As a method of cooperation, BHP and Rio opted for a JV for a number of reasons. ... (yyyy) stated that each participant in a JV is motivated to promote its own self-interest but has determined that cooperation is the best way to achieve its goals. In order to understand the decision of Rio and BHP to form a JV, it is important to first understand its involved advantages. Cavusgil, Knight, & Riesenberger (2008) explained that separate companies can combine their operations strengths by owning a joint operation that they create together.
It must be noted that firms that enter into a JV usually expect to benefit in one or more ways (...). ... claimed that through the creation of a JV it is possible to combine the knowledge and technology abilities of both companies, allowing each firm to "gain knowledge and expertise that it lacks." According to many authors, a JV was also a way to reduce and spread individual firms' risks, attain synergy and competitive advantages and gain the benefits of rapid market penetration while keeping cost down (...).
To be more exact, this leads to maximum production that can increase the economies of scale and scope, consequently reducing the costs of production and transportation (Weston & Weaver 2001). Beyond that, a JV only exists for the main purpose for which it was created without combining the partners' total assets and diluting the company's ownership, like a merger or acquisition would (Astbury 2010). Indeed, Chen, Park, and Newburry (2009) state that the future growth of each company will be optimized through a successful JV due to a large and efficient investment of capital that would attract more opportunities and development.
All in all, Deresky (2008) concluded that JVs make it possible for the collaborating companies to grow globally, increase market awareness of their brands, and develop a positive public image among the partners.
BHP Billiton and Rio Tinto Joint Venture
... mentioned that the success of any cooperative undertaking depends on choosing appropriate partner(s). Regarding the specific case of BHP and Rio, the main reason of the formation of this JV was "to save their production costs in the Western Australian iron ore operations, penetrate the market widely, and mutually benefit from their overlapping resources (...).
With reference to BHP CEO Marius Kloppers "This JV brings together world-class iron ore resources, infrastructure and people and unlocks large synergies". Both Rio and BHP have their own iron ore production and, therefore, a JV between them means consolidation of production volume, expertise, knowledge, and skills as well as a reduction of overall costs and an increase in market negotiation power and greater economy of scale. Thus it can be said that their partnership will be complementary (BHP Billiton Group 2010 & Rio Tinto 2010).
In fact, BHP is the world's leader iron ore supplier while Rio leads in mineral resources mining. Accordingly, ... suggested that "their advantage of being world leading resource suppliers companies and experts in the industry would add more strengths, give them a competitive advantage against their competitors and create an even larger leading gap between the other iron ore companies."
Commenting on the JV, Rio Tinto Chairman Jan du Plessis said, "The JV will establish an unrivalled iron ore business with world class assets and infrastructure ... and will create a business combination ... with unparalleled efficiency" (Rio Tinto 2009, p. ##).
Precisely, Rio Tinto's superior expertise and competitive edge synergy in its vast ore reserves and iron ore assets in Western Australia complemented the strength of BHP's market penetration and increased their selling opportunities. In fact, Rio's superior iron ore assets and expansion potential in the Pilbara region were good possibilities for BHP to minimize its production costs and penetrate the Australian market more effectively.
Additionally, according to BHP and Rio's annual report of ..., the combined strengths of the two firms would "blend opportunities, maximize product recovery, provide further operating efficiencies, keep abreast of technological innovations, and optimize future growth opportunities."
For that reasons, Rio would also benefit from BHP's customer base, the flexibility to blend iron ore from any of their mines, the use of all rail and port infrastructure and combined production power in the Australian market. Further, According to Rio CEO Tom Albanese, "The full value of the synergies on offer from a 50:50 JV was a prize well worth pursuing" (yyyy, p. #). That is forming a JV with BHP enables Rio to increase number of diversified revenue streams and benefit from the ongoing business connections and will consequently protect them from harsh economic conditions and preserve their position as world leading resource supplier in today stiff competition.
Based on Porter's five forces analysis, were a partnership between Rio and BHP to place, the partnership would offset the threat of the entry of new competitors, respond to the intensity of competitive rivalry, and increase their supplier bargaining power (Appendix P...).
For the above reasons, it can be said that increase in profitability, cost reduction, and risk spreading are Rio and BHP's economic motives, while increasing their sales and growing their managerial prestige will satisfy their personal motives. Ultimately, the strategic motive for Rio and BHP's partnership decision is in the pursuit of market power.
Another aspect that cannot be ignored must also be examined. At the time of formation of this JV, there were a number of new competitors entering the market, in particularly, state-owned Chinese companies, due to a higher demand for iron ore in China as the country industrializes. In fact, according to ..., the mineral resource sector had been and is still facing a lot of competition; consequently, this situation led to even greater competitive rivalry. These reasons pressured Rio and BHP to enter into the JV agreement in order to produce more iron ore at lower cost and remain competitive.
