Competition and cooperation.

• Author: Levmore, Saul
• Position: Corporate policies to cooperate with competing firms

INTRODUCTION

When do competitors share assets and other opportunities for mutual gain? Conversely, when do they prefer to distinguish themselves by establishing firm boundaries that produce a minimum of sharing or cooperation despite potential gains from trade? Why, for example, do competing law schools in a single city cooperate so little in offering joint programs and economizing on certain costs even as they use the same casebooks in their courses and borrow from one another's libraries? Why do two competing auto makers rarely sell one another components or use the same expert advertising agency or law firm but then quite often equip their cars with identical tires or consider the same architect when planning new office buildings? The literatures on the boundaries of the firm and on conflicts of interest do not much investigate these fundamental questions, and other literatures, such as that which explores exclusive dealing arrangements, touch on the puzzles associated with these questions in but passing fashion.

My focus in this Essay on the nature of the relationship between cooperation and competition is in many ways an attempt to interest those who work in law in what economists think of as the "make-or-buy" decisions of firms. I also aim to advance our thinking about these decisions. The make-or-buy expression draws attention to the choice between an organization's internal expansion on the one hand, and its ability to purchase from externally organized producers on the other. Part of my claim, or at least of my starting point, is that the make-or-buy decision is influenced by an apparent disinclination in some cases to share sources of supply with one's competitors. This influence might lead firms to choose between making or not, which is to say between expansion on the one hand and contentment or passivity on the other. Firms may eschew the alternative of expanding by way of purchasing from external suppliers.

Part I sketches the framework for my questions and analysis and offers some refinements to the make-or-buy perspective. Part II sets out the central thesis. It suggests circumstances in which third parties, or markets more generally, facilitate cooperation among competitors. Whether the roles of these outside parties are understood in psychological, economic, or temporary disequilibrium terms, they provide important lessons for the theory of the firm and for our understanding of the make-or-buy decision. Part III returns to the starting point and considers alternative explanations for the puzzling arrangements that I attempt to explain. I claim, of course, that these alternatives are inferior, but they are not without their own attractions and lessons. Part IV turns to the role of law.

1. COOPERATION AND THE SIZE OF FIRMS

   Attention to the make-or-buy decision dates back at least to Coase's famous article on the theory of the firm.(1) If agency costs did not becomes more serious as a given firm grew, then we might expect that firm to choose to make things it needed, expanding in the process, because it could control factors better than if it were to buy these things from external sources which, almost by assumption, would generate transaction costs. The early literature thus emphasized that a different, or competing, set of transaction costs, namely agency costs, becomes more serious with internal expansion so that the make-or-buy-decision weighs internal and external transaction costs with the size of the firm hanging in the balance.(2) Later authors refined this perspective, sometimes turning it on its head, and an entire academic industry has developed in thinking about these transaction costs.

   When I refer to cooperation as a further determinant of the firm's boundaries, I mean that if, to take a plain example, the advantages associated with making something internally run up against problems of economies of scale or simply lumpiness, then an ability to share or to cooperate with another firm might determine whether internal expansion takes place. Thus, a firm might build a new factory, where the efficient factory size is expected to yield output greater than the firm projects it will need for its own immediate purposes, if it could line up another firm or even a competitor, to buy some of the output of this new factory. If the transaction were arranged in advance in the form of a joint venture or the like, then we might think of the two firms as engaging in explicit cooperation. If, on the other hand, the economy of scale is achieved by an outsider building a factory of efficient size and selling its output to our firm and to its competitor, then we might think of the two buyers as engaging in implicit cooperation. Falling in between these two alternatives is the possibility that our firm builds the factory itself but sells some of the output, perhaps even to a competitor. The trading between competitors is now explicit although the investment in the factory was implicitly cooperative. In yet starker contrast, our firm might be disinclined to sell to a competitor; symmetrically, its competitor might be disinclined to buy from our firm (which is to say its competitor). Similarly, these firms may decline to buy components from suppliers who sell identical components to competitors. And, in the most extreme version, they may refuse to deal with suppliers who deal at all with competitor firms. I think of the firms' decisionmakers in these last categories as disinclined to cooperate. Possible motivations for these disinclinations are taken up below. In any event, I use cooperation to signal a transaction implicating a competitor rather than any other make-or-buy decision.

   When an enterprise, E, declines to cooperate, it may find itself with no alternative external source of supply. Any efficient supplier might, for example, need to sell to E's competitors in order to survive; E's refusal to implicitly cooperate precludes E from purchasing its supplies. In such cases, the noncooperating firm, E, must still decide whether to make or not, which is to say whether to grow or not. It is thus immediately apparent that a disinclination to cooperate bears on the size of the firm. Make-or-buy is in this way an incomplete description of the important determinant of organizational arrangements with which it deals. A more complete description is that a firm decides whether to make or buy or do neither -- perhaps because it prefers not to cooperate. Less obvious but as important is the point that the make-or-buy choice itself may be a product of a firm's inclination to cooperate. Transaction costs alone might point to a decision to buy, but the difficulty or cost of arranging for exclusivity (so as to avoid cooperation) might lead to a decision to make.(3)

   The disinclination to cooperate may also affect the boundaries of such entities as families, cities, and nations which also decide whether to undertake new ventures and modify old ones. The business firm's choices among contractual arrangements with outside suppliers, internal growth (with or without sales to competitors), and refusals to cooperate (even if that means neither making nor buying) have counterparts where these other organizations are concerned. Some of these counterparts have received more attention than others. The literature on international relations does not regard trade among nations in ways suggested by the theory of the firm. Conventional thinking about not-for-profit entities is hardly peppered with explorations of specialization and transaction costs. On the other hand, the literature on local government and finance has considered questions of annexation and privatization in terms that would seem familiar to theorists of the corporate firm,(4) and there are occasional hints in a variety of fields that the soil is ripe for the planting of a unified theory of boundaries. I do not intend in the present paper to aim so high, but I do suspect that this discussion, which considers a variety of examples of disinclinations to cooperate, constitutes a useful step in developing a complete theory of boundaries.

2. THE ROLE OF MARKETS

   1. Markets as Means of Implicit Cooperation

      Insufficient attention has been paid to what I have been calling the disinclination to cooperate. This inattention leaves us largely with shared experiences, intuitions, and anecdotal evidence as the sources of data with which we might then "explain" the cooperation among competitors that is and is not found. More rigorous testing of my claims will need to follow; rejection or modification and improvement are likely.

      Put plainly, one claim is that markets sometimes intermediate and allow parties to overcome their disinclination to cooperate. It bears emphasizing that disinclinations to cooperate even in implicit fashion must surely have a direct effect on the decision to make or buy; an inclination to cooperate implicitly but not explicitly may unambiguously encourage buying rather than making even where a competitor could internally produce -- perhaps more than it needs of some component -- at a lower cost than that associated with the best outside supplier.

      A few concrete examples of the markets-as-facilitators idea make the point better than a more abstract model or description.(5) Competing auto makers equip their cars with identical tires purchased from Firestone, Michelin, and other unrelated manufacturers, but it would be surprising to find a component in a Ford automobile that was made by General Motors (and identified as such).(6) The auto makers can be described as cooperating with respect to the research and production skills of tire makers by buying from common sources and declining to insist on exclusive supply arrangements or exclusive labeling. They seem unwilling, however, to go so far as to trade directly with one another. In other industries, of course, competitors do sometimes supply one another, as when Microsoft sells to Apple, and even...