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

Author

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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.

Suggested Citation

  • J. Yannis Bakos & Erik Brynjolfsson, 1997. "From Vendors to Partners: Information Technology and Incomplete Contracts in Buyer-Supplier Relationships," Working Paper Series 154, MIT Center for Coordination Science.
    • Handle: RePEc:wop:mitccs:154
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    File URL: http://ccs.mit.edu/papers/CCSWP154/CCSWP154.html
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    Cited by:

    1. Motohashi, Kazuyuki, 2007. "Firm-level analysis of information network use and productivity in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 21(1), pages 121-137, March.
    2. Grieger, Martin, 2003. "Electronic marketplaces: A literature review and a call for supply chain management research," European Journal of Operational Research, Elsevier, vol. 144(2), pages 280-294, January.
    3. 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.
    4. Daron Acemoglu & Pol Antràs & Elhanan Helpman, 2007. "Contracts and Technology Adoption," American Economic Review, American Economic Association, vol. 97(3), pages 916-943, June.
    5. Steven Globerman, 2004. "E-Business And Global Sourcing – Inferences From Securities Exchanges," International Trade 0404006, University Library of Munich, Germany.
    6. Nadav Levy, 2004. "The Organization of Supply: a Vertical Equilibrium Analysis," Discussion Papers 04-01, University at Albany, SUNY, Department of Economics.
    7. Raghunathan, Srinivasan, 2003. "Impact of demand correlation on the value of and incentives for information sharing in a supply chain," European Journal of Operational Research, Elsevier, vol. 146(3), pages 634-649, May.
    8. Mendelson, Haim & Pillai, Ravindran R., 1999. "Information Age organizations, dynamics and performance," Journal of Economic Behavior & Organization, Elsevier, vol. 38(3), pages 253-281, March.
    9. Daron Acemoglu & Pol Antràs & Elhanan Helpman, 2005. "Contracts and the Division of Labor," NBER Working Papers 11356, National Bureau of Economic Research, Inc.
    10. 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.
    11. 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.
    12. 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.
    13. Qu, Wen Guang & Yang, Zhiyong & Wang, Zhongming, 2011. "Multi-level framework of open source software adoption," Journal of Business Research, Elsevier, vol. 64(9), pages 997-1003, September.
    14. Essaji, Azim & Fujiwara, Kinya, 2012. "Contracting institutions and product quality," Journal of Comparative Economics, Elsevier, vol. 40(2), pages 269-278.

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