Do different governance modes affect buyer-supplier integration: an exploratory investigation

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1 Do different governance modes affect buyer-supplier integration: an exploratory investigation Mariya Kabantsova University of Groningen, Department of Operations, The Netherlands Dirk Pieter van Donk University of Groningen, Department of Operations, The Netherlands Damien Power University of Groningen, Department of Operations, The Netherlands/ University of Melbourne, Australia Abstract There is a longstanding, unresolved debate as to whether different modes of governance are complementary or mutually exclusive. This paper adds to the discussion by investigating the relationship between governance and three dimensions of SC integration, taking into account as a contextual factor supply complexity. Twelve exploratory cases form the empirical base. We find that both complementarity and mutually exclusiveness do exist, that context plays a role in what mode of governance is present, and that distinguishing three dimensions (practices, patterns, attitudes) adds to our understanding of the complexity of supply chain integration and its relations with context and governance. Keywords: governance, supply chain integration, supply complexity Introduction Managers in a buyer-supplier relationship find it difficult to choose between different ways of managing the relationship with their partners in the chain. One option is to stress contractual issues and legal agreements and to closely control all activities. Alternatively, one might aim to build up trust and confidence with buyers or suppliers in order to possibly eliminate the need to maintain control. Additionally, such choice might need to be determined by contingency factors such as uncertainty, technology, or dependency. These managerial questions have also been part of an academic debate for some time: the choice between contractual and relational governance and the implications for both (e.g. Carey and Lawson, 2011). Governance is defined as the inter-organizational framework that supports transactions and coordination between two parties (Cai et al, 2003, p. 3). On the one hand, companies might need contractual safeguards to assure the required quality, delivery or prices, which is specifically studied within transaction cost theory that further explains conditions under which contracts are best employed (e.g. Williamson, 2008). On the other hand, it is argued that legal contracts are insufficient to ensure what is important in a relationship, including inter-dependence and continuity over time which is better covered by relational governance. Relational governance is embedded in social exchange theory, and states that relationships develop over time to build trust, cooperation and avoid opportunism 1

2 (e.g. Ambrose et al., 2010). In fact, in this context this theory predicts that social norms act to ensure that expectations, that may otherwise be protected by contracts, are met. Some researchers argued that the Transaction Cost and Social Exchange perspectives represent conflicting and contradicting arguments, and are more or less mutually exclusive (e.g. Lumineau and Henderson, 2012). Others have stated that there is a complimentary aspect in both types of governance, as both contractual and normative safeguards are needed in buyersupplier relationships. Current literature is inconclusive with respect to these points and the debate is ongoing as to whether both types of governance complement or substitute each other (e.g. Carey and Lawson, 2011; Li et al., 2010). While there is a discussion on how the two modes of governance relate, whether they are complementary or are mutually exclusive, we do not know much on the effects of both and how they influence the type of supply chain integration. Also we do know little on the effects of contingency factors on these choices, while there is increasing evidence suggesting the influence of such factors (e.g. Flynn et al., 2010; Wong et al., 2011, Giménez et al., 2012). That is the specific point of interest taken in this paper: whether different modes of governance affect the type and level of integration between trading partners and if context and specifically supply complexity plays a role and what that role is. As little is known on this subject we found that multiple case studies would be appropriate to explore possible connections between the different concepts. The empirical part of this study relies on interviews conducted in twelve Dutch, metal parts producing companies exploring the relationship with their main buyer. Our paper contributes by focusing on the direct effects modes of governance have on supply chain integration, which in turn is distinguished into different aspects - attitudes, patterns and practices as developed by Van der Vaart and Van Donk (2008). Thus, our research aims to see whether a governance mode can be complementary or whether choices need to be made between one type and the other depending on context. We explore this initially by including a contextual variable capturing the supply complexity of the trading partner relationship, following the approach of Van der Vaart and Van Donk (2006) and Giménez et al. (2012). In investigating the above question we follow the suggestions from the review paper by Van der Vaart and Van Donk (2008) to consider different aspects of supply chain integration i.e. attitudes, patterns and practices of integration, and not just the total amount of integration. We also explore whether different types of governance might be consistent with a stronger or weaker emphasis on each of these aspects differently, in line with a recent paper by Vallet- Bellmunt and Rivera-Torres (2013), that also makes this distinction. Cognate Theory Governance Mode Cai et al (2009) give the following description of governance mode the inter-organizational framework that supports transactions and coordination between two parties (Cai et al, 2009). As indicated the literature distinguishes between contractual governance and relational governance (e.g. Poppo and Zenger, 2002), which are grounded in transaction cost theory and social exchange theory respectively (Ambrose et al., 2010). Both theories are claimed to be essential for understanding buyer-supplier relationships (Ambrose et al., 2010). From a transaction cost economics perspective, companies might seek contractual safeguards to be able to cope with opportunistic behaviour of their partner in case there is uncertain information and/or in case of asset specific investment for that partner (Chirsty and Grout, 1994). Transaction cost economics proposes that governance should be arranged in such a way that cost are minimal, while ensuring the quantity, price and quality of the supplies wanted. (Poppo and Zenger, 2002). Comparable approaches have attempted to develop frameworks of safeguards based on such theories as game theory, neo-classical and principal- 2

