The Role of Relationship Scope in Sustaining Relational Contracts in Interfirm Networks

Abstract: A key strategic decision for many firms is the breadth of its relationships with its partners. Whether those partners are suppliers, commercial buyers or complementors, firms must decide how many different activities to include in their transactions with them. Existing economic theories of relationship scope are limited in that they do not consider the implications of the fact that most firms transact within networks of partners. They focus on dyads only. In addition, those theories tend to consider one-sided moral hazard only, whereas many partnerships involve two-sided moral hazard. Organization theory, on the other hand, tends to rely on the notion of emotion- or norm-based trust to explain relationship scope, though such is not present and hard to establish in many settings. We develop a general theory of partnership scope in interfirm networks that addresses these deficiencies. We show how, by broadening the scope of business it conducts with a partner, a firm can sustain a self-enforcing exchange relationship with that partner (a “relational contract”) in which both parties cooperate with each other repeatedly, thereby maximizing the value created by the relationship. We provide numerous examples of empirical settings in which our model applies, including franchising, supply chains, and platform-based ecosystems.