Trust can emerge in economic exchanges in any of the three ways discussed. However, these three types of trust are not equally likely to be sources of competitive advantage. A strategic analysis of trust and trustworthiness focuses on the conditions under which a particular type of trust will be a source of competitive advantage.
1. WEAK FORM TRUST AND COMPETITIVE ADVANTAGE
The exchange attributes that make weak form trust possible suggest that weak form trust will usually not be a source of competitive advantage. As suggested earlier, weak form trust is most likely to emerge in highly competitive commodity markets. It is well known that exchange partners in highly competitive commodity markets can expect to gain few, if any, competitive advantages (Porter 1980). In particular, while those partici- pating in these markets will be able to rely on the existence of weak form trust in their exchange relationships, the advantages of weak form trust will accrue to all exchange partners in these markets equally, thereby giving no one of them a competitive advantage.
Indeed one of the few ways those trading in these markets can expect to gain advantages from weak form trust is if some competitors fail to rely on weak form trust and, indeed, invest in unnecessary and costly governance devices to create semi-strong form trust. Both those that rely on weak form and semi-strong form trust, in these highly competitive commodity markets, can expect trust to exist in their exchange relationships. However, those that invest in governance to generate semi-strong form trust will have higher costs compared to those that rely on weak form trust. Over time, those that have invested in unnecessary (and costly) governance will either abandon those governance devices or suffer from competitive disadvantages.
Put differently, the cost advantage of those that rely on weak form trust over those that rely on semi-strong form trust, in these highly competitive conditions, is a measure of the economic value of weak form trust. How- ever, if numerous competitors are all able to obtain this value at the same low cost, then it will not be a source of competitive advantage to any one of them (Barney 1991b).
2. SEMI-STRONG FORM TRUST AND COMPETITIVE ADVANTAGE
Semi-strong trust in exchange relationships is economically valuable, in the sense that its creation assures parties to an exchange that their vulnerabil- ities will not be exploited. However, the ability to create semi-strong trust in economic exchanges depends on several important governance skills and abilities that parties to an exchange must possess. For example, for semi-strong trust to emerge, exchange partners must be able to accurately anticipate sources and levels of opportunistic threat in the exchanges in which they may participate. Also, to create semi-strong trust, exchange partners must be able to rely on existing social governance mechanisms, and/or to conceive of, implement, and manage the appropriate market- based and contractual governance mechanisms. Only if exchange partners can accomplish these tasks will the ‘right’ types of governance be chosen to create semi-strong trust, and will the value of semi-strong trust be realized. However, for semi-strong trust to be a source of competitive advantage, there must be heterogeneity in the exchange governance skills and abilities of competing firms (Barney 1991b). If most competing firms or individuals have similar governance skills and abilities, they will all be equally able to create the conditions under which semi-strong trust will emerge in their exchange relationships. Moreover, the cost of creating semi-strong trust will also not vary dramatically across these equally skilled competitors. Since these competitors do not vary in their exchange governance skills, no one of them will be able to gain a competitive advantage based on the semi-strong trust that they are able to create with these skills.7
Of course, there is no reason to believe, a priori, that competing exchange partners will be equally skilled or able in creating the conditions necessary for semi-strong trust. For example, some exchange partners may have developed a high degree of skill in managing, say, intermediate market forms of governance (e.g. equity joint ventures). These highly skilled actors may be able to create semi-strong trust using these intermediate market forms of governance in economic exchanges where less skilled actors may be forced to use hierarchical forms of governance. If intermediate market forms of governance are, in fact, less costly than hierarchical forms of governance, those that obtain semi-strong trust through intermediate mar- ket forms will have a competitive advantage over those that must obtain trust in that exchange through hierarchical forms of governance. Similar reasoning could apply to those that are highly skilled in managing contrac- tual forms of governance (e.g. contingent claims contracts) compared to those that are only able to use more costly intermediate market forms of governance or hierarchical forms of governance.