3 agent theory to identify sourcing strategies and competitive environments underlying and supporting the mechanism to achieve stable, competitive and profitable supply chains (Chirsty and Grout, 1994). In general, legal contracts can serve as safeguards in such frameworks, making sure the agreed transaction takes place. In practice, contracts made by companies might include such details as delivery conditions, tasks and responsibilities of both parties, and special provisions on how disputes are to be resolved. However, sometimes this is not sufficient (on its own) to ensure that what are seen to be necessary transactions take place. In other words, sometimes formal agreements such as legal contracts fail to be the intended safeguard. It is well known from Transaction Cost Theory that contracts are by nature incomplete and even more so if the environment is highly uncertain and keeping to the contract would could result in the opposite outcome to that intended. It might be that those other aspects are covered by relational governance. The second type of governance is closely related to social exchange theory, which is based on relationship exchange (Hawkins et al., 2008). Relationship exchange is ruled by relational norms (MacNeil, 2000), which develop over time (Nielsen, 2010), demand the exchange of information, building trust (McHugh et al., 2003), a willingness to cooperate, avoid opportunistic behaviour and maintain long-term relationship (Ambrose et al., 2010; Carey and Lawson, 2011). Flexibility (shared expectations for adjustments), participation (willingness to make investments and share information) and solidarity (expectation to act to increase mutual benefit) are the traditional elements of relational norms (Lumineau and Henderson, 2012). Thus, relational governance ensures that certain promises and obligations are enforced through social processes (Poppo and Zenger, 2002), rather than by contract and law. This might help to overcome the inflexibility of contractual governance (Lumineau and Henderson, 2012). Setting the agreements and fulfilling them is part of the relation and enables adapting and discussing agreements in contrast to the fixed nature of legal contracts. In the relational governance structure shared aims and mutual interest are more central and openly discussed. There is an ongoing academic debate whether both types of governance complement or substitute each other (Li et al., 2010; Carey and Lawson, 2011; Liu and Ngo, 2004; Liu et al., 2009). Traditionally they were considered to be options that managers had to choose between, where each has a different effect on transaction outcomes between trading partner (Lumineau and Henderson, 2012). Carey and Lawson (2011) claim that relational governance complements contractual governance, as the latter establishes basic safeguards for transactions and through relational governance self-enforcing mechanisms facilitate buyersupplier cooperation. This complementarity is partly confirmed by Li et al. (2010) based on data from Chinese companies, that show complementarity for international operations, while relational and transactional governance tend to contradict each other for domestic operations. It is specifically interesting to investigate if and how each form of governance impacted on different types of supply chain integration. The aim of this paper is to investigate if and how both governance types can be complementary or whether they are subject to trade-offs whereby managers need to choose between one or the other. Supply chain integration There is an abundant empirical literature on supply chain integration and its beneficial effects, starting from the seminal paper by Frohlich and Westbrook (2001). While their paper used a single construct to reflect supply chain integration, increasingly over the last ten years, researchers have argued that in fact different dimensions or aspects might exist. Paulraj et al. (2008) and Das et al (2006) were among the first to explicitly identify distinct dimensions. A few systematic reviews have added to our understanding in this respect, specifically the papers by Fabbe-Costes and Jahre (2007) and Van der Vaart and Van Donk (2008). They both argue that the current research in supply chain integration falls short in the rigour of its 3

