An amazing paper by Prof Murali Patibandla of IIM Bangalore. He mixes so many areas – financial services, transaction costs, emerging economy issues, joint venture economics etc etc.
There are two ways to look at JVs:
The issue of joint ventures between MNEs and local firms in the host country is basically an extension of the internalization issue along the lines of Williamson’s (1985; 1999) transaction cost theory. If savings in costs of production are higher than transaction costs of the joint ventures, joint ventures are profitable (Kogut, 1988). In Williamson’s theory, agents invest in assets specific to a transaction after they enter into a contract. In other words, assets are acquired after the contracts are formulated, and opportunism takes place when one of the agents gets locked into an asset specific to the transaction.
On the other hand, in the resource-based view of the firm (Penrose, 1959; Teece, 1982), different firms (agents) possess different (physical and human capital) assets prior to a contract (joint venture). If the assets possessed by the two agents are complimentary, there is an incentive for a joint venture to form.
The paper talks about two JVs between Multinational corporations a local firm is based in India. The JV is in area of financial services. Interestingly both JVs are different. In most such JVs between MNC and a local partner from an EME, the former gives its brand name and the back office work is done by the local partner. However, here it was just the reverse.
Emerging economies present the case of rapid changes in markets and institutions. In this context, joint ventures between multinational enterprises (MNEs) and local firms are subject to a gamut of calculations between the partners for arriving at mutually beneficial contractual arrangements. In this note, we analyze two case studies utilizing a combination of the intangible asset theory of MNEs, Williamson’s concepts of asset specificity and hold-up, and the resource-based theory of the firm. Both case studies involve financial services, namely, credit cards and insurance products.
In these two cases, a large local bank provided the brand name while the MNEs provided the back-end technical-support, which is a seeming reversal of the normal pattern in emerging markets. From a resource based theory perspective, at the inception of such joint ventures, investments in relation specific assets may be small and the possibility of hold-up seem remote, but when markets become complex the possibility of hold-up increases dramatically. In this kind of context, joint venture partners have to adopt a dynamic perspective and formulate ex ante strategies for addressing the holdup problem, even though static analysis may suggest there is only limited or no possibility of such hold-up. Our analysis brings forth fresh insights on the issue of joint ventures, especially in the context of financial services, in an emerging economy.
The cases here are : 1) SBI Cards a JV between SBI and GE Capital and 2) SBI Life between SBI and Cardiff. In both SBI provided the brand name with no mention of either partner. And the back-end work was done by the two respective MNCs.This was because unlike real products financial products are different. People might have better regard for say a Honda motorcycle (which is well known) vs a GE credit card (not as well known). Moreover SBI was a household name and seen as a government bank and hence more secure to park savings:
The pertinent question then becomes why the MNEs, GE Capital and Cardiff, did not use their brand names and go for an integrated venture instead of forming a joint venture with the SBI? A plausible answer is that SBI has a large established network of branches and a significant customer base across the country. Over the years, it built up strong brand equity with its customers particularly the middle-income group (the middle class). The middle class market for credit cards and insurance products has a higher growth potential than higher income groups.
Secondly, the financial services market has certain unique characteristics, which makes it different from other services and manufactured goods. The incidence of high agency costs associated with moral hazard and adverse selection is more prevalent in the financial markets than in the other markets (Akerloff, 1970). The depositors need to have confidence in the bank to deposit their savings. Banking customers may have higher confidence in a local bank than in a foreign bank, especially when the government protects the local bank. Furthermore, the adverse selection outcomes or costs of default are higher, the larger the number of cardholders and policyholders for any single bank or financial institution. This, in turn, may discourage foreign banks to cater to the large section of middle class customers in India especially when market and institutional conditions are underdeveloped.
Things have been fine so far but could become complex once there comes a time to break up the JV.
As the financial services become more sophisticated and complex in response to intense competition, which induces firms to create new sources of value and strengthen the means of monetizing the value (Aron and Singh, 2002), the lock-in and switching costs for SBI with GE may increase. This means GE’s firm-specific advantage may become more sticky and difficult to replicate by SBI in the future. In other words, GE’s service, which began as low-end technical support at the beginning, may develop strong intangible asset properties as market complexity and back-end processing sophistication increase.
The degree of lock-in depends on the kinds of services that are outsourced to GE – if complex financial services such as real time updating of customer balances, operating expenses control and yield computations are outsourced to GE, SBI will become highly dependent on GE’s services. When the complexity of the services increases and the revenue distance decreases, it’s better for the final service provider, namely SBI, to set up its own captive processing unit instead of outsourcing. This is where the issue of how sticky or firm-specific GE’s advantage becomes in dynamic terms assumes a crucial influence on SBI’s ability to develop capabilities to replicate the back-end service assets of GE.
In the case of the joint venture between the SBI and Cardiff in the insurance markets, Cardiff had strong intangible assets at the beginning itself. As the services provided by the venture increases, the relative advantage and bargaining of Cardiff in the partnership will increase as it augments the complexity of its intangible services. If Cardiff is able to develop its reputation and build a critical customer base of its own, it has the incentive to break up and go on its own in the future.
In the end:
What are the possible strategic business policy implications of this? On an ex ante basis itself, the partnering firms should attempt to foresee the dynamics of change and the fluid markets of an emerging economy. They need to adopt appropriate hold-up hazard mitigating strategies.
Interesting and different reading on financial markets. Touching on so many ideas together..