From arms-length to collaborative relationships inthe supply chain : An evolutionary process

Text-only Preview

The current issue and full text archive of this journal is available at
From arms-length to
collaborative relationships in
the supply chain
An evolutionary process
Received September
James Hoyt
Revised February 2000, Sorrell College of Business, Troy State University, Alabama, USA, and
May 2000
Faizul Huq
College of Business Administration, The University of Texas at
Arlington, Texas, USA
Keywords Channel relations, Supply chain, Change management
Abstract Buyer-supplier relationships play an important role in an organization's ability to
respond to dynamic and unpredictable change.If the relationship is too restrictive, flexibility will
be difficult to achieve and, if it is too lenient the risk of opportunism will be present.This paper
provides a framework for understanding how buyer-supplier relationships have evolved over the
past two decades from transaction processes based on arms-length agreements to collaborative
processes based on trust and information sharing.To achieve this objective, buyer-supplier
relationships are reviewed from the perspectives of transaction cost theory, strategy-structure
theory and resource-based theory of the firm.Findings from early supply chain research are
contrasted with the findings of more current research to provide a better understanding of how
these relationships have changed.Current theory is extended by offering two proposals that test
the influence of trust and information sharing and a third proposal that rejects the notion that
supply chain alliances lead to monopolistic practices.
Buyer-supplier relationships play an important role in manufacturing strategy
when the environment is uncertain and dynamic (Handfield and Nichols, 1999;
Youssef, 1992). Relationships in the supply chain can be simple if they involve
the purchase of commodities or, they can be complex if they involve specialty
products obtainable only from a limited number of suppliers or if they require
specialized assets to produce (Ellram, 1992). The level of risk associated with
these relationships is the result of transaction uncertainty due to asset
specificity, competition in the suppliers market, and the willingness of both
parties to assume some level of risk (Dyer and Singh, 1998; Chiles and
McMackin, 1996). However, the ways in which organizations manage this risk
has been changing over the past two decades. As late as the mid-1980s,
transactions between buyers and sellers tended to rely on arms-length
agreements, based on market price, while relationships in the 1990s rely more on
trust derived from collaboration and information sharing. The dynamics of
International Journal of Physical
change and organizational issues associated with supply chain relationships are
Distribution & Logistics
Management, Vol. 30 No. 9, 2000,
an important subject for study because they directly influence the ``make-or-
pp. 750-764. # MCB University
Press, 0960-0035
buy'' decision (Alston and Gillespie, 1989; Jones, 1987; Walker and Weber, 1984).

The growing importance of trust in buyer-supplier relationships leads to Relationships in
some new opportunities for research because collaborative and trusting the supply chain
relationships are often counterintuitive to the traditional ways of doing
business in many US companies. Furthermore, for these types of relationships
to be successful, management must implement radical changes to
organizational processes and structures that support them (Liedtka, 1996;
Mariotti, 1999). As new forms of buyer-supplier relationships emerge, new
organizational paradigms must be developed to explain their evolution and
how these changes affect future performance. Traditional processes, based on
market price, must be replaced by a more systematic view of transactions
based on total costs if one wishes to explain the dynamics of current buyer-
supplier relationships (Doktor et al., 1991). This paper reviews the evolution of
buyer-supplier relationships from the perspectives of transaction cost analysis,
organizational structure theory and, resource-based theory of the firm. To
achieve this objective, the authors review a selection of supply chain literature
beginning with the mid-1980s and extending to the late 1990s. Philosophical
changes in buyer-supplier relationships during this period are then used to
develop a set of testable proposals suitable for future research.
Two decades of change in buyer-supplier relationships
Supply chain management philosophies have changed over the past two
decades. In 1984, Walker and Weber proposed a model to explain the effects of
transaction costs on the make-or-buy decision (see Figure 1). They concluded
that production costs exerted a major influence on the make-or-buy decision,
while volume uncertainty and supplier competition produced a significant
effect but one that was considerably smaller. They found, for example, that a
decision to make-in-house was positively correlated with volume and technical
uncertainty. However, when a supplier's price was less than the cost to produce
in-house or, competition in the supplier's industry was high, buyers generally
Figure 1.
Determinants of the
make-or-buy decision

