Executive Summary
Marketers, (purchasing) managers, and lawyers must strike a difficult balance between “too little” and “too much” contracting for information technology (IT) procurement. Using 971 IT procurement transactions, the authors analyze the costs and benefits of striking loose versus rigid contract terms. Writing more detailed contracts enables managers to set goals, clarify expectations, lower misunderstandings, and reduce the counterparty’s range of opportunistic behavior. However, drafting more detailed contracts also requires managerial time and effort in searching for information, projecting scenarios, identifying feasible contingencies, and negotiating acceptable solutions. In contrast, keeping contract terms open enables parties to make value-enhancing adjustments and is likely to foster trust because parties do not hold each other to precise terms of the contract; however, opportunistic counterparties can exploit unspecified loopholes, leading to wasteful renegotiations and holdup. The results suggest that managers need to understand the properties of the transaction under consideration. Transactions that involve lock-in, those that are more complex, and those for which it is difficult to evaluate the vendor’s products upfront are likely to generate implementation hazards compared with simpler transactions. Such inherently complex transactions will require valuable time and effort in constructing contract terms but are also likely to have more problems ex post. Thus, contracts that are decoupled from the essential nature of the transaction are not likely to be effective. The authors prescribe a three-step decision frame to address these issues.
First, managers need to assess the hazards posed by transactional attributes. If these hazards are low, managers need not expend effort in constructing detailed contracts. In contrast, if the hazards are high, managers need to be more selective because these transactions have higher ex ante and ex post costs. Managers then need to balance these costs with the value added from entering into such hazardous transactions. For example, they need to assess whether the improvements in productivity and cost efficiency from procuring customized configurations is worth the potential costs of managing these transactions. Second, if the value added from productivity improvements is substantial and desired, a balance needs to be achieved between the ex ante and the ex post costs. For example, in some contexts, it might be beneficial to craft rigid contracts because the resulting reduction in the ex post implementation problems overcome the added managerial costs of writing these contracts in sufficient details. Crucially, this level of “rigidity” must reflect the level of hazards posed in the context. In short, managers need to construct contracts that are not too costly to design yet are specific enough to reduce hazards. Third, given that complex transactions require high management effort, it would be useful to build in realistic expectations. Projects involving the procurement of complex, customized products/services are likely to take time in “fixing the bugs” and have ex post implementation issues. It is then advisable that provisions be made for such slack.
Biography
Erik A. Mooi is an assistant professor in the Marketing Department at the VU University, Amsterdam. Previously, he worked at Aston University in the United Kingdom. He received his PhD from the VU University Amsterdam in 2007. His research interest lies in business-to-business marketing. In particular, he works on interorganizational governance topics, such as contract design for intellectual property, norm-based governance, channel conflict, and contract enforcement.
Mrinal Ghosh is the W. “H” and Callie Clark Associate Professor of Marketing at the University of Arizona. He has a PhD in Marketing from the University of Minnesota and previously held positions in the Marketing Department at the University of Michigan. His primary research interests lie in developing and testing theoretical models of interorganizational exchange in the substantive context of business-to-business markets, distribution channels, and sales force compensation and management. His current research focuses on understanding the role of contractual terms, such as leasing and product bundling in interfirm ties and using structural modeling approaches to understand the impact of channel choices. His work has appeared in Journal of Marketing, Journal of Marketing Research, Marketing Science, Marketing Letters, Review of Industrial Organization, and Applied Economic Letters.
Journal of Marketing, Volume 74, Number 2, March 2010
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