Professeur Visitant, CERAM Sophia Antipolis, European School of Business
Post-Doc Researcher, Hanken, Swedish School of Economics and Business Administration
Trust has over the past decades become an increasingly central concept in the field of management research. The notion of trust –although perhaps more implicitly- is also equally central to executives in everyday business life. As companies are increasingly basing their strategies on different kinds of cooperation with partners, a central question is how to create and manage this cooperation as efficiently as possible. While detailed contracts are widely used to frame such arrangements, studies have shown they can in fact do more damage than good. On the other hand, simply trusting the other part of the cooperation –as many academics seem to suggest- may be as harmful. The key question is hence how to develop a central, but seemingly simple and vague, concept like trust into a relevant and useful tool for enabling companies to more efficiently achieving their strategic objectives.
This article is based on in-depth interviews with 24 North European ICT (Information and Communication Technology) executives. It suggests some practical aids for operationalizing trust in forms of analytic and pragmatic formulas.
The pressure to pursue cooperative strategies
Several studies have shown that many industries are changing at an increasing pace (Eisenhardt and Brown 1998). Typical for this type of high velocity environments is that there is an increasing pressure on management to make important decisions efficiently and implement these decision in a rapid manner. In such an environment, any activity that slows down the process of strategy implementation without adding value can have serious consequences on the company’s performance.
One of the strategic options in order to survive in a high velocity environment is to cooperate actively with other companies, i.e. to create alliances. A volatile, fast moving business environment is further not the only business driver towards this direction. It has been argued (Culpan 2002 and Das and Teng 2000) that globalization, technological advances and the resulting awareness of global consumers leads to a competitive pressure that no company can handle alone. Again, the key to tackling all of these challenges is to realize the limitation of the own company and look for partners, with whom the company can jointly create competitive offerings that have a chance of being attractive on the global market.
Basing a company’s strategy on cooperation is not, however, an unique approach that automatically increases competitiveness. Instead, mastering the implementation of this approach becomes a key differentiator between successful and unsuccessful companies. Here time is of essence. Studies have shown that it can easily up to nine to twelve months to create an alliance. It is easy to understand that a company that is able to half this time has a huge advantage over its rivals.
The difference between bulk and specialty
During an interview made for this study, a senior executive of a global ICT company asked me if I knew the difference between specialty and bulk chemicals (he had a history working for a chemical company). As I answered that I did not, he said “six months”.
This quote illustrates quite well how many industries work today. The difference between launching a cutting-edge product and launching a mass product can be as little as a few months. Surely, in this type of environment (and if this is the case in the chemical industry, it is bound to be true also in other industries) it cannot be acceptable to use up to a full year to start the cooperation with another company. A question, which arises is why it takes so long to create an alliance with another company? The interviewees were almost unanimous in their response: “because of contracting”.
Most of the interviewees then told stories about initiatives for cooperation which had been identified, and where the two parties had quite quickly worked out the basic logic of the alliances. Following this, however, the alliance creation processes had increasingly become a matter of the alliance contract and a matter of specifying all kinds of events (related to e.g. ownerships changes, insolvency, breach of confidentiality etc) and what would happen in case of these events. When further asked what the reason was for such rigorous contracting, the interviewees highlighted two things; existing practices and trust. On the other hand they felt that this was the way alliances had always been created, and as such contracting had become a part of their process description (either implicitly or explicitly) of alliance creation. On the other hand, the interviewees brought up the notion of trust. Here, the logic was quite clear. Because you cannot fully trust your alliance partner not to take advantage of the information and resources it gets access to during the alliance, you have to shield yourself with as watertight contracts as possible. This way, if the other party starts to act in an unfavorable manner, you can at least go back to the contract to check what kind of rules were agreed on, and if necessary, pose sanctions.
An obvious follow-up question to the interviewees was that if they feel that the long contracting process is undermining the success of many cooperation initiatives, then why not simply do less detailed contracts, and this way get the cooperation started while it is still valid? Many interviewees actually agreed to this, and e.g. an executive for a telecom operator semi-seriously said:
“Of course lawyers have to make a living, and so there are people who promote distrust and contracts. It is still very peculiar that in private life we can behave and be polite and reasonable towards each other without contracts, but in business we change our behavior.”
Even if most of the executives interviewed agreed that basing cooperation on trust could be beneficial, they had difficulties with grasping exactly how trust could replace contracts in alliance initiatives. It seemed that to the executives, trust was something which existed in personal relationships (both in- and outside business), but which was so hard to measure, analyze and quantify, that it could not really be used as a management tool per se.
What is trust?
Academic literature has been doing quite little to help the executives with their problem of how to make the concept of trust useful in everyday business life. While trust has been highlighted as a central concept in many studies, it has from a practitioner’s point-of-view been left relatively vague.
Trust has been defined as the increase of one’s vulnerability to the behavior of others (Deutsch 1962, as quoted in Zand 1972) and the acceptance of the possibility that things will go wrong (Noteboom 1999). Some authors have also identified different aspects of trust. According to this view, trust can e.g. be either calculative, predictive or affective trust (Child and Faulkner 1998). It has further been suggested that trust grows over time (Noteboom 1999), and that there are certain elements like familiarity, habituation, shared norms and expectations, which over a long period of time can lead to two parties to trust each other, and hence e.g. not need to draw up detailed contracts to start new forms of cooperation.
