Competitive advantage can be enhanced by the effective management of relationships with suppliers or distributors. Added value can be dissipated by the ineffective management of the same contracts. In this chapter, I describe the problems and opportunities created by these vertical relationships.
In any vertical relationship, whether with suppliers or distributors, the first, and central, issue is the contract price. This will partly be dependent on the style of the negotiation. Sometimes there is a formal or informal auction; sometimes there is a bargaining process which gives each party scope for obtaining information and revising offers. But the most important influence on the outcome is the range of alternatives available. The distribution of added value between the parties to a relationship depends on the number of alternative contractors to which each has access and the costs to each of a failure to reach agreement.
But contracts are not simply zero sum games, in which one party gains what the other loses. A contract is made to add value, and the design of the contract will influence the amount of value which it adds. The style of the contract is important, because it influences the ability and the willingness of the parties to exchange information and respond flexibly to changing circumstances. I define conditions under which firms should make spot contracts, and when they need long-term ones; when these should be classical, and when relational.
Other factors influence the total amount of added value created by a business relationship. Any contract implies an allocation of risks between the parties. While most negotiators attempt simply to impose as many risks as possible on the other side, this violates the fundamental principle that you can only take a profit on a contract once. So I consider how different risk allocations can influence added value by increasing or minimizing the costs of risk-bearing. And I review other influences on the value of a business relationship--how they can be framed to favour sales of one product over another, and how they may influence market structure. Anti-trust