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ConTRACTing And RElATionsHiPs 173
3 Safeguards. For effective control there need to be structures in place to enforce the
contract – it has to be worth the paper it’s written on!
Although the ‘best’ contract is generally assumed to be the most ‘complete’ one (the
one that covers the greatest number of contingencies), all organisations entering into a
contractual exchange face information asymmetry – that is, imperfect and incomplete
information about their suppliers’ preferences and characteristics. Table 5.2 summa-
rises the problems that can arise as a result of this asymmetric information.
So, whatever the specific cause, in most exchanges one party has an unavoidable
informational advantage over another. And, in purely contractual terms, it could
potentially be exploited to the benefit of that party at the expense of the partner. This
reinforces the tendency to incur additional contract-related costs such as up-front sup-
plier search and selection costs (adverse selection risk) and ongoing monitoring and
enforcement costs (moral hazard and hold-up risks).

Partnership supply relationships

Partnership supply relationships, sometimes called just ‘relationships’, are those
inter-organisational mechanisms that are not part of formal contractual positions but
emerge from ongoing interactions (e.g., regular calls to enquire ‘how is it going?’). Part-
nership supply relationships can be based, at least partly, on social processes such as
personal bonding. Because of this they tend to be ‘emergent’ arrangements, develop-
ing over time, that are not readily accessible through written documents and often
cannot be directly observed. Their development between customers and suppliers in
supply networks is sometimes seen as a compromise between the ‘extremes’ of vertical
integration and contractual market trading. It attempts to achieve some of the close-
ness and coordination efficiencies of vertical integration without the necessity to own
the assets, and it attempts to achieve the sharpness of service and the incentive to con-
tinually improve, which is often seen as the benefit of traditional market trading. Yet
partnership is more than a mixture of vertical integration and market trading; it is an
approach to how relationships in supply networks can be formed with a degree of trust
that effectively substitutes for the ownership of assets. Partnership relationships can be
viewed as strategic alliances that have been defined as
‘relatively enduring inter-firm cooperative arrangements, involving flows and
linkages that use resources and/or governance structures from autonomous
organisations, for the joint accomplishment of individual goals linked to the
corporate mission of each sponsoring firm’. 8

Table 5.2 A summary of some problems that can arise from asymmetric information
Risk ‘Adverse selection’ ‘Moral hazard’ ‘Hold up’
Timing Ex ante (before signing contract) Ex post (after signing a contract) Ex post (after signing a contract)

Illustration Cannot accurately judge supplier Cannot completely control Regardless of performance,
‘quality’ as determined by soft supplier activities (even if buyer further employs a
skills, education, etc. the buyer can fully monitor particular supplier because
Cannot judge the future plans actions) but observes that of irreversible investments
of the supplier. supplier maximising own (‘sunk costs’).
profit instead of realising the
buyer’s objectives.

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