Multiple sourcing/single sourcing Business-to-Business Marketing Industrial Buyer-Seller Relationships, Transaction Cost Analysis

The Effect of Multiple Sourcing on Buyer Control in Industrial Buyer- Seller relationships This paper explores the effect of sourcing strategy and employment of specific assets on hierarchical governance in supplier-manufacturer relationships. Multiple sourcing/single sourcing Business-to-Business Marketing Industrial Buyer-Seller Relationships, Transaction Cost Analysis

1 Some arguments for sole sourcing: Japanese business practice recommends sole sourcing as the best strategy to economize on purchasing costs and operation costs (Deming, 1986). Closer relationships with single suppliers will improve inter-firm coordination and create stronger ties between business actors through technology transfer, training, joint product development processes and production planning. The added costs of coordinating closely with one specific supplier is expected to be more than offset by less rework problems, warranty claims and better product quality. 1

2 Some contra arguments for sole sourcing: This strategy contrasts strongly with basic considerations within the strategy literature (Porter, 1985) which recommends multiple sourcing and competition in order to assure low price and high quality. The availability of several sources of supply should increase the bargaining power of the buying firm and further provide a stronger bench-marking for competitive terms of trade. 2

3 Our main concern in this research is that the selection of sourcing arrangements depends on: The nature of the products considered and the market condition surrounding the economic transactions between the buyers and suppliers. Based on transaction cost economics reasoning (Williamson, 1985; 1996), we will argue that employment of specific investments on the supplier side is decisive for how to select sourcing strategy. The unit of analysis is one specific and identified relationship between a buyer and a seller. 3

4 Multiple sourcing (MULTIPL). The measure of this construct is based on a dummy variable Consider the most important product delivered by your identified focal supplier. Has your firm bought the same product from any other suppliers during the last year? An answer of no was coded as 0 and yes was coded as 1.0. The major part of the manufacturers (64%) reported that they used multiple sourcing (yes), while 36% of the sample reported sole sourcing for the product delivered from their focal supplier. The average share for external purchasing among the manufacturers who reported that they used multiple sourcing was 28%. 4

5 Research Problem: We want to explore how the following sourcing strategies effect hierarchical governance (buyer control) in buyer-seller relationships Table 1. Sourcing Strategy and Asset Specificity Sourcing Strategy: Asset Specificity on the supplier side LOW HIGH Multiple Sourcing Cell 1: Monopolistic competition or perfect competition Cell 2: Hybrid governance Bilateral monopoly supported by competition. Plural form Single Sourcing Cell 4: Competitive Cell 3: Bilateral market/perfect competition or monopoly. Small number conditions monopoly 5

6 Cell 1: Multiple sourcing and no specific investments When several suppliers offer heterogeneous (differentiated) products, the sourcing strategy will normally be based on monopolistic competition in the supply market with several suppliers (multiple sourcing, cell 1 in Table 1). Under such circumstances, the role of purchasing should become more proactive, involving a broad set of actors participating in a collective decision making process including selection of buying criteria, supplier evaluation, and purchasing decision (Van Weele, 2010). This situation might also correspond to perfect competition with several suppliers. Confer the problem of too heavy concentration on corner stone suppliers. 6

7 Cell 3: Substantial specific investments and single sourcing The classical arena for TCA considerations (Williamson, 1985) When the supplier makes specific adaptations to its trade partner, for instance through extensive customization of products or employment of other specific investments on behalf of the buying firm, conventional market conditions is transformed into small number conditions (Williamson, 1996) and substantial switching costs. Terms of trade are now mainly a negotiation issue, and the main role of the purchasing firm is to handle bilateral negotiations with its supplier. Small number conditions in buyer-supplier relationships will increase the buyer s dependence on the supplier (Richardson and Roumasset, 1995). The potential problem for the buying firm in a sole sourcing situation (confer cell 3 in Table 1) is that the supplier might act opportunistically (Williamson, 1975; 1985) by charging higher prices and/or lower the performance. 7

8 Under such conditions, there is a strong need for substantial hierarchical governance arrangements on the buyer side in order to secure fair terms of trade and high manufacturing performance at the supplier plant (Heide and John, 1992). 8

