JV piggybacking: the pros and cons of purchasing shareholder-provided services
April 2018 | FEATURE | ACCOUNTING & FINANCE
Financier Worldwide Magazine
April 2018 Issue
Pooling resources is generally an advantageous strategy toward achieving a common goal. In the joint venture (JV) space this idea is a given, as many JVs are inclined to purchase services from a parent company.
The advantages of tapping into the knowledge and expertise of a larger association are substantial. JVs do so to access parent scale and expertise or to give their transaction an immediate boost. On the other side of the fence, such services can provide a parent company with added transparency, assurance and influence over day-to-day JV operations – for example, by providing financial management systems, accounting support, internal audit services or assistance in regulatory and government affairs.
“The concept of shared service arrangements can make sense,” says James Bamford, co-founder and managing director at Water Street Partners LLC. “They let a JV get off to a quick start without having to set up a separate back office, allow them to ‘piggyback’ off the scale of the parent companies and access expertise that may not be readily available in the market. They also offer shareholders a level of real-time visibility that keeps them from ‘torturing’ JV management with daily requests for information.”
However, perhaps inevitably, there is a catch. According to the 2018 Water Street Partners report ‘A Double-Edged Sword: Shareholder-Provided Services in Joint Ventures’, an estimated 60 percent of JV management teams claim to be dissatisfied with at least one dimension of shared-service performance.
“Most JV chief executives and chief financial officers are silently screaming,” believes Mr Bamford. “They feel that services are priced far above market rates – especially common when the JV agreement makes the JV captive to the service – and staffed with the leftovers not picked for high-profile 100 percent-owned shareholder projects, and forced upon them by shareholders at capability and volume levels far beyond what the venture actually requires.”
Satisfaction or discontent
It is cost with timelines of delivery trailing as the second leading factor – over and above concerns about the quality and efficacy of the guidance they receive, which is the factor that accounts for the greatest dissatisfaction among JV management teams. Add to this ineffective communication and a lack of mutual understanding, and a fractious shared services relationship is the result.
“The dissatisfaction around cost is for a variety of complex reasons,” suggests Mr Bamford. “The JV chief executive often has performance metrics that depend on meeting cost targets, but can lack control over up to 30 to 50 percent of fixed costs depending on how many mandatory services the JV must take. And the pricing model is rarely market competitive.
“Many shareholders treat the JV as a captive to extract rents from, while loading up the invoice with allocated service costs. In some cases, shareholders go so far as to bill the JV, inappropriately, for time spent holding strategy meetings, preparing for board discussions and travelling to the asset, which are not services to the JV but fundamental requirements of being a shareholder,” he adds.
According to the Water Street Partners report, in approximately half of JVs, better negotiation and governance, market-benchmarked pricing and more flexible service terms would allow the JV to reduce shared service costs by 10 to 35 percent. For a typical JV with $1bn in annual revenues, this would unlock up to $120m in shareholder value.
Bridging the gap
How then can JV boards bridge the gap between the services they are requested to provide and those they ultimately deliver? What is certainly beyond doubt is the need for them to be doing more to reverse the dissatisfaction expressed by their JV management team cohorts.
According to Water Street Partners, a board’s self-examination should include asking itself the following. First, when was the last time it took a hard look at its shared services and is the JV stuck in a shared-service model that is no longer appropriate? Second, how much transparency does it have into the real cost and performance of those services? Third, does it know how much the JV shared-services would cost if it purchased them externally, and is that even possible? Finally, do the JV chief executive and chief financial officer (CFO) wish to change certain usage levels or terms, but are effectively prevented from raising the issues out of concerns that doing so would create larger negative consequences?
“JV boards have been too passive on these issues,” says Mr Bamford. “They wear their corporate executive hat while neglecting their duties to the JV itself. It is time for board members to be asking some pointed questions to assess the value at stake in shared services.”
Irretrievable or repairable? The relationship between JV management teams and JV boards is clearly under strain, but this is surely a temporary aberration and not beyond salvation.
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