Joint Venture Risk Analysis

This report analyzes the risks ELD would be exposed to on its decision to go ahead with the proposition placed forth by FIH for joint venture partnership. Following are the four identified risks with the acceptance of the joint venture proposal: 1. Management Risk 2. Overseas Risk 3. Default Risk 4. Exchange Risk

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Joint Venture Risk Analysis
Joint Ventures refer to a joint contractual partnership between two entities that are based on
profit-loss and risk sharing methodologies. For ELD and FIH, the joint venture would be
termed as an international joint venture with various risk pertinent to the professional
relationship. This report analyzes the risks ELD would be exposed to on its decision to go
ahead with the proposition placed forth by FIH for joint venture partnership. As the thorough
analysis conducted by the ELD about FIH, there are certain points that lie proportional to
ELD's expansion plans, for instance the rapid growth experienced by FIH, whereas, some
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contradict or appear as red flags to the company's anticipation of good returns, for instance,
no reported profits from time of inception up till the current date. However, through joint
venture proposition, better decisions can be taken to uplift the two companies in the UK
region, providing them with a joint understanding, with risk and reward sharing strategies, to
minimize the exposure of each of the company, whereas, ensuring the maximum returns are
reaped from the monetary and time-based investments conducted by each of the entities
involved.
Following are the four identified risks with the acceptance of the joint venture proposal:
1. Management Risk
2. Overseas Risk
3. Default Risk
4. Exchange Risk
Below is the brief description of each of the risk in the context of the joint venture proposition
of ELD and FIH in the UK region. Furthermore, a brief understanding of the four T's risk
management framework is developed in the same context, to better understand what risk
mitigation or management strategies are effective or useful for each of the mentioned risk
exposures.
Management Risk
The first risk that the company would be exposed to is Management risk. The usual issue
with joint ventures is the clash of cultures and management styles. At a higher level, it is a
joint effort to bring together to companies to achieve a common goal and partake a share in
risk and rewards that the venture entails. However, at a closer inspection, it is evident that
there is more that is at conflict then what meets the eye. The differences in culture of
workspaces along with management styles, can lead to clashes and probable delays in how
processes are effectively carried out on each of the individual entity. Furthermore, the
differences can lead to inefficiencies that further impact the viability of the joint venture,
risking the partnership before it even has time to mature.
For ELD, there is a substantial amount of management risk involved, considering the biggest
difference of US-UK best practices, that might not be correctly implemented, or may be
conflicting. This can cause bottlenecks in the projected progress of the company. To deal
with the management risk, a more open and welcoming culture can be introduced through
introductory meetups to get the employees and managers to interact at an informal level and
understand either of the company's best practices in their respective areas.
Overseas Risk
Another risk associated with proceeding with the joint venture is the overseas risk, that is
closely related to the management risk faced by the two entities. Since ELD intends to
initiate their joint venture in the UK and therefore, would need to invest time and money to
understand their cultural practices, their laws and taxation processes. The taxation laws may
be more relaxed in the UK than in the US, allowing a certain amount of flexibility, however,
changes in laws governing businesses and franchising can change and cause adverse
effects to the company. This risk is further analysed, and mitigation is suggested through the
four T's of risk management framework in the proceeding section. Conclusively, it is a
higher-level risk that cannot be mitigated through financial means and would require
termination and not dealing with it on an immediate basis.
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Default Risk
The default risk is referred to as the likelihood that a company will go bankrupt or be unable
to keep up with their end of the bargain, in this scenario, the risk-reward sharing in the joint
venture. FIH has experienced rapid growth over the last few years. However, one alarming
situation is it has not posted any profits till date from its inception in 2006. Further analysis of
the financial statements can add more clarity to the subject matter. However, the situation
can be assessed at a higher-level as requiring further investigation. Thus, the default risk is
more pertinent and would require effective mitigation tactic to hedge against it, provided the
company chooses to go through with the joint venture. Insurance and similar alternative
hedging products can allow for reduced exposure to the default risk caused due to partaking
in the joint venture. ELD is currently heavily insured and therefore, can look into moving
ahead with this decision of initiating a joint venture. It is recommended, however, to assess
and include more financial products for international businesses and related risk and
insurance.
