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CHAPTER 2

ECONOMICS OF VERTICAL TRADE

RELATIONSHIP

Organizations dominate our socio-economic landscape. The perspective and theories

of organizations are different today as it was mentioned in literature twenty years

ago. The later theories precisely define the nature of organization, in the manner of

creating knowledge. This chapter elaborates the current various theories of

organization and inter organization interaction. The chapter also briefly explains

role of power and dependence in inter firm interaction and explain integrative

constructs under power and dependence and its role in inter organizational

relationship.

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2.0-GENERAL

Scott (1988) articulates three prominent definitions that capture well the spectrum of

how organizations are conceived. Each definition calls attention to certain significant,

enduring and essential features of organizations that distinguish them from related

types of collectivities (e.g., families, small groups), and embodies different as-

sumptions and beliefs about the nature of organizations. The definitions are given in

order of their historical appearance, and each can be seen, at least in part, as a critical

response to perceived inadequacies and limitations of the prior conceptions.

Rational system: Organizations are collectivities oriented to the pursuit of relatively

specific goals and exhibiting relatively highly formalized social structures.

Natural system: Organizations are collectivities whose participants share a Common

interest in the survival of the system and who engage in collective activities,

informally structured, to secure this end.

Open system: Organizations are systems of interdependent activities linking shifting

coalitions of participants; the systems are embedded in - dependent on continuing

exchanges with and constituted by - the environment in which they operate.

Most of the recent definitions of organizations tend to combine elements of rational,

natural, and open systems definitions. Some also argue that these definitions capture

different aspects of organization. For example, the rational, natural and open system

views correspond to the technical, managerial and institutional dimensions of

organizations, respectively (Thompson, 1967).

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2.1-THEORY OF ORGANISATION

Some of the main lines of thinking within each conception, and attempt to capture the

basic spirit of the ideas are as below

A. Rational System Origins

The Greek root of organization, "organon," meaning instrument or tool, captures the

image projected in the rational system view. Organizations are designed (created) to

achieve specific goals; and rational view theorists normatively and descriptively

argue that organizational designs involve formal structures - rules, roles and

relationships that are created to emphasize efficiency in achieving well-defined

objectives. In this view, organizations are portrayed as machine-like bureaucracies in

which all actions and behaviors are controlled and coordinated to ensure goal

achievement in the greatest economy. They are comprised of standard operating

procedures and formal structures, which specify responsibilities and ensure that these

all procedures are reliably performed.

Historically, the study of organizations has been dominated by the rational system

definition, and its early focus on goal-directed activity-systems was critical to

establishing "complex organizations" as a distinctive field of study. The rational

systems approach emerged in Europe and North America alongside the rapid

industrialization and increasing rationalization of business enterprises at the turn of

the twentieth century. In Europe, Max Weber ([1922] 1978) and Robert Michels

(1911) documented the rise of the "bureaucracy," an organizational form based on a

belief in normative rules and a hierarchy of officials elevated to authority under those

rules who issue commands. In North America, Frederick Taylor and his followers

(e.g., Frank and Lillian Gilbreth and Henry Gantt) championed "scientific

management," which aimed to rationalize the activities of both managers and

workers based on an analytical "regimen of science." On both continents, business

practitioners - most notably French industrialist Henri Fayol and General Motors

executives James Mooney and Allan Reiley - searched for a universal set of

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principles of administration to guide the specialization, grouping, and coordination of

work activities. The enduring contribution of these early thinkers was the elaboration

of the concept of the formal organization as an instrument purposefully designed to

achieve explicit goals with the greatest economy of resources.

Perhaps the most influential rational system contribution, however, is the pioneering

work of Herbert Simon and his colleagues James March and Richard Cyert, known

collectively as "the Carnegie School" (Simon, 1945: March and Simon, 1958; Cyert

and March, 1963). Many of the themes they introduced - among them, goals and con-

straints, formalized structure, bounded rationality, information processing, decision

making, political coalitions, and performance programs - remain central to

contemporary organizational research. Simon and his colleagues were highly critical

of earlier "prescriptive" efforts both for searching for a simple set of "dos and don'ts"

and for focusing on activities rather than the choices that determined them.

Underlying their model is a conception of human cognitive limits in which

incomplete information about means and ends - bounded rationality - leads to

"satisficing" choices that meet some minimum set of criteria, rather than best

possible choices. Thus, while, like neoclassical "economic man" motivated by self-

interests, Simon's (1945) "administrative man" does not always know what his

interests are, is aware of only a few alternatives, and is willing to settle for an

adequate solution.

In their "behavioral theory of the firm" (Cyert and March, 1963), formalized structure

economizes on human cognitive limits and promotes rational decision making by

providing a set of "givens" in which choice and action takes place. Rationality thus

resides in the structure itself - in specialized roles, rules, training programs and

operating procedures that assure members will behave in ways designed to achieve

desired objectives, in control arrangements that evaluate performance and detect

deviations, in reward systems that give members incentives to perform proscribed

tasks, and in criteria for hiring, firing, and promotion. Their conceptualization reveals

a tension between two images of adaptation, however. On the one hand,

organizations' behavior is directed toward performance improvement; compatible

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with rationalistic assumptions of traditional economic theories of the firm. On the

other hand, their behavior tends to be complex, slow and sensitive to organizational

conditions, characteristic of bounded rationality. Thus, while intendedly adaptive,

organizations' behavior might not necessarily result in performance improvement -

structures developed to promote rationality may, under some conditions, have the

opposite effect.

B. Natural System Origins

If goals, formal structure and efficiency best describe the rational system view,

emergent purpose, informal structure and adaptation depict the natural system view.

In addition, natural system theorists put little emphasis on formal structure, arguing

that the informal structure of roles and relationships that emerge among individuals

and groups shape organizational activities and goals. In this view, organizations are

not purposively designed instruments performing tasks with machine-like efficiency,

but rather organic entities that become infused value and meaning beyond the

purpose intended in the formal structure. So, organizations may initially be created to

pursue specific goals, but alternative (supplementing or supplanting) purposes and

meanings emerge through human interaction and displace the initial objectives.

Although there is no single "unified" natural systems model of organizations, what

sets natural systems models apart is their focus on the non-rational, informal and

moral bases of social conduct and cooperation. Starting with Chester Barnard(1938) ,

Elton Mayo(1945), and Fritz Roethlisberger and William Dickson(1939), the

interplay between formal and informal structures is a recurring natural system theme.

Whereas formal structure is viewed as a conscious expression of a cost-and-

efficiency logic, informal structure represents the spontaneous logic of human

sentiments and needs. Informal relationships facilitate communication and getting

things done, maintain cohesion, and are at the center of political life in organizations.

