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Marketing alliances can reduce equity risk and impact investor expectations, claims study

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Recently published in the Journal of Marketing, a report from researchers Felipe Thomaz and Vanitha Swaminathan has shown that marketing alliances can reduce equity risk – but only as long as the alliance is a new one and if the two companies’ existing network of partners is not too interconnected.

The authors examined two kinds of equity risk. One is called “idiosyncratic” risk, which involves investor expectations of a firm’s own volatility and other firm-specific factors unrelated to the broader financial market. The other is known as “systematic” risk and pertains to a firm’s exposure to macroeconomic developments such as fluctuations in exchange rates and the price of energy. 

Firms enter into marketing alliances to gain access to new resources, markets, brands, and products. Therefore, the authors concluded, marketing alliances help diversify a firm’s product portfolio and expands its geographic reach – both of which reduce the volatility of the firm’s demand. 

“Investors evaluating a marketing alliance announcement will generate new value expectations from firm-specific factors, which in turn will affect the firm’s idiosyncratic risk,” the report suggested. “Marketing alliances can be a diversifying force, helping the firm gain access to new markets or products through external partnerships rather than through costly internal development. Insofar as these new acquisitions are unrelated to the firm’s existing market or product offerings, the firm’s cash flow volatility should decrease.” 

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For example, US toy manufacturer Hasbro partnered with French game developer Gameloft to leverage some of its intellectual property on-mobile gaming platforms. This agreement extended Hasbro’s portfolio into digital gaming, in which revenues increased more than four per cent in 2011, while the toy industry in the US experienced a two per cent decline in the same period. In this case, Hasbro entered into an alliance to increase the number of product categories in which it operated. 

“By combining unrelated businesses or markets, a firm can reduce investors’ expectations of the volatility of its cash flows and, by doing so, reduce its idiosyncratic risk,” the report claimed. “More importantly, this result holds after we control for the magnitude of alliance returns; this suggests that the reduction in risk after a marketing alliance cannot be accounted for by the belief that marketing alliances are inherently less risky – and also linked to low returns. 

“Instead, we find that even after controlling for variations due to the magnitude of returns, marketing alliances are heralded by the stock market as contributing significantly to reducing equity volatility.”

The authors found that marketing alliances reduce equity risk in general. A marketing alliance reduces idiosyncratic risk, but only if the alliance is a new one. At the same time, if a company has a dense network of partners, a new alliance can increase idiosyncratic risk as well as systematic risk.

“The bottom line is that managers should carefully evaluate not only the benefits but the risks associated with strategic alliance partners before embarking on a new alliance,” it claimed. “Although a company can lower its equity risk after forming a new partnership, those benefits can be erased by the company’s own and the partner’s existing network of alliances.”

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