4 measures, consistency in using measures and making clear what integration covers or not. Van der Vaart and Van Donk additionally argue that existing constructs use items that relate to rather different types of activities or underlying constructs. They distinguish between three categories of items to understand the integration of suppliers with their key buyers: supply chain practices (specific activities), supply chain patterns (modes of communication) and supply chain attitudes (relational aspects, trust). First, supply chain practices are defined as tangible activities or technologies that play a role in the collaboration of a focal firm with its suppliers and/or customers. Examples are the use of EDI, integrated production planning, vendor-managed inventories and delivery synchronisation. Second, supply chain patterns relate to the interaction and/or communication patterns between the focal firm and its suppliers and/or customers. Examples are regular visits to the supplier s facility, frequent face-to-face communication and high, corporate-level communication on important issues Third, supply chain attitudes refer to the attitude of buyers and/or suppliers towards each other or towards SCM in general. Examples are a firm s expectation with respect to the future of their relationship with suppliers and/or buyers, how they consider problems that arise in the course of this relationship, and whether they share the responsibility for making sure that the relationship works for both parties. This typology has recently been used by Vallet and Rivera (2013) to investigate integration empirically. Their first and for this paper most relevant conclusion is that integration has a three-dimensional structure, each dimension illustrating a different approach to the concept of integration. Attitudes can therefore be assigned to the corporate philosophy, with a relational dimension; patterns can be linked to the more strategic part and with the collaboration dimension; and practices is related to the more operative part or the interaction dimension (p. 318). Interestingly, the relation between the dimensions is not that clear in their study. In line with these papers Leuschner et al. (2013) perform a meta-analysis distinguishing different dimensions of SC integration, partly in line with the above distinction, and find that some relate to performance but not all. They suggest (p.46) to take into account drivers, facilities and management resources available for managing the relationship. All in all, we feel safe to state that although SC integration has a positive relationship to performance outcomes, the underlying pattern and constraints are more complex and might be very much situational. These three dimensions of SC integration can help to understand how each type of governance structure works in buyer-supplier relationships. For example, a focus on transactional governance might lead to more formal activities, that can be structured and described easily, such as formal meetings, but may not facilitate informal contacts that might be needed in case of high uncertainties. So governance might be seen as an antecedent of the three different dimensions of integration as represented by practices, patterns and attitudes. Transactional or relational governance might in that perspective be more supportive for a specific dimension. Supply complexity Giménez et al. (2012) consider supply complexity at the the level of the individual buyersupplier relationship and define it as the complexity of the process in which buyer s orders are converted into the supplier s manufacturing orders, resulting in the delivery of goods according to the buyer s expectations (p. 588). Building on earlier work (see Giménez et al. for a discussion and references) in case studies as well as on more conceptual papers, they distinguish a number of process and product related characteristics that indicate supply chain complexity: volume and type of products, complexity of the routing, batch sizes and set-up times, time window for delivery and order winning characteristics. Earlier case research by Van der Vaart and Van Donk (2006) used similar characteristics to show that higher levels of integration are to be found if supply complexity is higher, whereas with low levels of supply 4

5 Position of interviewe e # Suppliers # Customer s Order winner Market share % (as defined by # Employee s Turnover (Mil. ) Main market complexity integration seems neither needed nor effective. Giménez et al. (2012) confirm those findings in a survey setting. However, the interactions of the dimensions and the influence of mode of governance have not been dealt with so far. Methodology Although there is a considerable amount of work in this field, the specific influence of governance modes on different aspects of supply chain integration related to supply complexity have not yet fully been investigated. Therefore we decided to conduct multiple case studies among suppliers. Development of the research protocol Although this research relies on cases and semi-structured interviews, we built on the survey research of Giménez et al. (2012) to develop our research protocol. The items are structured around the three types of integration distinguished above: practices, patterns, and attitudes. Practices might refer to transport and packaging integration, patterns to intensity and type of meetings and attitudes to joint decision making. For the questions of supply complexity we relied on the protocol developed in Van der Vaart and van Donk (2006). The main indicators used here are order winners, percentages MTO/MTS, volume and product variety, average batch size and throughput time. Governance was adapted from Wuyts and Geyskens (2005) and Jap and Ganesan (2000): contractual using keys as written and detailed contracts, while relational governance refers to communication type and intensity and type of problem solving. The protocol was pretested and slightly adapted afterwards. Table 1 Key characteristics of the case companies A Agricultural Logistics and Quality equipment Quality manager B Springs (autom./industrial.) Price Owner C Textile industry Production top three Customization 1 30 tools manager D Safety & security products Quality 200 n/a* Sales manager E General metal Volume Operational n/a components flexibility director/owner F General metal Volume Operational n/a 1500 n/a components flexibility director G Metal components for OEM n/a On time delivery 100 n/a Sales manager H Metal components Volume General manager 8 60 n/a 200 n/a for OEM flexibility (owner) I Metal components Product n/a for SMEs innovation 7000 n/a Area director J Construction/OEM industry n/a Customization n/a Sales Director K Extrusion billets Manager and rolling ingots (aluminum) Quality 15 5 Logistics and Sales L Ship building, Operations Quality architecture, art Manager *n/a: either not available for that company or respondent refused to provide this information 5

