The role of relationship scope in sustaining relational contracts in interfirm networks

• Author: Janet Bercovitz,Giorgio Zanarone,Nicholas Argyres
• Published date: 01 February 2020
• DOI: http://doi.org/10.1002/smj.3095
• Date: 01 February 2020

RESEARCH ARTICLE

The role of relationship scope in sustaining

relational contracts in interfirm networks

Nicholas Argyres

1

| Janet Bercovitz

2

| Giorgio Zanarone

1

1

Olin Business School, Washington

University in St. Louis, St. Louis, Missouri

2

Leeds School of Business, University of

Colorado, Boulder, Boulder, Colorado

Correspondence

Nicholas Argyres, Olin Business School,

Washington University in St. Louis,

St. Louis, MO 63130.

Email: argyres@wustl.edu

Abstract

Research summary:A key strategic decision for many

firms is the scope of their relationships with partners. Exis-

ting theories of relationship scope are limited in that they

disregard the facts that: (a) most firms transact within net-

works of multiple partners, and (b) these partnerships often

involve two-sided moral hazard. We develop a theory of

partnership scope in interfirm networks that addresses these

deficiencies. We show how, by broadening the scope of

business it conducts with its partners, a firm can reduce

externalities between them, and thereby sustain self-

enforcing exchange relationships (“relational contracts”)in

which both parties cooperate with each other repeatedly

and maximize the value created. We discuss numerous set-

tings in which our model applies, including franchising,

supply chains, and platform-based ecosystems.

Managerial summary:A key strategic decision for many

firms is the number of transactions or activities they conduct

with a given supplier, business customer, or company that

sells complementary products or services. We offer a theory

to explain why firms often prefer relationships with broader

scope. Whereas other theories are based on the ability to

leverage partner knowledge or cheaper supervision, our the-

ory is based on the concept of a “relational contract”,in

which a firm and its partner cooperate with each other repeat-

edly according to an informal agreement between them. We

show that under relational contracting, broader scope rela-

tionships encourage better mutual cooperation than narrow

scope relationships, thereby maximizing the value created by

Received: 14 December 2018 Revised: 20 August 2019 Accepted: 22 August 2019 Published on: 15 October 2019

DOI: 10.1002/smj.3095

222 © 2019 John Wiley & Sons, Ltd. Strat Mgmt J. 2020;41:222–245.wileyonlinelibrary.com/journal/smj

them. We discuss how our model applies to franchising, sup-

ply chains, and platform-based ecosystems.

KEYWORDS

interfirm cooperation, interfirm networks, interorganizational

relationships, relational contracts, relationship scope

1|INTRODUCTION

A key strategic decision for many firms is the scope of their relationships with suppliers, distributors,

and other collaborators. A buyer chooses to procure multiple components or few components from a

given supplier. A franchisor assigns multiple outlets or a few outlets to a given franchisee. A computer

platform provider licenses an independent developer to sell multiple applications for the platform, or

only a few applications. While broad relationship scope entails costs such as monitoring of a partner's

multiple activities (Oxley & Sampson 2004; Kalnins & Lafontaine 2004), it has emerged in the last

two decades as a widespread governance form in interfirm collaborations (e.g., Moeen, Somaya, &

Mahoney, 2013). Thus, it is important to understand the channels through which broad relationship

scope may benefit or harm firms, and what determinesa firm's optimal choice of relationship scope.

Our article contributes to this research agenda by developing a formal model which shows how

broadening the scope of its relationships with its various “partners”(suppliers, distributors, or sellers

of complementary products) enables a firm to build self-enforcing relational contracts that prevent

opportunism and enhance value creation. We model relational contracts following research in organi-

zational economics and the theory of repeated games (e.g., Baker, Gibbons, & Murphy, 1994, 2002;

Levin, 2003). Our model is motivated in part by empirical research on buyer–supplier relationships

suggesting that broad relationship scope strengthens mutual cooperation when combined with

repeated exchange (e.g., Dyer, 1996, Dyer & Hatch, 2006; Ahmadjian & Oxley, 2013; Helper &

Henderson, 2014; Aral, Bakos, & Brynjolfsson, 2018).

Our model's key theoretical contribution is to jointly analyze the benefits and costs of broad rela-

tionship scope as a means to enhance cooperation, and to examine how they depend on repeated

exchange versus arm's length contracting. The key feature of broad scope in our model is that it leads

partners of a central firm to internalize the externalities among them. While inter-partner externalities

have been analyzed in the specific context of franchising (e.g., Brickley & Dark, 1987), they are pre-

sent in most interfirm networks. For example, a supplier that sells poor quality or time-delayed prod-

ucts to the central firm can undermine the final product or upset the production schedule, thus

negatively affecting the central firm's business, which in turn negatively affects other suppliers’busi-

nesses via reduced demand. Externalities are also important in platform-based industries (“ecosys-

tems”) in which complementors’decisions about product quality or features can significantly affect

the profitability of the platform provider, but in so doing can also affect the profitability of other

complementors in the network (Adner, 2017; Gawer & Cusumano, 2002). Broad scope partners

internalize these externalities because they are incentivized are to take account of the negative effects

of their actions on multiple businesses or activities simultaneously.

We show that in the presence of two-sided moral hazard, the internalization of cross-partner exter-

nalities is at the same time a source of benefits and potential costs of broad relationship scope. On

the benefit side, broad scope incentivizes each partner to exert more effort that produces value for the

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