Identifying Risk in Strategic Alliances

by Barry B. LePatner, Esq.

As one who serves as business advisor and attorney to design firms, large and small, I regularly meet with principals of firms who are constantly seeking the latest and best way to secure new business. Their questions invariably get around to: "What do you see as the hot markets in the years ahead?" "Will there be enough strength in the schools or office tower business to justify my firm keeping all of its present staff?" "Should we be going global or should we move into design\build or possibly pursue a strategic affiliation?"

These questions however, often fail to reflect how critically important it is to identify a firm's strengths and weaknesses before one can select the best mechanism to meet long term objectives.

I believe the better questions for design professionals to focus on are the following:

• Where do you want your firm to be in two years? In five years?
• What are your firm's strengths that will enable you to accomplish this goal?
• Are there other ways to achieve the same results that are faster, better, cheaper?

All too often, architects and other design professionals are not well-prepared to answer these questions although they may have been thinking about the problem for some time.

For those of you attending this excellent program, many of these same questions have brought you to this conference. I would imagine that some of you here are poised to venture into a strategic alliance or have given it some thought in recent days. Others may be wondering whether this is just another "flavor of the month" idea that gets floated about every now and then by marketers or various governmental agencies.

If you and your fellow principals are prepared to make the necessary commitment, strategic alliances are an imperative if:

(1) you are comfortable working with other market-driven firms; or

(2) you are seeking to remain or become a strong, vital organization; or

(3) one that strives to keep and attract the best talent; or

(4) one that wishes to stay focused on the best and most challenging projects; or

(5) if you are or hope to become a highly profitable firm producing projects of the highest caliber.

Twenty years ago, only 1% or 2% of the revenues of U. S. corporations came from shared alliances. Today, that percentage has grown to 18%! Most successful alliance companies expect that number to grow to 35% by the year 2005.

Why this growth? As one management consultant wrote: Strategic alliances form when one company alone can't fill the gap in serving the needs of the marketplace.

Your perspective should be that of your clients, who are demanding that their design professionals and construction teams begin to act much as the rest of the business world - by forming alliances and teaming to meet the special needs of projects at home and abroad. These alliances are all familiar to us in our everyday life.

When The New York Times and Starbucks team up to offer the newspaper to a nationwide cadre of morning coffee drinkers, we understand the synergy behind it.

When the National Football League allies with Motorola and Sprint to market telephones with your team's logo and to obtain preferential cell rate plans, we get it.

Similarly, when MasterCard forms an alliance with SONY so that purchases of electronic appliances permit its card users to obtain American Airlines bonus mileage, we all see the benefits to be gained.

It is time for each of you to "get it" - to understand how your new alliances can serve to benefit you and your firms. As one management consultant put it: Perhaps the best way to understand what's special about strategic alliances is to ask, when the future business is successful, who in the end, will own that business. - John Harbison, Booz-Allen & Hamilton

As you have undoubtedly heard from others during this conference, forming and maintaining strategic alliances poses its own special brand of organizational, management and risk issues. Since I was asked to focus on these special problems today, I would like to provide you with a game plan for doing so - a plan that will provide you with a comprehensive check list that will ensure the best and most workable frameworks for the alliances you form.

Drafting agreements for strategic alliances poses a number of special problems for both the parties engaging in the alliance as well as for drafting the agreement with future clients. For one thing, it is quite common that one or both parties to the new alliance have had little or no experience in this type of business arrangement. Although there are some elements common to joint ventures or partnerships, there are substantial differences that require careful planning if strategic alliances are to be framed properly at the outset.

Before entering into the realm of drafting agreements to minimize risk in this new relationship, it is important to understand the types of risk - some that may be entirely new to you - that a strategic alliance poses.

Essentially, these risks fall into two categories: 1. Relational risk; and 2. Performance risk.

 

DEFINITION OF "RISK"

The concept of "risk" refers to the probability that intended strategic goals of an alliance may not be achieved, even though cooperation between the partners is satisfactory. One expert stated it this way: "The concept of 'risk' often refers to factors either external or internal to the firm that impact on the risk experienced by the firm", i.e., the sources of risk.

Thus, relational risks are concerned with cooperative relationships, i.e., they arise out of firm to firm interactions. These risks are premised upon the possibility that a partner does not perform in an acceptable way or participate with your firm in a spirit of cooperation. Consider the possibility that you have sought out a firm that you know over the years. They are led by quality architects, highly respected in their discipline and employ talented associates at every level. Perhaps, what may not be clear at the outset, what you may not have been able to find out, is that this firm has no business acumen, has never billed a client for an additional service, and will turn on your firm and support the client to your detriment if the client or the contractor challenges the services of the alliance. Clearly, a relational risk.

