Formal versus informal contracts: achieving alliance success.

Introduction

The application and use of strategic alliances is of considerable interest to both industry practitioners and academics. However, recent research has shown that the balance between theoretical and practical knowledge concerning alliances is far from equivalent[1-3]. Specifically, practical knowledge is lacking which links alliance theory (what to do) with alliance practice Chow to do it).

One area of significance to industry practitioners is the establishment and maintenance of long-term commitment between alliance partners. In particular, what mechanism can managers utilize to facilitate economic and social co-operation of allying parties over the life of the alliance? Although traditional business practice relies considerably on formal contractual arrangements to achieve such commitment[4,5], informal social contracts or "handshake agreements" are also utilized[6-8]. With the increased experimentation and development of strategic alliances, the role of formal and informal agreements has become of particular interest to alliance participants, especially with respect to the level of loyalty, co-operation, trust and success the agreement affords[9].

The purpose of this article is to examine the role of formal written contracts and informal social contracts on logistical alliances. Specifically, the paper will:

* consider the role of contracts in alliance arrangements;

* compare and contrast research results that examine the use of formal written contracts to informal social contracts in actual alliance practice, and

* discuss the impact of these results to offer managers concrete guidelines for positioning successful alliance practice.

The article begins with background information which defines the type of strategic alliances examined in this research. Next, the nature of contracts in general is examined. Literature that compares formal written contracts to informal verbal agreements is briefly reviewed. Then the role of formal and informal contracts in alliances is considered by examining the results of ten case studies of actual alliance practice. This section reviews how and when contracts were utilized in best practice alliances and discusses the effect of contractual provisions on alliance success. Finally, the impact of the case study results will be detailed to offer managers guidelines for creating successful long-term alliances. In particular, the discussion will focus on the characteristics of formal and informal contracts that relate to, and support, alliance success.

Background

Much has been written in the academic and business press regarding strategic alliances in general. Many different terms are used to describe the concept such as partnerships[12], value-adding partnerships[12] and networks[13-14], as well as a variety of notions based on the concept of relational exchangef[15-21]. These terms essentially describe a similar proposition or process. In order to resolve the differences in terminology, this paper utilizes the following definition of an alliance.

An alliance reflects a process wherein participants willingly modify their basic business practices to reduce duplication and waste while facilitating improved performance[22].

This definition has evolved from best practice research conducted at a major university in the USA. The early definition focused on a business relationship where parties worked closely together to achieve specific objectives. The research was enhanced by later work which detailed the benefits of co-operative, as opposed to adversarial, business relationships. Implicit within this perspective is a focus on long-term, mutually satisfying goals rather than short-term, self-serving objectives.

This article examines alliances that attempt to reduce supply chain duplication and waste by improving logistical activities between partnering firms. The following definition of logistics is utilized in this paper:

Logistics is the process of planning, implementing and controlling the efficient, effective flow and storage of goods, services, and related information from point of origin to point of consumption for the purpose of conforming to customer requirements[23].

From this perspective, logistical alliances focus on partners' willingness to modify logistical processes of movement and storage of products, services and related Information to increase efficiency and effectiveness and improve overall supply chain performance. Although benefits are alliance-specific, the following are generally perceived to be the most common:

* reduced cost through specialization.,

* improved synergistic performance,.

* increased information to support joint planning,

* enhanced customer service,

* reduced risk and uncertainty,

* shared creativity; and

* competitive advantage[24].

The nature of contracts

Alliances, as well as more traditional (and often adversarial) relationships, require some degree of agreement to exchange goods, services and information. Relationships between exchange partners can be stabilized through either formal or informal mechanisms. Formal mechanisms clearly specify the required degree of co-operation, conformance and inter-organizational integration through the use of a written document or agreement. As noted previously, the nature of alliances encourages both parties to take a significant, long-term interest in the relationship. One way to achieve a long@term interest is through the use of a written agreement or contract. Bucklin and Sengupta[25,26] discussed the benefit of a written contract in terms of creating an "opportunity to design desired patterns of partner behaviour and to extract penalties from failures to perform". Dobler et al.[27] suggested that long@term agreements (especially written) provide the required degree of stability which allows a supplier to make investments to improve material offerings to a manufacturer without risk of business loss.

Informal mechanisms consider the historical and social context of a relationship as well as specifically acknowledging that the performance and enforcement of obligations are an outcome of mutual interest between parties[6,7,28]. The use of informal mechanisms, such as implicit contracts[29,30], are defined as unwritten agreements between firms which are enforced not by formal authority and power but rather by the desire to create and maintain a positive reputation for integrity and fairness[31] and build trust[32]. In other words, informal mechanisms may provide a valuable alternative compared to written contracts as a way to encourage mutual interest without written legal obligation. Recent research has suggested that such considerations are a viable option. Young and Wilkinson[33] found "written agreements tended to produce more conflict than did unwritten ones". Larson[32] concluded that firms discounted the use of written contracts and concentrated more on the development of "informal and implicit social contracts" to achieve effective control and co-ordination in alliances. Ring and Van de Ven[34] proposed that informal contracts would serve as a substitute for formal contracts when trust is exhibited, and that, if a written contract is required, it is for the benefit of "principals -- the stakeholders of their respective organizations".

Schmitz[35] observed that these informal and implicit social contracts were illustrated when key employees, responsible for managing an alliance, formed strong personal ties, …