Monster Under THE BED.

Strategic partnerships of all kinds are fast determining the zones of competition on the Web.

But how do you take advantage of the opportunities without being eaten alive?

Even those not moved by industry buzzwords like coopetition and strategic synergy would have to pay heed to statistics that show CEOs are focusing more than ever on savvy alliance building. According to an Ernst & Young survey of computing and electronics business leaders, more than two thirds of CEOs expect to increase marketing, technology licensing, joint product development, and distribution alliances over the next five years. More than two-thirds say alliances are critical to their strategic plans. Most want to access new markets; others see enhanced distribution as key for developing partnerships.

Interestingly, though, almost three-fourths recognize that alliances fail primarily because of overly optimistic expectations, poor communications, and a lack of shared benefits. In the following panel discussion held in partnership with BMC Software at CE's New York dotCEO conference, BMC's Max Watson, Koch Ventures' John Pittenger, and uBid.com's Greg Jones lead a discussion among e-commerce business leaders on the use and misuse of alliances and joint ventures in furthering a company's strategic goals. Watson, whose company is an industry leader in delivering application service assurance solutions and e-business management systems, warns against "press release partnerships" that are more triumph of hope than mutual commitment. Pittenger also warns that alliances should not be used a substitute for strategy. uBid.com's Jones notes the alliance-building concerns from the startup's point of view.

In the end, most agree that contracts don't cover close relationships, which is what an alliance must be about if it hopes to survive. Trust, commitment, and transparency are more important, say participants, if one sees the alliance as part of a broad, long-term aim.

Ultimately, such attributes must come from the CEO. One never knows when circumstances will change, and having a plan for an amicable separation is better than a messy divorce-- particularly when valuable intellectual property hangs in the balance.

Meaningful Relationships

Max Watson (BMC Software): You're seeing a lot of partnerships--what we call "press release partnerships"--where people decide that there's some market event they want to take advantage of and they kind of piggyback on each other. A press release goes out and six months later everybody wonders what the hell happened because there's no substance to it.

At BMC Software, we believe that in order to have a meaningful partnership there should be some substance behind it, and that means a couple of things. One is that there has to be shared risk and shared reward. The risk means that you develop as part of the partnership's interdependency so that both parties have to deliver. It's not a one-way situation. Each is dependent on the other for certain things. And the rewards should obviously be mutually shared.

We have a relatively small set of partnerships we engage in because we feel like we want to put the energy behind them. And, over time, unwinding a partnership can be very difficult because we're in the intellectual property business. It's hard to break up ideas or to dismantle ideas and say, "This was our idea, not yours, so we're taking it when the partnership's over." But when it's done right and there's shared dependency and shared reward, it can be very meaningful.

John Pittenger (Koch Ventures): It's my experience that there's no difference between the principles that guide dot-corn alliances and those that guide traditional alliances.

First off, you don't do alliances for "announce-ware" and you don't do them for press releases. The biggest thing we see as investors is that every small company has an alliance with some Fortune 500 company because it lends credibility. And there's nothing wrong with that but, rest assured, if you put that down in an investment book or a PPM, the first thing we do is call that company and find out what the nature of the alliance really is. And those contracts are always subject to a lot of inspection. So we take that with a pretty large grain of salt.

In e-commerce, I think Fortune 500 companies started to enter into joint ventures to give the illusion of progress, and I think there's a strategic element, too. Alliances and announcements are used in many ways as preemptive strategies; people use them as a blocking mechanism, or at least to frighten people away from trying to get into a given business.

Over the years, we've learned that a coalition is not a strategy; it's a means to achieve a strategy. If you don't have a very specific objective in mind, then you're doomed to fail. Second, the benefits of any kind of combination between two entities--we use this as a rule of thumb--have to be at least 10 times what you think the costs are because the costs will be five times what you think they are. These are very unwieldy, messy organizations and they take a great deal of management time. Third, you have to keep things simple because the cost goes up geometrically with the number of times you have to contact two entities or the number of entities involved.

