Dealing with risk in dyadic interactions

Research into how companies use institutional devices for dealing with risk in direct dyadic interactions has attracted most attention, and consistently advances within and outside

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business network research (Lusch & Brown, 1996; Eggleston, Posner & Zeckhauser, 2000; Seshadri & Mishra, 2004; Mouzas & Ford, 2006; Weber & Mayer, 2011). Common classifications of research investigating the use of contracts in business-to-business relationships distinguish between:(a) relational contracting, focusing on the role of trust, commitment and norms (Macaulay, 1963; Macneil 1985; Eisenberg, 2000; Mouzas & Blois, 2013); and (b) formal contracting (Mouzas & Furmston, 2008; Mouzas & Ford, 2012).

In both streams of research, contracts provide the ‘architecture’ of business relationships by orchestrating actors, resources and activities in repeated, direct interaction over time (Mouzas & Furmston, 2008), and facilitate the continuity of business interactions in the face of future contingencies.

The purpose of contracts is to find:

“relatively simple specifications that come close to achieving what a complete, contingent contract could do under situations of environmental risk (i.e., the whims of Mother Nature) and behavioural risk (i.e., the potentially opportunistic behaviour of trading partners” (Lyons, 1996, p.29).

Despite continuous research investigating the use of contracts in business relationships, and particularly the use of umbrella agreements (also referred to as ‘framework contracts’) in retailer-manufacturer relationships (Mouzas, 2006; Mouzas & Blois, 2008; Mouzas & Furmston, 2008), the majority of contract research remains conceptual, offering limited empirical evidence. While this may be explained by challenges in accessing confidential contracts-in-use, Argyres, Bercovitz and Meyer (2007, p.3) highlight other contributing factors, such as the significant research emphasis on trust and norms following Macaulay’s work on non-contractual relations in 1963, and respective scepticism towards the importance of formal contracts in business relationships.

However, research into major litigation cases, such as between British retailer Marks & Spencer and the supplier Baird, highlights that reliance on non-contractual relations can cause serious enforceability problems for any actor (Blois, 2003). Consequently, depriving a business relationship of formal contracts appears unwise, because the actors miss the benefit of legal enforcement in court if all negotiation efforts fail. While it appears that it is not necessarily the actual legal enforcement, but rather the looming possibility of legal enforcement that motivates contractual performance (Ring, 2008), the formality of contracting remains central. Recourse to formal contracts draws attention to the fundamental principle that what is exchanged between business actors “are not [only] physical entities but the rights to perform certain actions – and those rights are established by the legal system” (Ring, 2008, p.510).

Considering the issues associated with relational approaches to contracting, and the limitations of relying on norms and customs in globally dispersed interactions across multiple

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actors, this research is concerned with understanding how companies use formal contracts for dealing with risk in direct relationships. In taking this approach, the researcher follows Suchman’s (2003, p.96) call to study ‘contracts-as-artefacts’ rather than ‘contracts-as- doctrine’ or ‘contracts-as-relation’. What distinguishes the contract-as-artefact from alternative approaches is that it is primarily concerned with understanding the substance of contract in its own, yet contextual, use. In his seminal piece, Contracts as Social Artefact (2003, pp.96-97), Suchman suggests that:

“despite the ubiquity of contract documents in modern life, this question has received surprisingly short shrift from the existing literature. Doctrinalists tend to trivialize contract documents as mere occasions for applying Contract Law, while relationalists tend to marginalize contract documents as mere legalistic formalities. From an artefactualist perspective, however, such dismissals ignore a fundamental empirical puzzle: Evidence suggests that in most transactions, legal doctrine is obscure, and the threat of legal enforcement is remote; yet actors often invest substantial resources into producing written contracts…This paperwork, moreover, generally exhibits a systematic internal structure and generally changes in systematic ways over time. For better or worse, contract documents behave not like extraneous phenomena, but rather like systematically produced social artefacts, and we might learn something of value if we occasionally were to study them in precisely those terms.”

Moreover, while Suchman highlights the significance of researching the contract-in-use, because “the use of handwritten amendments to printed contracts … indicates direct attention to a particular clause” (2003, p.109) his suggestions were followed with limited empirically founded research.

Existent research highlights the benefits of contracting for addressing idiosyncratic risks in direct relationships. Contracts create:

“tailored obligations, responsibilities, benefits and arbitration arrangements ex-ante to [the exchanges]… In the presence of market ambiguity, a customized contract functions as an ex-ante safeguard against a partner’s opportunism because it legitimizes monitoring and adds more term specificity and contingency adaptability to the contract. For example, a customized contract enables firms to accurately measure and reward productivity…avoid productivity and avoid performance risk by modifying goals, activities and arbitration arrangements in advance” (Yang, Su & Fam, 2012, pp.43-44).

Such measures facilitate safeguarding resources from risk, including the relationship itself, which is considered a primary asset in marketing literature and practice. Contracts derive their power from their ongoing adaptability to the requirements of multiple, idiosyncratic relationships, as the terms are tailored to meet the present demands and concerns of both actors, while projecting courses of joint action into the future. Moreover, contracts – as forms of rule-based devices – help actors assume “certain behaviour by others, without having to confirm it in concrete situations” (Koppenjan & Klijn, 2004, p.80).

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In the context of retailer-manufacturer relationships, research on ‘umbrella agreements’ is of particular relevance to this thesis. Umbrella agreements provide a ‘frame’ for future transactions and facilitate re-negotiation in “regular, stable and established business relationships” (Mouzas & Furmston, 2008, p.40). Instead of specifying transaction parameters, such as volume or delivery times, umbrella agreements provide a ‘constitution-like’ set of rules within which future exchanges are concluded (Mouzas & Ford, 2006). Key clauses in umbrella agreements deal with exclusivity, confidentiality, property rights, force majeure, termination conditions and renegotiation (Mouzas, 2006). The benefits of drafting umbrella agreements include reduced “time and effort to select, manage and oversee single transactions […provision of] certainty regarding the conditions under which exchanges may take place […and the provision of] a platform for an on-ongoing negotiation” (Mouzas & Furmston, 2008, p.38). Umbrella agreements constitute a device for dealing with idiosyncratic issues relevant in single dyads, by offering a codification of rules for future interactions.

While existent research confirms the value of contracting in direct, dyadic relationships, there are limitations to contracting if applied across a high number of direct and indirect interactions: Since contracting presumes mutual negotiation, it becomes prohibitive in terms of time and cost to replicate this practice across multiple direct and indirect interactions. For example, recalling the case of Wal-Mart with over 100,000 suppliers, negotiation of individual contracts becomes absolutely impossible. This raises the question: How do companies deal with risk emerging from multiple, potentially indirect relationships? To answer this question, it is useful to review research conducted at the next higher level of network interactions: the focal network.