Business relationships – risks & opportunism


It is noted by experts that in establishing a customer-supplier relationship, there is tension between safeguarding and adaptation. Vertical coordination can facilitate stronger customer seller ties but at the same time may increase the risk to the customers’ and suppliers’ specific investments.

Specific investments are those expenditures tailored to a particular company and value chain partner like investments in company-specific training equipment, and operating procedures or systems or special purpose machines. Specific investment help firms grow profits and achieve their positioning.

For example, Xerox has worked closely with its suppliers to develop customized processes and components that reduced its copier manufacturing costs by 30 to 40 percent. In return, suppliers received sales and volume guarantees, an enhanced understanding of their customer needs, and a strong position with Xerox for future sales.

Specific investments also entail considerable risk to both the customer and supplier. Transaction theory from economics maintains that because these investments are partially sunk, they lock in the firms that make the investment to a particular relationship. Sensitive cost and process information may need to be exchanged.

A buyer may be vulnerable to holdup because of switching costs; a supplier may be more vulnerable to holdup in future contracts because of dedicated assets and/or expropriation of technology/knowledge. In terms of the latter risk, consider the following example.

An automobile component manufacturer wins a contract to supply an under hood component to an original equipment manufacturer (OEM). A one-year, sole-source contract safeguards the supplier’s OEM-specific investment in a dedicated production line However, the supplier may also be obliged to work (non contractually) as a partner with the OEM’s internal engineering staff (using linked computing facilities) to exchange detailed engineering information and coordination frequent design and manufacturing changes over the term of the contract. These interactions could reduce costs and/or increase quality by improving the firm’s responsiveness to marketplace changes. Such interactions could also potentially magnify the threat to the supplier’s intellectual property.

When buyers cannot easily monitor supplier performance, the supplier might shirk or cheat and not deliver the expected value. Opportunism can be though of as “some form of cheating or undersupply relative to an implicit or explicit contract.� It may involve blatant self-interest and deliberate misrepresentation that violates contractual agreements.

In creating the 1996 version of the Ford Taurus, Ford Corporation chose to outsource the whole process to one supplier, Lear Corporation. Lear committed to a contract that, for various reasons, it knew it was unable to fulfill. According to Ford, Lear missed deadline, failed to meet weight and price objectives, and furnished parts that did not work. A more passive form of opportunism might involve a refusal or unwillingness to adapt to changing circumstances

Opportunism is a concern because firms must devote resources to control and monitoring that otherwise could be allocated to more productive purposes. Contracts may become inadequate to govern supplier transactions when supplier opportunism becomes difficult to detect; as firms make specific investments in assets that cannot be used elsewhere, and as contingencies are harder to anticipate.

Customers and suppliers are more likely to form a joint venture (versus a simple contract) when the supplier’s degree of asset specificity is high, monitoring the supplier’s behavior is difficult, and the supplier has a poor reputation. When a supplier has a good reputation, for example, it is more likely to avoid opportunism to protect this valuable intangible asset.

The presence of a significant future time horizon and/or strong solidarity norms so that customers and suppliers are willing to strive for joint benefits can cause a shift in the effect of specific investments, from increased opportunism on the receiver’s party to bonding (reduced opportunism).