Some, including George Homans (1950), concluded from this view that small face-

to-face groups, joined together by reciprocal bonds of activities, interactions and

feelings were the basic building blocks of organizations. Others, including Robert

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Merton (1957), drew less "reductionist" conclusions, viewing organizations more

holistically as finely balanced systems of mutual social constraint in which each

individual's actions are shaped by the demands and expectations in his or her "role

set."

Another natural system pioneer and Merton student. Philip Selznick (1949, 1957)

stressed that, although organizations are "instruments designed to attain specific

goals," they are also "adaptive organisms" that take on lives of their own, changing

their unifying purposes and very reasons for existence in order to perpetuate

themselves. Over time, he suggests, each organization develops a "distinctive

character and competence" and becomes "infused with value beyond the technical

requirements of the task at hand". Selznick referred to the process by which an

organization developed a distinctive character and became invested with meaning

beyond its utilitarian value as institution; Selznick's natural system approach is the

foundation for contemporary research in the institutional perspective, or "neo-

instltutionalism," and as also influenced research on power and dependence.

Selznick's institutionalism and its descendants follow the Weberian ([1922] 1978)

tradition of focusing on the subjective meaning of action - and on the effects of

institutional structure. Subjective meaning underpins human behavior - we behave in

ways that are meaningful to us, whether that meaning is associated with salvation or

with material accumulation.

C. Open System Origins

In the rational and natural system views, organizations and their environments are

separate entities with clear boundaries. In the open system perspective, however, this

distinction is not so obvious, and focus is placed on the relationship and

interdependencies between organizations and environments. Inspired by general

systems theory and cybernetics (Boulding, 1956; Buckley, 1967; Katz and Kahn

[1966] 1978), open systems models conceive organizations as both systems of

internal relationships and as inhabitants of a larger system encompassing the

environments in which they operate and on which they depend for resources.

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Organizations are conceived of as a throughput model, obtaining resources from the

environment, processing them and distributing the output back to the environment. If

the rational view projects a machine image and the natural systems view an organic

one, the open system view suggests an organism analogy organizations are adaptive

and interdependent systems, comprised of various interrelated - possibly conflicting

subsystems - attempting to meet and influence the dynamic demands of the

environment.

Early open systems work focused on development of a "contingency theory" in

which the best way to organize depended on the demands placed on the organization

by the environment in which it operated, in addition to internal characteristics

including the complexity of inputs, processes, and knowledge (Lawrence and Lorsch,

1967; Perrow, 1967; Thompson, 1967; Woodward, 1965). For example,

environments characterized by uncertainty and rapid technological or market change

place different demands on organizations than do stable environments. Because

different organizational subunits (e.g., research and development vs production) may

confront different environments, they may require specialized subunits with differing

features. The more differentiated the organizational structure, the more difficult it

will be to coordinate various subunit activities, and so, the greater the need for

coordinating mechanisms. Thus, combining open and rational system logics,

contingency theory asked: "Given that an organization is open to the uncertainties of

its environment, how can it function as a rational system?" (Scott, 1988) .

In contrast to contingency theorists' content-oriented, "rational-open" systems ap-

proach. Karl Weick (1979) advanced a process-oriented, "natural-open" systems

model of "organizing." in which organizational activities are directed toward

resolving equivocal informational inputs from the environment. Organizational

activities are carried out in three stages - enactment, selection, and retention - a

translation of Donald Campbell's (1965) influential variation-selection-retention

model of sociocultural evolution. Weick replaces "variation" with "enactment" to

emphasize the active role organizational members play in defining, giving meaning

to, and influencing their environments. Over time, organizational activities become

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structured as loosely coupled systems of repeated, contingent, interlocked behaviors

that establish a workable level of certainty for organizational members, but also

allow variation in interpretation and action as organizational members selectively

attend to their environments. Although, like Simon and colleagues, Weick gives great

attention to the role of cognition in creating and sustaining organizations, his focus is

on "interpretation" and "meaning creation" rather than on "computation" and

"information processing."

2.1.1-Power & Dependence for Rational/Open and Natural System

Dissatisfied with the rational system view of organizations as ruled by environmental

constraints and efficiency considerations, the power and dependence perspective, a

descendant of Karl Marx (1894), stresses the importance of varying interests and

goals and particularly the role of power in determining whose interests are most

likely to prevail. The focus is on how powerful groups manage to get their way using

force and persuasion to promote the practices and policies they favor. One stream,

the legacy of C. Wright Mills (1956) explores the structure and influence of the

"corporate elite." The main idea is that elite networks whose interests transcend those

of particular organizations develop strategies collectively, shaping organizations and

public policy (Useem, 1984). A second stream concerns the exercise of power within

and between organizations. Contemporary research in this stream has its origins in

political economy (Zald, 1970), exchange (Emerson, 1962; Thompson, 1967).

strategic contingency and resource dependence (Pfeffer and Salancik, 1978), and

network (Burt. 1980) theories of power and dependence. A power struggle among

competing management groups - marketing versus finance managers. for example -

may determine corporate response, and the group that wins control of the

organization may direct future decisions for some time to come (Fligstein, 1990).

Power struggles for control also go on between organizations.

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2.1.2-Summary of Theory of Organisation

The rise of open systems perspectives had several important side effects on

organization science. Key among these was the increasing clarity and explicitness

with which different levels of organization were recognized, conceptualized and

studied - from individual members, to face-to-face groups, to departments, to

organizations. to organizational populations and communities. These different levels

can be seen as forming an inclusive hierarchy with the levels nested one within the

other. Each "whole" is composed of parts at lower levels of organization, and are

themselves parts of more extensive wholes. Organizational communities, for

example, are composed of populations of organizations, themselves composed of

organizations, and so on. A multilevel approach is thus useful because organizational

systems are hierarchically arranged .

Although it is possible to identify a great number of organizational levels,

perspective is approached from three commonly studied levels of organization. The

levels are distinguished primarily by the phenomenon of interest to be explained

(Like the dependent variable). At the intra organization level, the focus is on

understanding the people. Groups, knowledge. tools and tasks that make up organiza-

tions. At the organizational level, the focus is on understanding organizational

processes, boundaries, activity-systems and strategies. At the inter organizational

level, the focus is on understanding the relationships and interactions within and

among aggregates of organizations.