Heterogeneity in the skills and ability to create semi-strong form trust in an exchange may also reflect important social differences among exchange partners. For example, if a particular firm is contemplating an exchange with another firm, where that relationship is deeply embed- ded in a large complex network of social relations, these firms may be able to rely on (relatively inexpensive) social governance mechanisms to develop semi-strong form trust. On the other hand, if a competing firm is anticipating a similar exchange that is not deeply embedded in this broader social network of relations, parties to this exchange may have to rely on (more costly) economic forms of governance to ensure semi-strong form trust. The firm that can rely on social governance to generate semi- strong form trust will have a cost-based competitive advantage over the firm that must rely on economic governance to generate semi-strong form trust.
Heterogeneity in governance skills and abilities is an important expla- nation of variance in a wide variety of different economic exchanges. Compare, for example, the exchanges between Toyota and its suppliers, on the one hand, and General Motors (GM) and its suppliers (Womack, Jones, and Roos 1990; Dyer and Ouchi 1993), on the other. Toyota’s supply relationships are deeply embedded in long-standing networks of social and economic relationships. These social governance mechanisms have enabled both Toyota and its suppliers to engage in very vulnerable exchanges (due to high transaction-specific investments that lead to a high risk of holdup) with substantially less contractual or other forms of governance than is the case at GM. Without the ability to rely on social embeddedness to constrain the opportunistic behavior of its suppliers, GM has had to reduce the threat of opportunism by reducing the level of transaction-specific investment in its suppliers (i.e. by having multiple competing suppliers), by insisting on elaborate contractual protections, or by vertically integrating the supply relationship (Womack, Jones, and Roos 1990; Dyer and Ouchi 1993). Overall, the cost of creating semi-strong form trust at Toyota has been substantially lower than the cost of creating semi-strong trust at GM.8
Of course, if several competitors all possess these special governance skills and abilities to approximately the same level, then they will not be a source of competitive advantage for any of them, even if there are some competitors who do not possess these skills. However, as long as the num- ber of competitors that have these special governance skills and abilities is less than what is required to generate perfect competition dynamics, then they can be a source of competitive advantage for those that possess them (Barney 1991b).
Moreover, if these skills and abilities can rapidly diffuse among competitors, they will be the source of only temporary competitive advantages. However, it seems likely that these skills and abilities will not diffuse through most populations. For example, the ability to rely on social governance mechanisms in different exchanges depends on the structure of the network of relations within which an exchange is embedded. Those networks of relations, in turn, are developed over long periods, and are unique to a particular point in history. Such path-dependent (Arthur 1989) phenomena are subject to time decompression diseconomies (Dierickx and Cool 1989), and thus costly to imitate. The development of special governance skills is also path-dependent. Moreover, these skills are often socially complex, and thus costly to imitate (Barney 1991b).
Whenever exchange partners possess rare and costly-to-imitate gover- nance skills and abilities, they may be able to use those abilities to gain competitive advantages in creating semi-strong trust. On the other hand, when competing exchange partners possess similar governance skills and abilities, the creation of semi-strong trust will generate only competitive parity.
3. STRONG FORM TRUST AND COMPETITIVE ADVANTAGE
For strong form trustworthiness to be economically valuable, all those with a significant stake in an exchange must be strong form trustworthy. If one or more parties to an exchange may behave opportunistically in that exchange, then all parties to that exchange will need to invest in a variety of social and economic governance mechanisms to ensure semi-strong trust. Any potential economic advantages of being strong form trustworthy are irrelevant when semi-strong governance protections are erected and exploited, since strong form trustworthy parties are forced to behave as if they were only semi-strong trustworthy.
Economic opportunities in strong form trust exchanges
On the other hand, if all those with a significant stake in an exchange are strong form trustworthy, some important and valuable economic oppor- tunities may exist. These opportunities reflect either the governance cost advantages that strong form trust exchanges may enjoy over semi-strong form trust exchanges, or the ability that strong form trustworthy exchange partners may have to explore exchange options not available to semi-strong form trustworthy exchange partners.
When two or more strong form trustworthy individuals or firms engage in an exchange, they can all be assured that any vulnerabilities that might exist in this exchange will not be exploited by their partners. Moreover, this assurance comes with no additional investment in social or economic forms of governance. As long as the cost of developing and maintaining strong form trustworthiness in an individual or firm, plus the cost of dis- covering strong form trustworthy partners, is less than the cost of exploit- ing or creating semi-strong form governance devices, those engaging in a strong form trustworthy context will gain a cost advantage over those exchanging in a semi-strong trustworthy context.
