The relational view: Sources of relational rents

1. Theoretical Discussion

By examining the relevant characteristics of arm’s-length market relationships, we find clues that guide our search for relational advantages. Arm’s-length market relationships are charac- terized by

  1. nonspecific asset investments,
  2. minimal information exchange (i.e., prices act as coordinating devices by signaling all relevant information to buyers and sellers),
  3. separable technological and functional sys- tems within each firm that are characterized by low levels of interdependence (i.e., the two organizations have only a sales-to- purchasing interface and do not jointly cre- ate new products through multifunctional interfaces), and
  4. low transaction costs and minimal invest- ment in governance mechanisms (William- son, 1985).

Under these conditions it is easy for firms to switch trading partners with little penalty be-cause other sellers offer virtually identical prod-ucts. As Ghoshal notes, “Efficiency in the execu-tion of routine tasks is the strength of markets” (1995: 16). Thus, arm’s-length market relation-ships are incapable of generating relational rents because there is nothing idiosyncratic about the exchange relationship that enables the two parties to generate profits above and beyond what other seller-buyer combinations can generate. The relationships are not rare or difficult to imitate. Buyers can only achieve a differential advantage if they bring greater bargaining power to the table.

This analysis suggests that alliances generate competitive advantages only as they move the relationship away from the attributes of market relationships. In other words, the competitive advantages of partnerships, as documented in studies to date, seem to fall into four categories:

  1. investments in relation-specific assets;
  2. substantial knowledge exchange, including the exchange of knowledge that results in joint learning;
  3. the combining of complementary, but scarce, resources or capabilities (typically through multiple functional interfaces), which results in the joint creation of unique new products, services, or technologies; and
  4. lower transaction costs than competitor al- liances, owing to more effective governance mechanisms.

We define a relational rent as a supernormal profit jointly generated in an exchange relation- ship that cannot be generated by either firm in isolation and can only be created through the joint idiosyncratic contributions of the specific alliance partners.

In summary, at a fundamental level, relational rents are possible when alliance partners combine, exchange, or invest in idiosyncratic assets, knowledge, and resources/capabilities, and/or they employ effective governance mech- anisms that lower transaction costs or permit the realization of rents through the synergistic combination of assets, knowledge, or capabilities. In the sections that follow we examine in detail these four key sources of relational rents; in each section we develop a major proposition and a set of subpropositions, as summarized in Figure 1. After examining assets, knowledge, and resources, we examine governance, because although governance may generate relational rents by simply lowering transaction costs, governance issues cut across each of the other sources of rents (e.g., influence what relation-specific investments will be made, what knowledge will be shared, and so on). We believe it is easier to understand how governance influences the ability to generate rents through assets, knowledge, and capabilities if we have first examined these constructs.

2. Interfirm Relation-Specific Assets

Amit and Schoemaker argue that specialization of assets is “a necessary condition for rent” and “strategic assets by their very nature are specialized” (1993: 39). Thus, by definition, firms must do something specialized or unique to de- velop a competitive advantage. A firm may choose to seek advantages by creating assets that are specialized in conjunction with the assets of an alliance partner (Klein, Crawford, & Alchian, 1978; Teece, 1987). Productivity gains in the value chain are possible when firms are willing to make relation/transaction-specific investments (Perry, 1989; Williamson, 1985).

Williamson (1985) identifies three types of as- set specificity: (1) site specificity, (2) physical asset specificity, and (3) human asset specificity. Site specificity refers to the situation whereby successive production stages that are immobile in nature are located close to one another. Previous studies suggest that site-specific investments can substantially reduce inventory and transportation costs and can lower the costs of coordinating activities (Dyer, 1996a). Physical asset specificity refers to transaction-specific capital investments (e.g., in customized machinery, tools, dies, and so on) that tailor processes to particular exchange partners. Physical asset specialization has been found to allow for product differentiation and may improve quality by increasing product integrity or fit (Clark & Fuji- moto, 1991; Nishiguchi, 1994). Human asset specificity refers to transaction-specific know-how accumulated by transactors through longstanding relationships (e.g., dedicated supplier engineers who learn the systems, procedures, and the individuals idiosyncratic to the buyer). Human cospecialization increases as alliance partners develop experience working together and accumulate specialized information, language, and know-how. This allows them to com- municate efficiently and effectively, which re- duces communication errors, thereby enhancing quality and increasing speed to market (Asanuma, 1989; Dyer, 1996a).

