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172 CHAPTER 5 • PuRCHAsing And suPPly sTRATEgy

Contracting and relationships

There are two basic ingredients of any supply arrangement: they are ‘contracts’ and
‘relationships’. Whatever arrangement with its suppliers a firm chooses to take, it could
be described by the balance between contracts and relationships (see Figure 5.9). They
are strongly complementary and, in the same way that separating marketing and opera-
tions decisions can cause major supply dysfunction, a lack of alignment between con-
tracting activity (negotiating, legal procedures etc.) and relationship strategy can cause
significant damage. Moreover, what is clear from the do/buy typology is that effective
supply management – effective in the sense that it maximises the benefits to the buyer
whilst protecting against opportunism – will require a range of different approaches in
different capability and market contexts. If a very strong trusting relationship can be
built with a supplier, then the risk of outsourcing even very critical capabilities might
be acceptable. In the absence of this trust, even the most sophisticated contractual form
may be felt to afford insufficient protection – for example, against intellectual property
rights (IPR) infringements.

Contracts and contracting
Contracts are those explicit (usually written, often detailed) and formal documents that
specify the legally binding obligations and roles of both parties in a relationship. Using
the logic of transaction cost economics (TCE), contracts are intended to both reduce
uncertainty (e.g. by providing a clear specification of what is and what is not allowed
within a relationship) and minimise the risk of opportunism (e.g. by enforcing legal
rules, standards and other remedies implied in law). There are lots of different contract
types, usually categorised according to the type of payment.
For a buyer to be able to achieve effective control of its supply by using contracts,
three underlining conditions need to be fulfilled.
1 Codification. Formal contracts are reliant on tasks working broadly to plan and the
‘up front’ measurability of outcomes.
2 Monitoring. Formal contracts require monitoring to determine supplier behaviour
with regards to the rules set out in the contract.

Figure 5.9 supply arrangements are a balance between contracting and relationship

‘Transactional’ or ‘market-based’ ‘Partnership’ supply
supply arrangements arrangements

Emphasis predominantly
on relationships

Emphasis predominantly
on contracting

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