Consider, for example, several competing firms looking to purchase raw materials from a set of suppliers. Suppose that a small number of these buyers and sellers are strong form trustworthy, and that there are some significant exchange vulnerabilities in this raw materials purchase. In order to complete this purchase, those purchasing from semi-strong suppliers will need to rely on or erect a variety of social and economic governance devices. While these governance devices are costly, their existence will enable firms to purchase the raw material in question. On the other hand, strong form trustworthy buyers purchasing from strong form trustworthy suppliers will not have to rely on or erect social or economic forms of governance in order to complete their purchase of the raw material. As long as the cost of developing and maintaining strong form trustworthiness, plus the cost of discovering strong form trustworthy exchange partners, is less than the cost of relying on or erecting social or economic governance devices, the firms purchasing raw materials in a strong form trust exchange will have a cost advantage over those firms purchasing raw materials in a semi-strong trust exchange.9
Perhaps even more important than this governance cost advantage, those engaging in strong form trust exchanges may be able to exploit exchange opportunities that are not available to those who are only able to engage in semi-strong trust exchanges. It has already been suggested that valuable semi-strong exchanges will not be pursued when the cost of governance needed to generate semi-strong trust is greater than the expected gains from trade. This can happen when the expected gains from trade are small (but modest vulnerabilities in this exchange require modest levels of expensive governance) or when the expected gains from trade are substantial (but very large vulnerabilities in this exchange require very sub- stantial levels of costly governance). While semi-strong trust exchanges will not be pursued in these situations, it may be possible to pursue strong form trust exchanges. In this sense, strong form trustworthiness may increase the set of exchange opportunities available to an individual or firm, compared to those who are only semi-strong trustworthy (Zajac and Olsen 1993; Ring and Van de Ven 1994).
Consider, for example, several competing firms looking to cooperate with one or more of several other firms in the development and exploita- tion of a new, and sophisticated, technology. Suppose that only a small number of these two sets of firms are strong form trustworthy, that the technology in question has significant economic potential, but that there are enormous exchange vulnerabilities in the technology development process. Semi-strong trustworthy firms, in this setting, will need to invest in substantial amounts of costly governance to try to create semi-strong trust. It may even be the case that no form of governance will create semi- strong trust (Grossman and Hart 1986). The potential economic return that could be obtained from this exchange will need to be reduced by an amount equal to the present value of the cost of governing this exchange. Moreover, the present value of this exchange will also have to be discounted by any residual threat of opportunism. The reduced value of this exchange could lead semi-strong trustworthy firms to decide not to pursue it, even though substantial economic value may exist.
On the other hand, exchanges of this sort between strong form trust- worthy firms are burdened neither by the high cost of governance nor any residual threat of opportunism. Strong form trustworthy firms will be able to pursue these valuable, but highly vulnerable exchanges, while semi-strong form trustworthy firms will be unable to pursue them. This may represent a substantial opportunity cost for semi-strong trustworthy exchange partners, and a source of competitive advantage for strong form trustworthy exchange partners.10
Traditional transactions cost logic suggests that when faced with these valuable but highly vulnerable exchanges, exchange partners will opt for hierarchical forms of governance and use managerial fiat as a way to man- age trustworthiness problems (Williamson 1985). However, hierarchical governance is not always a solution to these problems. First, there may be important legal and political restrictions on the use of hierarchical gover- nance. For example, one cannot acquire a direct competitor if such actions lead to unacceptably high levels of industry concentration. Also, firms may be required, for political reasons, to maintain market or intermediate market relationships with an exchange partner (e.g. when entering into a new country market).