Exchange Risk
Lastly, a major risk that international businesses are prone to be exchange risk. It is referred
to as undesirable fluctuations in the exchange rate of the currency of the home country and
the country where the business is being established. The exchange risk can drastically skew
the projected budgets and forecasted sales, causing anticipated profits to turn into
breakeven or much worse, as losses. Usually, political and economic scenarios cause
fluctuations in exchange rates. They are also heavily influenced by the involved countries.
The relationship between the UK and the US are strong and therefore, lesser at risk of
exploiting the exchange rate of the two countries. However, an internal matter of Brexit can
cause the UK pounds to drastically drop, as it was observed in the Brexit referendum in
2016, causing the pounds to sharply decline and depreciate in the open market. The risk can
be hedged against using specialised financial instruments and would require funds to ensure
the exposure to the exchange risk is reduced to as low as possible.
Three Risk Financing Solutions
Each of the suggested risk exposure would require a certain amount of risk financing. Risk
financing refers to the accumulation and allocation of funds to mitigate the risks, in this case,
of proceeding with the joint venture with an international company situated in another
continent. Following are the three suggested risk financing solutions that are suggested for
each of the above-mentioned risk exposure after analysis through the four T's framework of
risk management, as briefly discussed alongside each of the financing solutions.
1. Insurance
2. Derivatives
3. Do Nothing
Each of the risk financing solutions is discussed below with the intent to understand the
particular risk it targets to resolves, following its strategy used based on the T's of the risk
management framework.
Insurance
ELD is currently heavily insured and has a very low-risk appetite. Banking on the same
financing method, insurance is an effective and reliable method to mitigate some of the risks
that were discussed above. For instance, for management and default related risk
exposures, insurance products can be sought after that cover a certain portion of the risk
through regular premium payments made by ELD. Furthermore, through the transfer
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technique, as suggested through the risk management framework, can be employed by
sharing the risk of failure with FIH. ELD can invoke FIH to take a larger share in the risk
mitigation tactic, considering the company would be operating in its locality. Through similar
streams protracted as an insurance product, the same can be employed with the joint
venture risk sharing or transfer technique. This methodology will tackle the management and
default risk of the four risk exposures of the ELD company.
Derivatives
For risk such as the exchange rates, hedging and limiting the exposure has been made very
convenient through the usage of derivatives and specialised financial instruments. These
instruments are specially designed to offset the fluctuations in the respective underlying
asset and therefore, are effective products for minimising risk exposure by taking on a risk-
neutral stance. Options and swaps are generally used with the foreign exchange that allows
for fixed rates and hence, allowing for the reduction in losses overall. Options are rights, but
not obligations, to buy or sell a security at an agreed upon price. Therefore, pounds can be
the underlying asset with a pre-fixed price that allows ELD to limit their exposure to
exchange risk. Swaps are instruments that allow for swapping cashflows through an
intermediary, thereby only reducing the exchange to the differences in the exchange rates as
opposed to the entire amounts. This is particularly useful for loans and other such debt
financing related options that ELD might opt for to initiate the joint venture business in the
UK. The exchange risk can, therefore, be mitigated using the treat factor in the risk
management framework.
Do Nothing
As for the last risk financing measure, that pertains to the risk exposure to the management
risk is doing nothing. As per the risk management framework, terminate refers to the act of
eliminating the possibility of exposure to the risk in the near future. The concept is that there
is not much mitigation or reduction in the risk exposure that can be obtained through
financing or other measures. Therefore, the best strategy is to proceed with the business
considering the minimal impact of the risk mentioned. In this case, the overseas risk cannot
be effectively mitigated and is tied to more severe players in the market and events beyond
the control of the company. Therefore, the company can choose to eliminate the risk from its
risk management tactics and proceed with the business as is. However, with management
clashes, one preferred method of mitigating that risk is through investing in formal and
informal events to reduce the cultural gap between the two managerial teams of the
company. This, however, would require the company to invest in its human capital and
cannot be mitigated but reduced through proper training and workshops of the parties
involved.