Asanuma (1989) was among the first to doc- ument how the relation-specific skills developed between Japanese suppliers and their automakers generated surplus profits and competitive advantages for collaborating firms. Similarly, Dyer (1996a) found a positive relationship between relation-specific investments and performance in a sample of automakers and their suppliers. Additionally, Sax- enian (1994) found that Hewlett Packard and other Silicon Valley firms greatly improved performance by developing long-term partnerships with physically proximate suppliers. She claims that proximity in high- technology industries “greatly facilitates the collaboration required for fast-changing and complex technologies” (1990: 101). Indeed, several scholars have shown that physical proximity created through site-specific investments fa- cilitates interfirm cooperation and coordination, thereby enhancing performance (Dyer, 1996a; Enright, 1995; Nishiguchi, 1994). Finally, Parkhe (1993) found that the commitment of “nonrecoverable investments” in a sample of strategic alliances was positively related to performance. These studies indicate that relational rents generated through relation- specific investments are realized through lower total value chain costs, greater product differentiation, fewer defects, and faster product development cycles.

Proposition 1: The greater the alliance partners’ investment is in relation- specific assets, the greater the poten- tial will be for relational rents.

Regarding relation-specific assets, there are two key subprocesses that influence the ability of partners to generate relational rents. First, the length (i.e., in years) of the governance arrange- ment designed to safeguard against opportunism influences the ability of alliance partners to invest in relation-specific assets. Since relation- specific investments create appropriable quasirents, transactors need to safeguard those investments (Klein et al., 1978). Partners are more likely to make investments in relation-specific assets when they have crafted effective safeguards (Williamson, 1985). Moreover, there is typically a fixed, up-front cost associated with making a particular type of relation-specific investment (such as in specialized equipment or a dedicated plant). Some relation-specific investments (e.g., a dedicated plant) are more durable and costly than others (e.g., a specialized tool or jig)-

Given the fixed-cost nature of some invest- ments, alliance partners need to assess whether or not they will make the necessary return on the investment during the payback period or length of the governance agreement (e.g., length of con- tract). For example, Dyer (1997) found that Japa- nese suppliers were more likely to make durable and costly relation-specific investments because automakers provided safeguards on those investments for at least 8 years or more. In contrast, U.S. automakers offered average con- tracts of 2.3 years, and suppliers rationally refused to make relation-specific investments with a long payback period.

Proposition 1a: The greater the length of the safeguard is to protect against opportunism, the greater the potential will be to generate relational rents through relation-specific assets.

Second, the ability to substitute special-purpose assets for general-purpose assets is influenced by the total volume (scale) and breadth (scope) of transactions between the alliance partners. Just as firms that achieve production economies of scale are able to increase productivity by substituting special-purpose assets for generalpurpose assets, alliance partners are also able to increase the efficiency associated with interfirm exchanges as they increase the volume and scope of transactions between the alliance partners. A similar argument has been made by Williamson (1985), who claims that transactors engaging in frequent, recurring transactions can afford to adopt more specialized and complex governance structures.

Proposition 1b: The greater the volume of exchange is between the alliance partners, the greater the potential will be to generate relational rents through relation-specific assets.

In summary, the length of the safeguard and the volume of transactions are key subprocesses that influence the ability of alliance partners to generate rents through relation-specific assets.

3. Interfirm Knowledge-Sharing Routines

Various scholars have argued that interorgan- izational learning is critical to competitive success, noting that organizations often learn by collaborating with other organizations (Levinson & Asahi, 1996; March & Simon, 1958; Powell et al., 1996). For example, Von Hippel (1988) found that in some industries (e.g., scientific in- struments) more than two-thirds of the innova- tions he studied could be traced back to a cus- tomer’s initial suggestions or ideas. In other industries (e.g., wire termination equipment) the majority of innovations could be traced back to suppliers. Von Hippel argues that a production network with superior knowledge-transfer mechanisms among users, suppliers, and man- ufacturers will be able to “out innovate” produc- tion networks with less effective knowledge- sharing routines. Similarly, Powell et al. (1996) found that the locus of innovation in the biotech- nology industry was the network—not the indi- vidual firm. Patents were typically filed by a large number of individuals working for a number of different organizations, including biotech firms, pharmaceutical companies, and universities. Powell et al. (1996) argue that biotech firms who are unable to create (or position themselves in) learning networks are at a competitive dis- advantage.