Gregory Jones (uBid.com): We were purchased by CMGI for about half a billion dollars in January, and we were wholly acquired. I believe that's one of the best alliances you can have. What CMGI has done with us is leave us alone--and that's a great way to acquire a business. If you believe in the business and you believe in the management team, you believe you can add value with some of their other properties, which is the way that we've been set up. What they've done is take a lot of the hassles of alliances and integration, and all the problems that are created with acquisitions, mergers, and strategic partnerships, and they've basically said, "You run the business, you make the numbers, and we're going to help fortify that and leave you alone."

CMGI set it up so that the rewards for our business unit are pretty substantial, if we meet the objectives they're looking for and bring the company back out all right. Even if there's friction in the synergies of the companies or the chemistries of the businesses, if the rewards are great enough and the upside is great enough, you'll magically see those teams come together and work forward towards a progressive goal.

From my perspective, it's real simple: It's got to make money and it's got to be good for you as well. I also think the best way to do it is find the right management, let it move on its own, and don't interrupt it. Instead, provide the financial incentives necessary to make a very successful movement in that area.

Mine, Yours, or Ours?

Donlon: It's obvious that when an alliance is created, some degree of intellectual property is generated by that. So who really owns it? How is it shared? And when the alliance no longer meets its originally stated goals, when does it have to be unraveled?

Watson: That's where we've had the biggest difficulties in doing joint ventures. Where do you draw that line on intellectual property? Who does what and the contamination at the edge is clearly going to bleed over into both parties.

The divorce mechanisms and the understanding of those mechanisms up front are

probably the greatest inhibitor to doing joint ventures in our business. How do you clean it up when it has to unravel? And sometime it will. It's the divorce situation that keeps us from getting married in the first place and understanding that.

Pittenger: The joint ventures we've done closest to that are when we're the trading entity connected to an asset. What we found in those things is that you just grind through all the details as best you can, find out whether it works or not, do as much preparation as you can, and at the end of the day it's got to be good for both parties. If it isn't, have a quick divorce mechanism and get on with your life because that's the only thing we found that works.

By having the divorce mechanism, if, in fact, the intellectual property does get nebulous in the middle and something belongs to the joint venture, you've got a jump ball on who's going to bid for that. At least the other side gets 50 percent of the profit, so I'm a big believer in mutual buy-sells as well, and when you can force that kind of closure with both people involved.

Jones: The idea of a quick divorce is always a good one, but it's awfully hard to figure out how to make that happen and make everybody committed at the same time. I think this is where the rub comes in any type of transaction or deal. Mutual buy-sells seem to be the best way to do that or a 'shoot-out' where you can buy it out for X price, make an offer, and the other guy can take it for that price.

But you end up spending an enormous amount of time in that stage of the transaction, the joint venture, or the relationship in figuring out how to resolve those scenarios. And the venture is awfully impaired during that period--and it can be months until the thing is fixed.

Spectator Sport

Mark Blumenthal (Microfranchise Development Corp.): If you're clearly a small fish dealing with a big fish, the buy-out seems to be the way to go, if I'm understanding Greg's remarks correctly. My issue is valuation--whether it's getting involved in a buy-out, just selling, or whatever. I find that's always the stickiest point.

Jones: Very low valuations have actually turned out to be much better deals than very high valuations, I have a philosophy--and I hope this is true-- that most management teams and companies that have been run by a management team for a while or have a strong track record, always do what's best for the company as whole. That may mean a lower valuation. The venture capital guys always want to have the highest valuation and that's their business. They're doing what's best for their business, but the reality is that it's the CEO's and the board's responsibility to do what's best for the corporation regardless of the situation.

Pittenger: In a shotgun, a prior right to purchase, or some other kind of structure, with adequate time, you can actually get to a market value. If the person who ends up with the buy side thinks there's a better alternative or a different strategic alternative, he'll take it in that direction.

