Negotiating alliance contracts: Strategy and behavioral effects of alternative compensation arrangements

A key issue in alliances (defined here as any cooperative or joint activity between two or more firms) is the payment or compensation structure stated in the formal agreement between the parties. These days, most agreements include a multiplicity of payment types, including royalties, lumpsum payments and returns on equity. The paper outlines reasons for this and presents a general framework for alliance negotiations. A simulation example shows key negotiation variables, together with non-zero-sum tradeoffs between them. Each map of variable pairs indicates a ‘zone of mutual benefit’ where the joint profits of both partners can increase. There is often a contradiction between profit maximization and other strategic, behavioral, tax and regulatory considerations which themselves point in non-congruent directions for structuring the alliance. No wonder alliances are such fragile things! Nevertheless, alliances are an indispensable part of the management landscape, and negotiators must know how to structure them. The approach outlined in this paper, the simulation method presented, the caveats indicated for non-financial variables, and the behavioral responses to each, will however help companies to craft better and longer-lasting alliances.