elected to purchase the product in the market. Their findings suggested that
make-or-buy decisions tended to rely on economic factors and relational
contracting was not an important issue. Six years later, Walker and Poppo
(1991) studied two types of buyer-supplier relationships. They compared
suppliers within the organization, and single-source suppliers external to the
organization. Their study revealed four variables that affect transaction costs
asset uniqueness, competition in the supplier's market, newness of technology
and required investments (see Figure 2).
Of the four variables, ``asset uniqueness'' produced a smaller effect on
transaction costs than a relational contract and, ``competition in the supplier's
market'' produced no measurable affect on transaction costs. This study still
defended the essence of arm's length transactions based on transaction cost
theory (TCT). However, the authors recognized the complexity of buyer
supplier relationships and concluded that relational contracting could dampen
the effects of asset specificity on transaction costs. They also recognized the
existence of hybrid relationships that combine the economic factors of TCT
and collaboration.
Forrest and Martin (1990) studied the role of governance mechanisms in the
success/failure of supply chain alliances in the biotechnology industry. Their
findings showed that the most important reason for the formation of a buyer-
supplier alliance was to exploit new technology. They cited three reasons for
the formation of a supply chain alliance: technology development, technology
commercialization, and financial benefits. Nishiguchi (1994) identified six
dimensions of the buyer-supplier environment:
(1) competition in the supplier's industry;
(2) supplier cost advantage;
(3) buyer's experience in the manufacturing process;
(4) technology uncertainty;
(5) volume uncertainty; and
(6) newness of technology.
Figure 2.
Determinants of
transaction cost

He concluded that each of these conditions influenced the success of customer- Relationships in
supplier alliances as well as the ``make-or-buy'' decision.
the supply chain
Heide and John (1990) studied the dimensions of industrial buyer-supplier
relationships to test the following proposal:
Establishment of closer relationships between organizations leads to a shift away from
market-based exchange toward a more bilateral governance.
They proposed three measures of performance for supply chain partnerships:
(1) level of joint activity;
(2) expectation of a continuing relationship; and
(3) level of surveillance that the buyer exercises over the supplier's process.
They concluded that customer/supplier cooperation was positively correlated
with three conditions:
(1) expectations of continuing relationships;
(2) increased verification efforts by the customer; and
(3) specific investments in the relationship.
Despite a growing awareness of the role of collaboration, early supply chain
research tended to emphasize the importance of arm's-length relationships as
the traditional way of doing business. Such processes, founded on the principles
of TCT, provided a platform for explaining buyer-supplier governance
mechanisms into the early 1990s (Williamson, 1979; Teece, 1992).
However, an awareness of the role of trust and collaboration began to evolve
in the early 1990s. For example, in 1992, Ellram studied international alliances
to determine their affect on the purchasing function. Of 729 reported
international alliances, 12.5 per cent gave purchasing as the primary reason for
the alliance and 34 per cent of the alliances cited technology development as
their most important objective. Her findings were then tested in six case
studies. Ellram concluded that high-tech industries such as pharmaceuticals,
chemicals, energy, computers and semiconductors and telecommunications
had the highest propensity to form alliances. She was also one of the first to
recognize that mutual commitment was more meaningful to the success of an
alliance and also carried more weight than formal agreements.
As the latter half of the 1990s approached, the concepts of trust and
collaboration in the supply chain, began to challenge the explanatory power of
TCT (Ghoshal and Moran, 1996; Chiles and McMackin, 1996). By the late 1990s,
researchers were proposing new organizational paradigms as an alternative to
the governance mechanisms proposed by TCT. Handfield and Nichols (1999)
discussed the importance of trusting relationships in the supply chain and how
the sharing of information and assets was essential for the success of a strategic
alliance. Dyer and Singh (1998) argued that when firms collaborate, they are
often in a position to generate relational rents if they are in a position to share
knowledge and resources. Liedtka (1996) discussed the importance of learning

