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How to Manage Alliances Strategically Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for How to Manage Alliances Strategically case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. How to Manage Alliances Strategically case study is a Harvard Business School (HBR) case study written by Ha Hoang, Frank T. Rothaermel. The How to Manage Alliances Strategically (referred as “Alliances Alliance” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, .

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment






Case Description of How to Manage Alliances Strategically Case Study


This is an MIT Sloan Management Review Article. Two key strategic alliances were crucial to the early success of Tesla Motors Inc. A partnership with Daimler AG provided a much-needed cash injection; a partnership with Toyota Motor Corp. gave Tesla access to a world-class automobile manufacturing facility located near its headquarters in Palo Alto, California. In 2014, Tesla Motors signed yet another strategic alliance -- this one with Panasonic Corp., a world leader in battery technology.The alliances highlight the fact that companies may not need to own all of the resources, skills, and knowledge necessary to undertake key strategic growth initiatives. When conditions are uncertain and the stakes are high, partnerships can be an attractive alternative to going it alone or to mergers and acquisitions. Accordingly, many companies now maintain alliance portfolios. As a result, executives must manage multiple alliances with diverse partners across the globe simultaneously. However, the skills required to develop and manage alliances are still not well understood. In this article, the authors attempt to address these shortcomings by offering an integrative and holistic framework of alliance management along with practical guidance. Although strategic alliances are often viewed as a critical tool for pursuing growth opportunities, recent survey data suggest that roughly half of alliance portfolios underperform. Although the assessments of performance are subjective, it is fair to say that many alliances fail to live up to expectations. Why? As the authors found in their research, companies move at different rates down the learning curve related to managing alliances. Smaller companies may have advantages in this relative to larger partners because they are usually less complex internally and have stronger incentives to learn. Moreover, the benefits of alliance experience depend on the extent to which the organization can actively capture and leverage its experience (for instance, one partner may be able to draw additional benefits from an alliance, while the other may continue to make the same old mistakes). Hence, the authors argue, companies need to take a holistic and strategic approach. Tesla, for instance, doesn't view its alliances as individual deals but as part of an overall strategy to establish a new standard in automotive technology and, along the way, to gain a competitive advantage. Much prior research on alliance management has tended to focus on one aspect of the process -- for example, how to manage a stand-alone alliance. The authors note that executives often need to manage multiple alliances at once with partners in different geographies and at different stages of the alliance life cycle. Using the experience of Lego A/S as an illustration, the authors present a process framework with five distinct steps (partner selection, deal negotiation, execution, exit, and portfolio management).


Case Authors : Ha Hoang, Frank T. Rothaermel

Topic : Strategy & Execution

Related Areas :




Calculating Net Present Value (NPV) at 6% for How to Manage Alliances Strategically Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10029727) -10029727 - -
Year 1 3472281 -6557446 3472281 0.9434 3275737
Year 2 3981151 -2576295 7453432 0.89 3543210
Year 3 3958682 1382387 11412114 0.8396 3323786
Year 4 3223835 4606222 14635949 0.7921 2553579
TOTAL 14635949 12696312




The Net Present Value at 6% discount rate is 2666585

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting


What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.




Capital Budgeting Approaches

Methods of Capital Budgeting


There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Internal Rate of Return
3. Profitability Index
4. Net Present Value

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Alliances Alliance shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Alliances Alliance have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.






Formula and Steps to Calculate Net Present Value (NPV) of How to Manage Alliances Strategically

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Strategy & Execution Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Alliances Alliance often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Alliances Alliance needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.



Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 15 %
Discounted
Cash Flows
Year 0 (10029727) -10029727 - -
Year 1 3472281 -6557446 3472281 0.8696 3019375
Year 2 3981151 -2576295 7453432 0.7561 3010322
Year 3 3958682 1382387 11412114 0.6575 2602898
Year 4 3223835 4606222 14635949 0.5718 1843238
TOTAL 10475833


The Net NPV after 4 years is 446106

(10475833 - 10029727 )








Calculating Net Present Value (NPV) at 20%


If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 20 %
Discounted
Cash Flows
Year 0 (10029727) -10029727 - -
Year 1 3472281 -6557446 3472281 0.8333 2893568
Year 2 3981151 -2576295 7453432 0.6944 2764688
Year 3 3958682 1382387 11412114 0.5787 2290904
Year 4 3223835 4606222 14635949 0.4823 1554704
TOTAL 9503864


The Net NPV after 4 years is -525863

At 20% discount rate the NPV is negative (9503864 - 10029727 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Alliances Alliance to discount cash flow at lower discount rates such as 15%.





Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Alliances Alliance has a NPV value higher than Zero then finance managers at Alliances Alliance can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Alliances Alliance, then the stock price of the Alliances Alliance should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Alliances Alliance should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.






Negotiation Strategy of How to Manage Alliances Strategically

References & Further Readings

Ha Hoang, Frank T. Rothaermel (2018), "How to Manage Alliances Strategically Harvard Business Review Case Study. Published by HBR Publications.


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