As with their rational, natural and open systems predecessors, these current

perspectives are based partly on different disciplines (e.g., economics, sociology,

psychology, anthropology, and biology). They also reflect differences between

"subjectivists," who hold that knowledge is constitutively a social product, and

"objectivists," who see knowledge as being distinct from and independent of the

social realm. A majority of the perspectives. however, draw on multiple disciplines

and include both subjectivist and objectivist accounts. Selected perspectives include

some that are well established (e.g., economics, ecology, institutions, power and

88

dependence), some that are now expanding rapidly (e.g., cognition and interpretation.

networks, learning, technology), and some that are still emerging (e.g., complexity

and computation, evolution).( Figure 2.01)

Figure 2.01 Mapping contemporary perspectives on organizations: Rational, natural

and open systems

Source: Baum,A.C & Rowley,T.J(2002)

2.2- THEORY ON ECONOMIC OF VERTICAL COORDINATION

There are several areas of literature that provide the theory that is required to

understand the effect of governance structure on prices and costs. Literature from

several disciplines of economic theory is relevant to this thesis, including Transaction

Cost Economics, Agency Theory, Competency Theory and the Economics of

Information. The concepts from these areas of economic literature that are relevant to

the theoretical framework, theoretical model and methodology chapters of this thesis

are discussed in this chapter.

New institutional economics (NIE) is an economic perspective that attempts to

extend economics by focusing on the social and legal norms and rules that underlie

economic activity and with analysis beyond earlier institutional

economics and neoclassical economics. NIE has its roots in two articles by Ronald

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Coase, "The Nature of the Firm" . The Coase Theorem (subsequently so termed)

maintains that without transaction costs alternative property right assignments can

equivalently internalize conflicts and externalities. Therefore, comparative

institutional analysis arising from such assignments is required to make

recommendations about efficient internalization of externalities and institutional

design, including Law and Economics.

At present NIE analyses are built on a more complex set of methodological principles

and criteria. They work within a modified Neoclassical framework in considering

both efficiency and distribution issues, in contrast to "traditional," "old" or

"original" institutional economics, which is critical of mainstream neoclassical

economics.

The term 'new institutional economics' was coined by Oliver Williamson in 1975.

Among the many aspects in current NIE analyses are these: organizational

arrangements, property rights, transaction costs, credible commitments, modes

of governance, persuasive abilities, social norms, ideological values, decisive

perceptions, gained control, enforcement mechanism, asset specificity, human

assets, social capital, asymmetric information, strategic behavior, bounded

rationality, opportunism, adverse selection, moral hazard, contractual safeguards,

surrounding uncertainty, monitoring costs, incentives to collude, hierarchical

structures,bargaining strength, etc.

A. Transaction Cost Theory (TCT)

The genesis of TCE was provided by Coase (1937) in his seminal paper "The Nature

of the Firm." The central thesis of Coase's paper was that the fundamental purpose of

a firm is to organize transactions, and that firms and markets are the alternative

means of conducting transactions. Firms can choose to transact a good through the

market mechanism or internalize the transaction within the firm. Coase posited that

there is a cost to using the market mechanism for making vertical transactions

between firms in a supply chain. Moreover, Coase suggested that the number of

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successive stages of production that are contained within a firm was a decision

variable that depended on the relative costs of using the market versus internalizing

the transaction within the firm. A firm internalizes successive stages of production

within a firm until the marginal benefit of transacting through the market is greater

than the marginal benefit of internalizing the transaction. In this thesis, transactions

with different types of buyers differ in the successive stages of production that are

contained within the producer firm. Transactions with grain companies use the

market, while selling through a broker, POF or directly to processor internalize more

aspects of the transaction.

Williamson (1979) further developed Coase's concept and in doing so created

modem TCE theory. Williamson postulated that the "governance structures" that

determine the rules of transactions are not a given, but are decision variables that

are chosen by comparing their relative costs.

In his classic 1979 paper, Williamson states that alternative governance structures

(i.e.ways of organizing the procurement of inputs) arise due to the presence of

transaction costs. If transaction costs were negligible, then switching from one mode

of organizational structure to another is costless via costless contracting. But in

practice contracting is not costless and therefore transaction costs are non-negligible.

Williamson maps the main characteristics of transactions to their optimal governance

structures. According to one such mapping, each of the following increases the

likelihood of vertical integration: the presence of relationship specific investments, a

higher frequency and idiosyncrasy of transactions and the higher the degree of

uncertainty (Williamson, 1979).

Relationship specific investments and idiosyncratic transactions require some

explanation. Idiosyncratic transactions refer to the degree of complexity or

alternatively the degree of standardization of the product(s) involved in the

transaction – buying an ‘off the shelf product’ is the least idiosyncratic form of

transaction. Relationship specific investments are those which have a lower return (at

the extreme no return) in alternative uses (i.e. outside the relation). Such investments

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create quasi-rents, which are the difference between the returns to the investment

inside and outside the relationship. The existence of quasi rents creates a lock-in

between the parties involved in that relationship ex post (i.e. after the investment is

sunk). Because of lock in there is a potential for holdup, allowing the party that has

not made the investment to extract better terms (quasi rents).

When both parties have made relation-specific investments then both possess the

threat of withdrawing, leaving the other party held up with his/her specific

investment or reliance (referred to as the threat point). Taking advantage of this

situation, both parties will attempt to appropriate as much as they can from the

existing quasi-rents whenever they have a chance to do so. Williamson has specified

five sources of holdup: asset specificity, site specificity, human asset specificity,

dedicated assets and brand name capital (Williamson, 1985; 1991). But with

Williamson’s assumption of bounded rationality, negotiated long term contracts to

obtain this are incomplete.

Williamson's work also described the basic behavioural assumptions of TCE and the

fundamental properties of transactions. The first main assumption of TCE is that

parties in a transaction exhibit bounded rationality. In general, bounded rationality

implies that individuals attempt to act rationally, but are unable to do so because they

do not have complete information. The assumption of bounded rationality means that

parties in a transaction will agree to a contract that is in their best interests, but they

do not have perfect information regarding the other party or what transpires in the

future with respect to the contract.

The second assumption of TCE is that parties in a transaction may act

opportunistically, which is defined by Williamson as "self-interest seeking with

guile" . The opportunism assumption means that a party to a transaction may act in a

way that exploits the other party to their own advantage. Combining the behaviours

of bounded rationality and opportunism, parties to a transaction will not willfully

enter into a contract where their partner exploits them, but they may enter into a

situation where they are exploited because they have no means of predicting future

exploitation at the time that the contract is made. The theoretical framework of this

thesis uses the behavioural assumptions of bounded rationality and opportunism.

Williamson proposed that transactions can be characterized by their endowments of

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uncertainty, asset specificity and frequency. The degree of uncertainty in transactions

is the party's perception of the likeliness that a transaction will occur as expected, for

example, in terms of price, time of payment, quality and quantity. The degree of

asset specificity in transactions is determined by the degree to which one party has

invested resources specific to the transaction that have little or no value in an

alternative use. Williamson dubbed the term "fundamental transformation" as the

change that occurs after specific assets become part of a contract and are then

vulnerable to appropriation due to the bilateral trading relationship that is created.

