The role of relationship scope in sustaining relational contracts in interfirm networks

Research summary: A key strategic decision for many firms is the scope of their relationships with partners. Existing theories of relationship scope are limited in that they disregard the facts that: (a) most firms transact within networks of multiple partners, and (b) these partnerships often involve two-sided moral hazard. We develop a theory of partnership scope in interfirm networks that addresses these deficiencies. We show how, by broadening the scope of business it conducts with its partners, a firm can reduce externalities between them, and thereby sustain self-enforcing exchange relationships (“relational contracts”) in which both parties cooperate with each other repeatedly and maximize the value created. We discuss numerous settings in which our model applies, including franchising, supply chains, and platform-based ecosystems. Managerial summary: A key strategic decision for many firms is the number of transactions or activities they conduct with a given supplier, business customer, or company that sells complementary products or services. We offer a theory to explain why firms often prefer relationships with broader scope. Whereas other theories are based on the ability to leverage partner knowledge or cheaper supervision, our theory is based on the concept of a “relational contract”, in which a firm and its partner cooperate with each other repeatedly according to an informal agreement between them. We show that under relational contracting, broader scope relationships encourage better mutual cooperation than narrow scope relationships, thereby maximizing the value created by them. We discuss how our model applies to franchising, supply chains, and platform-based ecosystems.