Managing Firms through Relational Contracts
2nd Workshop on Relational Contracts

CUNEF, September 23-24, 2016

By the mid-1980s, General Motors, once the automobile industry’s leader, lagged behind Japanese rival Toyota in terms of productivity, innovation, and quality. However, “It took General Motors more than two decades to imitate Toyota’s managerial practices consistently because Toyota’s practices were rooted in agreements based on subjective measures of performance that could neither be fully specified beforehand, nor verified after the fact.” (Helper and Henderson, Journal of Economic Perspectives, 2014).

In the 1990s, Danish hearing aids manufacturer Oticon became world famous for launching a “company without bosses”, where the employees’ freedom to initiate projects would motivate them to become radical innovators. However, Oticon’s employees misunderstood this corporate culture of delegation as a “blank check”, and grew frustrated as the headquarters rejected some of their projects. To restore their morale and trust in the company, Oticon had to reformulate its corporate culture, clarifying that the employees would be free to initiate new projects, but only within the guidelines issued by a centralized “Competence Center” (Foss, Organization Science, 2003).

Across the past decades, Italy’s success in manufacturing has been primarily forged by its industrial “districts”. The strength of these districts is the ability of their firms to informally cooperate despite being separate business entities. For example, large air conditioning manufacturers systematically share unexpected increases in labor and energy costs with their networks of small suppliers, despite the absence of formal cost-sharing agreements protecting the suppliers (Camuffo, Furlan, and Rettore, Strategic Management Journal, 2007).    

These and other stories of business success and failure are examples of how a company’s organizational “software”—that is, its managerial practices, its corporate culture, and its body of subjective performance metrics—is a potent source of competitive advantage. Yet, successful managerial practices are difficult to articulate, define, and imitate. The reason for this difficulty is that managerial practices are “relational contracts”: they are based on managers’ and employees’ mutual understanding of company needs in an ever-changing environment, and on their ability to flexibly adapt to such needs, and thus, unlike traditional organizational charts and employment or distribution agreements, they are primarily informal and trust-based.

The objective of this workshop is to advance our understanding of how firms can develop and effectively communicate to their employees, suppliers, distributors, and business partners, relational contracts that will help them adapt to unforeseen challenges, resolve internal conflicts, and ultimately, gain competitive advantage. 

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