Second, as Grossman and Hart (1986) suggest, hierarchical gover- nance does not necessarily ‘solve’ opportunism problems. Rather, it simply shifts those problems from a market or intermediate market context to inside the boundaries of the firm. Where, in market-based exchanges, firms face the threat of opportunism in exchanges with other firms, bringing these transactions within the boundaries of a firm can simply lead to division facing the threat of opportunism in exchanges with other divi- sions. Put differently, hierarchical governance does not automatically create strong form trust exchanges (Ouchi 1980). These issues are discussed in more detail in section the ‘Discussion’ section of Chapter 8 which provides a resource-based analysis of vertical integration.
Where hierarchical governance may not always be a solution to the threat of opportunism, exchanges between strong form trustworthy exchange partners—whether those exchanges are within the boundary of a sin- gle firm or not—will, in general, create strong form trust. Strong form trustworthy individuals or firms will often be able to gain governance cost advantages over semi-strong trustworthy individuals or firms. More- over, strong form trustworthy individuals or firms will often be able to engage in economic exchanges that cannot be pursued by semi-strong trustworthy exchange partners. Put differently, the level of vulnerability in some economic exchanges may be greater than the ability of any standard governance devices to protect against the threat of opportunism. The only way to pursue these exchanges is through strong form trustworthiness.
Of course, if most competitors are strong form trustworthy, and engage in exchanges with others that are also strong form trustworthy, then the advantages of strong form trustworthiness would only be a source of com- petitive parity, and not competitive advantage. However, while the number of strong form trustworthy exchange partners in a particular segment of the economy is ultimately an empirical question, it seems like a reasonable guess that strong form trustworthiness in at least some segments of the economy is probably rare, and thus (assuming exchanges with other strong form trustworthy exchange partners are developed) at least a source of temporary competitive advantage for strong form trustworthy individuals and firms.
Locating strong form trustworthy exchange partners
Given the important competitive advantages that may attend exchanges between strong form trustworthy exchange partners, an important ques- tion becomes: how can strong form trustworthy exchange partners recog- nize each other? This process is problematic, since exchange partners that are not strong form trustworthy have a strong incentive to assert that they are. If a strong form trustworthy individual or firm believes that an exchange partner is strong form trustworthy, even though this partner is not, then that strong form trustworthy individual or firm will be willing to engage in a highly vulnerable exchange without social or economic devices. Without these devices in place, the untrustworthy exchange partner could exploit the strong form trustworthy partner’s exchange vulnerabilities with impunity. Thus, simple assertions that one is strong form trustworthy are not sufficient for assuming that an exchange partner is, in fact, strong form trustworthy.
Of course, a simple solution to this adverse selection problem would be to directly observe whether a potential exchange partner is strong form trustworthy, and respond appropriately. Unfortunately, the individual and organizational attributes that create strong form trustworthiness are difficult to directly observe. At an individual level, the values, princi- ples, and standards around which strong form trustworthy individuals organize their lives are clearly not directly observable. At the firm level, an organization’s culture, and associated control systems, may be difficult to observe, and their implications for individual behavior ambiguous— at least to those not deeply embedded in this culture and control system. Moreover, if the development of strong form trust depends on the strong form trustworthiness of small groups of people in a larger organization, evaluating the individual values, principles, and standards of these people remains difficult.
Even with these challenges, strong form trustworthy exchange partners can still be found. It will often be the case, for example, that exchange partners will begin a relationship assuming that others are at least semi- strong trustworthy. As this relationship evolves over time, parties to an exchange may be able to gain sufficient information to accurately judge whether others are strong form trustworthy. If two or more parties to an exchange discover that they are strong form trustworthy, any subse- quent exchanges between these parties can generate strong form trust, and these exchange partners will subsequently obtain all the advantages of strong form trustworthiness. On the other hand, if experience shows that an exchange partner is only semi-strong form trustworthy, then future exchanges with this partner will continue with semi-strong form trust generating governance mechanism in place.
Note that this process of discovering strong form trustworthy exchange partners assumes that one’s trustworthiness type does not automatically change as a result of experience in a semi-strong trust relationship. If the creation of semi-strong trust exchanges inevitably led exchange partners to become strong form trustworthy, then all exchanges would inevitably be characterized by strong form trust, and strong form trustworthiness would not be a source of competitive advantage to any individual or firm. Rather than changing an exchange partner’s trustworthiness type, the creation of a semi-strong trust exchange creates an opportunity for exchange partners to more directly observe another’s trustworthiness type. While it is certainly true that an exchange partner’s trustworthiness type may evolve over the long run, the historical, path-dependent, socially complex, and causally ambiguous nature of strong form trustworthiness makes it unlikely that semi-strong form trustworthy firms will be able to become strong form trustworthy in the short or medium term.