These studies suggest that a firm’s alliance partners are, in many cases, the most important source of new ideas and information that result in performance-enhancing technology and inno- vations. Thus, alliance partners can generate rents by developing superior interfirm knowledge- sharing routines. We define an interfirm knowledge-sharing routine as a regular pattern of inter firm interactions that permits the transfer, recombination, or creation of specialized knowledge (Grant, 1996). These are institution- alized interfirm processes that are purposefully designed to facilitate knowledge exchanges be- tween alliance partners.

Proposition 2: The greater the alliance partners’ investment is in interfirm knowledge-sharing routines, the greater the potential will be for relational rents.

Beyond simply arguing that alliance partners can generate relational rents through knowledge- sharing routines, it is important to understand how partners create knowledge-sharing routines that result in competitive advantage. Many scholars divide knowledge into two types: (1) information and (2) know-how (Grant, 1996; Kogut & Zander, 1992; Ryle, 1984). We can define information as easily codifiable knowledge that can be transmitted “without loss of integrity once the syntactical rules required for deciphering it are known. Information includes facts, axiomatic propositions, and symbols” (Kogut & Zander, 1992: 386). By comparison, know-how involves knowledge that is tacit, “sticky,” complex, and difficult to codify (Kogut & Zander, 1992; Nelson & Winter, 1982; Szulanski, 1996). Since know- how is tacit, sticky, and difficult to codify, it is difficult to imitate and transfer. However, these properties also suggest that, compared to information, know-how is more likely to result in advantages that are sustainable. As a result, alliance partners that are particularly effective at transferring know-how are likely to outperform competitors who are not.

The ability to exploit outside sources of knowledge is largely a function of prior related knowledge or the “absorptive capacity” of the recipient of knowledge. Cohen and Levinthal define absorptive capacity as “the ability of a firm to recognize the value of new, external in- formation, assimilate it, and apply it to commer- cial ends” (1990: 128). However, their definition suggests that if a firm has absorptive capacity, it is equally capable of learning from all other organizations. Although Cohen and Levinthal focus on the absolute absorptive capacity of in- dividual firms, the concept is particularly useful in thinking about how alliance partners may systematically engage in interorganizational learning. Thus, partner-specific absorptive ca- pacity refers to the idea that a firm has developed the ability to recognize and assimilate valuable knowledge from a particular alliance partner. This capacity would entail implementing a set of interorganizational processes that allows collaborating firms to systematically identify valuable know-how and then transfer it across organizational boundaries. Partner- specific absorptive capacity is a function of (1) the extent to which partners have developed overlapping knowledge bases and (2) the extent to which partners have developed interaction routines that maximize the frequency and intensity of sociotechnical interactions. Previous work suggests that the ability of a receiver of knowledge to “unpackage” and assimilate it is largely a function of whether or not the firm has overlapping knowledge bases with the source (Mowery, Oxley, & Silverman, 1996; Szulanski, 1996). Thus, this is a critical component of part- ner-specific absorptive capacity.

In addition, partner-specific absorptive capacity is enhanced as individuals within the alliance partners get to know each other well enough to know who knows what and where critical expertise resides within each firm. In many cases this knowledge develops informally over time through interfirm interactions. However, it may be possible to codify at least some of this knowledge. For example, Fuji and Xerox have attempted to codify this knowledge by creating a “communications matrix,” which identifies a set of relevant issues (e.g., products, technologies, markets, and so on) and then identifies the individuals (by function) within Fuji-Xerox, Fuji, and Xerox who have relevant expertise on that particular issue. This matrix provides valuable information regarding where relevant expertise resides within the partnering firms.