Advantages and Disadvantages of risk financing solutions
Each of the risk financing solutions comes with its own advantages and disadvantages. Each
of the above-mentioned risk financing solutions has its pros and cons; therefore, requires
further analysis before it can be adopted as a measure of mitigation by ELD company.
Hence, in this section, each of the risk financing solutions is explored in terms of its
advantages and disadvantages to the ELD company if it seeks to adopt it as its risk financing
measure.
The first risk financing solution is an insurance product. Insurance is a reliable solution in
terms of the fact that it tends to cover most of the specified areas of risk exposures. The
specialised products as well tend to cover more areas than the conventionally offered ones.
The advantages of using insurance as a risk financing product are that firstly that the cash
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outflow is broken down into smaller portions, spread over a very long period. Mostly, the
insurance outflow is infinitely ongoing until the specified event occurs. In case of the event
occurrence, no matter how low the probability, the insurance company is likely to cover the
maximum of the losses incurred by the client company.
Through specialised and alternative insurance products, the events covered, and the areas
insured can be customised to fit the need of the client company, although it incurs larger
premium over time but does the job of financially covering the potential losses. However, the
disadvantages of the insurance product are the limitation of the coverage. Despite the
customisation and even in the conventional products, the coverage of the area can be very
strictly specified, ruling out many of the areas that should ideally fall under the coverage or
are not anticipated due to the likely losses. Furthermore, another disadvantage of insurance-
based products is that it can be very costly. The risk appetite of ELD is very low, and they
are currently already heavily insured. A further addition to the insurance products, that too
involving international business opportunity would ultimately lead to higher costs that might
adversely impact the forecasted sales and revenue generation, leaving very little to no
amount left for profits.
In case of derivatives, the biggest advantage is the flexibility of the instruments to allow you
to engage in the contract, in case of options, without the obligations to fulfil it given the
fluctuations are not in favour of the company. However, the disadvantage in using
derivatives is the option costs that are not redeemable and in case of not exercising the
options, would result in a loss limited to the option costs. Similarly, for swaps, the
intermediary may require a higher percentage and therefore, cause either of the parties to
sustain higher costs in case of currency depreciation or major fluctuations in the exchange
rate.
Another advantage of using derivatives is that the involved parties can customise the
contracts to suit their needs. Most of the financial instruments or derivatives are traded over
the counter and therefore, dealt with in de-regularised markets. This is an added pro where
the involved parties can structure the cash flows through using the options contract or a
combination of different contracts to minimise the losses, taxation and other such charges
through effective cashflows. This comes under the area of financial engineering, and
therefore, requires specialised members to take care of creating the right synthetic
instrument that is better suited for the involved parties. However, this de-regularised
exchanges and instruments is also a disadvantage as the involved parties take on an added
risk of default from the other entity since there is no guarantee that the party involved would
live up to its part of the bargain. Hence, derivatives may be sufficiently flexible and
customizable but have a risk to themselves as well and can be effectively costly too.
Lastly, the risk financing method of doing nothing is useful in the sense it does not seek to
invest large sums of money in mitigating a potentially undiversifiable risk. Therefore, it is
effective in the sense that it relies on doing nothing to mitigate the risk and hence, actively
surveying the political happenings to ensure the business does not incur any unwanted loss
or cost due to uncontrollable events before it is too late.
