen. A fall 2006 survey by Mercer in Australia indicates that only 46 percent of HR leaders there were involved in deal making prior to the close. The same study noted successful transactions almost always included early HR involvement on crucial issues. In those less successful cases, almost all human capital issues were addressed after closing or not at all.ii As noted before, one key to success in a JV is a sound business strategy, which is only as good as its execution. HR has an important role to play in ensuring sound execution through an effective management team and capable, motivated employees critical components of the people side of JVs. The sooner HR leaders get a seat on the deal team, the better the outcome is likely to be.

Key human capital and HR issues

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This will likely run counter to employee expectations. Executives may expect their current reward packages to be replicated under the JV. They also may perceive that the risk they take in leaving the parent organization justifies their expectations of greater compensation; however, as start-ups, few JVs have the resources.

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In addition, JVs, which are not corporations, cannot offer stock options. This problem intensifies when executives and personnel from different business cultures are brought together. Consider the case of two prospective JV partners: one headquartered in Asia, the other in Europe.

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In their negotiations, the two firms anticipated a JV management team of 10 executives, five from each company. But there was a twist: Executives of the Asian firm did not have stock options as part of their compensation package. The Europeans, on the other hand, enjoyed rich stock options, which were an important component of their rewards. The challenge for HR in this situation was substantial: It had to structure compensation in a way that the European executives would not feel slighted without giving their Asian counterparts something they neither had nor expected to have.

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In the absence of a satisfactory solution, the leadership of this JV would have been divided into two factions: five contented Asians and five disgruntled Europeans, with the groups further divided by culture (national and organizational) and language. An unhappy ending to the JV would have been practically guaranteed.

Although a JV has no shares to offer employees, its possible to create and reward employees with phantom shares. These shares can be created through thirdparty valuation of the entity, and employees are awarded fractional interests based on the reward plan.

Tight timetable for JV formation In some respects, a JV represents a golden opportunity for HR executives to get the people side of the business right with the new entity. There would be no legacy HR programs and there would be the opportunity to design people programs on a clean slate.

Company A contributes a manufacturing unit and Company B contributes a pan-European distribution unit; each entity has its own sales and HR staff. The redundancies must be eliminated, but whose sales and HR departments must go? Or should the JV select some individuals from each of the two sales and HR departments? Each situation demands a unique response from business leaders and HR.

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Unfortunately, there is seldom time to develop a state-of-theart payroll system, the ideal HR information system or the optimal retirement plan. In many cases, HR has only 60 to 90 days to get everything in place. Consider this example: A large pharmaceutical company and a major health care provider joined forces in a JV to address a narrow but promising business opportunity. The CEO would come from

Redundancies In many JV deals, HR executives must also face the problem of redundancies, which are frequent when JVs bring two fairly independent business units together. Consider this example:

one company and the CFO from the other. Everyone else, 90 people in all including the HR director, would be hired from the outside. Once she was on board, the new HR director recognized that the small operation could not support a major HR infrastructure. She had less than a month to get things in place, including determining the pay and benefits of job candidates. The HR director turned to outside vendors for payroll, benefits administration, an off-theshelf 401(k) plan and so forth. Her solution may not have been ideal, but it was quick and right for the organization. Another alternative for HR executives is a transition service agreement through which one or the other parent company continues to provide payroll or other services for the first year of the venture. HRs role in the formation and operation of a successful JV is substantial. With so important a role, the HR leaders of the parent companies and the HR leader of the new entity should have a place at the table with other decision makers.

Career risk Parent companies of a JV want leadership they know and trust, and typically most key executive, management and employee positions are filled from the partner companies. Who gets the top jobs in the JV is determined by (sometimes contentious) negotiation among the partner companies. But getting the right people to take those jobs can engender resistance, since moving to the JV entails career risk. Consider this: Only about 53 percent of JVs are deemed successful, and many fold within just a few years. Consequently, the terms of employment must be structured and presented in such a way that valued employees will abandon their relatively safe corporate jobs and join the risky venture. Also, personnel transferred from the parent companies may want a bridge back to their old jobs if the JV fails. Will there be one? HR executives must anticipate and deal with these issues. Moving from a large corporation to a smaller start-up venture, however, has many advantages. The ambitious executive or manager becomes a big fish in a small pond, getting greater autonomy, broader responsibilities and more opportunities to make his/her mark.

Conclusion
Many companies are pursuing joint ventures for a variety of reasons, including access to new markets, greater capabilities and technologies, and profitable growth. As different as their reasons, all successful JVs have a common ingredient early involvement from HR and an emphasis on human capital issues. In the cases of the joint venture of Nokia Siemens Networks and Korean Air/Sinotrans, mentioned at the beginning of the article, both have encountered typical challenges in the early stages. Nokia Siemans targeted a start date of January 2007, but the JV

was delayed until April 2007 due to a corruption investigation at Siemens, according to PC Magazine. That magazine reports that Nokias CEO will become chairman of the board, which will have four members from Nokia and three from Siemens. The Sinotrans/Korean Air joint venture is expected to begin its 30-year term in the second half of 2007. Time will tell whether these and other joint ventures succeed. However, if they overcome common key challenges and involve HR leadership long before Day 1, they have a greater probability of seeing their parent companies dreams come to fruition.

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Endnotes

M&A Research Report: Australia, Mercer Human Resource Consulting, October 2006. Why Alliances Are Gaining Momentum: Mergers & Acquisitions. The Dealmakers Journal, June 2005.

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