This example illustrates that alliance partners can increase partner-specific absorptive capacity by designing interfirm routines that facilitate information-sharing and increase sociotechnical interactions. These types of routines are particularly important since know-how transfers typically involve an iterative process of exchange, and the success of such transfers depends on whether personnel from the two firms have

direct, intimate, and extensive face- to-face interactions (Arrow, 1974; Badaraco, 1991; Daft & Lengel, 1986; Marsden, 1990).

Proposition 2a: The greater the part- ner-specific absorptive capacity is, the greater the potential will be to gener- ate relational rents through knowledge sharing.

Finally, the ability of alliance partners to gen- erate rents through knowledge sharing is de- pendent on an alignment of incentives that en- courages the partners to be transparent, to transfer knowledge, and not to free ride on the knowledge acquired from the partner. In particular, the transferring firm must have an incentive to devote the resources required to transfer the know-how since it typically incurs significant costs during the transfer—costs comparable to those incurred by the receiving firm (Szu- lanski, 1996). Thus, the mechanisms employed to govern the alliance relationship must create appropriate incentives for knowledge sharing. These may be formal financial incentives (e.g., equity arrangements) or informal norms of reciprocity. In various studies scholars have found that equity arrangements are particularly effective at aligning partner incentives and, therefore, promote greater interfirm knowledge transfers than contractual arrangements (Kogut, 1988; Mowery et al., 1996).

Proposition 2b: The greater the align- ment of incentives by alliance partners is to encourage transparency and reciprocity and to discourage free riding, the greater the potential will be to generate relational rents through knowledge sharing.

A comparison of Toyota’s and GM’s production networks illustrates how knowledgesharing routines can create interorganizational competitive advantage. Toyota has developed a number of practices that facilitate knowledge transfers to—and among—suppliers. For example, Toyota may transfer knowledge directly to suppliers, through its “operations management consulting division” consultants, who will reside at the supplier for days, weeks, or even months to see that the transfer takes place (Nishiguchi, 1994; Womack, Jones, & Roos, 1990). Toyota also transfers its personnel to the supplier (on a temporary or permanent basis) to increase the supplier’s ability to assimilate and apply the new knowledge. These transfers result in dense

interfirm social networks that increase partner- specific absorptive capacity. Consequently, Toyota personnel know what knowledge will be useful to the supplier, whom to contact at the supplier, and where the absorptive capacity resides at the supplier.

In contrast, GM and its suppliers have a history of keeping innovations proprietary. This strategy is viewed, according to the RBV, as the best way for an individual firm to generate rents from a particular innovation. Of course, the decision not to share knowledge is the only rational one for suppliers, since GM has not cultivated a stable network of supplier companies that have developed overlapping knowledge bases, dense social interactions, or a norm of reciprocity for knowledge sharing. GM does not have a supplier association to facilitate knowledge sharing, nor does GM transfer or lend personnel to suppliers to facilitate interfirm knowledge sharing. Consequently, suppliers rationally refuse to engage in costly knowledge-sharing activities since they do not expect to receive some benefit (i.e., knowledge) in return. It is not surprising then that there is significantly greater knowledge sharing between Toyota and its suppliers than between GM and its suppliers (Dyer, 1997).

4. Complementary Resource Endowments

Another way firms can generate relational rents is by leveraging the complementary resource endowments of an alliance partner. In some instances a firm’s ability to generate rents from its resources may require that these resources be utilized in conjunction with the complementary resources of another firm. Complementary resource endowments have been the focus of much prior discussion on the formation and management of alliances and have been discussed widely as a key factor driving returns from alliances (Hamel, 1991; Harrigan, 1985; Hill & Hellriegel, 1994; Shan, Walker, & Kogut, 1994; Teece, 1987). We define complementary resource endowments as distinctive resources of alliance partners that collectively generate greater rents than the sum of those obtained from the individ- ual endowments of each partner. For these re- sources to generate rents through an alliance, it is necessarily the case that neither firm in the partnership can purchase the relevant resources in a secondary market. Also, these resources must be indivisible, thereby creating an incentive for each firm to form an alliance in order to access the complementary resources. As Oliver observes, “Strategic alliances allow firms to procure assets, competencies, or capabilities not readily available in competitive factor markets, particularly specialized expertise and intangible assets, such as reputation” (1997: 707).