Few executives would probably dispute the aspects and definitions of trust brought forward by previous studies. What remains a problem, however, is that while these aspects of trust are well formulated and certainly to the most part unquestionable, they do little to help companies operationalize trust into useful guidelines for managerial action. It would e.g. not be feasible for two companies that want to create an alliance in a fast moving market to wait for the “habituation” of trust before starting the cooperation.
Some previous research (Inkpen and Currall 1998; Ring and Van de Ven 1992) has raised the idea that trust could be used to replace complex written contracts. On the other hand, some studies (Poppo and Zenger 2002) have also suggested that both may in fact be needed, as complements to each other. Following this, it is here suggested that it may be possible to create a management tool for providing guidance as to when trust, and when detailed contract should be emphasized.
If a company decides to trust another company it should be an informed and rational decision. In other words, there must be some benefit for the company in doing so. Going back to suggestion of Eisenhardt and Brown (1998) on high velocity business environments, a typical benefit of trust could be to get e.g. joint products to market faster. For the decision to be rational, this benefit would then have to be weighed against the possible harm the own company is caused, if the other party betrays the trust, or in other words acts opportunistically. If there is a risk for the other party to act opportunistically –e.g. by using confidential information in cooperation with third parties-, the focal company needs to assess this from two perspectives. On one hand, by understanding the probability of this happening, and on the other, by understanding the harm done if indeed this happens.
If the benefit of trust is bigger than the probability adjusted loss in case of opportunism, the company should base the cooperation on trust. If, on the other hand, the potential damage seems to outweigh the benefits, it could be valid to take time to negotiate a proper alliance contract. This logic can be written as a formula as displayed below.
The benefit of trust = (Potential benefit of trustful behavior) - (Probability of opportunistic behavior X Potential damage caused by opportunism)
The potential loss or gain should be assessed case by case. Here standard business planning and business case calculations could be used to analyze the size of the opportunity and the potential damage. What could be somewhat harder is to analyze the probability of opportunistic behavior. Here, however, game theory can offer some guidelines.
As the probability of opportunistic behavior can depend on the potential benefit caused by the opportunistic behavior to the counterpart (the other alliance party), assessment of this potential counterparty benefit can be used to analyze the probability of opportunistic behavior. What is here also important to understand is the role of “repeated games”, i.e. potential future damage the opportunistic behavior may cause the counterpart. As e.g. Turocy and von Stengel (2001, p.10) put it:
“Game theorists have tried to tackle the obvious ‘inefficiency’ of the outcome of the Prisoner’s Dilemma game. For example, the game is fundamentally changed by playing it more than once. In such a repeated game, patterns of cooperation can be established as rational behavior when players’ fear of punishment in the future outweighs their gain from defecting today.”
When applying this in a business context, it is not only “future games” between the parties that are of importance. Also the future games (i.e. cooperation) by the other party and third parties may be affected. Many companies today operate in a transparent market in the sense that information (either formal or informal) moves fast between companies. In such circumstances, the opportunistic behavior of one of the parties may damage its reputation on the markets as an alliance partner. It could hence be argued that the focal company should assess the damage opportunistic behavior of the other party would cause it. In other words:
Probability of opportunistic behavior of the other party = (Benefit of opportunistic behavior to the other party) – (Damage caused to the other party in future games with the focal company) – (Damage caused to the other party in future games with third parties, i.e. to reputation)
An example of using the formula could be a situation, where the benefit of opportunistic behavior to the other party of e.g. misusing confidential information would be high. In such a case –at least in a Western European context- the damage caused to the party’s reputation and “future games” (not to mention possible legal consequences) would, however, probably be so high that the probability of opportunism would remain low. The outcome of this example could then be used to inform the first formula to make better decisions regarding the optimal way to pursue cooperative arrangements. Whether the formulas should be used quantitatively or as qualitative guidelines for the thought process, is not the key issue. Instead, the focus should be kept on making an optimally informed decision, based on the context and the case in hand.
There is a need to be much more pragmatic in the way trust is studied and defined. This method of assessment of the benefit of trustful behavior should not, however, be exaggerated. In a worst-case scenario, much effort is put on trying to find any reasons for the counterpart to act opportunistically, which may then be noticed by the other party, and become a self-realizing prophecy. Even so, it is suggested that due consideration should be given to the analysis, especially if the damage caused by the potential opportunistic behavior is high. It has already early been suggested that neither pure trust or pure distrust (contracting) is a feasible and sufficient way to look at cooperation between companies (Blau 1964). As such, it is crucial to analyze when each approach is applicable.
Giving proper consideration to the issues presented in this article may have radical impacts on the performance of companies, especially in industries characterized by rapid change. By being able e.g. to bring new products to the market faster companies can gain that slight edge that enable them to profile their offerings as “specialty” rather than “bulk”.
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 This article is extracted from the findings of a wider study on creating inter-firm alliances by Seppälä (2004).