through trust and collaboration, but also recognized the difficulties associated
with collaboration. Jones et al. (1997) discussed the network form of governance
as an alternative to TCT when conditions of asset specificity, demand
uncertainty, and task complexity were present. Lengnick-Hall (1998) argued
that trust, developed through effective communication, can create resources that
lead to a competitive advantage, while Henriott (1999) and Mariotti (1999)
argued for the importance of information exchange in the supply chain as a
prerequisite for trust. Finally, Peters and Hogensen (1999) and Monczka et al.
(1998) claimed that trust and collaboration were becoming more prevalent in
supply chain relationships because of their ability to reduce uncertainty.
In the following sections, buyer-supplier relationships are reviewed from
three different perspectives:
(1) transaction cost theory;
(2) strategy-structure theory; and
(3) resource-based theory of the firm.
In the 1980s, Williamson's TCT offered a plausible explanation of how
organizations deal with the risk of transacting business across their boundaries
(Williamson, 1979; Jones et al., 1997). TCT predicts that, in the absence of some
form of governance mechanism, agreements between organizations will always
be subject to risks from opportunistic behavior (John, 1984; Tirole, 1993). TCT
proponents argued that when governance mechanisms were used, they tended
to be a function of asset specificity, uncertainty, and the willingness of the
transaction partners to assume some level of risk (Walker and Poppo, 1991;
Chiles and McMackin, 1996).
Under TCT, when the market for supplies is competitive and asset
specificity is low, the buyer can easily dissolve the relationship if the supplier
fails to meet his obligations or if the resource is no longer needed (John, 1984;
Tirole, 1993). These relationships, referred to as ``arms length'', are
characterized by little or no investment in assets with minimal information
exchange. However, for more specialized products that require up-front
investment or have only a few suppliers, the governance mechanisms will be
more formalized and less flexible (Chiles and McMackin, 1996; Dyer and Singh,
1998). In the absence of collaboration, these agreements restrict organizational
responsiveness because they are rigid and not easily modified (John, 1984;
Tirole, 1993; Cooper and Gardner, 1993).
For nearly three decades TCT offered an acceptable explanation of
governance mechanisms in the supply chain. However, for many current day
markets where institutional environments and exchange practices are more
advanced, the appropriateness of TCT appears to be losing its explanatory
power (Ghoshal and Moran, 1996). For example, Nishiguchi (1994) reported
considerable differences in the ways that US, European and Japanese
manufacturing organizations support flexible manufacturing processes. In a

comparison of organizations from each country, he observed that US and UK Relationships in
companies appeared to support the principles of traditional Williamsonian the supply chain
TCT (Williamson, 1979), while Japanese organizations appeared to contradict
it. Two years later, in 1996, Ghoshal and Moran (1996) offered evidence to
suggest that US buyer-supplier relationships were shifting away from
governance mechanisms based on controls toward governance based on
collaboration and trust. They argued that opportunism was a fundamental
concept in the logic of TCT and such opportunism could, in fact, be a
self-fulfilling prophecy. They also suggested that, surveillance and fiat tend to
conjure up negative responses in individuals when they are obligated to
perform in a specified manner. This condition, they argued, could easily lead to
an increase in governance costs followed by a reduction in competitiveness.
Monczka et al. (1998) supported this finding. Their empirical study showed that
successful strategic alliances exhibited higher levels of commitment, trust,
coordination and interdependence.
A better understanding of the roles of trust and cooperation is undermining
TCT's ability to explain governance mechanisms in buyer-supplier relationships
(Ghoshal and Moran, 1996). It suggests that long-term relationships, based on a
win-win philosophy, are replacing the traditional adversarial relationships that
were explained so sensibly by TCT. More recent research also shows how
governance mechanisms based on trust and mutual cooperation can improve
manufacturing firm performance (Handfield and Nichols, 1999; Wetherbe, 1995;
Liedtka, 1996; Jones et al., 1997). These findings support the belief that, under the
principles of TCT, formal contracts between the buyer and seller should be
negatively correlated with performance when the environment is uncertain, since
they cannot be modified easily. On the other hand, agreements based on trust
should be positively correlated with responsiveness and performance because
they require less effort to modify.
Resource-based theory (RBT) of the firm
From the perspective of RBT, long-term relationships founded on a win-win
premise with a core group of suppliers can lead to a stronger sustainable
competitive advantage than those based on a bid-buy system (Harrison and St
John, 1996; Lambert et al., 1998). Trust among partners is essential for a win-
win relationship. It is defined as the expectation that partners to an exchange
will not act in an opportunistic manner even if there are short-term incentives
to do so (Chiles and McMackin, 1996). Trust is also earned over time evolving
slowly as the result of a successful history of performance between the partners
(Liedtka, 1996). RBT research shows that collaboration founded on trust
enables firms to accumulate resources that are rare, valuable, hard to imitate,
and have no readily available substitute (Dyer and Singh, 1998). Yet, despite
this fact, current research shows that over 50 per cent of US companies still
employ adversarial bid-buy methods in their relationships with suppliers
(Mariotti, 1999).