The problem there is liquidity differences. That is, we've got IX dollars in cash and you've got .1X dollars in cash. I think that's where you get in kind of the rub in a buy-sell. How do you provide adequate time for the person without the liquidity to acquire it? And presumably he can go acquire it by working with other bidders who are willing to back him on his vision. So, however you get there, you get to a market-based mechanism.

Peter Karoly (eRad): If you're creating new software that brings new technology into a vertical market, how do you create channels of distribution that are fair, competitive, and don't step on each other?

Watson: Channels have always been an issue. We have our own sales organization around the world and we sell our products that we develop to customers and prospects. If you look at Dell and Compaq, they have totally different business models, but both of them seem to be working. So, our attitude is that there are a variety of models you can use, you have to try some. Some are going to work, and some are not. It depends on particular markets and particular product segments.

We've recently done, I won't say a joint venture, but a partnership with KPM, which is a Dutch telephone company. It's a shared view of where a particular market should go. We're sharing technology and they'll be a channel for us. It's the first one where we've had a large telco be a channel. We're trying it, but we don't know if it's going to work or not. They think it's going to work, we think it's going to work, and we have the mechanisms in place, if we do have to unwind it.

John Ballentine (Enron Management Services): You guys have described a lot of the process for participating in alliances and joint ventures. Contrast that, if you will, with the decision process for participating in marketplaces, hubs, and exchanges.

Watson: If you look at marketplaces, we've gone into them in a variety of different ways. We are a substantial supplier to the ASP/ISP market. Some of them are well funded and want to buy products in the traditional manner. Some of them want to share risk and share reward, so we've gone to a model, in some instances, where we'll do it on a per-user basis; as they grow, we grow. We're making it up as we go and we'll entertain a lot of different ways to do things. We're working hard not to be constrained by our earlier biases and earlier concepts.

Jones: We feel the exchanges as technology businesses or as dot-com businesses are going to be unsuccessful. We feel the same thing, by the way, about all fixed-price commerce on the Web. We don't think any of those companies will survive either. You have to bring more value than just being a different channel of distribution or just bringing technology and saying, 'I'm a service provider for exchanges.'

You have to have tremendous domain expertise. Some companies are fixing the supply chain problems that have existed for years and they'll make their money on inventory turn improvement and all kinds of great things and reap a ton of money for companies. But the reality is that those suppliers are still going to be the same suppliers that exist today.

Pittenger: If you break exchanges down, the matching function in and of itself is not particularly valuable. And the entry barriers to a matching function are nothing once you can entice liquidity to an exchange. In that particular case, liquidity is a mobile asset and liquidity can be bid away from different exchanges, so we don't see it as particularly sustainable either. When you get behind the guts of the exchange--confirmations, credit delivery, assurance of delivery, nonrepudiation of a trade, and things that require more than just a matching engine-the company that can build that up can have a reasonably successful exchange.

In the long run, though, the value added in an exchange, as we see it, is not particularly compelling. A lot of exchanges have been around for a long time and they don't have particularly great values, but if you can convert that exchange, and the traffic on that exchange and continue to add different services that do add value to it, that's our vision of longer term success.

Jeff Miller (Andersen Consulting): Could you give us some perspective on what might be different for the early-stage, still-private dot-com looking at the venture and alliance opportunities, particularly with regard to how the business rationale might be different and the underlying business case might be different?

Pittenger: In a dot-com or a fast moving startup, the strategy nine months from now probably isn't what it was nine months ago and you're going to have to adapt fairly quickly. One of the big differences would be that the joint venture has to be more about the intangible glue. You have to have a higher level of trust and cultural exchange, and you've got to make the process work to adapt much more quickly.

The second thing is the dot-com, depending on where the capital market is this week, may or may not have liquidity. As a dot-com entering into a joint venture, as someone who has liquidity, I'm going to want to have a buy-sell agreement and be able to buy or sell what I want to buy. The dot-com that has a more difficult time will want a longer duration, if possible, of the original agreement. That is, they'll probably want a three- or four-year period, and in venture capital terms, that would typically be the time before redemption rights. So that duration would be valuable.