9 Cell 2: Substantial specific investments and multiple sourcing The dependence situation is substantially changed with stronger buyer power Classical plural form situation (market and hierarchical governance) A multiple sourcing strategy might function as a safeguarding mechanism that to some degree mitigates possible opportunism and the subsequent need for hierarchical buyer control. Multiple sourcing reduces the performance ambiguity problem 9

10 Cell 4: No specific investments and single sourcing Classical perfect competition or Monopoly Leverage product (Kraljic, 1983) Economics of transportation/supplier location 10

11 Buyer Control: Conceptualized as the extent of the buyer s authority and control over the supplier s decision making in a specific relationship (Heide, 1994). This corresponds to centralization, which refers to the concentration of decision making authority or the degree of vertical control in the relationship on the buyer side (cf. Heide, 2003). Implementation of such governance arrangements may stabilize terms of trade and overcome the performance measurement difficulties associated to bilateral dependence (Williamson, 1985). BUYCON1: Our firm determines all aspects of the implementation of quality assurance at our supplier s plant. BUCON2: Our firm determines in detail the methods and standards to be used for control of the products we purchase from this supplier. BUYCON3: Our firm determines completely which sub-contractors to employ for the production of products delivered to our firm by this supplier. BUYCON4: Our firms has considerable influence on terms of trade in the relationship with this supplier. 11

12 Specific supplier investments and hierarchical governance (buyer control) Supplier specific investments increases the exposure to opportunism and small number conditions (Williamson, 1985, 1991) Ex ante agreements should be implemented with ex post monitoring that implies that specific governance arrangements are introduced in the relationship to control activities and reduce the information asymmetry between the two parties (Lal, 1990). H 1 : There is a positive association between supplier specific investments and buyer control in industrial buyer-seller relationships. 12

13 The effect of multiple sourcing on buyer control: The motivation argument: Multiple sourcing will provide the buyer with better opportunities for comparison of supplier performance and prices. Multiple sourcing improves the buyer s abilities to assess and evaluate the focal supplier s performance and the buyer s perceived performance ambiguity should thereby be reduced (cf. Heide, 2003). Multiple sourcing may act a safeguarding arrangement on its own and attenuate the prospect of opportunistic behavior on the supplier side, which in turn should mitigate the need for buyer control. The ability argument: Multiple sourcing will increase the buyer s relative power over the supplier on resource-dependency considerations Increased buyer power will increase the buyer s ability to enforce stronger buyer control under conditions of multiple sourcing Based on this reasoning, we propose the following refutable hypothesis: 13

14 TWO ALTERNATIVE HYPOTHESES: H 2 : (The motivation argument): There is a weaker association between supplier specific assets and buyer control in buyer-seller relationships applying multiple sourcing than in relationships applying sole sourcing. H 2 : (ability argument): There is a stronger association between supplier specific assets and buyer control in buyer-seller relationships applying multiple sourcing than in relationships applying sole sourcing. 14

15 Table 2. Description of Items and Validity Measures. Scales Sample of items. Response format: 7-point Likert-type scale with end points inaccurate description and accurate description. Buyer Control: BUYCON1: Our firm determines all aspects of the implementation of BUYCON: 4 items quality assurance at our supplier s plant. χ 2 (2) = 2.90, p=0.23 BUCON2: Our firm determines in detail the methods and standards to be CFI=0.99, GFI=0.99 used for control of the products we purchase from this supplier. RMSEA= 0.05 BUYCON3: Our firm determines completely which sub-contractors to α =.68 employ for the production of products delivered to our firm by this supplier. BUYCON4: Our firms has considerable influence on terms of trade in Multiple sourcing: MULTI: Dummy Variable Supplier Specific investments: SUPPLSPEC: 4 items χ 2 (2) = 1.24, p=0.54 CFI=1.00, GFI=1.00 RMSEA= 0.0 α =.73 Buyer Specific investments: BUYSPEC: 5 items χ 2 (5) = 4.18, p=0.53 CFI=1.00 GFI=0.99 RMSEA= 0.0 α =.71 TIME: 1 item UNCERT:1 item TECNO: 1 item Buyer s manufacturing technology: $PURCHASE: 1 item the relationship with this supplier. Single sourcing (value = 0) Multiple sourcing (value = 1.00) SUPPLSPEC1: This supplier has committed a lot of time and resources to meet our requirements for specific routines and equipment for product control. SUPPLSPEC2: This supplier has made comprehensive product adjustments in order to meet our requirements. SUPPLSPEC3: This supplier has to a great extent adapted the execution and follow-up orders to the existing ordering routines in our firm. SUPPLSPEC4: Our supplier has carried out extensive investments in storage and transportation equipment in order to deal with deliveries to our company. BUYSPEC1: Our firm has completely adjusted our product specifications in accordance with this supplier s production technology and product range. BUYSPEC2: our firm has committed a lot of time and resources to achieving insight and adaptation to the technical standards of this supplier. BUYSPEC3: Our firm has completely restructured our production in order to improve the efficiency of the further processing of the products that we buy from this supplier. BUYSPEC4: Our firm has to a great extent adapted our ordering routines to this supplier s expediting routines. BUYSPEC5: Our firm has made substantial investments in information technology dedicated to the transactions with this supplier. TIME: Length of the relationship (natural logarithm) UNCERT: The demand for the product we buy from this supplier is very unpredictable. TECHNO: The work-flow of our firm s manufacturing department is strongly pre-programmed. Buyer s annual dollar purchases from focal supplier (natural logarithm) 15