The presence of uncertainty and asset specificity may result in opportunistic

behaviour. Parties are driven to reduce the risk of being exploited by incurring

transaction costs. Increasing frequency of transactions results in less risk of

opportunistic behaviour because individuals learn to avoid exploitative situations and

reputation effects reduce the payoff from opportunism. Frequent transactions with

the same party involve relational contracting. That is, both parties have a mutual

interest in maintaining the relationship and it is in both parties' interests to not exploit

the other.

Literature on the relevance of transaction cost concepts to contemporary supply chain

management is found in Hobbs (1995). Hobbs explains the conceptual relevance of

TCE in contemporary supply chain issues, and discusses the types of costs that arise

in transactions. Transactions costs can be divided into information (or search) costs,

negotiation costs and monitoring (or enforcement) costs. Information costs include

searching for information about products, prices, inputs and the characteristics of

buyers or sellers. Negotiation costs include the effort required in specifying the terms

of the contract. Monitoring and enforcement costs arise after an exchange has been

negotiated, and involve monitoring the behaviour of the transaction partner and

enforcing the pre agreed terms of the contract. Hobbs (1995) also discusses

methodological issues regarding the testing of hypotheses using TCE theory.

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B. Resource Dependency Theory

A few years after the sociologist had begun to develop theories for the social

exchange among individuals scholars in organizational theory began to consider the

relationship between the organization and the external environment as an important

aspect of organizational theory. Organizations were interpreted as open-system

structures which are matched with their environments by technical and exchange

interdependencies. This logic suggested that organizations that incorporate structural

elements isomorphic with the environment will be better able to manage

interdependencies. The same arguments also helped to explain the similarity of

structure observed in organizations operating in the same environment (Thompson,

1967). The important contribution of the open-systems perspective was to highlight

the necessity for organizations to manage their relationships with the external

environment. Building on Thompson's work, Pfeffer and Salancik (1978)

concentrated on power structures and external exchange relationships as main

themes that lead to the development of the resource dependence perspective.

Resource dependence theory (Pfeffer and Salancik, 1978) marked a watershed in

organizational research by positioning power at the core of organizational discourse.

Although the notion of power featured in different forms and with varying emphasis

in early organizational sociology (Barnard, 1938; Weber, 1922; Thompson, 1967),

resource dependence theory was instrumental to focusing scholars on the power to

control resource allocation as the key to organizational survival. The theory’s central

proposition is that organizations will try to manage their resource dependencies with

a variety of tactics, such as the cooptation (Selznick, 1949) of sources of constraint,

in order to achieve greater autonomy and thus reduce uncertainty in the flow of

needed resources from the environment (Pfeffer and Salancik, 1978).

Resource dependence theory advances two basic propositions: (l) organizations are

primary social actors and (2) inter-organizational relations can be understood as a

product of inter-organizational dependence and constraint. In contrast to previous

organizational research that had emphasized the role of individual decision-making

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based on rational-choice models, the resource dependence position views the

behavior of firms to be largely independent of the individuals running the firm. As a

consequence, the fundamental unit for analyzing inter-organizational relations must

be the organization and not the individual. In a society of organizations the internal

structures of control and power (e.g. dominant coalitions) are a result and not the

cause of the pattern of external exchanges. Resource dependence theory posits that

an organization's survival depends in large part on its capability to secure critical

resources from the external environment.

Organizations are constraint within a network of dependencies and do not control all

the conditions necessary to achieve a desired outcome. The resulting dependence on

external entities introduces uncertainty which in tum puts future success and

survival at risk. In order to ensure success and survival, organizations therefore need

to manage external inter-dependencies. Organizations can achieve this objective in a

variety of ways. Depending on the form and the level of uncertainty, organizational

responses to enhance the chances of success include internal and external

organizational buffering. Internal buffering can be achieved through improved

forecasting and preventive stock piling. External buffering tactics include

cooptation, alliances, and mergers. In sum, resource dependence theory suggests

that pattern of inter-organizational dependency produces power structures which in

tum determine organizational behavior (Pfeffer & Salancik, 1978).

The basic argument of resource dependence theory can be summarized as follows:

a) Organizations depend on resources.

b) These resources ultimately originate from an organization's environment.

c) The environment, to a considerable extent, contains other organizations.

d) The resources one organization needs are thus often in the hand of other

organizations.

e) Resources are a basis of power.

f) Legally independent organizations can therefore depend on each other.

g) Power and resource dependence are directly linked:

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Organization A's power over organization B is equal to organization B's

dependence on organization A's resources.Power is thus relational, situational and

potentially mutual.

Organizations depend on multidimensional resources: labor, capital, raw material,

etc. Organizations may not be able to come out with countervailing initiatives for all

these multiple resources. Hence organization should move through the principle of

criticality and principle of scarcity. Critical resources are those the organization must

have to function. For example, a burger outlet can't function without bread. An

organization may adopt various countervailing strategies—it may associate with

more suppliers, or integrate vertically or horizontally.

Resource dependence concerns more than the external organizations that provide,

distribute, finance, and compete with a firm. Although executive decisions have more

individual weight than non-executive decisions, in aggregate the latter have greater

organizational impact. Managers throughout the organization understand their

success is tied to customer demand. Managers' careers thrive when customer demand

expands. Thus customers are the ultimate resource on which companies depend.

Although this seems obvious in terms of revenue, it is actually organizational

incentives that make management see customers as a resource.

Recently, resource dependence theory has been under scrutiny in several review and

meta-analytic studies. Which all indicate and discuss the importance of this theory in

explaining the actions of organizations, by forming interlocks, alliances, joint

ventures, and mergers and acquisitions, in striving to overcome dependencies and

improve an organizational autonomy and legitimacy. While resource dependence

theory is one of many theories of organizational studies that characterize

organizational behavior, it is not a theory that explains an organization's performance

per se. But still in many ways, resource dependence theory predictions are similar to

those of transaction cost economics, but it also shares some aspects with institutional

theory. Institutional theory is "A widely accepted theoretical posture that emphasizes

rational myths, isomorphism, and legitimacy. There are two dominant trends in

institutional theory:

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Old Institutionalism sometimes associated with Historical institutionalism

New institutionalism

Although no single, universally accepted set of definitions has been developed, most

scholars doing research under the NIE methodological principles and criteria

follow Douglass North's demarcation between institutions and organizations.

Institutions are the "rules of the game", consisting of both the formal legal rules and

the informal social norms that govern individual behavior and structure social

interactions (institutional frameworks).Organizations, by contrast, are those groups of

people and the governance arrangements they create to coordinate their team action

against other teams performing also as organizations. Firms, Universities, clubs,

medical associations, unions etc. are some examples.

