Business Networking
The logic of business networking is striking – at least to academics who try to understand the determinants of corporate competitiveness. For companies the logic is frequently quite different.
What is co-operation between firms?
Co-operation between firms typically involves three features which can be analytically distinguished, namely relational contracting, information exchange / joint learning, and collective action.
Relational contracting is the opposite of arms-length relationships. Whereas the latter typically involve spot transactions, often based on auctions or auction-like arrangements, relational contracting involves a long-term business relationship. Arms-length relationships require extensive legal dealings, whereas relational contracting is often based on trust. Relational contracting occurs both within hierarchical settings (for instance in supplier relationships in Japanese industry) and in heterarchical environments (e.g. industrial districts).
Typical kinds of information exchange between firms include the following:
- Informal information exchange between firms in supplier/subcontracting arrangements, going beyond what is necessary for arms-length transactions. The customer may give assistance to his suppliers, e.g. how to work with certain new materials or how to deal with quality problems. This may happen both among neighbouring firms and within global supplier networks.
- Formal and informal information exchange between firms in strategic alliances. There has been a strong increase in the number of national and international strategic alliances between firms, i.e. co-operation ventures aiming at the development of a given technology on the basis of a contract. Behind this is the necessity to pool R&D resources to reduce development lead-times and to realise synergies.
- Formal and informal information exchange between firms in business associations. They often are a forum for technical discussions.
- Information exchange between firms' employees in professional associations, which may be formal (e.g. presentations in conferences) or informal (e.g. discussions during meetings and conferences).
Frequent types of collective action include the following:
- the provision of real services by business associations.
- jointly maintained, organisationally separate mesoinstitutions in fields like training, technology information, or export information.
- political lobbying and active participation in forums which work on shaping locational advantages.
In the real world, relational contracting, information exchange, and collective action will often go hand-in-hand; in fact, all three types of activities will reinforce each other, i.e. meetings in well-functioning business associations open opportunities to informal information exchange, and information exchange may reach barriers that can only be overcome through collective action. Taken together, this leads to the emergence of inter-firm networks.
Why firms may co-operate
In the view of institutional economics there are two major reasons why firms co-operate, namely transaction costs and principal-agent problems in arms-length relationships. Arms-length relationships require an elaborate contract which is costly to set up, negotiate, and enforce, thus causing high transaction costs. Principal-agent problems emerge to the extent that, for instance, a subcontractor or supplier is contractually obliged to employ certain process technologies but chooses a cheaper alternative, and the principal contractor is not easily able to tell the difference (for instance in surface treatment or chemical treatment of textiles). Some co-operation arrangements (e.g. strategic alliances) may also involve principal-agent-problems. Relational contracting and dense, long-term networks may offer substantial benefits in terms of minimising transaction costs and reducing principal-agent problems. Such arrangements are based on mutual trust. Agreements are self-enforcing to the extent that firms run the risk of eroding trust, and thus possibly drop out of the network, if they behave opportunistically.
In the perspective of innovation economics, co-operation between firms is a crucial feature since innovation is a cumulative process, involves learning-by-doing, -using, and -interacting, and often yields increasing returns. Particularly important is learning-by-interacting. There is both an empirical and a theoretical argument behind the emphasis innovation economics puts on learning-by-interacting. Behind the empirical argument is the notion that the most frequent type of innovation, namely incremental innovation, is not an event but a process of continuous improvements. The process of incremental innovation takes up speed as a development trajectory of a given technology becomes established, that is as an increasing number of researchers and firms agree that a given technology is preferable compared to other technologies. After this (often implicit) agreement, two things happen. First, there is less uncertainty, i.e. the risk that investment in R&D will have to be completely written off because a given technology has to be dropped is minimised. Second, an increasing number of researchers concentrate on improving a given technology, and a mesolevel structure of research groups or institutes, training courses and textbooks, norms and standards, etc. is being created.