Trends in supply chain relationships are also important and examples of
increasing cooperation among supply chain partners are beginning to emerge.
For example, Walmart, Proctor and Gamble, Lucent Technologies, and Sara
Lee now collaborate readily with their supply chain partners in the areas of
planning, forecasting and replenishment (Handfield and Nichols, 1999; Peters
and Hogensen, 1999). Collaborative supply chain partnerships such as these,
support the development of flexibility, responsiveness, and low-cost/
low-volume manufacturing skills (Goldhar and Lei, 1991). They also enhance
access to complementary assets and technology which helps firms to
commercialize core competencies (Teece, 1992).
Organizations must develop an integrated set of performance metrics and
information linkages from factory nodes and other points in the supply chain if
they are to achieve a sustainable competitive advantage (Goldhar and Lei, 1991;
Lengnick-Hall, 1998). Information flow is a stepwise process between links in
the supply chain; and every time information is exchanged there is a risk of
error or an increase in cycle times. Compatible information technology among
supply chain members enhances communication, reduces risk and supports the
efficient transfer of information (Henriott, 1999; Mariotti, 1999). The importance
of efficient information transfer was reaffirmed by the Automotive Action
Group when they observed that materials information sent to third- and fourth-
tier suppliers often took four to six weeks to arrive and, when it did arrive, it
was often distorted (Henriott, 1999). From the perspective of RBT, one can see
that an efficient flow of information, trust, and a willingness to collaborate,
support the development of a sustainable competitive advantage.
Strategy-structure theory
Strategy-structure theory (SST) supports the view that successful firms appear
to be taking a more systematic and dynamic view of their supply chain in order
to develop more efficient information transfer systems (Handfield and Nichols,
1999; Barney, 1995). As a result, horizontal/modular structures are now
considered to be a dominant organizational form for successful supply chains
(Easton et al., 1999).
SST also provides some insight into the dynamics of supply chains.
Consider, for example, the computer industry, where supply chains have
transitioned from structures that were predominately vertical in the 1970s, to
forms that are now more horizontal (Easton et al., 1999). Fine (1999) describes
this phenomena as one which is cyclical with a period determined by conditions
within each industry. He notes that supply chain structures appear to cycle
between integral/vertical and horizontal/modular forms driven by the rate at
which companies and products evolve. He refers to the length or period of this
cycle as the industry ``clockspeed'' and notes that it is particularly visible in the
high-technology industries where companies and products evolve at a very
high rate compared to other industries. Awareness of an industry's clockspeed
allows one to predict future opportunities (or threats) by considering the events
of past cycles. Easton et al. (1999) demonstrated this phenomena by comparing

the computer industry to the automotive industry. For the computer industry Relationships in
the cycle of vertical to horizontal supply chain structure took less than two the supply chain
decades to complete while the automotive industry appears to be completing a
cycle that started at the turn of the century.
Boundaries within or between organizations have been shown to restrict the
flow of information and inhibit the development of trust between co-operating
partners (Forrester and Drexler, 1999; Jick, 1992). We are now experiencing the
evolution of the network form of organizational partnerships, where
communication flows are unrestricted and firms leverage their core
competencies through a series of cooperative supply chain relationships based
on trust. In the network approach to supply chain management, restrictive
control mechanisms are being replaced by an atmosphere of trust where
technical and market information flows freely (Allred et al., 1996; Forrester and
Drexler, 1999; Jones et al., 1997). Supply chain structures that support
cooperation have been shown to be positively correlated with expectations of a
continued relationship and a willingness to invest by both the buyer and seller
(Heide and John, 1990; Monczka et al., 1998). Two critical end-products of trust,
therefore, are the likelihood of a continued relationship and the willingness to
participate in the process (Chiles and McMackin, 1996; Handfield and Nichols,
1999; Wetherbe, 1995).
Supply chain alliances
Simple buyer-supplier relationships often evolve into a more formal relationship
known as a supply chain alliance. Teece (1992) defines a supply chain alliance
as: ``A constellation of agreements typified by a commitment between two or
more partner firms to reach a common goal that involves a pooling of resources
and activities.'' These alliances enhance an organization's ability to deal with the
risks of opportunistic behavior often associated with asset specificity and small
numbers bargaining (Goldhar and Lei, 1991; Goldman and Nagel, 1993).
However, when the threat of opportunism is real, buyers must consider the
tradeoffs between flexible, informal agreements, based on trust, and inflexible,
formal agreements founded on a legal document. Research shows that the
ultimate success or failure of a supply chain alliance is determined by the level
of commitment, trust and cooperation (Monczka et al., 1998).
In the 1970s, Japanese supply chain processes were an interesting contrast to
supply chain governance mechanisms that many US companies relied on. An
efficient system of buyer-supplier relationships gave Japanese organizations an
advantage over comparable US firms (Nishiguchi, 1994). Japanese supply chain
alliances tended to rely on consultative relationships and inter-firm associations
which, in turn, lead to an extensive network of cooperative agreements
(Ashkenas, 1990). Consider the following example: In the 1970s US auto makers
dealt with 1,000 to 3,000 suppliers, while their Japanese counterparts dealt with
one-tenth that number. Unlike the US companies, Japanese trading partners
knew each other's manufacturing costs and shared a sense of common
objectives and a willingness to share risk (Lewis, 1990). This approach to the