The cooperative relationship between Nestle and Coca-Cola to distribute hot canned drinks through vending machines (a business largely unknown outside of Japan) is an example of an alliance in which complementary resource en- dowments are a source of relational rents. This alliance combines Nestle’s brand names (Nescafe and Nestea) and competence in developing and producing soluble coffee and tea products with Coca-Cola’s powerful international distribution and vending machine network (Hamel & Prahalad, 1994: 187). The alliance creates advan- tages over Japanese competitors (e.g., Suntory), who are better than Coca-Cola at soluble coffee and tea and have a larger distribution and vending machine network than Nestle, but cannot match the Coca-Cola-Nestle combination of capabilities.

Shan and Hamilton (1991) offer another illus- tration. They found that complementarity of both firm- and country-specific resources between domestic and foreign firms was a key factor in the formation of cross-border strategic alliances in biotechnology. The complementarity in the cases they studied consisted of linkages between the strong basic research capabilities of U.S. firms with the unique local knowledge and distribution capabilities of their partners in overseas markets.

In the cases described above, the alliance partners brought distinctive resources to the al- liance, which, when combined with the resources of the partner, resulted in a synergistic effect whereby the combined resource endowments were more valuable, rare, and difficult to imitate than they had been before they were combined. Consequently, these alliances produced stronger competitive positions than those achievable by the firms operating individually. It is important to note, however, that not all of the resources of a potential alliance partner will be complementary. In assessing the extent to which alliance partners can generate relational rents by combining complementary resources, it is worthwhile to think about the proportion of the potential partner’s strategic resources that is synergy sensitive with the firm’s resources. As the proportion of synergy-sensitive resources in the potential partners increases, so does the potential for earning relational rents by combining the complementary resources.

Proposition 3: The greater the propor- tion is of synergy-sensitive resources owned by alliance partners that, when combined, increase the degree to which the resources are valuable, rare, and difficult to imitate, the greater the potential will be to generate relational rents.

There are several challenges faced by firms attempting to generate relational rents with complementary resources. In particular, they must find each other and recognize the potential value of combining resources. If potential alliance partners possessed perfect information, they could easily calculate the value of different partner combinations and then rationally ally with the partner(s) who would generate the greatest combined value. However, it is often very costly and difficult (if not impossible) to place a value on the complementary resources of potential partners. In fact, firms vary in their ability to identify potential partners and value their complementary resources for three primary reasons: (1) differences in prior alliance experi- ence, (2) differences in internal search and eval- uation capability, and (3) differences in their ability to acquire information about potential partners owing to different positions in their so- cial/economic network(s).

First, firms with higher levels of experience in alliance management may have a more precise view on the kinds of partner/resource combina- tions that allow them to generate supernormal returns. Previous research suggests that prior alliance experience results in more opportunities to enter into future alliances, presumably because of the development of alliance capabilities and reputation (Gulati, 1995a; Mitchell & Singh, 1996; Walker, Kogut, & Shan, 1997).

Second, many organizations are developing ways to accumulate knowledge on screening potential partners by creating a “strategic alliance” function. For example, firms such as Hewlett Packard, Xerox, and Microsoft have appointed a Director of Strategic Alliances, with his or her own staff and resources. The role of these individuals is to identify and evaluate potential alliance partners as well as to monitor and coordinate their firm’s current alliances. The creation of these roles ensures some accountability for the selection and ongoing management of alliance partners and also ensures that knowledge on successful partner combinations and on effective alliance management practices will be accumulated. An opportunity exists to codify some of this knowledge, as illustrated by the fact that some firms, such as Hewlett Packard, have created manuals that attempt to codify alliance- specific knowledge (Hewlett Packard’s manual has more than 300 pages). Research on acquisitions suggests that codification of knowledge is predictive of success in post-acquisition contexts (Singh & Zollo, 1997). Although alliances are a different context than acquisitions, a parallel argument can be applied to the management of alliances.

