by Richard Veryard
Masood Mortazavi uses Transaction Cost Economics to explain the difference between Managing to Contract vs. Managing to Relationship. In this post, I want to link this discussion to the key notions of Asymmetric Demand and Asymmetric Governance.
“Managing to contract” implies a two-phase procurement process. In the first phase, all possible scenarios are identified, and a contract is negotiated that defines rights and obligations for each scenario. In the second phase, the emphasis is on compliance with the agreed rights and obligations. Unfortunately, it is hard to find good sources for this phrase on the Internet. Most of the hits lead to the antique humour of “managing to contract disease“. In contrast, “managing to relationship” implies a degree of trust between the parties, and an expectation that issues will be resolved to mutual advantage. Under certain simplifying conditions, there may be no observable difference between managing to contract and managing to relationship. The greatest observable difference can be found in highly complex procurement arrangements, involving either long-running contracts, or a series of separate contracts within a long-running relationship.Managing to relationship may still involve detailed contractual negotiations, but the emphasis is often upon establishing a collaborative governance process, rather than an attempt to anticipate all possible scenarios.
Masood draws three axioms from Transaction Cost Economics:
- open, competitive markets cannot always provide goods and services that are needed (asymmetry)
- contracts are inherently incomplete (bounded rationality, uncertainty)
- relationships as safeguards against opportunistic defections (game theory?)
Drawing on these axioms, we can see that the limitations of managing to contract are not just based on economic inefficiency (excessive transaction costs) but on ethical asymmetry – including asymmetric information and moral hazard. Managing to contract can produce destructive tactical behaviours such as chicken.
Chicken: the first party to flinch is the loser. So when a project is going off track, each party tries to ignore the evidence that things are going wrong, in the hope that the other party will bail out first and bear all the costs.
So there are some basic structural problems with traditional procurement arrangements, and managing to relationship won’t solve these problems alone.