Attacking your partners

When Volkswagen and Suzuki signed a framework agreement in December 2009, it seemed like a match made in heaven. Volkswagen was eager to gain from Suzuki's knowhow in low-cost cars and get support to enter the hard-to-crack Indian market. Suzuki would get help from Volkswagen in product development – a hybrid motor system, as well as battery packs for electric vehicles. Despite the disparity in size between the German behemoth and the smaller Japanese carmaker, they recognised each other as independent, equal partners. But lack of trust soon came to the surface. Suzuki complained that they couldn't access Volkswagen's core technology and next-generation fuel-efficient powertrain technologies as promised. Volkswagen accused Suzuki of violating their partnership agreement by agreeing to an engine supply deal with Italy's Fiat.

The flashpoint came in January 2011, when Volkswagen decided to apply the equity method to its shares in Suzuki for accounting purposes. This means that the investing company logs its share of the profits or losses booked by the partner company. It is typically used when a company owns more than 20% in an "associate" company and has a significant influence in its operations. Volkswagen owned just short of the magic figure, at 19.9%, and Suzuki felt that the German company was trying to wield undue influence. Things began to fall apart.

Just short of two years into the alliance, in November 2011 the relationship came to an end. Suzuki terminated the agreement and demanded that Volkswagen return its shareholding in the company. There followed a messy arbitration process lasting a further four years, with a court ruling ending the dispute only in 2015. Asked about future partnerships with Volkswagen, Suzuki's chairman Osamu Suzuki said "you will not remarry someone you have divorced." Volkswagen responded by raising the stakes, loading features into its cars and undercutting in price to emerge as a direct competitor to Suzuki in the hot hatchback category.

The automotive industry is notoriously fickle in alliance making. But ample anecdotal evidence indicates that industrial alliances are often followed by aggressive competition between partners across product markets. Pharmaceutical firm Merck allied with Novartis, Pfizer, Bristol-Myers, and Depomed in the 1990s yet later competed with these firms in product markets. Similar instances appear in the telecommunications and other industries. Despite the abundant evidence, however, researchers have not paid adequate attention to the influence of alliances on competition between partners in product markets.

Exploitative and exploratory alliances

Our study examines how different combinations of exploitative and exploratory alliances between two firms affect their competition in the product market. First a word on definition of terms for the two types of collaboration.

Exploitative collaborations are arm's-length relationships designed to exchange existing knowledge and resources for short-term economic returns, such as marketing and licensing alliances. Firms engaging in exploitative collaborations typically do not require close interactions, since they can be guided by contracts to accomplish their respective duties in a relatively stand-alone fashion.

Exploratory collaborations are those alliances designed to synthesise knowledge assets from both parties so as to develop critical innovations of great strategic importance for long-term stakes. They consequently demand more intensive interactions for sharing tacit know-how. Exploratory collaborations cannot be perfectly regulated by contracts, since they consist of non-routinised searches and learning that involves experimentation with new and often unforeseen alternatives and outcomes.

We capture the composition of collaborative portfolios using the concept of relative exploration, defined as the proportion of exploratory collaborations among all collaborations between a firm and its partner.

Portfolio composition makes a difference

We find that differing compositions of a collaborative portfolio have varying implications for competition in the product market. When the proportion of exploitative alliances is high, the overlap in the two firms' long-term stakes is relatively small, so that a short-term horizon and a ‘transaction-oriented' perspective dominates. This orientation allows both parties to tolerate self-serving behaviour, or even to take it for granted. Interactions focus on maximising immediate profits, so that each firm is motivated to use what it learns from its partner to increase private benefits.

Exploratory alliances raise the stakes

Exploratory collaborations, on the other hand, help firms more precisely identify the strengths and weaknesses in partners' organisational systems and innovation schemes, information that could be used to launch calibrated attacks and provides strong incentives for competitive actions. Proprietary know-how has been shared, and complex knowledge transferred between allies. These collaborations require intensive hands-on coaching to facilitate joint problem solving. Such coaching often draws on latent knowledge bases, showing the connections between divisional areas of knowledge and organisations. This fine-grained knowledge transfer enhances the absorption of tacit know-how and facilitates the appropriation of fundamental knowledge that spills over during close interactions. Incentives to apply such technological know-how in designing substitute products is high, since doing so can cause destructive damage to incumbent products and reward the attackers with enhanced private benefits.

