What is a Joint Venture? Why Is It Important?

Definition:

A joint venture or JV is defined as a particular business arrangement where two or more parties agree to use their collective resources to set up a particular venture.

This helps both parties or businesses collectively manage the challenges in their particular industry while also improving the chances of decreased losses. A joint venture also reduces the cost of developing new technologies.

A joint venture is a completely separate entity from both parties’ other businesses while the profit, losses, and any associated costs are borne by both parties.

A joint venture is not necessarily a straight down 50-50 venture. One company may keep more of the joint venture than the other one. It really depends upon both parties how they divide the new venture’s share between them.

Joint ventures are a kind of partnership, but the legal status of the JV really depends upon both the partners and how they want to structure it. It can be a limited liability company, a general partnership, or any other type of JV.

One of the examples of a joint venture is the recent partnership announced between General Motors and Honda. Both car companies have agreed to jointly develop electric vehicles to help reduce the cost of developing electric vehicles.

Why do a Joint Venture?

Joint ventures are a great way to reduce costs and increase profits. It also allows for combining resources and expertise. The three biggest reasons two companies should form a joint venture is given in figure 1 below:

Figure 1: Why should two companies form a Joint Venture?

The three biggest reasons for forming a JV are shown in figure 1. Both parties are able to pool resources and also make huge cost savings, while also combining the expertise of both parties. One other reason is market penetration.

See also  HOW TO MEASURE SYSTEMATIC BUSINESS RISKS?

Some companies have to form joint ventures to get access to that market. For example, many western companies form joint ventures to get access to the Chinese market.

The three biggest reason companies form a Joint venture is explained in much more detail below:

Pooling of Resources

The joint venture allows for both companies to leverage their resources to achieve the goals of the joint venture. One company may be great at manufacturing a product, but not so great at selling that product.

The other company may have a great distribution network, but its manufacturing facilities are not great. The joint venture allows both partners in the Joint venture to pool their best resources that will greatly improve the operational efficiency of the whole project.

The pooling of resources also allows both companies or partners to minimize risk while maximizing reward.

It also allows both partners to operate at a much larger scale than any of the single partners would be able to only own their own. This scale allows for better negotiation terms with the suppliers.

By pooling both of their resources, companies are also able to produce new and innovative products that help them capture more of the market share. This way both of the partners can unlock new growth segments.

Cost Savings

Joint ventures are a great way to reduce costs. The scale achieved by the combination of resources of both companies can help achieve great cost saving.

In economics, this is called economies of scale, which is that a higher number of production numbers of the same product can lead to a lower cost per unit of the product.

See also  Long Term Finance: Sources, Advantages, And Disadvantages

The other way Joint ventures reduce the cost of operation and production is by implementing technology changes that would have been expensive to implement alone for both partners.

There is also a huge reduction in fixed costs such as research and development due to the joint venture formed by both companies.

This is because both companies can share the equipment and software they are using for research and development.

The combined expertise of both companies also allows for better management of resources which leads to a cost reduction.

The joint venture also allows for shorter production lead times, which means a company is able to change its production goals relative to the demand and consumer taste which also increase the revenues and profits for the company.

Combining the expertise

One company is better at making products, the other is better at selling them, by combining both of their expertise, the companies are able to increase their revenues, quality of products is also improved drastically, while costs of products are also reduced dramatically.

Each of the partner companies is able to combine its skill set to achieve the goals of the Joint venture.

For example, Foxconn and Apple Joint venture. Foxconn is a contract electronics manufacturer, while Apple is a products and service company.

Foxconn holds expertise in manufacturing, while Apple holds expertise in supply chain management and software development.

Both companies are able to leverage their expertise to create value for both themselves and the consumers. This increases the revenue and profits of both companies many folds.

See also  Mortgage Loan Underwriters: What is Mortgage Loan Underwriters? How to Become a Mortgage Loan Underwriter?

Advantages of a Joint Venture

There are many advantages of joint ventures. The main advantages of joint ventures for both parties are as follows:

1) Maximize profits and minimize costs by achieving scales of economics.

2) Pooling of physical resources between the partners.

3) Opening of new markets for one of the partners.

4) Getting hold of new technology for one partner.

5) Filling the gap in people or skills resources.

6) Addition of new sales channels.

Disadvantages of a joint Venture

The main disadvantages of a joint venture are as follows:

1) Corporate culture clash between the two partners.

2) Losing core technology to the joint venture partner.

3) The synergies are not available in the joint venture.

4) Issues of management.

Conclusion

A joint venture can be a great way for partners to meet the common challenges being faced by both of them.

The combination of resources and expertise can drive a great synergetic union. But, it should be kept in mind before forming a joint venture the main issues that may arise and how to deal with them.

Scroll to Top