Third, the ability of a firm to identify and eval- uate partners with complementary resources de- pends on the extent to which the firm has access to accurate and timely information on potential partners. An investment in an internal alliance function likely will facilitate the acquisition of this information, but it also depends on the extent to which the firm occupies an information- rich position within social/economic networks. Previous research suggests that firms occupying central network positions with greater network ties have superior access to information and, thus, are more likely to increase the number of their alliances in the future (Gulati, 1995a; Mitchell & Singh, 1996; Walker et al., 1997). When a firm is well positioned in networks, the firm has access to more reliable information about potential partners because of trusted informants within the network who may have direct experience with the potential partner (Burt, 1992; Chung, Singh, & Lee, in press; Granovetter, 1985; Nohria, 1992). An information-rich position within a network, therefore, provides a firm with additional information about the nature and degree of accessibility of the complementary resources of potential partners.

Proposition 3a: The ability of firms to generate relational rents by combining complementary resources increases with the firm’s (1) prior alliance experience, (2) investment in internal search and evaluation capability, and (3) ability to occupy an information- rich position in its social/ economic networks.

Thus far, our discussion has focused on the benefits associated with combining resources with strategic complementarity. However, once a firm has identified a potential partner with the requisite complementary strategic resources, another challenge is developing organizational complementarity—the organizational mechanisms necessary to access the benefits from complementary strategic resources. The ability of alliance partners to realize the benefits from complementary strategic resources is conditioned on compatibility in decision processes, information and control systems, and culture (Doz, 1996; Kanter, 1994). Although complemen- tarity of strategic resources creates the potential for relational rents, the rents can only be realized if the firms have systems and cultures that are compatible enough to facilitate coordinated action. Previous research suggests that a primary reason for failure of both acquisitions and alliances is not that the two firms do not possess strategic complementarity of resources, but rather because they do not have compatible operating systems, decision-making processes, and cultures (Buono & Bowditch, 1989). Doz (1996), therefore, distinguishes between initial complementarity (strategic complementarity), based on potential combinations of resources, and revealed complementarities           (organizational complementarity), based on the realized results of cooperation between the firms involved in the partnership.

Proposition 3b: The ability of alliance partners to generate relational rents from complementary strategic re- sources increases with the degree of compatibility in their organizational systems, processes, and cultures (or- ganizational complementarity).

In summary, both strategic and organizational complementarity are critical for realizing the potential benefits of combining complementary strategic resources.

5. Effective Governance

Governance plays a key role in the creation of relational rents because it influences transaction costs, as well as the willingness of alliance partners to engage in value-creation initiatives. For example, although alliance partners can generate relational rents through investments in relation-specific assets, their incentive to make specialized investments is tempered by the fact that the more specialized a resource becomes, the lower its value is in alternative uses. The contingent value of a specialized resource exposes its owner to a greater risk of opportunism than does a generalized resource (Klein et al., 1978). An important objective for transactors is to choose a governance structure (safeguard) that minimizes transaction costs, thereby enhancing efficiency (North, 1990; Williamson, 1985).

We distinguish between two classes of gover- nance used by alliance partners: the first relies on third-party enforcement of agreements (e.g., legal contracts), whereas the second relies on self- enforcing agreements, in which “no third party intervenes to determine whether a violation has taken place” (Telser, 1980: 27). The transaction cost economics perspective falls primarily within the first class, suggesting that dispute resolution requires access to a third- party enforcer, whether it be the state (i.e., through contracts) or a legitimate organization authority (Williamson, 1991b). In contrast, self- enforcing agreements (sometimes called “private ordering” in the economics literature or “trust/embeddedness” in the sociology literature) involve safeguards that allow for selfenforcement. Within the self- enforcement class of governance mechanisms, we further distinguish between “formal” safeguards, such as financial and investment hostages (Klein, 1980; Williamson, 1983), and “informal” safeguards, such as goodwill trust or embeddedness (Gulati, 1995b; Powell, 1990; Sako, 1991; Uzzi, 1997) and reputation (Larson, 1992; Weigelt & Camerer, 1988).

Formal self-enforcing safeguards are economic hostages created intentionally to control opportunism by aligning the economic incentives of the transactors (Klein, 1980; Williamson, 1983). These hostages may be financial (e.g., equity) or symmetric     investments     in     specialized or cospecialized assets, which constitute a visible collateral bond that aligns the economic incen- tives of exchange partners. The fact that the value of the economic hostage will decrease in value if a party is opportunistic provides an incentive for trading partners to behave in a more trustworthy fashion (Dyer & Ouchi, 1993; Pisano, 1989). Further, since these investments may increase in value if the alliance partners cooperate, there is an incentive for the alliance partners to engage in value-creation initiatives.

