The role of e-marketplaces in relationship-based supply chains: a survey

IBM Systems Journal,  March, 2005  by W. Grey,  T. Olavson,  D. Shi

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Business transactions involve an agreement, explicit or implicit, between buyers and sellers on many terms and conditions. We refer to the means by which transaction terms are determined as the coordination mechanism. For example, transaction prices may be announced, negotiated, or determined by a market mechanism. Transaction quantities may be stipulated contractually or determined by demand and availability. Coordination mechanisms vary from industry to industry, depending on factors such as the importance of buyer-supplier relationships, the degree of buyer and supplier concentration, the uniqueness of the product or service, and the frequency of transactions. (17)

The role of relationships in B2B commerce

Despite the high visibility of anonymous, arm's length transactions in consumer and commodity markets, the majority of economic transactions involve long-term relationships. According to Blinder et al. (18) the most common means of buyer-supplier coordination in B2B transactions is through long-term relationships and supply contracts. About 38 percent of private sector GDP (gross domestic product) is covered by explicit contracts, about three-quarters of which set prices for a standard period of time. Furthermore, about two-thirds of all U.S. companies have either implicit contracts for prices or implicit understandings with their customers that they will not "take advantage of the situation by raising prices when the market is tight."

Supply chain partners benefit from relationship-based contract coordination in several ways. These include reductions in transaction and agency costs, improved information sharing for production coordination, customized pricing, and price stickiness. Grey, Olavson and Shi (19,20) discuss these sources of value in greater detail.

A concise way to articulate the advantages and disadvantages of different coordination mechanisms is through the economic framework of transaction costs. In markets based on long-term relationships, the cost of doing business through contracts and relationships is presumably lower than the cost of using market transactions. Long-term relationships can be a more efficient way to maintain ongoing business relations, and by sharing information, firms can improve production planning and reduce inventory and order fulfillment costs.

The economics literature on transaction costs emphasizes the importance of agency costs, suggesting that a concern for the future often provides incentives for cooperative long-term relationships that avoid the opportunistic behavior associated with short-term planning. (21,22) Agency costs are particularly important when relationship-specific assets are involved, such as capital investments made on behalf of a specific customer or jointly developed intellectual property. Long-term partners are less likely to "hold up" (take advantage of) one another for short-term gain. Short of vertical integration, developing long-term relationships is the best way to reduce agency costs. Other reasons for establishing long-term relationships include the presence of strategic synergies, like joint technological capabilities, reductions in product-development cycle time through collaboration, and cross-organization learning effects.