C. Modern Property Rights Theory (PRT)

Property rights theory (PRT) in its modern form was initiated by the work of

Grossman and Hart (1986); and Hart and Moore (1990) (hence GHM). Whilst

transaction cost theories have gained widespread empirical support, there has been

little empirical work on the PRT. They blames the lack of formal testing of the

property rights approach on the limitation of the data relevant to GHM. When the

owner of the firm and its only manager are the same person then PRT is similar to

Standard TCT. GHM predict that in an environment of ex ante incontractability, the

greater the specificity of investments the greater the chance for opportunistic

behavior and hold up problems, and so the more likely it is to observe vertical

integration as a way to overcome such problems , which is the same conclusion as

given by TCT.

But PRT and the standard TCT may yield opposite results if the firm is not a simple

owner-managed entity. In that case, the actual property rights arrangement in place

plays a central role in shaping outcomes. For instance, hired managers of certain

units within a firm may seek their own personal objectives (e.g. personal profits) at

the expense of stockholders’ (joint profit maximization). Thus, the separation of

ownership from control becomes an issue. Take the case of an integrated firm that

operates its subunits in the same way as before integration to avoid centralization of

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management. These sub-unit managers may have “residual control rights” over the

assets of the sub-units. Thus, a problem may arise that the managers of the sub-units

behave in ways that are not in the interest of the integrated firm .

As an example, imagine a buyer who is subject to a hold up problem created by a

specific investment, which lowers his bargaining position in the relationship.

Suppose he integrates backwards with his/her basic input provider. Hence, the buyer

(now the manager-owner) owns the assets of both firms and so has residual control

rights over them, i.e. can decide who can work with and what should be done with

these assets. Integration alleviates the buyer’s (manager-owner’s) hold up problem.

But it creates a corresponding hold up risk for the employees in the supplier sub-unit.

The managers in this sub-unit –given this ownership structure- now face the risk of

being fired (i.e. being separated from the assets), and so do not have the same

incentive to undertake quality enhancing investments which they may have been

doing prior to integration. Such a situation creates an efficiency loss. This fact is

precisely what motivates the importance of asset ownership in their theory,

illustrating that the manner by which property rights in the firm are allocated (i.e.

how contracts are written) will affect the nature of the firm’s objective (function)

making it of one form or another. Thus, according to GHM, investment incentives

should be granted depending on the relative importance of the impact of each

manager’s investment decisions and on the relative specificity of the investment to

the relationship. Greater incentives should go to the manager with the highest relative

importance. In case of non-contractible investments, this cannot be achieved through

a contract but only through asset ownership.

Ownership of assets matters to the extent that it influences residual control rights

(revenue based control), which in turn has an effect on the bargaining positions of the

contracting parties once they are locked into the relationship. Bargaining power in

turn affects both ex ante investment decisions (initial, i.e. before uncertainty of

contracting environment is resolved) and each party’s relative surplus. Whilst PRT

resembles Williamson’s setting by assuming ex ante incontractability, asset

specificity and uncertainty, it makes a crucial assumption to derive the above result.

That is, PRT makes ex post (after the uncertainty of the environment has been

resolved) negotiation costless. This kind of bargaining is very costly in Williamson’s

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framework. His argument is that if the parties cannot, due to costly haggling, contract

or agree on adaptations before the resolution of uncertainty why would they suddenly

become able to? For that reason, Williamson describes GHM’s setup as one of

selective bounded rationality (Williamson, 2000).

Once again, the fundamental difference between PRT and Williamson is that

ownership under GHM does not necessarily imply control. In other words in some

cases there exist separation of ownership from control.Accordingly, there need not

necessarily exist a unified payoff function for the managers involved. The formal

implication for this is that each manager has his/her separate payoff function on

which s/he bases his/her ex ante investment decisions. Williamson, however views

unified ownership as the norm as well as the means by which to effect cooperation.

He states, “via integration a single ownership entity spans both sides of the

transaction, and a presumption of joint profit maximization is warranted”

(Williamson, 1979).

The heart of both TCT and PRT lies in the presence of specific investment(s) in a

buyer-seller relationship. Montverde and Teece (1982) examined human asset

specificity in the context of internal production of a certain automobile part versus

contracting out. The cost of developing the automobile component was used as a

measure of engineering effort required to design that automobile part which in turn

infers the degree of human asset specificity related to it. This measure was obtained

with the help of an automobile design engineer who rated the engineering investment

required for each component on a 10-point scale from “none” to “a lot”. They also

used a dummy variable to determine whether a component is “specific” to a single

assembler or not, which infers the degree of switching costs related with each

component and so the degree of potential opportunistic behavior and loss of

transaction-specific know how in case of cutting the relationship with the assembler.

Tackling the same question some literature uses two measures of relationship specific

investments for an aerospace firm: design specificity and site specificity. The firm’s

procurement team gave their rankings of the various components with respect to their

“specificity” and “complexity”. Design specificity was measured by questionnaire

responses as to whether the components were “specific, “somewhat specific,” or

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standard vis à vis the whole system. Site specificity was measured by location. And

finally, measures of the degree of component complexity were designed to capture

the costs of writing complete contracts.

With respect to uncertainty as stressed in TCT’s setting Anderson and Schmittlein

(1984) conducted a study on integration of personal selling. It is an analysis of

determinants of using manufacturer representatives (the market) versus direct sale

people, which are employees of one manufacturer (integrated governance). In

addition to controlling for human asset specificity, the authors distinguished two

types of uncertainty Williamson has referred to in his work. First, the one described

in his 1979 paper as one form of environmental uncertainty, which is that of

environmental unpredictability. Second, they mention that in his later writings

Williamson recognizes a second form of uncertainty, that is “internal” uncertainty,

which is related to monitoring costs associated with group production, multitasking

and with agency problems in general.

Based on that, they have adopted two different measures for uncertainty. For the

former type of uncertainty, they used the expected deviation between forecast and

actual sales in the next year, expressed as a percentage (plus or minus). For the latter

type, they used a semantic differential in response to the question “It is very difficult

to equitably measure the results of individual sales people”.

As for the results, Montverde and Teece (1982) and Anderson and Schmittlein(1984)

all have provided support for the hypothesis that variations in relationship specific

investment (i.e. asset specificity of various forms) increases the likelihood of vertical

integration. Thus, they all provide support for TCT. Gordon Hanson (1995) examines

PRT theory by analyzing the choice of ownership structure (subcontracting versus

internal production) using data on Mexican apparel subcontracting. He assumes that

the intensity of investments in design and distribution varies with the level of product

standardization. Standardized products in this context are those whose designs

changes relatively little as product styles change. He therefore describes stockings,

underwear, shirts, and uniforms as standardized products. Relying on the Mexican

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Census’s classification of women’s and men’s outerwear into “batch made” items,

which are made for the general public, and “tailor-made” items, which are made for

specific clients he adds batch-produced outerwear to his list of standardized products.