Moreover, another problem which emerged was the global economic crisis from 2004 to present, which has increased the costs of production due to the rising costs in energy and lack of fungible money available to consumers (Ping, Yi-Hsin, Wenyi, & Hsueh-Liang 2009). This pressured the market and pushed several companies to develop strategies to overcome it and this pressure, which was also felt by Rio and BHP, forced them to consolidate and react to the market conditions by forming a JV.
However, during the mentioned period of time, Australia had not been as significantly affected by the global economic crisis (...). In addition, Australia presented an opportunity as a global trade destination due to its favourable taxation system (Astbury, 2010). On that account, these offered an opportunity to Rio and BHP where, through a JV, they could penetrate the Australian market more effectively.
In summary, because of the aforementioned circumstances, pressures, and market opportunities and to gain the advantages of a JV, a JV between Rio and BHP was proposed.
Question 2
2.1 Role and Impact of regulatory authorities on strategic business decisions
According to Carter and Jones-Evans (2006), a government can be a strategic planner, an economic agent, and a regulator that direct on political, economic, and social objectives as well as investments and trade. For this reason, ... pointed out that government intervention affects the normal operation of economic activity and business strategies by hindering or helping the ability of firms to compete.
... mentioned that, due to its ability to influence business activities through taxation and spending; through laws and regulations; and through business support, government intervention can alter the competitive position of companies in a number of ways. Consequently, government as well as other regulatory authorities have strong impact in making business decisions.
Indeed, companies must evaluate and identify government interventions and make decisions based on trade barriers, rule of law, business regulations, and intellectual property rights (...). This further emphasizes that regulatory authorities actually influence strategic decision making in companies.
2.2 Role and impact of the regulatory authorities in the process
For this reason, Rio and BHP have decided to end their proposed iron ore JV in Western Australia after extensive discussions with regulators. Owing to the fact that Rio and BHP are the world's second- and third-largest iron ore companies, combining their iron ore operations in Western Australia could hurt competition, affect the price of iron ore, coal, uranium, and aluminium and negatively impact the industry.
In fact, according to EUROFER director general Gordon Moffat the Rio/ BHP JV will "unavoidably lead to market concentration and an increase in pricing power of the combined company" (yyyy, p. ##). Precisely, since Rio and BHP operate in an uncertain scientific environment as they deal with mining of a natural resource, the global regulatory authorities and governments want to ensure there is sustainability and fair competition (Pattberg, 2006). The main goal of them is to advocate for fair competition; therefore, they do not permit companies to form anticompetitive agreements that may result in the restriction of economic growth (...).
Indeed, with reference to Tyson (2007), although a JV was mainly structured in the form of a JV, in actual sense it was actually the development of a merger. Because of that, a number of concerned governments and regulatory bodies led by the European Commission opened an investigation on anti-competitive behaviour to analyze the impact and potential risks of the venture on the economy and all the industries that are to be affected.
Another issue which has to be pointed out is that the regulators overseeing the Rio/ BHP JV are third parties. ... claimed that third parties play the role of expert, legitimizer, and provocateur in regulating the JV. On that account, the third parties provide guidance, challenged the status quo of the JV and verified the strategic decisions, risks, and impacts pertaining to the proposed iron-ore JV to prevent the possibility that companies might harm the interests of the consumer (Saxton 1995).
Therefore, the JV between Rio and BHP was cancelled on the grounds that the formation of the venture would end up realigning its minority shareholders, giving Rio and BHP too much bargaining power and harming consumer interest.
Nonetheless, despite the number of advantages third-party involvement seems to have, it frequently leads to adverse unintended consequences (...). Thus, weighing both the advantages and disadvantages of third-party involvement, it can be said that, because third-party intervention must be very carefully planned and implemented, determining the appropriateness of third-party involvement is extremely complex.
To conclude, considering the impacts and influences of regulatory authorities on business decisions, it's clear that as long as regulatory authorities influence the success of the formation of a business venture and as long as the formation of a business venture depends upon the approval of regulatory third parties, they will continue to play an extremely important role in companies' strategic business decision-making processes.
Question 3
3.1 Potential problems of corporate culture discovered when negotiating
According to ..., a JV can be a very useful vehicle of business collaboration. However, in order to successfully achieve the most desirable result, many issues must be addressed (...). The most common problems encountered in negotiating a JV are "partner compatibility, differing objectives and expectations, partners' contribution, preparation time and difference in culture" (...)
