Relational Contracts and Collaboration in the Supply Chain: Impact of Expected Future Business Volume on the Make‐or‐Buy Decision

• DOI: http://doi.org/10.1111/jscm.12110
• Author: Francisco Brahm,Jorge Tarzijan
• Date: 01 July 2016
• Published date: 01 July 2016

RELATIONAL CONTRACTS AND COLLABORATION IN

THE SUPPLY CHAIN: IMPACT OF EXPECTED FUTURE

BUSINESS VOLUME ON THE MAKE-OR-BUY DECISION

FRANCISCO BRAHM

University of Cambridge

Pontificia Universidad Cat

olica de Chile

JORGE TARZIJAN

Pontificia Universidad Cat

olica de Chile

Relational contracts are key to supply chain collaboration. The literature

has focused on the role of trust stemming from prior business with cur-

rent suppliers. However, the role of expected future business volume on

the make-or-buy decision has been relatively neglected. This paper con-

tributes to the literature by examining how the level of expected future

business volume affects the make-or-buy decision, that is, the choice to

produce the product or service internally rather than to outsource it.

Using regression analysis of secondary data from 12,272 construction

projects and controlling for endogeneity, our results show that expected

future business volume promotes outsourcing and that this impact is lar-

ger when the level of prior business with external suppliers is stronger

and there is more specificity in the relationship. Our results are consis-

tent with a game theoretic logic in which informally promising future

interactions to sustain collaboration is more credible to external suppli-

ers than to internal units because the former can use their assets else-

where. Also, our results suggest that trust stemming from prior business

reinforces the calculativeness logic that stems from the expectation of

future business.

Keywords: relational contracts; make-or-buy; outsourcing; transaction cost

economics; secondary data; econometric modeling

INTRODUCTION

Supply chains involve many actors, which typically

have different objectives. Consequently, it is very

important to align all the players’ actions for the

success of the supply chain. The vast research on

supply chain collaboration is a testament to this fact

(e.g., Adams, Richey, Autry, Morgan & Gabler, 2014;

Fawcett, Fawcett, Watson & Magnan, 2012; Flynn,

Huo & Zhao, 2010; Leuschner, Rogers & Charvet,

2013; Stank, Keller & Daugherty, 2001). This body

of research has shed light on many topics, such as

the broad spectrum of outsourcing arrangements

and their risks (Feeny, Lacity & Willcocks, 2005;

Sanders, Locke, Moore & Autry, 2007), the integra-

tion of supply chains (Leuschner et al., 2013), and

the structure and boundary of the supply chain

(Carter, Rogers & Choi, 2015). Fundamental insights

from this literature suggest that formal contracts are

insufficient to attain alignment and that supply

chain managers need to think in terms of “relational

Acknowledgments: We thank the JSCM editors, Associate Editor,

and three anonymous reviewers for their comments and sugges-

tions, which helped improve the article significantly. We also

thank participants at the economic theory lunch at the Pontificia

Universidad Cato

´lica de Chile. We acknowledge financial sup-

port from the Chilean Government through the Fondecyt

Research Grant #1141101.

Volume 52, Number 348

contracts” (Sanders et al., 2007; Vinhas, Heide &

Jap, 2012).

1

Although some progress has been made, we contend

that the existing supply chain management research on

relational contracts suffers from two limitations. First,

supply chain scholars have focused on how current

relationships in the supply chain have been built from

previous interactions. Thus, they neglect the impor-

tance of expectations of future interactions stemming

from future business volume. Past and expected future

interactions suggest different logics of collaboration,

and thus, the literature should identify and study both.

In short, whereas past interactions breed goodwill and

trust, which lead to cooperative behavior (Flynn et al.,

2010; Gulati & Nickerson, 2008; Poppo, Zhou & Zen-

ger, 2008; Wathne & Heide, 2000), expectations of

future interactions involve a tradeoff between collabo-

rating today to increase the likelihood of obtaining

future rewards and behaving opportunistically at the

expense of future rewards (Baker, Gibbons & Murphy,

2002; Gil & Marion, 2013). While past interactions tap

into the psychological and sociological motivations

that sustain collaboration, the expectation of future

interactions taps into self-interest maximizing behavior.

