Presented by: Hyeonsuh Lee Why firms make unilateral investments specific to other firms: The case of OEM suppliers Kang, Mahoney, and Tan (2009) Presented by: Hyeonsuh Lee

Unilateral relationship-specific investment Overview Unilateral relationship-specific investment Economic hold-up hazards Negative NPV Myopia, mismanagement Transaction Cost Economics Consider real options value Beyond the individual resource exchange Extended Transaction Cost Economics “Positive spillover effects” With the same exchange partner From other third parties

Unilateral relationship-specific investment in TCE TCE focuses on the individual transaction Failed to consider the possibility of interdependent transactions and existence of spillover effects (learning and capability development) Might cause economic holdup hazards  negative NPV Safeguards are necessary Forms of economic safeguards: Signing a formal contract Entering into an equity alliance jointly Mutual sunk-cost commitment (mutual hostage model, Williamson 1996)

Extending Transaction Cost Economics Transactions may be interdependent (real options value) Two positive spillover effects: Inter-project spillovers with the same transaction partner Lower search and communication costs Develop multiple projects and economic bonding relationships Fundamental transformation from an ex ante asymmetric bargaining relationship into a ex post bilateral exchange relationship. Inter-project spillovers with other transaction partner Facilitate knowledge transfer from the transaction partner Increase bargaining power – capability improvement, reputation enhancement

Case of Taiwanese OEM suppliers Even knowing that their clients may behave opportunistically, some OEM suppliers in Taiwan are still willing to make client-specific investments without economic safeguards. OEM suppliers place much of the value of their strategic move on the positive spillovers these current transactions may yield from future transactions with the same OEM buyers or form other transaction parties. Unilateral relationship-specific investments(site-specific investment, build JIT warehouse near Dell assembly sites) may be understood as a stepping stone to reposition suppliers’ resource profiles and to enhance their capability to enter new markets. HIPRO – no brand name recognition. After winning an order from Dell HIPRO found it easier to approach other OEM buyers (Cisco). Potential learning effect and the reputation effect of being classified as a top-tier supplier led to strategic advantage in dealing with other buyers and provided HIPRO with value beyond the transaction at hand.

Why Play Such An Unfair Game? Knowledge Spillovers: Knowledge and information transfer and sharing between buyers and suppliers(customized service, product designs, and business processes) secure more future projects from existing buyers and enable the suppliers to gain business from other buyers. Reputation Spillovers: Being classified as a top-tier supplier led to strategic advantage in dealing with other buyers under the value-maximizing strategy.

Hypothesis 1 – Knowledge spillovers and economic bonding relationships Accumulate partner-specific knowledge and develop inter-organizational routines.  Improved exchange efficiency and enhance transaction value. Increase the economic incentive of their clients to transfer knowledge and information by reducing buyer’s concerns about leakage. Increase the likelihood of winning new and more valuable projects from the same partner. H1. The greater the economic value of inter-project knowledge spillover effects with a particular client, the more likely OEM suppliers will make unilateral relationship-specific investments.

Hypothesis 2 – Knowledge spillovers and capability leveraging Enables the supplier to develop dynamic capabilities that over time enable OEM supplier to gain profitable business from other buyers. Tacit knowledge & positive reputation  leverage these in dealing with third parties. Asymmetric flow of knowledge between OEM buyers and suppliers  improvements in the suppliers’ resource profiles, capabilities and absorptive capacity. H2. The greater the economic value of inter-project knowledge spillover effects with other clients, the more likely OEM suppliers will make unilateral relationship-specific investments.

Hypothesis 3 – Reputation spillovers and endorsement effect Being classified as a top-tier supplier led to strategic advantage in dealing with other buyers. Being endorsed by a major OEM buyer reduces the market uncertainty of other buyers concerning the supplier’s capabilities. H3. The greater the economic value of reputation spillover effects with other clients, the more likely OEM suppliers will make unilateral relationship-specific investments.

Method Survey of 82 suppliers in IT industry (response rate 17.5%) On-site Interviews of 41 suppliers in bicycle industry (41/45) Dependent variable: relationship-specific investment 7 indicators using Likert seven-point scale, in which 4 for tangible investment and 3 for intangible investment Independent variables: Knowledge spillovers: multiple projects, integrated services, capability upgrading Reputation spillovers Control variables: industry, length of association, firm size&relative scales, reciprocal investments

Results H1 H2 H3

Discussion and Implication It responds to the call that organization should incorporate learning and capability development into governance choice and investment decisions. It examines the strategic issue regarding whether or not to invest with empirical findings indicating firms are more likely to invest in specific investments when they expect their investments to have more positive spillovers. It incorporates real options logic into TCE, considering unilateral relationship-specific investment as an option in gaining favorable access to future opportunities.

Discussion From the client’s perspective, is this spillover effect desirable? (Martinze-Noya, Garcia-Canal and Guillen, Journal of Management Studies, 2013) The effect of supplier’s relationship-specific investment on relationship performance can differ based on the client’s view: The client’s need to transfer proprietary core knowledge to the supplier The client’s perception of the supplier’s opportunities for exploiting the acquired knowledge outside the scope of the agreement.