Getting it right with joint ventures

Joint ventures are on the rise as global companies increasingly expand into emerging economies. They offer great benefits, but finding a suitable local partner in Africa to venture with can be difficult. TradeInvestAfrica explores factors to consider when scouting for a local partner in the continent.

As growth opportunities diminish in domestic markets, companies in developed countries are increasingly shifting their attention to Africa and other emerging economies, which are touted as the markets of the future. According to management consultant McKinsey & Co, Africa currently offers the highest rates of return in the developing world and companies that enter the continent early will have great opportunities to create markets, establish brands and long-term relationships.

Joint ventures are on the rise as global companies refocus on expansion plans that were shelved following the global economic crisis. The upswing in this mode of market entry, according to auditing firm KPMG, is expected to continue.

‘In these post-credit-crunch days, you have to ask whether corporates will hunker down and concentrate solely on their existing markets or will they still pursue growth from new products and markets in spite of difficult conditions? I believe it will be the latter, in which case – with new debt so much harder to come by – the joint venture will suddenly find itself back in vogue,’ says Doug McPhee, a partner with KPMG’s Corporate Finance practice in the United Kingdom.

Joint ventures were at their peak in the year 2000, when over 3500 deals were announced globally. By 2004, that number was down to just 800 but then a turnaround began. During 2007 there were 1759 deals made globally.

‘Now seems like an ideal time for corporates to reacquaint themselves with the joint venture. Despite everything happening around us, excellent growth opportunities still remain, especially in the emerging markets, yet companies risk missing out. A joint venture can be very powerful in quickly achieving exposure to new technologies and products, distribution channels and markets – and all with limited capital investment,’ says McPhee

Top global players

The United States, Japan, United Kingdom, Canada, China, Australia, India, Germany, France and Hong Kong have been the top 10 most active countries in terms of their involvement with joint ventures over the last eight years. Japan dropped out of the top five in 2007, while China has been in the top five since 2001.

With Africa’s vast natural resources, commodities and huge market remaining the overwhelming attractions, the most popular mode of entry for investors venturing into Africa today is a unique hybrid form defined by the spike of foreign direct investment from China.

‘We are now seeing a growing trend of private Chinese entrepreneurial and investment activity in several African countries. Brazil, Russia and India – the BRIC countries along with China – have emulated the Chinese model of investing in Africa,’ says Remi Bello, the chief executive officer of B&M Consulting, a US-based political risk consulting firm.

When joint ventures make sense

Establishing a joint venture can spread risks and provide valuable insight into a new market. A good example of this is the developments in the mobile telecommunications market where many operators are forming joint ventures to share networks, thereby reducing risk and financing costs.

In Africa, the telecommunications sector is undergoing tremendous transformation brought about by the convergence of telecommunications, financial services and information technology. A prime example is the partnership between Kenya’s mobile phone operator Safaricom and Equity Bank in delivering the M-Kesho product that allows users to operate interest earning bank accounts on their cell phones.

Joint ventures have also been the mode of market entry for many South African companies expanding into the rest of Africa. Some examples include Africa Legal, a division of Law firm Deneys Reitz, which recently established a joint venture with Tanzanian commercial law firm CRB Attorneys. ICT firm Altech gained entry into the Kenyan market by partnering with Kenya Data Networks, while Standard Bank took on board a local partner in Nigeria to establish Stanbic IBTC.

Companies that want to enter markets with attractive growth opportunities but lack capital can also opt to take the joint venture route. In some countries and strategic sectors, establishing a joint venture is a formal regulatory pre-requisite to do business at all.

‘In countries such as Nigeria, where the bulk of foreign direct investment still flows into infrastructure intensive sectors like oil and gas, taking a reliable local partner with firm community roots can have a “good neighbour” effect and help reduce local resentment of a project and thus alleviate the risk of civil strife and infrastructure vandalism,’ says Bello.

‘Alliances may be more useful when the partners have complementary product lines, assets, or functions. In the pharmaceutical industry, for example, one partner may bring in an attractive product pipeline while the other provides the distribution infrastructure,’ adds Harshavardhan Raghunath, the partner for Boston Consulting Group (BCG) in Mumbai.

So, how do you choose the right local partner to venture with, and how do you ensure the ‘marriage’ is successful?

In many cases, the answer would be to marry the girl next door – partner with someone you know, for instance an existing customer, distributor or supplier. But this does not always apply.

‘Selecting the right local partner is often the difference between success and failure for most foreign investors expanding into Africa,’ says Bello. Bello’s B&M Consulting, which also scouts for suitable local partners in Africa for its clients, believes selecting the right business partners is one of the most effective forms of risk management.

