Supplier relations and the market context: A theory of handshakes

This paper analyzes the degree of formality in industrial procurement. Cont racts impose cost discipline on suppliers, but stifle cooperative innovatio n; noncontractual procurement provides cooperation but poor cost discipline . However, cost discipline comes naturally when there is not much vertical integration, because the promise of finding an alternative buyer to use as a bargaining threat enhances the supplier's incentive to make efficiency-en hancing investments. Thus, highly integrated industries use contracts, whil e less integrated industries do business on handshakes. In the latter, coop erative innovations flourish. This may help explain some international comp arisons and changes in business practices observed over time. (C) 1999 Else vier Science B.V. All rights reserved.