6 Relational Governance Sample and data collection From publicly available lists we selected producers of metal parts in the northern part of The Netherlands, with a minimum of 50 people employed. Of the companies approached twelve suppliers participated. Table 1 shows that our sample has a broad diversity in terms of turnover, main market, order winners and employees, although real large companies are absent. Interviews were conducted face-to-face, using the interview protocol, in April and May Interviews lasting around 1-2 hours were recorded and transcribed. Summaries of the interviews were sent to the interviewees for verification and clarification. Data analysis The transcribed interviews were put into tabular form, summarizing main statements and using quotes to highlight specific elements related to our main research constructs. For complexity, we relied on the coding technique used in Van der Vaart and Van Donk (2006), distinguishing between high and low complexity. For all other constructs we searched for typical keys in the interviews, assessed the level of that activity/key and transferred it into a numerical scale. To make things easier to represent and compare we finally calculated relative scores (0-100), using the highest score on each construct as a benchmark/point of reference. Findings We are in the process of analyzing the data. Our case companies do show a variety of governance structures. Ranging from having only relational ties, through to a mixture of both up to a focus purely on contractual governance, solely. Two patterns emerge from the data (see Figure 1 below). Relational / Contractual Governance and Complexity Black = Low Complexity Grey = High Complexity B C F & I K D G A L&E H J Contractul Governance Figure 1 - Distribution of case firms by governance mode Firstly for seven of the eight cases where supply complexity is high a mix of both governance modes is observed, with F and I being lower on contractual. In only one case is there a strong bias recorded toward a particular mode and in that case (case J) a very low level of relational governance is observed. A typical quote being that they were not relationally oriented, and would rather cover costs without discussion then get into a conversation with customers. Secondly, where complexity is low two of the four firms recorded no contractual governance at all (cases B & C) while the other two placed a strong emphasis on both governance modes. 6

7 What was common to all four of these firms was a relative strong emphasis on relational governance with an exception for C. As in case D, they would even take the blame or scarify yourself to the benefit of the relationship. In Figure 2 the further dimension of overall level of integration is added. One observation we made from this is that where relational governance is very low and contractual governance is dominant integration levels appear also to be low (case J). On the other hand where contractual governance is very low and relational governance is dominant integration levels remain high (cases B & C). This is consistent with levels of integration (likely including asset specific investment) being more consistent with relational governance than with reliance on contracts. Partly, this is reflected in a quote of company K by contractual governance you can win the argument but lose your customer. Figure 2 - Governance mode emphasis and extent of integration for each case firm Figure 3 - Emphasis on Practices, Patterns and Attitudes for each case firm Further Figure 3 shows the level of the three different dimensions of supply chain integration specifically attitudes, patterns and practices of integration for each case firm. While the overall level of integration does vary considerably between the cases (some being at 50% of 7