The theoretical argument addresses the issues of opportunity costs and increasing returns. The alternative to inter-firm co-operation in innovation would be an autarchy approach, i.e. each firm tries to go through its own research effort and learning processes. In a certain way, this occurs in the real world; it is usually referred to as the not-invented-here-syndrome. This approach involves high opportunity costs as firms could have avoided replication and repeating dead-end tracks by learning from the experience of other firms.
In the view of innovation economics, the issue of transaction costs involves the different forms learning-by-interacting can take. Formal technology transfer, e.g. by licensing, is one of them. However, as the use of technology implies a lot of tacit knowledge, no technology transfer contract can define all the details that are involved; it can try to define as many as possible, something that would be extremely costly in terms of drafting, supervising and enforcing the contract. The alternative is a combination of formal agreements and informal communication. Moreover, there are other forms of technological learning based on communication between firms, e.g. discussions in standardisation bodies or at congresses. These mechanisms have low transaction costs.
Agreement between various actors -- firms, researchers, and others -- on a given technological trajectory can create the preconditions for increasing returns. There are both increasing returns to scale due to a large number of firms and researchers improving the same technology, i.e. returns for the producers, and to adoption of a given technology, i.e. returns for the users.
Why firms may not co-operate
Despite all its advantages, it is by no means self-evident that firms co-operate. The advantages of co-operation may be obvious to innovation economists and SME-support policy-makers, but many business-people do not find them obvious at all, and for good reasons. Avoiding co-operation may be perfectly rational behaviour. In our fieldwork we have found four main reasons why entrepreneurs may choose go-it-alone as much as possible.
First, business-people often find the idea of co-operation repulsive because they consider other firms in the same branch to be rivals, and one would prefer not to communicate with them in order to avoid uncovering business secrets.
Second, macroeconomic conditions may discourage inter-firm co-operation. There may be high taxes on inter-firm transactions, thus stimulating vertical integration. If the macroeconomic framework is unstable and the "rules of the game" are constantly changing, transactions between firms may be seen as isolated rather than repeated prisoner's dilemmas, creating a situation where defaulting may appear as an attractive option.
Third, even though co-operation can reduce transaction costs, it also creates them. Co-ordinating a network often involves a substantial amount of time to prepare meetings, to participate in them, and to take care of the follow-up. Also, it is quite natural that conflicts will occur, and resolving them again will require a lot of time and effort. Therefore, there may be a discrepancy between the incentive for individual firms to co-operate and the intensity of co-operation that would be desirable from a macro perspective.
Fourth, there is the issue of the business culture and trust. In an environment where firms are highly vertically integrated, where they stick to themselves, where there have been occurrences of failed co-operation ventures and predatory behaviour, a business culture arises that is characterised by isolation and low trust. Both co-operation and non-co-operation in a certain way result in increasing returns. In the case of co-operation, successful joint ventures create more social capital, thus improving the conditions for more co-operation. In the case of non-co-operation, failed co-operative ventures strengthen the notion that co-operation is impossible, thus undermining the prospects of success of further efforts to stimulate co-operation. Both co-operation and non-co-operation are thus path-dependent, with a particularly strong lock-in effect in the case of non-co-operation as it is much easier to destroy trust than distrust.
Against this background, the observation that clusters, i.e. geographical concentrations of firms, do not necessarily mean dense co-operation between firms does not come as a surprise. The emergence of clusters is a ubiquitous phenomenon that is mainly due to the uneven distribution of production factors, positive externalities, and historical chance events. It is by no means a matter of course that co-operation emerges within clusters. Whether is actually occurs, and which forms it may take, depends on specific historical, local, institutional and sub-sector circumstances. In the next section we look at distinct patterns of co-operation in different types of industrial clusters in developing countries.
See also: Promoting inter-firm co-operation and Networking, Business Contacts (first triangle: SME Promotion)
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last chapter: business-friendly orientation of government
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