management of supplier relationships gave the Japanese auto-maker as much as
a 22 per cent manufacturing cost advantage in the 1970s (Dyer and Ouchi, 1993).
As time progressed, US organizations began to recognize the advantage of
collaboration based on trust in supply chain relationships as wel as the value of
non-adversarial ways of doing business. They also learned the value of
relationships based on shared goals and reasonable expectations (Liedtka,
1996). US manufacturers now outsource 46 per cent of their activities and this
practice is expected to increase in the future (Henriott, 1999).
Customer-supplier partnerships (CSPs) form for a number of reasons: a need to
reduce manufacturing costs (Bartek, 1990), technological uncertainty (El ram,
1992), shorter product life-cycles (Bil ington, 1994) and an ability to deal with
uncertainty and to create organizational flexibility (Harrison and St John, 1996).
They tend to be most successful when there is a need for rapid innovation and
geographical/organizational dispersion of know-how (El ram, 1992; Teece, 1992).
Supply chain partnerships also fail. Forrest and Martin (1990) offered the
following five reasons for their failure:
(1) the partner was not paying enough attention to the relationship;
(2) lack of continuous and mutual trust;
(3) changes in the market;
(4) the partner was perceived to be a potential competitor; or
(5) the project was too long.
Tirole (1993) proposed three factors that limit the success of customer-supplier
(1) legal and ethical issues;
(2) time and energy required to support the effort; and
(3) a decrease in the value of the customer-supplier relationship as the life-
cycle advances.
Finally, Serapio and Cascio (1996) offered five reasons for the demise of supply
chain alliances:
(1) they were no longer successful;
(2) differences between partners (personalities or management styles);
(3) breach of agreement;
(4) relationship can no longer be justified; and
(5) better opportunities elsewhere.
Theory development
Buyer-supplier relationships lead to a series of research questions and, in this
paper, we consider two:

(1) Are supply chain partnerships that rely on trust more resilient to Relationships in
changes in the economy than partnerships which rely on arms-length the supply chain
transaction processes?
(2) Should a successful CSP be considered collusive or anti-competitive?
As a first step in answering these questions, three testable propositions are
Research question No.1: ``How do CSPs respond to recessionary periods?''
As noted earlier, the nature of the product (i.e. commodity or specialty) will
influence the decisions relating to the CSP. Decisions for commodity-type
products are generally governed by simple ``bid-buy'' actions where the terms
are spelled out in a standard purchase order (Ellram, 1996). These are the
``arms-length'' transactions that typically involve low levels of trust and
minimal collaboration. However, the make or buy decision becomes more
complex if the procurement involves products that are unique or have special
characteristics. For these products, if the cost of transacting in the market (CM)
is greater than the cost to manufacture internally (CH) there can be strong
economic justifications for manufacturing the item internally (Walker and
Weber, 1984). However, if the cost of transacting in the market for these
products (CM) is less than the cost of transacting in-house (CH), the motivation
would be to subcontract the task to an outside supplier and a CSP would be the
preferred course of action (Walker and Weber, 1984). But, a decision to procure
the product from an external supplier tends to be riskier than the decision to
manufacture in-house because parties to the transaction cannot see the
consequences of their actions with certainty. Because of this situation,
contracts or agreements will seldom be complete (Teece, 1992) and, in the
presence of small numbers bargaining and (or) asset specificity, the risk of
opportunism will be greater.
To reduce this risk, buyers often turn to some form of binding agreement or
contract (Williamson, 1979) and this creates a new dilemma for both parties
who must weigh the advantages of flexibility against the risk of opportunism.
The solution to the problem involves a choice between an agreement based on
trust and collaboration or a formal contract enforceable in a court of law. In the
case where the product is purchased from an external supplier, the possibility
of disequilibrium in the market during periods of economic recession must be
taken into consideration. For example, during recessionary times, the buying
organization could justify in-house production of the product as long as such
action makes some contribution to overhead expenses. This situation, referred
to as ``marginal cost analysis'' leads to two propositions for CSPs involving
specialty products:
P1a: Supply chain partnerships with low levels of trust and cooperation, will
restructure, renegotiate or dissolve during periods of extended
economic recession.