Sociologists, anthropologists, and law and so- ciety scholars long have argued that informal social controls supplement—and often supplant— formal controls (Black, 1976; Ellickson, 1991; Granovetter, 1985; Macaulay, 1963). Thus, informal self-enforcing agreements may rely on personal trust relations (direct experience) or reputation (indirect experience) as governance mechanisms. A number of scholars have suggested that informal safeguards (e.g., goodwill trust) are the most effective and least costly means of safeguarding specialized investments and facilitating complex exchange (Hill, 1995; Sako, 1991; Uzzi, 1997). For example, some scholars have argued that goodwill trust reduces transaction costs related to bargaining and monitoring, thereby enhancing performance (Barney & Hansen, 1994; Sako, 1991).5 Thus, self- enforcing safeguards result in transaction costs that are lower than they are in situations where transactors must erect more elaborate governance structures (e.g., contracts), which are costly to write, monitor, and enforce.

The ability of exchange partners to match governance structures with exchange attributes is viewed as critical to realizing “economizing advantages.”6 Williamson states, “The main hy- pothesis out of which transaction cost economics works is this: align transactions, which differ in their attributes, with governance structures, which differ in their costs and competencies, in a discriminating (mainly transaction cost minimiz- ing) way” (1991a: 79; emphasis in original). Wil- liamson (1991a) argues that misalignments occur frequently because of bounded rationality and uncertainty. Thus, transactors who are effective at aligning transactions with governance structures will have an advantage over competing transactors who do not employ efficient governance mechanisms.

Proposition 4: The greater the alliance partners’ ability is to align transactions with governance structures in a discriminating (transaction cost mini- mizing and value maximizing) way, the greater the potential will be for relational rents.

We should emphasize that, although the dis- cussion thus far has followed a transaction cost logic with an emphasis on efficiency, we use the term effective governance to suggest that gov- ernance mechanisms play an important role in generating relational rents that extends beyond efficiency arguments. More specifically, a small but growing body of literature on transaction value is emphasizing the influence of governance on the value-creation initiatives of alliance partners (Dyer, 1997; Hansen, Hoskisson, & Barney, 1997; Madhok, 1997; Ring & Van de Ven, 1992; Zajac & Olsen, 1993). Effective governance can generate relational rents by either (1) low- ering transaction costs or (2) providing incentives for value-creation initiatives, such as investing in relation-specific assets, sharing knowledge, or combining complementary strategic resources.

In the first case transactors achieve an advan-tage by incurring lower transaction costs than competitors to achieve a given level of investment in specialized assets. In the second case effective governance (e.g., trust) may allow transactors to make greater investments in specialized assets than competing transactors, who refuse to make the relation-specific investments because of the high cost of safeguarding them. Similarly, alliance partners may be unwilling to share valuable, proprietary knowledge with trading partners if they are not credibly assured that this knowledge will not be readily shared with competitors. The willingness of firms to combine complementary strategic resources may also hinge upon credible assurances that the trading partner will not attempt to duplicate those same resources, thereby becoming a future competitor. Thus, effective governance mechanisms may generate rents by either lowering transaction costs or by providing incentives for partners to engage in value-creation initiatives.

In general, self-enforcing mechanisms are more effective than third-party enforcement mechanisms at both minimizing transaction costs and maximizing value-creation initiatives. Transaction costs are lower under self-enforcing agreements for four primary reasons.