Network embeddedness plays a role

We build a comprehensive model examining the impact of alliance network embeddedness on the relationship between relative exploration and product competition between allies. We focus on three dimensions: relational, positional, and structural. Relational embeddedness, reflected in repeated alliance ties between two firms, emphasises cohesive and reliable relationships. Positional embeddedness, reflected in network centrality, shows how a firm's status and power are manifested within the overall network. Structural embeddedness, reflected in the common ties shared by the firm and its partner, highlights the information sharing, social monitoring, and reputational effects that regulate inter-firm interactions. We find that certain compositions of collaborative relationships can lead to a new path of interaction – a transition from collaboration to competition in product markets. Furthermore, the firms' network embeddedness can modify this transition process.

Horizontal alliances breed competition

Using a 20-year dataset, we focus on horizontal alliances within the US pharmaceutical industry (1984–2003). Firms in horizontal alliances often have a strong competitive inclination because of either existing or potential rivalries in products or resources. Aggressive learning can be translated into competition, for two reasons. Firstly, proprietary technological knowledge obtained from a partner can be applied outside the alliance when contracts do not adequately direct and constrain the use of knowledge-based assets. Firms can apply such knowledge to develop or improve their own products, constituting a threat to their partners' existing products. Secondly, learning about partners' organisational systems, behavioral patterns, and intentions can help firms design calibrated attacks on their partners in the product market in order to maximise their own performance.

A tipping point is reached

Heavy engagement in exploratory collaboration allows both partners to hold a great deal of high-value information about each other's operations. Information about technological pitfalls or managerial incompetence, for example, could be used to design targeted retaliatory attacks. The stakes of betrayal become substantively higher as the strategic importance of the exploratory partnership increases, so that the ‘tit-for-tat' retaliation risk escalates substantially. But the consequences of retaliatory attacks can be tremendously destructive, resulting in significant costs to the attacker.

We find that the proportion of exploratory alliances in the overall portfolio increases the firm's competition against its partner, up to a tipping point beyond which competition starts to decline. From then onwards, the escalating damage to long-term benefits and the risk of ‘tit-for-tat' retaliatory attacks mean that the expected costs become higher than the expected benefits of launching further competitive attacks.

A win-win relationship can emerge

As firms become more reliant on one another for developing exploratory innovations, a more positive outcome can emerge. Developing innovations involves great uncertainty, and thus demands more cooperative effort. Competition accordingly becomes a growing threat to firms' common stakes, curbing their incentive to launch attacks. Shared stakes rise to the point where the partnership becomes strategically important to both parties' long-term prosperity. As the marginal cost of competition continues to increase, the likelihood of competition is reduced. A symbiotic relationship can emerge featuring a long-term perspective and ‘relation-oriented' interactions.

Takeaways

Exploratory alliances encourage long-term outlook. Firms are more likely to adopt a long-term outlook that encourages relationship building and cooperation when the collaboration portfolio is dominated by exploratory alliances, reducing its motivation to compete with its partner. The overall collaborative portfolio between partners plays an important role in determining their competitive interactions.

Network embeddedness affects the relationship between relative exploration and product market competition. Our research speaks directly to the importance of looking beyond dyadic interactions when examining competition between two partners. Firms' network characteristics influence their interaction patterns and performance.

Power asymmetries matter. The likelihood that allies will compete against each other is not evenly distributed within a dyad: the firm with more advantageous network positioning or richer experience in managing the transition from collaboration to competition is more likely to initiate competition.

Aggressive action provokes retaliation. When alliances fall apart, the attacked firm is likely to respond to the aggressor's actions, having developed the capacity to do so through alliance learning. Further, the attacked firm is more likely to respond if the number of repeated ties with the aggressor is high, because these ties provide ample knowledge and enable effective retaliatory action. However, the attacked firm is less likely to respond if it is either less centrally located within the alliance network or less experienced in managing the transition from collaboration to competition than the aggressor.

Competition is about more than rivalries

Our findings provide strong support for the recent conceptualisation of competition as "relational". Different from the traditional "rivalrous view" of competitive dynamics, which highlights a firm-centric perspective, the "relational" view emphasises the necessity of understanding others' needs and preferences, as well as the interdependencies between self and others, before deciding on competitive moves. Our research extends this line of argument by suggesting that firms can increase their "relational" savvy through learning in various forms of interactions, including alliances, competition, and the transition between the two. All of these relationships may inform subsequent competitive encounters.