‘Perhaps just as important as technical and professional aptitude, one key quality that we look for when scouting for a local partner in the continent is previous successful experience working in a similar capacity with another foreign company or investor,’ says Bello.

B&M has found such checks reduce the likelihood of a culture clash and mitigates relational risk as local partners with a reputation of successfully partnering with foreign firms are more likely to want to keep it.

A survey on joint ventures released by KPMG in 2009 concurs with Bello’s view. When the respondent’s companies actively searched for a joint venture partner, they were more likely to have a worse opinion of the performance of the subsequent joint venture. Those that formed a partnership from an existing relationship were most likely to have their expectations met.

‘Actively looking for a new partner is one of the most difficult ways to set up a partnership, especially when the relationship has to be built from scratch. There can be difficulties in building trust between the parties, and so a reluctance to release key information for the purpose of due diligence can develop. This can lead to companies that do not fit well being incorrectly matched,’ says the survey.

Africa Investment Publishing (AIP), which owns print and online business publications including www.tradeinvestnigeria.com, established a formidable presence in Nigeria by first testing the waters with prospective partners on a commercial basis.

Says chief executive officer Richard Pembroke: ‘We had already been servicing clients in Nigeria so we had some arm’s-length exposure to the market and on the whole had found the experience better than originally feared. We increased our activity in Nigeria thorough establishing a local company and working more closely with contacts that had been established.’

Trust between partners is crucial for areas such as due diligence and it’s advisable to build it right from the start.

‘The most fundamental criteria firms must adhere to are a financial and strategic fit in order to create a win-win relationship. However, our extensive experience with alliances and joint ventures tells us that cultural coherence and the partners’ prior alliance experience are major factors predicting success. Every company entering a joint venture must be aware of the control it chooses to share,’ says BCG’s Raghunath.

Due diligence

Failure to undertake thorough commercial and financial due diligence on the operations and assets being contributed to the joint venture can present big problems. South African businessman Shane Griffins found himself in hot water after a partnership with a US-based firm, which needed security solutions his company possessed, became bankrupt.

‘We decided to enter into a partnership that would give me as the only South African director shares in the global company. I did not hesitate because the business was very profitable. Unfortunately the US company filed for bankruptcy and did not have the decency to contact me. Until that moment, I had absolutely no idea that the group was in trouble,’ says Griffins.

‘My advice to local investors who are considering entering in such partnership with foreigners is to conduct due diligence on the other party and ensure it is a sound business. My biggest mistake was signing collateral for the business. Never do that, even if they offer you the world,’ adds Griffins.

Griffins did not get a settlement due to logistical and financial challenges he encountered when he tried to get redress in the US justice system.

Joint ventures in Africa are not governed by separate laws, and successful resolutions of disputes will depend on a country’s business environment.

‘Ensure you have a contingency plan. A well-drafted document will eliminate complications – but you also need to think about an exit strategy in case the venture itself is terminated,’ says George Sale, partner at Wanam Sale, a Kenya-based law firm that specialises in intellectual property law.

AIP’s experience in Nigeria is that the business community respects the law and legal contracts, contrary to popular perception.

‘The frustrations come in the form of the less definable areas such as business generation and proactivity, particularly in regard to joint ventures or at the other end of the scale fundamental shifts in the environment that completely alter the goal-posts. You are much more likely to find an ineffective partner in Nigeria than a dishonest one,’ says Pembroke.

Government policies

One of the biggest criticisms of China’s recent trade and investments in Africa is that its investors predominantly use Chinese workers and partners at the expense of local partners.

‘In many cases, this has been true. However, the Chinese can hardly be singularly blamed for this problem as some mostly weaker and smaller African governments, perhaps initially intimidated by the stature and deep wallets of state-backed Chinese investors, failed to insist on them hiring local partners and workers. We are now witnessing a trend of several African countries becoming firmer in these demands, while still remaining foreign-investor-friendly,’ says Bello.

In April, Nigerian President Goodluck Jonathan signed into law the Nigerian Content Development Bill (NCD), which seeks to increase the role of Nigerian companies in all aspects of the oil and gas industry, including the process of Nigerian firms bidding for local partner status.

Bello predicts that many African countries will soon be following Nigeria’s example.

This, according to Pembroke, would probably affect foreign direct investment flows into the continent badly because some investors prefer to fully own operations in foreign markets. But the benefits of acquiring a local partner cannot be over looked.

‘Local partners can provide insight and experience that outside companies will simply not possess. This can prevent expensive and sometimes catastrophic mistakes,’ says Pembroke.