This search for potential strong form trustworthy exchange partners can be shortened through the use of signals of strong form trustworthiness (Spence 1973). Signals of strong form trustworthiness must have two properties: (a) they must be correlated with the underlying (but costly to observe) actual level of strong form trustworthiness in a potential exchange partner, and (b) they must be less costly to exchange partners that are actually strong form trustworthy than they are to exchange partners that only claim they are strong form trustworthy (Spence 1973).
Several behaviors by exchange partners qualify as signals for strong form trustworthiness. For example, a reputation for being strong form trustworthy is a signal of strong form trustworthiness.11 Gaining a repu- tation as a strong form trustworthy exchange partner occurs, over time, as an exchange partner confronts situations where opportunistic behavior is possible, but chooses not to engage in opportunistic activities. There are no opportunity costs associated with a strong form trustworthy individual or firm not behaving opportunistically, since such behavior is not in this kind of exchange partner’s opportunity set. On the other hand, a non- strong form trustworthy exchange partner will have to absorb opportu- nity costs each time they decide to not behave in an opportunistic way. These opportunity costs make it more costly for an exchange partner that is not strong form trustworthy to develop a reputation as strong form trustworthy, compared to an exchange partner that is actually strong form trustworthy.
While a reputation for being strong form trustworthy is a signal of strong form trustworthiness, it is noisy. In particular, this reputation cannot dis- tinguish between those exchange partners that are actually strong form trustworthy, and those that are not strong form trustworthy, but have yet to engage in an exchange where returns to opportunistic behavior are large enough to motivate opportunistic behavior. While a reputation for being strong form trustworthy does eliminate those exchange partners who have acted opportunistically, it does not eliminate those exchange partners who might act opportunistically, given the right incentives.
Another signal of strong form trustworthiness is being open to outside auditing of the exchange relationship. This is less costly to strong form trustworthy exchange partners, compared to those that are not strong form trustworthy, since trustworthy exchange partners were not going to behave opportunistically anyway. One would expect to see strong form trustwor- thy firms and individuals to be very open to outside auditors, perhaps even paying the cost of outside auditors chosen by potential exchange partners.
A third signal of strong form trustworthiness might be to make unilat- eral transaction-specific investments in an exchange before that exchange is actually in place. Gulati, Khana, and Nohira (1994) have found, for example, that it is not uncommon for firms with a strong track record of successfully engaging in joint ventures to sign long-term, third-party supply contracts that are only valuable if a particular joint venture actually goes forward—before that joint venture agreement is complete. Such uni- lateral transaction-specific investments are less costly to strong form trust- worthy firms, since they were not going to behave in an opportunistic manner in developing this joint venture anyway. These investments foreclose opportunistic opportunities for firms that are not strong form trustworthy, and thus represent significant opportunity costs to these firms. If all those involved in an exchange independently make these kinds of unilateral transaction-specific investments, the others in these exchanges can conclude, with some reliability, that they are strong form trustworthy. If strong form trustworthiness is relatively rare among a set of competi- tors, and if two or more strong form trustworthy exchange partners are able to engage in trade, then these strong form trustworthy individuals or firms will gain at least a temporary competitive advantage over individ- uals or firms that are not strong form trustworthy. For this competitive advantage to remain, however, the individual and organizational attributes that make strong form trustworthiness possible must also be costly to imitate and immune from rapid diffusion. Fortunately, the individual and organizational attributes that make strong form trustworthiness possible (i.e. individual values, principles, and standards; an organization’s culture and associated control systems) reflect an exchange partner’s unique path through history (path dependence) and are socially complex. As was sug- gested earlier, these types of individual and organizational attributes are usually immune from imitation and rapid diffusion among competitors (Arthur 1989; Dierickx and Cool 1989; Barney 1991b).
Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.