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From Vendors to Partners: Information Technology and Incomplete Contracts in Buyer-Supplier Relationships

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  • J. Yannis Bakos
  • Erik Brynjolfsson

Abstract

As search costs and other coordination costs decline, theory predicts that firms should optimally increase the number of suppliers with which they do business. Despite recent declines in these costs due to information technology, there is little evidence of an increase in the number of suppliers used. On the contrary, in many industries, firms are working with fewer suppliers. This suggests that other forces must be accounted for in a more complete model of buyer supplier relationships. This article uses the theory of incomplete contracts to illustrate that incentive considerations can motivate a buyer to limit the number of employed suppliers. To induce suppliers to make investments that cannot be specified and enforced in a satisfactory manner via a contractual mechanism, the buyer must commit not to expropriate the ex post surplus from such investments. Under reasonable bargaining mechanisms, such a commitment will be more credible if the buyer can choose from fewer alternative suppliers. Information technology increases the importance of noncontractible investments by suppliers, such as quality, responsiveness, and innovation; it is shown that when such investments are particularly important, firms will employ fewer suppliers, and this will be true even when search and transaction costs are very low.

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Bibliographic Info

Paper provided by MIT Center for Coordination Science in its series Working Paper Series with number 154.

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Date of creation: Jan 1997
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Handle: RePEc:wop:mitccs:154

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Web page: http://ccs.mit.edu/wpmenu.html

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Cited by:
  1. Takeishi, Akira, 1958- & Cusumano, Michael A., 1954-, 1995. "What we have learned and have yet to learn from manufacturer-supplier relations in the auto industry," Working papers #126-95. Working paper (S, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  2. Van Alstyne, Marshall W. (Marshall Ware) & Brynjolfsson, Erik. & Madnick, Stuart E., 2003. "Why not one big database? : principles for data ownership," Working papers #94-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  3. Kaouthar Lajili & Joseph T. Mahoney, 2006. "Revisiting agency and transaction costs theory predictions on vertical financial ownership and contracting: electronic integration as an organizational form choice," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 27(7), pages 573-586.
  4. Daron Acemoglu & Pol Antras & Elhanan Helpman, 2005. "Contracts and the Division of Labor," Harvard Institute of Economic Research Working Papers 2074, Harvard - Institute of Economic Research.
  5. Nadav Levy, 2004. "The Organization of Supply: a Vertical Equilibrium Analysis," Econometric Society 2004 North American Summer Meetings 142, Econometric Society.
  6. Steven Globerman, 2004. "E-Business And Global Sourcing – Inferences From Securities Exchanges," International Trade 0404006, EconWPA.
  7. Acemoglu, Daron & Antras, Pol & Helpman, Elhanan, 2007. "Contracts and Technology Adoption," Scholarly Articles 3199063, Harvard University Department of Economics.
  8. Cusumano, Michael A., 1954- & Takeishi, Akira, 1958-, 1995. "What we have learned and have yet to learn from manufacturer-supplier relations in the auto industry," Working papers 3840-95., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  9. Creemers, Marcel R., 1997. "The move to ex-ante," Serie Research Memoranda 0055, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.

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