He accordingly defines a dummy variable that indicates whether the product is

standardized or not.

D.DESIRE TO AVOID RISK

i) Risk Adjusted PRT

Hanson (1995) develops a version of the GHM model that incorporates risk. Whilst

integrating backwards will alleviate hold up problems and opportunistic behavior by

the seller, it will create at the same time what Hanson calls a higher degree of

exposure to “natural risk” to the buyer, which is risk arising from variance in the

state of the nature. Were the buyer to be facing uncertainty in the production

environment (e.g. sales uncertainty), s/he would want to spread that risk (via asset

ownership spreading, i.e. independent ownership). This is especially so in an

environment where risk spreading channels (e.g. equity markets, stock markets,

insurance markets) are imperfect or absent. There is thus a trade off between hold up

and natural risk considerations and consequently between integration (joint asset

ownership) and independent ownership (Hanson, 1995).Thus, while GHM’s model

determines the optimal form of integration and asset ownership by balancing the

positive and negative effects of integration, Hanson adds the higher degree of

exposure to natural risk - which integration subjects the buyer to - to the list of

negative integration effects.

ii) Demand Variability Theories

Demand variability incentives to vertical integration were stressed in earlier theories,

e.g. Carlton (1979) & Chandler (1977).Carlton stresses that firms integrate to

minimize costs that are due to demand fluctuations. In order to avoid premium

payments for inputs induced by other buyers’ fluctuating demand, firms with more

stable input demand will integrate backwards (Carlton, 1979). Firm risk aversion as

implying that a firm is less likely to integrate (backwards) if there exist demand

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fluctuations in the input (upstream) market that are correlated with fluctuations in

that firm’s downstream market. Volatility in the downstream industry environment

(e.g. downstream demand) may reduce (backward) integration incentives.Thus,

whereas Williamson (TCT) predicts that uncertainty of environment increases the

likelihood of vertical integration some researcher predicts the opposite. Both demand

variability and natural risk make firms prefer to rely on the market, rather than

integrate, because of its risk pooling benefits. Examples of some empirical tests

follow.

Hanson (1995) in his research on apparel asserts that, in Mexico, the main risk

manufacturers face is frequent changes of product styles. Because the value of

investments to create a product line depends on how long the line remains popular

among consumers, he states that: “the level of risk depends on the product life cycle,

which varies across market segments” (Hanson, 1995). Accordingly, he measures the

degree of uncertainty with two dummy variables. Risk takes the higher value of 1 if

the product is a women’s outerwear item, as women’s fashions are subject to more

frequent changes than are unisex, men’s or children’s. This is so because outerwear is

more visible.

In addition to supporting TCT - as pointed out in the previous section , Hanson’s

(1995) results also support his natural risk model: the frequency with which fashion

changes increases subcontracting levels (i.e. market governance) through increasing

the degree of uncertainty.

E. Adjustment Cost Theory

Wernerfelt (1997) distinguishes between three different game forms or governance

structures of a buyer-seller relationship: the hierarchy (i.e. the firm), the price list and

negotiation as needed. Depending on communication costs, the author sets conditions

for the efficiency of each governance structure. When many possible adjustments are

needed frequently, the author predicts a case for the firm. The price list game form is

used when a sufficiently short price list can be constructed ex ante. And finally,

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negotiation as needed will be observed when possible adjustments are many but take

place rarely. The author takes this to be an adjustment cost theory in the sense that

the choice of optimal governance structure is linked to costs associated with

adjustments. The higher adjustment costs are the higher the likelihood for integration.

Birger Wernerfelt (1997) tested his theory by focusing on sales force organization.

He contrasts the lower negotiation costs incurred for employees paid a flat wage

(integration) versus an independent sales force (the market), who ask for higher

commission every time they are asked to adjust their selling effort.Wernerfelt (1997)

mailed a five-question questionnaire to 204 firm managers of Steam, Gas, Hydraulic

Turbines and Turbine Generator Set Units industries and of Electrical Machinery,

Equipment and Supplies industries. Only 51 firms responded. To get a variable that

reveals the frequency of adjustments he asked the question “we very often send

instructions to the sales force”. To measure the importance of diverse adjustments he

asked “non-selling tasks are a major component of sales force responsibility”. The

answers were given on a seven-point scale from “strongly disagree”, through

“neutral,” to “strongly agree.” He concluded that vertical integration or the hierarchy

is more likely to be used when diverse adaptations are required, thus, supporting his

theory.

F. Agency Theory and Vertical Integration

Agency Theory can be defined as the economic analysis of cooperation in situations

where externalities, uncertainty, limited observability, or asymmetric information

exclude the pure market organization.’ The problem of information asymmetry

occurs because the agent often knows more about their own activities than the

principal. The goal of the principal is to gain information or develop a system of

incentives to ensure that the agent's actions are in the principal's interests.

Agency theory complements the transaction cost approach to the theoretical

framework. It provides explanations of inefficiencies stemming from incentive

problems when using more coordinated contracting and vertical integration.

Contracting efficiencies exist for producer-oriented firms (POFs) compared to

investor-owned firms (lOFs) because the principal-agent relationship entails less

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incentive to withhold information and more trust when producers contract with a

firm that they own and control.

Williamson (1975) states that the advantages of a vertically integrated firm can be

divided into three components: incentives, controls, and "inherent strategic

advantages." Incentive advantages include the ability of a vertically integrated firm

to internalize and eliminate opportunism that may otherwise occur in market

transactions. The firm can provide strong incentives for all parts of the firm to work

as an agent to the owner/principal. Control advantages of vertical integration include

the ability to perform more precise own-performance evaluations and control

rewards and penalties within the organization. Other potential control benefits of

vertical integration include easier conflict resolution, resulting in lower negotiation

and enforcement costs for both parties and economies of market information

exchange. An inherent strategic advantage of vertical integration between the

production and marketing stages is that economies of information exchange can

occur. Quality, price, and quantity information is allowed to flow more freely within

the firm than between transaction partners.

G. Prediction of Organizational Choice

Mahoney (1992) adds to the literature on the choice of organization by providing a

thorough literature review of the reasons for and against vertical integration, as well

as providing a framework for predicting organizational form. Mahoney states that the

choice of organizational form may be determined from asset specificity and

measurement uncertainty. The resulting framework applies insights from two

theoretical perspectives - TCE and agency theory - and offers an integrative

organizational efficiency approach to the prediction of governance structure choice.