First, contracting costs are avoided because the exchange partners trust that payoffs will be divided fairly. Consequently, exchange partners do not have to bear the cost—or time—of spec- ifying every detail of the agreement in a contract. Further, contracts are likely to be less effective than self-enforcing agreements at controlling opportunism because they fail to anticipate all forms of cheating that may occur. Second, monitoring costs are lower because self- enforcement relies on self-monitoring rather than external or third-party monitoring. Exchange partners do not need to invest in costly monitoring mechanisms to ensure contract fulfillment and to document infractions to the satisfaction of a third party (e.g., court). Third, self-enforcing agreements lower the costs associated with complex adaptation, thereby al- lowing exchange partners to adjust the agreement “on the fly” to respond to unforeseen market changes (Uzzi, 1997: 48). Fourth, self- enforcing agreements are superior to contracts at minimizing transaction costs over the long run because they are not subject to the time limitations of contracts. Contracts are typically written for a fixed duration and, in effect, depre- ciate because they only provide protection during the designated length of the agreement. At the end of the contract duration, the alliance partners need to write a new contract (or employ a different safeguard). Exchange partners can avoid the costs of “recontracting” by employing self- enforcing agreements, which, over time, may in fact appreciate in the sense that trust or embeddedness increases with increased familiarity and interaction (Gulati, 1995b; Larson, 1992).

6. Self-enforcing agreements also call forth greater

value-creation initiatives on the part of the exchange partners. For example, it is difficult (if not impossible) to explicitly contract for value- creation initiatives, such as sharing finegrained tacit knowledge, exchanging resources that are difficult to price, or offering innovations or responsiveness not explicitly called for in the contract. Under self-enforcing agreements, ex- change partners are more likely to engage in these activities because they have credible assurances that they will be rewarded for them. Finally, contractual agreements are relatively easy to imitate as a form of governance and, therefore, are unlikely to create sustainable advantages. Competing firms are likely to have equal access to lawyers (to write the agreements) and the state (to enforce the agreements).

Proposition 4a: The greater the alliance partners’ ability is to employ self- enforcing safeguards (e.g., trust or hostages) rather than third-party safe- guards (e.g., legal contracts), the greater the potential will be for rela- tional rents, owing to (1) lower con- tracting costs, (2) lower monitoring costs, (3) lower adaptation costs, (4) lower recontracting costs, and (5) su- perior incentives for value-creation in- itiatives.

Likewise, within the self-enforcement mecha- nism category, informal safeguards are more likely to generate relational rents than are formal safeguards, for two primary reasons. First, the marginal cost associated with formal hostages typically is higher than for informal safeguards because formal hostages involve capital outlays for equity or other types of collateral bonds. Furthermore, formal safeguards are much easier for competitors to imitate. If the key to minimizing transaction costs and encouraging value-creation initiatives by partners is simply swapping stock, creating a joint venture, or having a partner (e.g., franchisee) post a bond, then competitors can imitate this governance mechanism with relative ease. Informal safeguards (goodwill trust or reputation) are much more difficult to imitate because they are socially complex and idiosyncratic to the exchange relationship.

Proposition 4b: The greater the alli-ance partners’ ability is to employ in- formal self-enforcing safeguards (e.g., trust) rather than formal self-enforcing safeguards (e.g., financial hostages), the greater the potential will be for relational rent, owing to (1) lower marginal costs and (2) difficulty of imitation.

Although informal safeguards have the greatest potential to generate relational rents, they are subject to two key liabilities: (1) they require substantial time to develop, because they require a history of interactions and personal ties, and (2) they are subject to the “paradox of trust,” which means that although trust establishes norms and expectations about appropriate behavior, lowering the perception of risk in the exchange, it provides the opportunity for abuse through opportunism (Granovetter, 1985). In practice, it appears that many effective alliances use multiple governance mechanisms simultaneously (Borch, 1994). Many alliances begin with the use of formal mechanisms and then, over time, employ more informal ones (Gulati, 1995b).

Recent empirical studies support the argument that effective governance, in the form of lower transaction costs, may be a source of relational rents. For example, Dyer (1997) found that General Motors’ procurement (transaction) costs were more than twice those of Chrysler’s and six times higher than Toyota’s. GM’s transaction costs are persistently higher than Toyota’s and Chrysler’s primarily because suppliers view GM as a much less trustworthy organization. Similarly, Zaheer et al. (1998) found that, in the electrical equipment industry, interorganizational trust reduced negotiation costs and conflict and had a positive effect on performance.

Source: Dyer Jeffrey H., Singh Harbir (1998), “The Relational View: Cooperative Strategy and Sources of Interorganizational Competitive Advantage”, The Academy of Management Review, Vol. 23, No. 4 (Oct.,1998), pp. 660-679.

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