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Today’s business environment is unforgiving of companies that are slow to adapt. To extend their capabilities and facilitate change, many organizations have experimented with different types of strategic partnerships with suppliers and customers that help them design and deliver products and services efficiently. But some innovative companies are attempting to redefine the parameters of strategic partnerships as we know them, navigating between the risk of being exploited by an opportunistic partner and the risk of being trapped in the rigidities of vertical integration. These organizations have initiated multileveled relationships with customers and suppliers that leverage the resources and capabilities of the respective parties in an effort to create superior products and services.
What makes such partnerships — which I call adaptive strategic partnerships — counter-intuitive is that they are being formed in situations where the two most relevant streams of organizational economics would predict vertical integration.1 Moreover, managerial literature cautions against establishing customer-supplier agreements that, like those contemplated here, lack conditions of specifiability, verifiability and predictability.2
Bharti Airtel Ltd., a telecommunications services company based in New Delhi, India, is among a growing group of companies that have nevertheless elected to take a different path. Back in 2004, Bharti Airtel, currently the world’s third largest wireless telecom service provider, with more than 275 million subscribers in 20 countries, was struggling to keep up with the growth of India’s wireless telecom market while also competing for broadband and landline telephone customers. Increasingly, Bharti Airtel managers found that negotiating and updating contracts with vendors interfered with their ability to focus on satisfying customers and outsmarting the company’s competition. Contrary to what other telecom operators have done, Bharti Airtel negotiated unconventional relationships with some of its leading vendors, including Nokia Siemens Networks (now Nokia Solutions and Networks), Ericsson and IBM — vendors whose interests at times have collided with its own.
Typically, companies with outside partners rely on simple tools such as service-level agreements, which specify what is expected from each party and provide for performance standards to assess compliance.
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1. Those two streams of organizational economics are Williamson’s transaction cost economics and Hart’s property rights theory. See O.E. Williamson, “Transaction-Cost Economics: The Governance of Contractual Relations,” Journal of Law and Economics 22, no. 2 (October 1979): 233-262; and O. Hart, “Firms, Contracts and Financial Structure” (Oxford, United Kingdom: Oxford University Press, 1995).
2. C.M. Christensen and M.E. Raynor, “The Innovator’s Solution: Creating and Sustaining Successful Growth” (Boston: Harvard Business School Press, 2003), 137.
3. The compound annual growth rate of Bharti Airtel’s revenues in Indian rupees for the 2004-2013 period was 36%. The growth rate in U.S. dollars for the same period was 33%, reflecting a 20% devaluation of the Indian rupee against the U.S. dollar in 2013.
4. An excellent overview of the related organizational economics literature is R. Gibbons and J. Roberts, eds., “The Handbook of Organizational Economics” (Princeton, New Jersey: Princeton University Press, 2012). See also J. Oxley, “Appropriability Hazards and Governance in Strategic Alliances: A Transaction Cost Approach,” Journal of Law, Economics & Organization 13, no. 2 (October 1997): 387-409, which discusses how the degree of appropriability hazard leads to a continuum of relationships that go from the arms-length transaction to vertical integration; J.H. Dyer and H. Singh, “The Relational View: Cooperative Strategy and Sources of Interorganizational Competitive Advantage,” Academy of Management Review 23, no. 4 (October 1998): 660-679; and J.H. Dyer, P. Kale and H. Singh, “How to Make Strategic Alliances Work,” MIT Sloan Management Review 42, no. 4 (summer 2001): 37-43. The latter articles view the capability to develop strategic alliances as a difficult-to-replicate core competency and a main source of competitive advantage. Finally, R. Gulati, “Social Structure and Alliance Formation Patterns: A Longitudinal Analysis,” Administrative Science Quarterly 40, no. 4 (December 1995): 619-652, presents the sociological view of strategic alliances.
5. O.E. Williamson, “The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting” (New York: Free Press, 1985).
6. S. Kerr, “On the Folly of Rewarding A, While Hoping for B,” Academy of Management Journal 18, no. 4 (December 1975): 769-783.
7. P. Casas-Arce and T. Kittsteiner, “Opportunism and Incomplete Contracts,” working paper, Arizona State University, 2010.
8. S. Purohit, interview with author, July 21, 2010.
9. T. Aeppel, C. Ansberry, M. Geyelin and R.L. Simison, “Road Signs: How Ford, Firestone Let the Warnings Slide by as Debacle Developed,” Wall Street Journal, Sept. 6, 2000.
10. V.G. Narayanan and L. Brem, “Supply Chain Partners: Virginia Mason and Owens & Minor (A),” Harvard Business School case no. 109-076 (Boston: Harvard Business School Publishing, 2009).
11. D. Boskovic and S. Hariramasamy, “Next Generation IT ADM O&O” (presented at the Seventh Annual Conference on Outsourcing and Offshoring, McKinsey & Co., New York, Nov. 13, 2008). In a comparative study of two application-development relationships in the financial services sector that had met with widely different success, Boskovic and Hariramasamy found that one of the critical differences between successful and unsuccessful relationships was the concentration of quality assurance on only four points of the life cycle versus in all the deliverables.
12. M.D. Ryall and R.C. Sampson, “Formal Contracts in the Presence of Relational Enforcement Mechanisms: Evidence from Technology Development Projects,” Management Science 55, no. 6 (June 2009): 906-925.
13. O. Hart and J. Moore, “Contracts as Reference Points,” Quarterly Journal of Economics 123, no. 1 (February 2008): 1-48; and E. Fehr, O. Hart and C. Zehnder, “Contracts as Reference Points — Experimental Evidence,” American Economic Review 101, no. 2 (April 2011): 493-525.
14. K. Miller, R.S. Kaplan and F.A. Martínez-Jerez, “Infosys’ Relationship Scorecard: Measuring Transformational Partnerships,” Harvard Business School case no. 109-006 (Boston: Harvard Business School Publishing, 2008).
15. V.G. Narayanan, S. Kulp and R.L. Verkleeren, “Metalcraft Supplier Scorecard,” Harvard Business School case no. 102-047 (Boston: Harvard Business School Publishing, 2002).
16. G. Grover, E. Lau and V. Sharma, “Building Better Links in High-Tech Supply Chains,” McKinsey Quarterly 14 (winter 2008): 14-19.
17. Hart and Moore, “Contracts as Reference Points.”
18. A. Gupta, interview with author, Jan. 2, 2009.
19. B.R. Klein, G. Crawford and A.A. Alchian, “Vertical Integration, Appropriable Rents, and the Competitive Contracting Process,” Journal of Law and Economics 21, no. 2 (October 1978): 297-326.
20. S. Samila and O. Sorenson, “Noncompete Covenants: Incentives to Innovate or Impediments to Growth,” Management Science 57, no. 3 (March 2011): 425-438. Samila and Sorenson show that in states where noncompete clauses are enforced, there is less innovation, as well as fewer startups and lower employment growth.