Lastly, if I were a dot-com going in, I would insist on a really rapid dispute resolution mechanism. If there were more rapid dispute mechanisms, the more able you are to get up to the CEO, the better shot you have of not being strangled to death by middle management.

Joe Michaels (Nexchange): We syndicate stores for retailers, which have fixed-price as their model. Since Greg predicts that they're all going to go out of business, should I head home and prepare for Armageddon?

Jones: A conglomeration of a bunch of retailers working with them, doing distribution, and co-marketing is a different situation. I'm talking about a pure Internet retailer that's selling fixed-price online. We do not think that's a survivable model. And by the way, right now in Amazon's present form, we don't know how they'll ever make money. It doesn't seem possible right now. I think that'll change because they'll have a ton of traffic and be able to utilize that. Let's put it this way: I would never count them out.

But if you're just a fixed-price guy and your only difference is the Internet, I think that is an extremely difficult road. It'll be almost impossible to survive once the larger corporations like Best Buy, Wal-Mart--you can name all the huge niche players--enter the online space. They have all the relationships, all the buying power, the customer bases, and the advertising power.

Sandy Woodruff (HitComedy.com): We are hearing a lot about prenuptial agreements and, obviously, you are all many times married up here. [Laughter] What are the general problems that cause these unpleasant divorces?

Watson: Each side believes, in most cases anyway, that the value they're putting in is greater than the value the other side is putting in as far as intellectual property. Plus, over the course of this venture, new intellectual property is created and that has significant competitive implications after the divorce.

When you get into those areas, it's very difficult to resolve the property you bring in because now it's shared and in a competitive situation, you've now enabled a potential competitor. How do you share that? Do you just distribute it equally and everybody gets rights to it or not? The intellectual property contamination is almost insurmountable.

Pittenger: Asymmetry of information is one of the most important drivers of profitability. If everybody knew what we did, how we did it, and what our business model was, then they'd imitate it and we wouldn't make any money. So, the asymmetry of information between two parties forming a third entity is a big driver of the problem because the two entities don't necessarily want to give up all the information. They don't want to compromise their competitive position for the success of the entity.

I also think that many companies fail to measure the success of the enterprise for both parties, to see that they're gaining from it, because the tendency of any successful company is to think that they can do it better themselves.

Bill Van Emburg (Quadrix Solutions): A customer of ours, a startup, courted a VO for some period of time. Everything was going forward, but it turns out that the VC was also dancing with another startup and took the ideas gleaned from the one relationship and put them into the other. What are your thoughts on how you protect yourself from that kind of downside when you never quite make it to that checking the account or fee on the bottom line?

Watson: That's why I say it's very difficult once you start sharing information because you've done it and you can't get it back. You can try to do it legally on the front end, normally, in the situation you described. But it's very difficult because you're asking for help and somebody who's going to give you money is not going to give you a lot of protection. It's just a dangerous situation.

Pittenger: Organizations do have values and character--and they flow from the top. You have to invest a lot of time doing reference checks, spending time with the people who are involved to understand what kind of people they are, and, for right or wrong, this is an issue we're faced with every day as a venture investor.

You know everybody can make a fortune taking advantage of somebody once. So the question becomes, what kind of person are you dealing with and what's their reserve price on when they're going to take advantage of you?

Jones: My advice would be that you need to do as much homework as you can on the people and the company you're investing in. But you always have to have something else going so that, if it doesn't come through, you've got another option to play or another way to go.

Who's WHO 

* Greg Jones is CEO of Chicago, I based uBid.com, an online auction marketplace with $205 million in revenues.

* John Pittenger is president of Scottsdale, AZ-based Koch Ventures, a financial services company.

* Max Watson is chairman, president, and chief executive of Houston, TX-based BMC Software, a $1.6 billion provider of management solutions.