WHY FIRMS MAKE UNILATERAL INVESTMENTS SPECIFIC TO OTHER FIRMS: THE CASE OF OEM SUPPLIERS Kang, Mahoney and Tan (2009) Presented by Hui Chen (Fall 2014)

Unilateral Relationship-Specific Investment in TCE TCE emphasizes the economic importance of not making unilateral relationship-specific investments without having sufficient economic safeguards in place; unilateral relationship-specific investments are expected to yield a negative NPV, giving rise to economic holdup hazards. Forms of economic safeguards:  Signing a formal contract  Entering into an equity alliance jointly  Posting an economic bond  Demanding payment for the specific investments before making their own

Mutual Sunk-Cost Commitment/Mutual Hostage Model(Williamson, 1996) The firm agrees to make relationship-specific invest- ments only if the transactional partner reciprocates by committing investments specific to the firm. The decision of making unilateral relationship-specific investments is considered to be “myopia” or mis- management.

TCE Theory Extension Relationship-specific investments in some cases may be a stepping stone for capturing potential positive economic spillovers generated from the initial contracts(eg. OEM contracting). The complementary analysis:  TCE focuses on the single transaction or individual resource exchange, ignoring potentially interdependent transactions.  The transaction may have a real option value for the long term.

Two Positive Spillover Effects Inter-project spillover with the same transaction partner: an opportunity to develop multiple projects and economic bonding relationships with a particular transaction partner (lower sourcing and communication costs) Inter-project spillover with other transaction parties: increasing its bargaining power with other firms (knowledge transfer, capability improvement, and reputation enhancement)

Case Study of Taiwanese OEM Suppliers Within an asymmetric interorganizational relationship context, in which the dynamics of learning are of particular importance, a weak OEM supplier will be willing to make unilateral relationship-specific investments despite potential bargaining hazards, if the supplier anticipates positive values from inter-project knowledge spillover and reputation spillover(Mayer, 2006).

Background Information The overall structure of OEM supplying network reinforces asymmetric bargaining relationships between buyers and suppliers.  Major OEM buyers have stronger bargaining power in the market due to a sufficient sourcing pool.  The OEM suppliers make substantial investments tailored to OEM buyers without protections for their unilateral relationship-specific investments.

Why Play Such An Unfair Game? Unilateral commitments can be a strategic move to gain from current contracts by capturing value via knowledge and reputation spillover effects for future contracts. 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.

Hypotheses H1: The greater the economic value of inter-project knowledge spillover effects with particular client, the more likely OEM supplier will make unilateral relationship-specific investments 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 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

Method

Results

Discussion and Implications The study goes beyond the individual transaction as the unit of analysis and considers the positive economic values via capability development, learning, and inter-project spillover. 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.

Contribution Why are weak OEM suppliers willing to make unilateral relationship-specific investment? The study emphasizes that a weaker bargaining positioned OEM supplier that delivers economic value to a major buyer can, over time, create dependency balancing, which can be a strategy to mitigate the economic safeguarding problem faced by a weaker transaction party.