Measurement uncertainty consists of the uncertainty of observing output as a means

to reward an agent's performance (the degree of "nonseparability") and the

uncertainty of observing input as a means to reward an agent's performance (the

degree of "task programmability") .

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Mahoney's framework for predicting governance structure choice can be summarized

in eight different circumstances, which are shown in Table 2.1. When the output of

the agent is easily measured (low non separability) and asset specificity is low (cases

1 and 5), the ease of input measurement (task programmability) is not important, and

in either case the spot market should be chosen. Any sort of vertical coordination is

not likely to be useful in both two cases as it provide no benefit to the spot

transation.

Table 2.1- Governance structure choice

Definitions:

Low task programmability: Observing input ( effort) is a poor measure for making

rewards.

High nonseparability: Observing output is a poor measure for making rewards.

High specificity: Human, physical and/or site firm-specific investments are high.

Spot market: The price system works smoothly.

Long-term contract: Obligations of principals and agents are specified and enforced

by thirdparties (courts).

Relational contract: Obligations of principals and agents are specified and self-

enforced. Social conditioning is applicable.

Inside contract: A hybrid arrangement between contract and hierarchy that is best

described as a 'manager as monitor' setup.

Joint ventures: An equity agreement whereby a separate entity is created.

Hierarchy: A superior-subordinate relationship; financial ownership (vertical

integration). Clan: Organization that is based on a vital sense of human solidarity.

Source: Mahoney (1992).

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H. Competency Theory

Competency theory also complements the transaction cost approach, as it can explain

vertical coordination inefficiencies that exhibit themselves through production costs.

The idea of competence theory, as described by Hodgson (1998), is that on the

margins of a firm's increasing scope, firms may not be as competent, and therefore,

may not be as cost efficient as a firm that specializes in that given task.

I. ECONOMICS OF INFORMATION

Stigler (1961) explains the effect of price information search costs on the frequency

dispersion of asking prices in a market. Stigler's analysis relaxes the assumption of

neoclassical economics that all individuals have perfect information, and claims that

the bidding price dispersion is a function of the amount of "ignorance" in the market

regarding the amount of search required. The amount of search is a negative function

of the cost per unit of search, and a positive function of the percentage of the seller's

expected revenue and the percentage of experienced producers in the market. The

variance of supply and demand in the organic wheat market can affect the size of the

price dispersion, with greater variance leading to greater price dispersion. According

to Stigler (1961), greater "geographical size", which can be interpreted in the case of

organic wheat as the difficulty of searching, can also lead to greater price dispersion,

and can potentially affect the cost of search.

J. TEAM AGENCY

In a principal-agent framework an agent’s private action affects the principal’s payoff

probability distribution through its effect on output.In such a setting of asymmetric

information shirking and so moral hazard,become viable threats. Neo-classical

agency theory has assumed that output is perfectly observable and so incentive

contracts will solve this problem. The size of the firm - through which these contracts

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are created – is taken as given. Team agency can be used to gain more insights into

the determinants of integration.

Team agency is summarized by a setting in which 1) several types of resources are

used, 2) production accrues through a team production technology,17 3) resources do

not belong to a single principal, and 4) marginal product of any one resource (i.e.

team member) is not costlessly observable. It is straight forward how this setting

gives rise to moral hazard and shirking of team members. The authors suggest that a

contractual structure, that is the firm, permits the appointing of a monitor who 1) is

specialized in monitoring (i.e. observes resource or input behavior), 2) is made

residual claimant, 3) is the central party common to all contracts with resources (i.e.

fires, hires and revises contracts of any member of the team). The residual claimant is

seen to be the owner of the firm whose existence enhances detection (i.e. reduces

costs of detection) of shirking among team production members and makes the

discipline provided through contract revision ability more economic. Thus, ceteris

paribus the boundaries of the firm are drawn by the extent to which the cost of

detection is smaller or equal than the residual claim the monitor is entitled to.

2.2.1 Concluding Note for Economic Theories

This chapter has reviewed the various theories of vertical integration and the

variables required to test these theories. Some theories, which appear to have limited

applicability to the Egyptian garment sector, are not discussed. Each theory focuses

on a different aspect that may explain vertical integration. These aspects fall under

the following headings: relationship specific investment (asset specificity), risk

aversion, agency issues, adjustment costs and upstream market concentration. All but

the desire to avoid risk and agency issues are meant to increase the likelihood for

vertical integration. The empirical review concludes - as have other reviews - that,

whilst transaction cost theory on vertical integration, in particular relationship

specific investment, has gained vast empirical support, there is limited evidence in

support of other theories simply because they have rarely been tested.

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2.3-MODELS BASED ON ECONOMIC THEORIES

RESOURCE BASED SCHOOL

This approach is widely adopted by managers developing their business strategies for

competitive advantage, and by academics and consultants attempting to raise

corporate competence in business strategy. This approach also tends to be one

dimensional. This is because it focuses primarily on what suppliers should do to

achieve sustainable competitive advantage, without necessarily thinking through the

likely responses of buyers or customers in any relationship. Furthermore the

approach tends to be prescriptive in that it argues that suppliers have only one

strategy choice and that is to pursue ‘isolating mechanisms’ that close markets to

their competitors so that they can leverage value from buyers.

There is a wide literature in the RB school, and it currently dominates strategic

management thinking academically, but perhaps the most fundamental argument of

the RB school is that a supplier can only achieve rents (above normal returns) in a

business relationship with a customer if it is able to close markets to competitors

through the development of isolating mechanisms. The key isolating mechanisms

that companies can seek to develop include:

a) _ property rights

b) _ economies of scale

c) _ information impactedness

d) _ causal ambiguity

e) _ reputation effects

f) _ buyer switching costs

g) _ buyer search costs

h) _ communication good effects

i) _ collusive effects

Perhaps the most important contribution of the RBM approach has been its

development of a comprehensive specification of relationship management choices

available for a supplier when interacting with a buyer. The approach is derived from

work in political economy and marketing channel management, in which issues such

as control, conflict and power are perceived to be of major significance for the choice

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of relationship management style by suppliers (Zald, 1970, Frazier, 1983 & Gaski,

1986).

Figure 2.02 : Four types of relationship are defined in the RPM approach. These are

defined as follows:

Source: Krapfel et. Al (1991)

1 Partner – a relationship with high interest communality and high relationship value,

with equitable sharing of profits.

2 Friend – a relationship with high interest communality but low relationship value,

with monitoring of future potential opportunities.

3 Rival – a relationship with low interest communality and high relationship value,

with attempts to find alternative partners.

4 Acquaintance – a relationship with low interest communality but low relationship

value, with only standard offerings provided.