However, in the circumstances where it leads to an inevitable situation and the potential
issues are incurred, then the same advantage becomes a disadvantage. The decision to not
act in the presence of risk needs to be duly well-informed to ensure in case the event occurs,
the losses are minimised or were anticipated. Therefore, in the case, for instance, some
political instability in the democratic relationship between US and UK or within the UK itself,
there can be significant losses incurred to the company due to, for instance, unavailability of
resources, natural disasters, etc. There should be sufficient backup funds to recover from
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disasters and losses. However, there can be no surety as to how much the potential losses
will be. Hence, the disadvantage of this strategy is much greater in magnitude, especially for
a company that actively avoids risk and has a very low-risk appetite profile.
Recommended Risk Financing Solution
Based on the analysis presented in the report, and the exploration of each of the risk
financing solutions offered, the recommended risk financing solution for ELD would be a
combination of the proposed solutions.
Considering how each of the risk associated with the joint venture has its own
characteristics, therefore, a combination of the risk financing solutions would ensure
maximum mitigation of the said risks and reduced exposure to each of them at a minimal
possible expense, while keeping in mind the low-risk tolerance of ELD.
The suggested risk financing solutions cover major aspects of the losses and therefore, offer
a holistic coverage to the risks involved. This allows ELD to better position itself in the joint
venture and proceed with it to maximise its outreach in the UK. From there on, it can seek to
expand the businesses to the US and other regions of the world, provided it generates and
meets its sales and revenues targets as projected at each of the quarter.
If ELD chooses to proceed with the joint venture and adopts the risk financing solutions,
namely using insurance to handle management and default related risk exposures, using
derivatives or specialized financing instruments to handle exchange rate risk and finally,
terminating the overseas and management risk by doing nothing considering the out-of-
scope factors involved in the risk measures, ELD can effectively benefit from the joint
venture and be able to generate positive cash flows from the partnership. Its international
expansion would further enable it to explore different horizons of investments, diversifying its
business across multiple regions. Such a form of business is in itself a diversified, market
neutral investment which seeks to perform effectively overall, even if in certain regions of the
world it does not fare so well.
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References
Journal Articles:
Bing, L., Tiong, R. L. K., Fan, W. W., & Chew, D. A. S. (1999). Risk management in
international construction joint ventures. Journal of construction engineering and
management, 125(4), 277-284.
Pan, Y., & Li, X. (2000). Joint venture formation of very large multinational firms. Journal of
International Business Studies, 31(1), 179-189.
Park, S. H., & Russo, M. V. (1996). When competition eclipses cooperation: An event history
analysis of joint venture failure. Management Science, 42(6), 875-890.
Monios, J., & Bergqvist, R. (2015). Using a “virtual joint venture” to facilitate the adoption of
intermodal transport. Supply chain management: an international journal, 20(5), 534-548.
Mata, J., & Portugal, P. (2015). The termination of international joint ventures: Closure and
acquisition by domestic and foreign partners. International Business Review, 24(4), 677-689.
Websites:
Benefits and Risks Associated with Joint Venture, Link: https://prowsechowne.com/benefits-
and-risks-associated-with-joint-ventures/
Joint Ventures and Business Partnerships, Link:
https://www.nibusinessinfo.co.uk/content/joint-venture-benefits-and-risks
Business Risks: Joint Venture, Link: https://www.allianceforintegrity.org/en/offer/Business-
Risks/Joint-ventures.php
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Glossary of keywords
Analyse
Find the relevant facts and examine these in depth. Examine the relationship between
various facts and make conclusions or recommendations.
Construct
To build or make something; construct a table.
Describe
Give an account in words (someone or something) including all relevant characteristics,
qualities or events.
Devise
To plan or create a method, procedure or system.
Discuss
To consider something in detail; examining the different ideas and opinions about
something, for example, to weigh up alternative views.
Explain
To make something clear and easy to understand with reasoning and justification.
Identify
Recognise and name.
Justify
Support an argument or conclusion. Prove or show grounds for a decision.
Outline
Give a general description briefly showing the essential features.
Recommend with reasons
Provide reasons in favour.
State
Express main points in brief, clear form.
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