It can be said that Rio and BHP stood to benefit equally from the JV as supported by the fact that they were to form a 50:50 JV (BHP Billiton Group 2010). As such, these two companies had the goal of gaining a win-win situation and thus followed the Collaboration Style of the Five Negotiation Styles (Appendix P. ...). Therefore, both Rio and BHP had high interest in the negotiation outcome and the need for a healthy business relationship.
Nevertheless it must be noted that, even though both companies were following the same objectives which is to reach a win-win situation and seemed to equally contribute to the venture base on the 50:50 JV ownership ratio, Rio's shareholders' suspicions that the deal looked more favourable for BHP could have led to a lack of trust and, eventually, the failure of the collaboration.
In fact, some mining industry participants noted that "some within Rio have deep doubts about the JV... and wouldn't be concerned if competition regulators blocked it."
Shell (2001) advised that when one party shows minimal concern about the welfare of the other party and the JV's relationship, it is advisable to withdraw.
Another important issue that could cause problems is that "more often than not, firms take the partner's national culture for granted and conduct insufficient advance planning" (author, yyyy).
With reference to ..., the roles assigned to individuals in the UK and Australia differ, as do their approach to values and their thought patterns. Based on Hofstede's fifth dimension, both the UK and Australia tend to tolerate risk and have relatively short-term orientation planning.
This aspect is supported by the fact that, at one point in 2009, Rio had decided to walk away from a proposed investment of Chinalco during the negotiation in favour of a tie-up with BHP. This could have indicated a lack of long-term planning.
Supporting this allegation, essentially the same pattern also happened on BHP's side. Soon after, when it was apparent that the JV between them and Rio would not receive the necessary anti-trust clearances, BHP quickly switched their interest to pursue the acquisition of PotashCorp.
These facts should raise concern about both parties' frequent plan changes and the potential of lacking of long-term planning had the JV actually taken place.
Subsequently, it can be said that BHP and Rio's decision to form a JV might not have taken all the potential problems into careful consideration and that they might be far too hasty to enter into a JV contact, leading to a risk of paying costs related to the aborted deal that could have been easily avoided with more careful planning.
3.2 Potential problems of corporate culture discovered during the initial period
After the JV has been successfully formed, the two corporate cultures must merge; i.e., the Australian and the British cultures must combine. According to ..., cultural differences are a high risk impact as they could lead to poor understanding and affect the efficiency and operations of the JV. Therefore, it is essential to understand and merge both cultures in order to allow the JV project to be able to last until the agreed dissolution day.
Realizing the importance of the impact of corporate culture, several cultural analysis models could have been employed (...). One of the most influential culture models that have been widely used to detect possible culture differences and conflicts is Hofstede's Five Dimensions Framework. The next section is going to focus on the cultures of the UK and Australia and link them to BHP and Rio Tinto.
3.2.1 Hofstede's five dimensions
Hofstede's work identified five important dimensions along which people from different national cultures seem to differ. These 5 dimensions are social orientation, power orientation, uncertainty orientation, goal orientation and time orientation.
The individualism/collectivism dimension suggests that the UK and Australia are very individualist, with an individualism score of 89 and 90, respectively. Considering the dimension, the results imply that Australians and British value individuality.
The power distance difference between Australia and UK is minimal. The PDI dimension awarded Australia and the UK respective values of 36 and 35, which is relatively low compared to the world average of 55. This low PDI level indicates that there is a low level of inequality in power in both Australia and the UK.
The uncertainty avoidance dimension rates Australia and the UK as comparatively low uncertainty avoidance nations, with values of 51 and 35, respectively. The UK's score of 35 means British culture is rather open to taking risks and dealing with change. Nonetheless, in comparison to the UK, Australia is not too keen on uncertainty and risk taking.
According to Hofstede's culture model, the UK and Australia's cultures both have a fairly high masculinity dimension, listed at 66 and 61 respectively, compared to the world average of 50. If the Hofstede model is to be considered valid, the UK and Australia will place a high premium on good career, money, and assertiveness.
The last dimension is time orientation scale. The UK and Australia have low long-term orientation scores of only 25 and 31, respectively. This suggests that the UK is more likely to adopt a rather short-term outlook than Australia; that is, firms as well as people in the UK are likely to emphasize a short-term orientation, while Australia has a slightly longer time orientation scale.
To conclude, although the differences present between the two cultures would not be called extreme, if the JV of BHP and Rio would have gone through, these slight cultural differences could nevertheless have led to potential conflicts if they were left unmanaged. Therefore, it can be said that, if Rio and BHP would have analyzed both companies' cultures within Hofstede's framework, potential problems could have been encountered and avoided.