The RPM approach further develops this segmentation by demonstrating the

relationship management modes that may be used in any transaction in relation to the

perceived power balance and the level of interest communality between the two

parties. The six types are defined as follows:

1 Collaboration – a transparent and trusting relationship mode, with extensive

information sharing in balanced power situations, with high interest communality.

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2 Negotiation – an arm’s-length relationship mode, with limited information sharing,

a balanced power situation, with low interest communality.

3 Administration – a uni-directional relationship mode, with the supplier directing

information flow but offering promises to the buyer.

4 Domination – a uni-directional relationship mode, with the supplier directing

information flow and threats rather than promises to the buyer.

5 Accommodation – a cooperative relationship mode in which the supplier provides

non-sensitive information to the buyer.

6 Submission – a non-cooperative, but submissive relationship management mode in

which the supplier provides information reluctantly to the buyer.

The IMP Group is a broad church and has developed its detailed insights into buyer

and supplier relationships over twenty years. The major benefit of the IMP approach

has been its unequivocal focus on the need to understand the complex

interrelationships between the buyer and the supplier from the perspective of both

parties when they interact. Thus the IMP approach has provided an extremely

comprehensive descriptive account of the nature of business relationships. This is

outlined in Figure 2.2

Figure 2.03-IMP Interaction Model

Source:IMP(1982)

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Figure 2.3 provides a way of thinking about the theoretical and practical basis for

business relationships. As the figure demonstrates, business relationships can be

understood operationally and they can be understood commercially. The key point

being made here is that, although both of these aspects are important, the ultimate

purpose of a business relationship is always fundamentally about commercial rather

than operational outcomes. In other words, success or failure in business

relationships must be understood primarily in commercial rather than operational

terms. It follows, however, that in some business relationships (in theory at least)

both parties will achieve their commercial goals (transactional harmony) and in other

transactions one party may be more satisfied than the other with the commercial

outcome (transactional tension). If both parties are dissatisfied with the commercial

outcome then a state of transactional conflict will exist. This raises the possibility

that conflict and tension is inevitable in business relationships, and that transactional

harmony may be the exception rather than the rule. What this means is that many

relationships occur even though the commercial goals of one or both of the parties

involved are not being completely achieved.

It is our view that this is likely to be the rule in business relationship management

and that transactional harmony may be difficult to sustain in many circumstances in

the real world.

Only the IMP, RPM and Power approaches, it has been argued, take a sufficiently

holistic approach to analysing the objective circumstances and the full range of

relationship management choices available for buyers and suppliers.

Given this, it is clear that it is through a combination of the Power

Perspectives specification of the key variables that impact on managerial choice, and

the IMP and RPM specifications of relationship management choices, that an

inclusive approach to relationship alignment for buyers and suppliers can be

achieved.

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Figure:2.04-Power Relations Buyer and Supplier

Source:Cox.A. et al.(2002)

INTERORGANISATIONAL SYSTEM AND BUYER SUPPLIER

RELATIONSHIP

The global economy is reshaping the supply chain and introduces new challenges in

logistics, asset protection, demand forecasting, and supply chain inventory visibility.

IOS technology has emerged as a key tool to help provide a superior level of

intelligence for managing the flow of items throughout the supply chain. Involved

players must band together to provide scalable systems that enable fashion apparel to

capture the true value of the technology and easily transition from pilot testing to

full-scale deployment. The desire to make a shared IOS in supply chain project a

reality clearly necessitates a deep desire for cooperation, commitment & trust from

all members of the supply chain. Power imbalance and interdependency should be

carefully taken care of for harmonal relationship and to reduce conflict.

Interorganisational System(IOS) deployment in Technological Context,

Organisataional context and Environmental context should be taken care

of(Maheshwari et.al.,2013).

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SUMMARY

2.3.1 Power Imbalance and Mutual Resource Dependence

Recent work has significantly advanced the original resource dependence model

proposed by Pfeffer and Salancik (1978). This effort exemplifies a trend in

organizational research to shift from an actor-centric to a relation centric

examination of power and dependence in economic exchange.

Casciaro and Piscorski(2005) responded to inconsistencies in the original

formulation of resource dependence theory that emerged from the tension between

the relational character of power and the dominantly actor-focused theoretical

predictions or practical recommendations. The main tenant of resource dependence

theory is that organizations that are constraint by a high level of dependency on a

particular partner should restructure their dependencies to reduce uncertainty. One of

the techniques to that end is to merge with or acquire the source of dependence. This

suggests that a resource dependent organization should seek to obtain control rights

over the critical resource from a more powerful exchange partner. Yet, the exclusive

focus on the dependent organization is problematic, since the more powerful partner

usually has incentives to the contrary. It is plausible that the more powerful partner

would like to protect the status quo in order to support the negotiation of favorable

exchange conditions. Together, this shows that at the same time as traditional actor-

centric perspectives of resource dependence logic concentrate on a focal

organization's motives to manage dependence in an exchange they fail to consider

the exchange partners' reciprocal dependence and thus ignore a central determinant

of the focal firm's ability to realize a constraint absorption strategy.

Given the expected resistance of power-advantaged partners to agree to giving up

control over an exchange relationship, it is somewhat counter-intuitive that empirical

work has been able to find support for a positive relationship between an

organization's dependency and its' propensity to absorb the source of the dependence

by acquisition or merger. In view of these puzzling empirical findings, (Casciaro and

Piscorski, 2005) conclude the concept of interdependence that underlies the original

formulation of resource dependence theory to be deficient. In their view it blurs the

related yet different effects of two separate constructs: power imbalance and mutual

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dependence.

Power imbalance describes the "difference in the power of each actor over the other"

(Casciaro and Piscorski, 2005). Power imbalance can be expressed as the difference

between or as a ratio of actor dependence. Contrary to the findings of earlier work,

Casciaro and Piscorski (2005) find power imbalance to be negatively related to the

rate of constraint absorption by the dependent organization. This result suggests that

a heightened motivation on part of the dependent organization to restructure its

dependence .

First, a robust conceptualization of dependence and power in exchange relations

must be based on following principles: (1) an imbalance in power potential derives

from an asymmetric dependence structure induced (a) by the magnitude of resources

exchanged (dyadic) and (b) by the partners' position in the exchange network (e.g.

availability of substitutes), (2) power potential and power use are properties of a

social relation, and (3) power and dependence structures are important determinants

of partner behavior in exchange relationships. Second, the use of power may be

constrained by partner interdependence, norms of equity, and relational commitment

dampening the effects of power potential asymmetry on exchange relationships.

Finally, a meaningful examination of the stability of inter-organizational exchanges

requires a theoretical lens that allows for integration of relational and structural

levels analysis since power and dependence in exchange result from both dyadic and

network processes.