16 Discriminat validity: Discriminant validity of the three basic TCA-constructs was then assessed by estimating a three-factor measurement model based on EQS (Bentler, 1989). The overall chi-square statistics indicate a reasonable fit to a three factor solution (χ 2 (62) = 77.38, p=0.09), and several indexes confirmed satisfactory fit of the three factor model, Bentler s Comparative Fit Index, CFI=0.98, the goodness-of-fit index, GFI=0.95 and the root mean square error of approximation, RMSEA=0.04. 16

17 Hypotheses Tests and Empirical Findings BUYCON = b 0 + b 1 SUPPLSPEC + + b 2 MULTIPLE+ b 3 SUPPLSPEC x MULTIPLE + b 4 BUYSPEC + b 5 TIME + b 6 TECHNO + b 7 UNCERT + b 8 $PURCHASE + ε Table 3. Regression Analysis: Dependent Variable: Buyer Control (BUYCON) Independent Variables Unstandardized Standardized t-value Coefficients Coefficients CONSTANT (b 0 ) 1.31 2.38** SUPPLSPEC (b 1 ) 0.70 0.71 5.81** MULTIPLE (b 2 ) 1.09 0.39 1.99** SUPPLSPEC x -0.30-0.48-2.11** MULTIPLE (b 3 ) BUYSPEC (b 4) -0.22-0.22-2.77** TIME (b 5 ) -0.22-0.15-2.10** TECHNO (b 6 ) 0.09 0.13 1.84** UNCERT (b 7 ) 0.12 0.17 2.48** $PURCHASE (b 8 ) 0.13 0.14 1.95* *** indicates p.01 (2 tail) Model Fit: R 2 adj = 0.29 F(8,150) = 9.19, p <.01 ** indicates p.05 (2 tail) * indicates p.10 (2 tail) (1) δbuycon/δsupplspec = 0.70-0.30 MULTIPLE (1) δbuycon/δmultiple = 1.09-0.30 SUPPLSPEC 17

18 Hierarchical Governance (buyer control) for different levels of specific investments and different sourcing strategy: Sourcing strategy Specific supplier investments Low (below mean value) High (mean and higher) Multiple Sourcing 3.5 4.0 Single Sourcing 3.0 4.5 18

19 Discussion: This paper represents an extension of traditional empirical TCA studies by investigating the impact on buyer control of single versus multiple sourcing strategies. Our findings support the main hypothesis that the impact of supplier specific investments on buyer control is significantly weakened when the buyer uses multiple sourcing compared to single sourcing. Multiple sourcing is likely to attenuate the prospect of opportunistic behavior on the supplier side, which in turn should mitigate the need for buyer control. The managerial implications of our findings would be that multiple sourcing could reduce the extent of supplier control and thereby the inherent transaction costs associated to small number bargaining. Diseconomics of scale of governance by multiple sourcing?? C(G 1 ) + C(G 2 ) < C(G 1+2 ) Does the buying firm lose economy of scale advantages in production? C(Q 1 ) + C(Q 2 ) > C(Q 1+2 ) Trade offs? Another interesting research question would be: Will it be sufficient for the buying firm to present a credible threat to use alternative suppliers, in order to reduce the focal supplier s opportunism and thereby the need for supplier control? 19

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