Question 4
4.1 Defining cost of capital and finance
According to (...), the cost of capital is the minimum acceptable rate of return on investment that must be realized in order to satisfy investors. ... claimed that the degree to which the cost of capital is critical in business decisions depends on the characteristic of each firm. However, ... noted the understanding that the cost of capital is critical within the business, decision making is ubiquitous to every firm, and that firms cannot expect long-term survival if they are unable to satisfy the burden of their financing decision and the cost of capital.
Indeed, investment naturally require capital and some form of finance. ... suggested that the method of finance that is employed by a particular firm defines its cost of capital and affects the amount of investment undertaken. Therefore, it can be said that, the investment and finance decisions of the firm are inevitably linked" (Brewster 1999).
Meanwhile, ... emphasized that companies with access to the greater volume of cheaper capital will be able to out-invest their competitors. As a result, firms operating under a less attractive capital environment fall behind and the gap between them and their competitors can grow very quickly (...). All in all, it can be concluded that different perspectives and understandings of the cost of capital can influence a company's competitiveness and the business decisions made.
4.2 Discussing strategic impact of different financing method
First of all, and in order to understand the strategic impacts of different financing methods, it must be noted that mergers and JVs often require enormous amounts of capital. To begin, most companies employ several types of capital, with equity financing and debt financing being the two most frequently used types. Although it's apparent that both financing methods are significantly different in nature, they have one feature in common; that is, the investors who provide the funds expect a return on their investment.
Rio and BHP had the option to finance their JV through equity or debt or a mix of the two depending on the market conditions, taxation, their attitude toward risk and the level of profitability required. Therefore, management's main aim is to identify the most efficient mix of these funds so as to obtain an optimal capital structure in order to execute investments.
For that reason, if Rio and BHP determine that their JV capital structure should have a heavier weighting of equity, this affect both companies' strategic decisions in a variety of ways. For instance, if they opted to issue ordinary shares, they risk handing over too much power to shareholders and relinquished voting control of the venture. Astbury (2010) mentioned that ordinary shareholders are entitled to company information, dividends and a right to vote. This means ordinary shareholders could potentially choose to exercise their voting rights and influence companies' strategic decisions.
Additionally, it must be noted that the issuing of new equities will not only dilute the current ownership of the company, but also cause the value of the firm and the holdings of its current shareholders to diminish. Further, Smith (2010) argued that equity capital is also expensive and its dividends cannot be used to reduce taxable profits.
Nevertheless, this source of finance also has its major advantages. With the equity financing method, the company only has to pay dividends after its retained earnings have reached a certain satisfactory point. This means the majority of the risk with this source of financing is borne by the shareholder.
Another one of the biggest capital financing method is debt. Issuers of debt are willing to finance companies due to the lower level of risk associated with it. The benefit of debt financing is that the rate of return is usually lower than that of equity as the borrower is already bound to meet the payback requirements. Moreover, debt financing has the potential to strengthen management incentives to improve efficiency and pay out excess capital. ... advised that the main advantage of debt is the tax advantage of interest deductibility.
However, there will always be two sides to the coin. This means that, should Rio and BHP decide to finance their JV through the debt financing method, they will have to pay back the principal sum of their loans, plus interest, despite the venture's performance. In some cases, through debt financing, companies may also face interference with their investment and operating decisions that can cause negative impacts on their operating value leading to possible underinvestment.
In addition, with reference to Agency Theory regarding stockholders and debtholders, stockholders are more interested in pursuing riskier business activities than debtholders would prefer. Accordingly, when operating in risky or uncertain ventures, debt financing may attract a high interest rate, due to the spectrum of risks associated with the venture and may implement greater control measures to discourage firms from investing capital in risky undertakings.
Generally speaking, a high cost of debt capital decreases firms' attractiveness and may affect their ability to operate effectively within their competitive environments. This element indicate that, for firms like BHP and Rio that may frequently need to engage in relatively risky business activities to remain competitive, the use of debt financing would be somewhat of an impediment that subjects them to constraints of the capital markets in some cases. On that account, the option of financing the BHP/Rio JV through equity financing is likely to be more attractive as it would enable them to grow the business rather than use the earning to repay loans had they used debt financing (Valdez 2005).
In summary, owing to the discussion above, it can be determined that the capital structure of a firm and the firm's cost of capital are critical in business decisions as they dictate the amount of investment undertaken, strategic decision and the required level of profitability that operations need to deliver. To be specific, a joint business operation will achieve a great competitive advantage in the market if it is able to determine an appropriate capital structure and through understand the impact and importance of the cost of capital.
