Organizational PArtnerships and the Virtual Corporation

Organizations are transforming their relationships with their businesspartners. For example, instead of playing off dozens or even hundreds ofcompeting suppliers against each other, many firms are finding it moreprofitable to work closely with only a small number of"partners". While these firms generally increase their amountof outsourcing, by focusing on a small number of partners they createvalue networks that are often referred to as"value-added-partnerships", "virtual organizations"or "modular corporations". In this work we explore some causesand consequences of this transformation. We apply the economic theory ofincomplete contracts to study the optimal number of business partners,with particular attention to the role of information technology.Surprisingly, we find that organizations will often maximize profits bylimiting their options and reducing their own bargaining power. This mayseem paradoxical in an age of cheap communications costs and aggressivecompetition. However, unlike earlier studies that focused oncoordination costs, we focus on the critical importance of providingincentives for business partners. Our results spring from the need tomake it worthwhile for business partners to invest in"non-contractibles" like innovation, responsiveness andinformation sharing. Such incentives will be stronger when the number ofcompeting partners is small. The findings of the theoretical modelsappear to be consistent with observations from empirical research whichhighlight the key role of information technology in enabling this transformation.