This week’s post addresses the question “How do organizations interact with each other?” I am grateful to have collaborated on this post with Dr. Franz Wohlgezogen, who is Senior Lecturer at the University of Melbourne.
tl;dr: Organizational interactions – such as the exchange of goods, services, information, etc. – were classically considered as opportunistic (self-serving) and dyadic (between two parties). According to this view, an organization would try to squeeze (and claim) every last bit of value from its exchanges, and would assume every other organization would do the same (or worse). More recently, relational networks, reputation, and trust are more commonly considered the basis for inter-organizational collaborations such as joint ventures, partnerships, and alliances. In a world of organizations where relationships and reputation matter, gains from opportunistic behavior may be short-lived, because reputational fallout may preclude opportunists from participating in beneficial relations and networks.
Classic View: Transaction Cost Economics
We can take as a starting point an insight we gained from the previous post (“What is an organization?”). In that post, we suggested that individuals participate in organizations to the extent doing so furthers their interests. Similarly, an organization will interact with other organizations when doing so furthers its goals and interests.
Given that interactions with (potentially) ruthless partners are risky a key question is: when will an organization interact with others in the first place? One classic view that addresses this question is called transaction cost economics (TCE). TCE’s guiding principle is sometimes called the “make-or-buy” question: is it cheaper for an organization to do or make something in-house, or to buy it?
The key idea of TCE is that the make-or-buy decision requires consideration not just of the total cost of making or buying a product or service, but also the effort and associated cost of contracting the provision of the product or service. It’s helpful to think about different steps of entering into a contract. Basically, there are three stages (and types of transaction costs): search, negotiation, and enforcement. Search has to do with finding parties and prices to contract with; negotiation with forming the actual contract; and enforcement with executing the terms of the contract.
If search, negotiation, and enforcement are difficult, transaction costs are high. These three steps also exist when an organization decides to make a product or service internally. Think about the effort involved in working through the internal bureaucracy to find the right decision maker to arrange for a senior process engineer to be seconded to a life-cycle analysis project – in some cases it may be easier (i.e., transaction costs may be lower) to hire an external consultant.
There are two important assumptions in TCE. One is that people behave with “opportunism,” that is in such a way that maximizes their own benefits, with minimal to no regard for effects on the other party. Oliver Williamson, one of the “fathers” of TCE, described this type of behavior as ‘self-interest seeking with guile‘.
Another simplifying assumption is TCE’s emphasis on “dyadic exchange,” that is, on transactions between two parties. Taken together with opportunism, TCE considers transactions as one-off interactions between exactly two parties, each seeking to maximize their own gains.
Our experience in the real world, however, shows that organizational interactions are often much more complicated. As we also concluded in the previous post, social systems are complex. First, an organization doesn’t always look to take advantage of others. Second, an organization is embedded in networks and social structures that include much more than its direct transaction partners.
ACCOUNTING FOR COMPLEXITY: POWER AND INTERDEPENDENCE
OMS scholars often explain interactions between organizations by considering relationships of power and interdependence. Early MOS researchers said one organization has power over another when it can sway (or coerce) the other’s decisions. Such power may come from the interdependence between organizations.
Let’s say the multinational corporation Widget Inc. depends heavily on two of its suppliers, Alpha and Beta, to achieve its goals. Alpha, in turn, depends on Widget, because it presently has no other major customers for its products. Beta on the other hand, also supplies to Widget’s key competitor, Gadget Corp, and had other interested clients come knocking on its door – clients that Beta cannot even supply at the moment. As a result, Beta is the least dependent and most powerful of the four organizations. But if Beta opportunistically exploited Widget’s dependence, word may get around to Gadget Corp and to prospective clients and may severely affect Beta’s ability to nurture and grow these commercial relationships.
One highlight from this example is that organizational interactions are rarely dyadic. Any of the four organizations’ decision-making involved consideration of its dependence on the remaining three actors and others in broader networks of existing and prospective relationships. This observation is an example of what OMS scholars would call “network embeddedness,” where actors vary in the degree to which they are tied to and dependent on (that is, embedded in) the web of medium or long-term relationships among other organizations.
In such a context, the preservation or development of these relationships may be the overriding consideration for organizations, rather than the transaction costs of a particular exchange. The housing bubble preceding the subprime mortgage crisis of the late 2000s saw such relationship preservation at play, with ratings agencies inappropriately providing favorable credit ratings to extremely risky securities created by investment banks. In this case, ratings agencies sought to preserve their favorable position with investment houses – thereby responding to reinforcing existing network embeddedness – while giving relatively less consideration to costs associated with proper enforcement of the securities contracts.
TRANSACTION VALUE AND COLLABORATION
If interdependence and embeddedness loosen the dyad assumption, what about opportunism? Should we assume ‘self-interest seeking with guile’ is the norm or at least a primary concern that leads organizations to build relationship aimed to minimize transaction costs?
One school of thought in OMS proposes that transaction value not transaction cost may be a more pertinent issue for organizations. Organizations that seek to maximize transaction value with exchange partners behave differently than those that seek to minimize transaction costs. They might share more information, because they hope that cross-pollination of ideas breeds innovation, and more available information allows partners to jointly use data analytics to improve efficiencies in their exchange processes.
A transaction value view focuses on the benefits – to all parties – that may arise from collaboration. We see this particularly in strategic alliances (e.g. Ford x Google to develop tech for the connected vehicle) or joint ventures (e.g. LG x GM for manufacturing electric vehicle batteries). For these long-term partnerships trust and reputation are crucial. But beyond alliances and joint venture the idea of shared value creation has become increasingly popular.
This post traced how conceptions of organizational interactions evolved in OMS over time. We started with transaction cost economics and its assumptions of dyads and opportunism. A resource-dependent view on power loosened the dyad assumption, while the more recent transaction value perspective attributes benefits to organizational collaboration.
As organizations around the world are striving to rebound from the COVID downturn, and face societal challenges like climate change, geopolitical tensions, and income inequality, what perspective do you think will best predict their behavior and interactions?