Buyers and sellers are also in competition, however. While both sides gain from a trade (else why trade in the first instance?), it is not necessary for both sides to gain equally for a trade to take place. For the buyer, the aim is to get value for money from a deal. If the buyer is a rational agent this means maximum value for money. Every time he or she is able to negotiate the price down a notch, the value for money that is obtained increases. Of course, for the vendor, passing value to its customers means smaller profits. Economists refer to the contested ground that exists between the two parties to a trade as the surplus value.

What determines who wins out in this competitive process is the incentive structures that underpin the exchange relationship. Take, for example, the vendor that finds itself in a highly competitive market where its many customers are free to pick and choose where they buy their goods and services. Such a context forces the vendor into a Dutch auction in which it is forced constantly to drop its prices to buy its customer’s business. In such a situation, the surplus value is bound to pass to the consumer. Compare that to a situation in which a particular customer has invested heavily in the vendor’s technologies, even building the value proposition that it offers its own customers around the technologies of a particular supplier. This happened in the case of the PC market, where PC manufacturers fell over themselves to advertise the fact that their machines had an ‘Intel inside’. In the end, it became impossible for PC manufacturers to compete unless they were able to make this boast. Unfortunately, this had the effect of handing enormous leverage over to Intel and as a result the surplus value passed from the consumer to the producer.

Consequently, much of supply management is reduced to a game between poachers and gamekeepers in which the vendor assumes the role of the poacher (trying to ’steal’ its customers’ scarce financial resources), while the procurement manager assumes the role of the gamekeeper, in trying to stop them. What follows is a cat-and-mouse game in which through a combination of guile and the development of distinctive capabilities the vendor attempts to close markets, while the procurement manager responds in kind with a range of counter-strategies, designed to stop its vendors by keeping its supply markets contested. To the victor go the spoils. Power (formally defined as the ability of one party adversely to affect the interests of another) and the pursuit of power are at the heart of the exchange process.

To some it might appear that the competitive elements of an exchange have been overstated. While it is true that some people in life are maximizers (ie they are always looking for the highest possible return from a deal), critics would argue that most people are in fact happy just to satisfice (ie obtain a settlement that provides them with a deal that they can live with). If two people cooperate on a venture, then generally speaking those people are happy to split the proceeds. This may or may not be true: it is hard to say. What is true, however, is that such an approach is sub-optimal and imprudent. That satisficing is sub-optimal should be self-evident. The fact that it is also imprudent needs further elaboration.

The issue of prudence arises in a number of contexts. Firstly, it puts the profitability and even the survival of a firm at risk. The reason that firms come into business in the first instance is to make a return for shareholders. While it is true, as a number of resource-based writers have observed, that markets are often heterogeneous (ie they are capable of supporting laggards as well as world-beaters), it is not true that markets are infinitely forgiving of the weak (Peteraf, 1993). Firms that fall too far behind the competitive frontier are on borrowed time. Firms that forget about the competitive elements of an exchange, however, risk seeing their costs rise and falling behind the competitive frontier.

The second problem with cooperation and trust is that it demonstrates an unwarranted confidence in the capacity and willingness of others to reciprocate. Many firms that acquire leverage are happy to use it. Even those that do not possess a structural advantage may attempt to use guile instead, where they think it will pay off for them. Furthermore, denials that this is not true cannot be taken at face value. The thing about people is that very few of them are honest all of the time. One only has to reflect on one’s own experience to see that this is true.

According to business economists, economic agents are not simply self-interested but they pursue this self-interest with guile – not all of the time, but sufficiently often that opportunism is a fact of commercial life. What permits the existence of opportunism is two things:

1) a lack of honesty (obviously); and

2) a lack of transparency between buyers and sellers.

Economists distinguish between public and private information (Molhow, 1997). Information is regarded as public if it involves something that is widely known. Information is regarded as private when access to it is restricted. When ‘restriction’ means that one side in an exchange knows something that the other side does not, then an information asymmetry is said to exist. It is information asymmetry that permits dishonesty to pay.

Business opportunism exists in a number of forms, but for buyers the three guises in which it is most common are adverse selection, moral hazard and holdup. Adverse selection is ex ante opportunism or misrepresentation that arises prior to the signing of a contract. Shorthand definitions of the concept might revolve around buying a ‘lemon’ or being sold a ‘turkey’. The scope for adverse selection varies but is more common under some circumstances than others. Commentators often distinguish between search, experience and credence goods. Search goods are products that allow buyers to make systematic comparisons prior to a purchase. They are normally tangible products like chairs, pens or iron ingots. Experience goods, by contrast, are products that can only be evaluated subsequent to purchase. Typically, they include services like cinemas or restaurants. However, the category can also include tangible products like cars or records. The final category of good is the credence good. Credence goods defy easy evaluation, even after consumption. They include intangible services such as advertising, consultancy or medical services. What makes evaluation so hard usually comes down to a difficulty with attributing blame or success. For example, a piece of professional advice might have been responsible for a commercial disaster. However, the blame might lie with some other concomitant factor. The point is, where pre-contractual evaluation of a product is difficult – either because evaluation is inherently difficult or because the buyer lacks the resources or expertise to undertake it – the buyer is open to the risk of adverse selection. Experience goods and credence goods, by definition, are difficult to evaluate prior to purchase.

If adverse selection involves being suckered before a contract is signed, moral hazard and hold-up involve being suckered once a party has signed on the dotted line. Moral hazard is concerned with shortfalls in effort. For example, prior to an agreement, a consultancy company might promise to dedicate its best staff to the task of servicing the client and set its costs accordingly. Unbeknown to the client, however, once the contract has been secured, the work is passed down to junior colleagues whose time is charged out at inflated rates. Alternatively, moral hazard may involve charging a client for materials that were never used or that were used but came from another job and had been paid for by another client.

Hold-up occurs as a result of an extended association with a supplier, where the terms of the association cannot be fully specified in advance and where the association requires one of the parties to incur significant sunk and/or switching costs. Over time the full requirements of the relationship are revealed, and this combination of factors allows the non-dependent party to renegotiate the terms of the deal in ways that are most favourable to it. The existence of high sunk and switching costs may also support blatantly opportunistic behaviour in which the non-dependent party even reneges on its promises that are covered by legal agreement. The calculation here is that any benefit that can be obtained through legal redress will be insufficient to compensate for the damage to, or loss of, the relationship.

Regardless of the form that opportunism takes, the potential for it means that firms must always be aware of the competitive nature of any trade. Even if a customer is honest and believes in giving the other party a fair break, the customer cannot be sure that the other side is operating according to the same code. Because a trade always involves some private information, we just don’t know what we don’t know – and what we don’t know might turn out to be quite important. One of the essential elements of procurement and supply chain competence, therefore, centres on the capacity of buyers to ensure that their vendors offer a good deal (or at least keep to the terms of the deal that has been agreed).

Gautam Koppala,

POME Author