8 others), the levels of the individual dimensions are greater and sometimes show at the firm level divergent pictures. For example, case firm J (very high emphasis on contractual governance and very low on relational) has little emphasis on patterns and practices, but shows a high level of attitudes. Others show low levels of attitudes but higher levels on patterns and practices (e.g. case A and F). For case firms B & C where relational governance is pre-eminent and contractual safeguards do not exist integration is more consistently underpinned by attitudes, practices and patterns. Discussion, Our findings indicate that a combination of contractual and relational governance was important for seven of the twelve case firms. This finding provides some support for the proposition that these two governance modes are not mutually exclusive and that trade-offs between them should not necessarily be assumed. This is also reflected in the comments of our respondents, indicating that they at times ignore the contract to keep the relationship good. So it seems that our findings are consistent with there being complementarities between them rather than one operating to the detriment of the other. On the other hand, however, the remaining five cases show an opposite picture: four rely on relational with no (B, C) or a limited level (F, I) of contractual governance and one relies fully on contractual (J) without relational governance, which all seems to be fitting into a trade-off of the two types. Additionally, the overall findings seem to indicate that there is not necessarily a logical order of governance (e.g. contract first or relational first) to be derived from our findings. P1: Contractual and relational governance modes can be complementary or contradictory Evidence also emerges that where complexity of dealings between trading partners is low the use of contractual governance is optional. This seems to be a surprising finding as supply complexity is related to the uncertainty experienced in the buyer-supplier relationship, and this finding is opposite of what would be logical from a TCE perspective. In our study two of the four firms recording low levels of complexity also recorded no use of contractual governance at all. This might also indicate that in those circumstances given the low level of uncertainty, nothing needs to be fixed in contracts as they are clear by themselves. At the same time all four firms placed a strong emphasis on relational governance. From the quote from company F it might also be a choice: they are reluctant to work with contracts and specifically the bigger the customer, the more details contracts get. It also indicates that some of this might be influenced by relative size and power in the relationship, as well. P2: When supply complexity of the buyer-suppler relationship is low, contractual governance is optional. P3: When supply complexity of the buyer-suppler relationship is low, relational governance is important. The above propositions show that in line with current SC integration research, governance seems also to depend on the context. This idea is further supported by some other observations from two cases. Case J is the only one of the twelve firms recorded with low levels of relational governance relying almost completely on contractual safeguards. This company provides specific construction elements, mostly in one-off projects. That is also why little emphasis on SC patterns and practices exist, while attitude is high, due to the fact that within the project the desire is to work as one team, as if the customer is your colleague. Company C offers another example, as being part of a holding, it has no contract with its main customer, but also a relatively low level of relational governance. These companies used to be 8

9 competitors and keep to their old habit of to keep everything secret for each other. This leads us to propose that: P4: Mode of governance present can be dictated by both rational and irrational context factors. In terms of integration with trading partners where relational governance was very low and contractual governance was high integration levels were low. However where contractual governance was very low and relational governance was high integration levels remained high. This is consistent with integration between trading partners being associated with relational governance than with reliance on contracts. P5: Relational governance is associated with trading partner integration. P6: Contractual governance is independent of trading partner integration. Finally, diving into the way the different dimensions are related to both mode of governance and each other, it seems little can be said about what the logic is of all configurations present, and if so, they clearly relate to contextual factors. It stresses the earlier made remarks on the necessity to distinguish between the dimensions and find how they relate and help to improve performance aspects. It is clear that a single measure is deemed to capture only little of what reality is. Relevance/contribution This study aims to help further understand the influence of two widely discussed governance modes and their relationship with supply chain integration. Our findings indicate that contractual and relational governance can be complementary but also sometimes contradictory. Interestingly, however, there is also evidence suggesting that contractual governance is optional under certain conditions in our study the supply complexity of trading partner interactions and other reasons. This is important as contractual governance is often assumed to be mandatory while relational governance is optional. Our study provides evidence that in fact the opposite may be the case. This finding is complemented by the further observation that relational governance is consistent with trading partner integration while contractual governance appears to be independent of this i.e. they may occur together but will not necessarily be associated. Finally the study shows the need to distinguish multiple dimensions of SC integration. All of the above is proposed rather than stated as fact as our study has been inductive and our findings are preliminary in form, also given limited number of cases and interviews. We encourage further research in this area to test each of the above propositions and throw further light on our findings. References Ambrose, E., Marshall, D., & Lynch, D. (2010). Buyer supplier perspectives on supply chain relationships, International Journal of Operations & Production Management, Vol.30, No.12, Carey, S., & Lawson, B. (2011). Governance and social capital formation in buyer-supplier relationships, Journal of Manufacturing Technology Management, Vol.22, No.2, Cai, S., Yang, Z., & Hu, Z. (2009). Exploring the governance mechanisms of quasi-integration in buyer supplier relationships, Journal of Business Research, Vol.62, No.6, Christy, D. P., & Grout, J. R. (1994). Safeguarding supply chain relationships. International Journal of Production Economics, Vol.36, No.3, pp Das, A., Narasimhan, R., & Talluri, S. (2006). Supplier integration Finding an optimal configuration. Journal Of Operations Management, Vol.24, No. 5, pp

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