Performance risk refers to the probability that the intended strategic goals of an alliance may not be achieved, even though cooperation between the partners may be satisfactory. This type of risk may arise when your strategic alliance takes on an assignment for a developer who has a history of suing every design professional he or she has ever retained. Similarly, the owner's retention of a general contractor or CM that is well known for its delay claims against architects on each project, will raise the performance risk for a strategic alliance.

While one can conclude that it is not possible to avoid performance risks in a strategic alliance any more than your firms can avoid such problems on your current projects, it is possible to anticipate and avoid some of both types of risks if the members devote time to the subject at the outset.

One can therefore conclude that successful strategic alliances depend substantially on effective cooperation between their partners, since the motive for entering into an alliance is to exploit the benefits of cooperation. If the partners, accepting the benefits of such cooperation, can also address, and accept up front, the risks of external factors that may affect the success of the alliance, realistic expectations can be established for the next three critical sequential steps:

(1) securing concrete commitments to team goals from each team member;

(2) negotiation of an alliance agreement; and

(3) executing the goals of the alliance.

So with this preamble, let me try to accomplish two goals for you this morning: first, to identify the questions you and your alliance team must address before a formalistic, mutually acceptable alliance agreement can be structured; and second, to identify the process of preparing the agreements needed to move a prospective alliance to fruition and hopefully, to success.

 

I. PARAMETERS OF A STRONG ALLIANCE

It is not enough for alliance team members to have a great marketing idea, a fabulous project at hand or a team of enthusiastic professionals. Planning for a successful alliance will be the trademark of the successful alliance.

What are the parameters of a strong alliance? How can your team address these critical elements that will define if you should go forward or not? Let me highlight for you five critical elements and attendant risks you must address at the outset of your perspective relationship.

Typical risks and dangers to be avoided - unclear roles and ill-defined responsibilities within the team will surely doom an alliance from the outset. This is so because it will create both relational and performance problems and result in the enhanced risks that will make it difficult for even the best firms to survive over time.

Lacking a clear, concise communications plan, i.e., the framework for ensuring how team members at all levels deal with each other and clients will place the affiliation on the wrong road to success.

You can ill-afford an ineffectively-drafted client-driven proposal. Certainly, conveying to clients the essence and purpose of the alliance in a way that is flexible and market-driven is an up-front priority of every alliance.

A weak or poorly-developed model for the alliance's delivery of services is essential. You must be certain that each client will be asking: "What will I be getting from the alliance that I can't get from hiring an architect or two and their consultants?"

Finally, as I will go into in a bit, your alliance cannot afford to go forward without implementing a problem-solving plan. Anticipating that both relational as well as performance risks are certain to loom over the horizon, is the best way to set up a program for early identification and problem solving as needed.

These risks are so important, I would like to address them at length.

A. Well-defined roles and responsibilities

Assuming roles and responsibilities in an alliance without fully developing them at the outset is a prescription for failure. Conflicts over role definition at all levels of an alliance are one of the most common problems that can preclude an otherwise successful venture. You need, from the outset, to define the following roles and responsibilities:

• Financial (who invests how much and when)
• Resources (technological and human)
• Time (of senior principals and everyone at all levels)
• Boundaries (geographic, size of projects, markets)

  Interactions at all levels of the alliance require a game plan for dealings by and between alliance players, staff at all levels, with clients, consultants and suppliers.

• Who will be the contact point?
• Who will make formal and informal presentations to clients? To governmental agencies?
• Who will decide on major marketing issues that define where and how far afield the alliance will go for new work?
• Who will handle client problems as they arise at different levels?

  A main requirement is that no one withhold any information important to the alliance from the other alliance members.

B. Creation of a client-driven proposal that is flexible

This effort helps to demonstrate the creative and leadership strengths of the team. The key here is to keep a focused perspective on client services, deliverables and project follow-through. Only when this need is left to chance will you come to realize how important it is for other, larger issues of importance to the alliance.

C. Successful model for delivery of services

Today, service and more service is king. Seamless delivery of services by top flight professionals is the goal. This means emphasizing coordination by alliance members on all teams including:

• Senior principals
• Project managers
• Technical specialists such as CAD and IT staff
• The consultant team
• Anticipation of all risks of each project and who will assume them
• A game plan for staying close to the client throughout the project

D. Put a problem-solving plan in place

Planning for a dispute resolution mechanism at every level of the partner\alliance team and the alliance\client relationship is critical.