As relational contracts encompass the analysis of both

types of interactions, which often produce complex pat-

terns, we contend that studying how they differ and

interact is very important to fully understanding supply

chain collaboration.

Second, the literature has focused on the study of

collaboration of a focal firm with external actors (e.g.,

suppliers), largely sidestepping the study of its alterna-

tive, namely, collaborating with internal actors (e.g.,

employees, divisions, and departments) (a notable

exception is Handfield, Cousins, Lawson & Petersen,

2015). Schematically, the literature examines how a

buyer and supplier relationship has evolved, identifies

which factors have enhanced it, and considers how

this relationship favors performance. However, supply

chains involve actors within and between firms; thus,

the study of collaboration should include both types

of actors. The key insight here is that, depending on

the circumstances, eliciting collaboration from

internal actors might be harder or easier than eliciting

collaboration from external actors. This variation cre-

ates a need to link relational contracts to the out-

sourcing decision, that is, to the choice to collaborate

externally (i.e., buy) versus internally (i.e., make). This

connection has been made theoretically by Baker

et al. (2002) and Klein (1996), but it has been largely

neglected by empirical studies both within and out-

side the supply chain community (two notable excep-

tions are Gulati & Nickerson, 2008 and Gil &

Hartmann, 2011). Consequently, we claim that we

should examine how relational contracts affect out-

sourcing as carefully as the literature has studied the

impact of relational contracts on current suppliers

assuming that the decision to use suppliers is unaf-

fected by relational contracts.

In this article, we attempt to bridge these two gaps by

empirically analyzing how the expectation of future

business volume impacts the make-or-buy decision in

supply transactions. In addition, we explore how this

impact is moderated by two factors: the level of prior

interactions with external suppliers and the specificity

of the activity being performed. We build from game

theoretic ideas to predict that a larger expectation of

future interactions leads to a larger increase of collabo-

ration incentives for the external supplier in compar-

ison to the increase of collaboration incentives for the

internal supplying units. The logic behind this predic-

tion is that when actors are trading off “opportunism

today” versus “the promise of future rewards,” granting

asset ownership to the supplying party (i.e., out-

sourcing) increases the credibility of the promise of

future rewards. Credibility increases because if the

buyer denies its promise to the external supplier the lat-

ter can use its assets in alternative buyers, an option

that is not easily available to the internal employee.

Credibility is important because often these promises

are not enforceable by third parties. Simply put, the

buyer0s downside risk of not keeping its word is higher

if it does not control the asset, and thus promising

future benefits to promote collaboration is more credi-

ble for an external supplier than for an internal

employee.

Further, we propose that our prediction regarding

the positive impact of the expected future business

volume on the use of outsourcing will hold with

more force under two conditions. First, we propose

that more prior interactions with external suppliers

will increase the impact of future business volume on

the use of outsourcing. On top of creating trust

between actors, prior interactions provide a signal of

expected future interactions. Both trust and signaling

will increase the credibility of promising future vol-

ume. This is consistent with recent evidence that has

shown that prior interactions reinforce the effect of

the expectation of future business volume on trust

1

By “relational contracts,” we mean unwritten norms and incen-

tives that govern behavior in a relationship. These norms and

incentives typically arise from a history of prior interactions that

builds trust and reciprocity (norms), as well as from the expecta-

tion of future interactions that facilitate keeping promises (in-

centives). As we argue below, the supply chain management

literature tends to use the ideas of “relational governance” to

refer mainly to norms of trust and reciprocity (e.g., Wallenburg

& Schaffler, 2014). We argue that using the term “relational con-

tract” conveys, in addition to the idea of an existing relation-

ship, the idea of incentives that is more commonly associated

with contracts. We also avoided the term “informal/implicit con-

tract” because relational contracts are much more than simply

nonwritten agreements.

July 2016

Relational Contracts and Collaboration in the Supply Chain

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