Trading in Strategic Resources: Necessary Conditions, Transaction Cost Problems, and Choice of Exchange Structure

Chi, Tailan (1994), Strategic Management Journal, 15 (4): 271-290.

Slides Prepared By Wenxin GUOSlides Prepared By Wenxin GUO

ThemesThe paper develops a theoretical framework for analyzing the exchange structure in the trading of imperfectly imitable and imperfectly mobile firm resources.

1. What is strategic resource?

2. Conditions for strategic resources to be gainfully traded

3. Barriers to imitation and impediments to trading (4 primary transaction cost problems)

4. Remedies: residual claimancy & residual control

5. Transaction modes & Implications

1.What is strategic resource?

Nature of Strategic Resources

Imperfectly imitableOther firms face uncertainty in replicating the resource on their own (Lippman and Rumelt, 1982)

Imperfectly mobileOther firms encounter difficulty in acquiring the resource from its present employer (Peteraf, 1993).

Sustainable competitive advantageIt provide rents that are more than temporary and have no substitutes (Barney, 1986b, 1991; Hill, 1991)

Components of Strategic Resources

Strategic Resources

Physical assets (Barney, 1991)

Skills (Barney, 1991)

Organization routines

(Nelson&Winter,1982)

Related Concepts

Complementary strategic resourcesStrategic resources are by definition idiosyncratic (Barney, 1991), Two sets of strategic resources that exhibit some complementarity have mutual dependence on each other and are thus co-specialized (Teece).

Normal resourcesResources that are easily imitable or mobileReceive normal returns only (with no rents)

2. Conditions for strategic resources to be gainfully traded

Modes of Trading

Acquisition of the whole firm or the part of the firm

Purchase of the resource's service

Transfer of the skills and organization routines

Conditions of Gainfully Trading

Condition 1:

Two firms that possess complementary strategic resources will have an incentive to trade their strategic resources when neither of them expects to be able to exploit the complementarity more profitably by trying to replicate the resources of the other

Conditions of Gainfully Trading

Condition 2:

When there exists complementarity between the strategic resources of one firm and the normal resources of another firm, the two firms will have an incentive to trade the strategic resources:

• (a) if the former does not expect to be able to exploit the complementarity more profitably by acquiring the normal resources on the open market

• (b) if the latter does not expect to be able to exploit the complementarity more profitably by trying to replicate the strategic resources of the former on its own or acquire imperfect substitutes on the open market.

3. Barriers to imitation and impediments to trading

Four primary transaction cost problems:

– Adverse Selection– Moral Hazard– Cheating– Holdup

Sources of Imperfect Imitability

Three characteristics (Reed and DeFillippi (1990))

Tacitness • Skills & organization routines whose creation and replication

heavily rely on learning by doing (Penrose, 1959; Polanyi, 1967).

Complexity • It arises from the existence of different and interrelated skills

and organization routines within a firm (Nelson and Winter, 1982).

Specificity• It refers to the condition that a resource is specialized to the

needs of specific transactions (Williamson, 1985).

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Relationships

tacitness complexity specificity

causal ambiguity

adverse selection

Sources of Imitability:

Shirking cheating holdup

Transaction Cost Problems (Trading Difficulties):

information asymmetry

Value creation Appropriation of value

Sources of Imperfect Imitability

Causal ambiguity (Lippman & Rumelt (1982))

Uncertainty about what resource attributes are responsible for superior performance and how a firm can build resources with the right attributes.

Tacitness Complexity Specificity

Causal ambiguity

Causal Ambiguity & Adverse Selection

Adverse selection is due to the difficulty that a prospective acquirer faces in assessing the skills and capabilities of the supplier. (e.g. :chemical compound bid)

divergent beliefs & expectations onerous negotiation

Causal Ambiguity

Adverse Selection

Tacitness & Moral Hazard

Moral hazard is due to the difficulty that the acquirer faces in ascertaining the supplier's effort in providing its skills and capabilities.

Polanyi (1967), tacit knowledge is difficult to articulate and can not be fully coded in technical manuals.

Deficient performance measurement with a positive opportunity cost for the provision of the service will induce the supplier to shirk

Loss of high-powered incentive (Williamson, 1985) of managers of the acquired firm can cause a significant degradation in their performance.

Complexity, Specificity & Cheating, Holdup

Resource interdependency When a firm's resources consist of many different and interrelated skills and organization routines, co-specialization arise.

Need for coordination

Hazard of CheatingHazard of holdup

Cheating in ex ante contractible aspects of coordination

The temptation to cheat is due to:

the existence of gain from cheating under imperfect price constraints (Hennart, 1993).

the absence of effective punishment for cheating under imperfect behavioral constraints (Hennart,1988; Teece, 1986).

Hazard of cheating is the primary transaction cost problem hindering coordination.

Holdup in ex ante non-contractible aspects of coordination

Frequent joint decision making

Negotiations

Bargaining Cost

Coordination

mismatch of negotiation strategies

asymmetric information about contingencies

uncertainty about each other's preferences

4. Remedies:

– Residual claimancy – Residual control

Measurement problems & Residual Claimancy

Residual claimancy

Refers to the extent to which an input contributor bears the variation of the outcome from the production process it participates in (Barzel, 1989).

It can be used to alleviate both the problems of adverse selection and moral hazard.

Different forms: profit, sales, output, productivity and quality

Rule: to make the input contributor's payoff contingent upon a variable (or variables) that most closely measures its contribution (Holmstrom, 1979)

Coordination Failures & Residual Control

Integration

Exclusive control (horizontal integration):• Used when the firm's own strategic resources exhibit

the property of non-exclusion in use

Unified control (vertical integration)• Used when specialized assets are required in an

adjacent stage of production that is not presently under the firm's control

Quasi-integration

the extension of a firm's control rights cover a subset rather than all of the resources

Coordination Failures & Residual Control

Deterrence building

Used when it is too costly to eliminate the conditions of resource interdependency

E.g.: punishment (withholding cooperation or reducing level of cooperation); Joint Ventures

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Remedies for Trading Difficulties

Adverse Selection & Shirking (Value Creation)

Apportionment of Residual Claimancy (input contributor’s payoff contingent on output measurement)

Cheating & Holdup (Appropriation)

Eliminate interdependencyDeterrence-Assignment of Residual Control

Transaction Problem Remedy

Overview of four primary transaction cost problems and two principal remedying mechanisms

5. Transaction Modes & Implications

Transaction Modes

Acquisition

Aim to effect the transfer of residual claimancy and residual control

The hazards of cheating and holdup can basically be removed

the acquirer may still face difficulty in assessing the value of the resources in the acquisition process and encounter a degradation of performance of the acquired personnel after the acquisition

Transaction Modes

Collaborative venturing (CV)

CVs are subject to both measurement difficulties and coordination failures.

The potential advantage of a CV over the complete acquisition is primarily due to the fact that both firms involved in the exchange can be apportioned some residual Claimancy.

A necessary condition for CVs to be the optimal choice is the presence of high transaction costs (Hennart, 1988, 1991; Shan, 1987, 1990).

• significant adverse selection or moral hazard,• resources specialized to the rest of that firm or engender significant

measurement difficulties

Interactions between Two Structural Dimension

The two dimensions of the exchange structure are not only distinct but also interrelated.

Conclusion: A broader definition of trading is needed to conduct a full analysis of the exchanges involving imperfectly imitable and imperfectly mobile firm resources

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