(1) Scope of Agreement

• establish boundaries of geography, customer segments, technologies, and fixed assets between the new entity and the parents
• leave room for future expansion as flexibility is essential to respond to change

  (2) Structure of Entity

• range from: J/V Entity ---- through ---- Arms Length Agreement
• consider tax implications and consult with tax advisors

  (3) Compensation

• Develop models for a range of projects and play out how the alliance and individual team members will be compensated.
• Structure compensation for key executives who spend considerable time on marketing, client relations, inter- firm relations that advance the interests of the alliance.

  (4) Term of Agreement

• Events that will trigger a right to terminate - e.g., (i) set term; (ii) change in ownership or control; (iii) one member's under performance; (iv) shift in member's priorities; or (v) alliance does not meet members's expectations. What if one member decides to drop out of the alliance? You just can't decide to drop out, take your ball and go home.

  "Partners in a strategic alliance have to understand that implications of their contract with its clients: They can't just walk away without first understanding that it's going to be deleterious to them, the alliance partners and the client."

  Who gets what upon termination? After all the risks are borne and the alliance closes its books is a long and uncertain time.

  (5) The Parties' Duties

• who is responsible for what?
• resource commitments of each party -- financial, personnel and other resources

  (6) Confidential and Proprietary Information - protecting proprietary and\or confidential assets that each member brings to the alliance is critical and cannot be left to address once the alliance is formed.

  (7) Dispute Resolution Procedure - Establish a plan for addressing disputes that are certain to arise, at each level of the alliance - staff, associate, principal and client in nature.

  (8) Indemnification - Parties should carefully review with counsel what and to what extent they are prepared to provide indemnities to fellow alliance members and to clients. This should not be left to chance.

  (9) Assignment and Withdrawal of Members - As with events of termination, your alliance agreement will need to address the what ifs of a member being bought by another firm or merging into another entity. o Do you wish to stay with a small firm alliance member who has just been merged into a huge, global design firm?

  (10) Audit Rights - Each member should become comfortable with the idea that all business records of its participation in the alliance are likely to be subject to audit by team accountants and by clients.

  (11) Copyright, Ownership and Use of Documents - Just as with confidential agreements, the copyright and ownership and use of alliance drawings and other design documents must be carefully considered. Giving up one's copyright should not be done without considerable thought, good business reasons and consideration.

  (12) Warranties and Guaranties - Professional service firms are not guarantors of design or their finished work product. Nor should any warranties be provided to alliance members or clients.

  (13) Insurance - This is where the rubber meets the road. No member should enter a strategic alliance without agreement to secure project policies for the team at each project or securing $3-5 million coverage for each member.

E. How To Make A Strategic Alliance Work.

Firms often tend to enter into alliances without securing even rudimentary internal cohesiveness. An alliance needs not only the top management's endorsement but also a collaboration of personnel at all levels of the member firms. Here are four specific steps to create a sustainable strategic alliance:

(1) Create a Task Force

• create a task force of representative of all parties while still in the alliance planning process
• provide for a diversity of views (e.g., finance, marketing, operations) from various levels of the parent companies

  (2) Establish Guiding Principles

• what is the vision for the alliance? What are the operating assumptions, ideals and consumer value propositions?
• will the alliance be independent or will it be dependent on the corporate parents for resources such as research, staff and marketing intelligence?

  (3) List All Major Decisions of the Alliance

• decisions will range from drafting bylaws to setting information technology strategies.
• decisions should be sorted into categories such as ownership structure, financial, third party transactions and human resources.

  (4) Create a Decision-Making Process

• this may range from one parent company having unilateral decision-making power to an informal negotiation process among the parties.

  In conclusion, it should be clear that all alliances are fraught with risk. So is your current practice, So is life itself. None of the risks cited this morning are insurmountable. None cannot be addressed and even overcome by careful planning by talking through each hurdle and applying good business judgment. It was once said that: Obstacles are those frightful things you see when you take your eyes off your goals.

The times demand creativity and will reward those who make the decisions to leave behind business models that are not going to be successful in the future. Strategic alliances are not for all design professionals. They are right for those who see a future that is beckoning for them to practice in ways that clients are demanding today. Thinking too long and too hard will only lead to hesitancy and focusing on risks. The great business guru, Peter Drucker said it best: "Whenever you see a successful business, someone once made a courageous decision."

Good luck in making those courageous decisions.