• Advertise
  • Contact Us
  • About Us
  • Supplier Directory
  • SCB YouTube
  • Login
  • Subscribe
  • Logout
  • My Profile
  • LOGISTICS
    • Air Cargo
    • All Logistics
    • Express/Small Shipments
    • Facility Location Planning
    • Freight Forwarding/Customs Brokerage
    • Global Gateways
    • Global Logistics
    • Last Mile Delivery
    • Logistics Outsourcing
    • LTL/Truckload Services
    • Ocean Transportation
    • Rail & Intermodal
    • Reverse Logistics
    • Service Parts Management
    • Transportation & Distribution
  • TECHNOLOGY
    • All Technology
    • Artificial Intelligence
    • Cloud & On-Demand Systems
    • Data Management (Big Data/IoT/Blockchain)
    • ERP & Enterprise Systems
    • Forecasting & Demand Planning
    • Global Trade Management
    • Inventory Planning/ Optimization
    • Product Lifecycle Management
    • Sales & Operations Planning
    • SC Finance & Revenue Management
    • SC Planning & Optimization
    • Sourcing/Procurement/SRM
    • Supply Chain Visibility
    • Transportation Management
  • GENERAL SCM
    • Business Strategy Alignment
    • Education & Professional Development
    • Global Supply Chain Management
    • Global Trade & Economics
    • HR & Labor Management
    • Quality & Metrics
    • Regulation & Compliance
    • SC Security & Risk Mgmt
    • Supply Chains in Crisis
    • Sustainability & Corporate Social Responsibility
  • WAREHOUSING
    • All Warehouse Services
    • Conveyors & Sortation
    • Lift Trucks & AGVs
    • Order Fulfillment
    • Packaging
    • RFID, Barcode, Mobility & Voice
    • Robotics
    • Warehouse Management Systems
  • INDUSTRIES
    • Aerospace & Defense
    • Apparel
    • Automotive
    • Chemicals & Energy
    • Consumer Packaged Goods
    • E-Commerce/Omni-Channel
    • Food & Beverage
    • Healthcare
    • High-Tech/Electronics
    • Industrial Manufacturing
    • Pharmaceutical/Biotech
    • Retail
  • THINK TANK
  • WEBINARS
    • On-Demand Webinars
    • Upcoming Webinars
    • Webinar Library
  • PODCASTS
  • VIDEOS
  • WHITEPAPERS
Home » Relational Contracting for Building Healthier Supplier Relationships

Relational Contracting for Building Healthier Supplier Relationships

May 10, 2022
Kate Vitasek, SupplyChainBrain Contributor

Companies understand that their suppliers are critical partners in lowering costs, increasing quality and driving innovation. However, when contract negotiations begin, the parties often default to a conventional transactional approach, which puts the buyer and supplier on opposite sides of the negotiating table, as both seek to negotiate terms and conditions that best protect their organizations from risk. 

Contracting parties agonize over every conceivable scenario, then try to put everything into black and white. A variety of contractual clauses — such as “termination for convenience,” which grants one party total freedom to end the contract after a specified period — are used to try to gain the upper hand. However, such tactics not only confer a false sense of security (because both parties’ switching costs are too high to actually invoke the clauses), but also foster negative behaviors that undermine the relationship and the contract itself.

The solution is a totally different kind of arrangement: a formal relational contract. We define is as “a legally enforceable written contract establishing a commercial partnership within a flexible contractual framework based on social norms and jointly defined objectives, prioritizing a relationship with continuous alignment of interests before the commercial transactions.”

Let’s examine how a formal relational contract is different from conventional transactional contracts, to see how it can offer a significant advantage when contracting in complex and dependent supplier relationships.

It focuses on the “relationship,” not the “deal.” The focus of contracting tends to be “this deal,” “this time,” and under “this set of business and legal terms.” Negotiators and lawyers think, “Get a signature, and you are done.” By contrast, a relational contract puts the relationship front and center, and recognizes that the deal points will change over time as business needs change. In the process, the parties embrace one another in “partnership” spirit.

It adopts a “partnership” versus “arms-length” mindset. A transactional contract establishes an arm’s-length relationship. Procurement professionals are taught to not get too “cozy” with suppliers. Conventional logic is that becoming overly dependent on your supplier is risky, and that buying organizations should avoid “lock-in." Moreover, the organization with the most power typically uses the upper hand to create contractual terms and conditions that shift risk. But power-based strategies don’t work in today’s networked and outsourced world. A relational contract abandons the arm’s-length mentality, choosing instead to use a partnership mentality, which understands that a highly collaborative strategic relationship with a supplier can create far more value. 

It embraces and formally embeds social norms. Social norms have been researched for decades, including by Nobel Prize-winning academics such as Douglas North and Eleanor Ostrom. Almost everyone recognizes when a social norm such as honesty, equity, integrity or autonomy is violated. A plethora of psychological research shows that most people want to treat others fairly and be treated fairly in return. But they’re also willing to punish unfair behavior when there’s a breach in social norms. The simple fact is that violating social norms makes the situation worse. This is why a formal relational contract not only embraces social norms, but also requires contracting parties to formally document and agree on how they will adhere to them.

It encourages risk mitigation through transparency and collaboration. The conventional approach to mitigating contracting risk comes from wielding one’s market power or state power. Market power is the ability to leave the relationship and contract with another player in the market. State power means the power to legally enforce contractual obligations. In reality, neither mechanism does a good job of mitigating risk in complex and dependent relationships.

Here's why. In complex and dependent relationships, market power falls short because invoking a termination for “convenience” isn’t, after all, convenient in complex and dependent relationships. State power also falls short because while you might be able to take the other party to court, this is costly and only happens as a last resort. Both market power and state power create an illusion of safety, when in reality they can be weak in managing known risk, and largely ineffective in dealing with those that are unknown or unanticipated.

A better approach is to establish a highly transparent and collaborative relationship, wherein the parties work together to identify risks and invest in risk-mitigation mechanisms. Embrace the fact that you’re in it together, and work collaboratively to optimize the situation, rather than fighting over who’s to blame and pulling out the force majeure clause.

It recognizes the fact that all complex contracts are incomplete. A contract is first and foremost an economic instrument, with the purpose of supporting the realization of business plans. Conventionally, this is done by allocating control over activities through contractual obligations such as developing a statement of work and price for the work. But in the words of Nobel laureate Oliver Williamson, all complex contracts are incomplete. A relational contract embraces the fact that “business happens,” and creates a flexible contract structure and formal governance mechanisms, whereby the parties work together to keep their interests in continual alignment.

Now more than ever, organizations need to embrace the fact that business is dynamic, and create formal relational contracts that are built on a flexible contract framework that puts the relationship first, and uses a common shared vision and social norms to keep the parties in continual alignment of interest. By developing formal relational contracts, parties can build trust and cooperate efficiently, without resorting to power plays and blame games.

Kate Vitasek is a graduate and executive education faculty member at the University of Tennessee.

Read more of SupplyChainBrain's 2022 Supply Chain ESG Guide here.

RELATED CONTENT

RELATED VIDEOS

Regulation & Compliance Sustainability & Corporate Social Responsibility
  • Related Articles

    3PLs Take Note: Relational Contracting Is on the Rise

    Four Steps to Building Better Supplier Relationships

    Relationships 101: Back to the Basics for Supplier Management

Kate Vitasek, SupplyChainBrain Contributor

The ‘Vested’ Approach: A Better Way to Outsource

More from this author

Subscribe to our Daily Newsletter!

Timely, incisive articles delivered directly to your inbox.

Popular Stories

  • DOCUMENTS BEARING THE INSIGNIA OF US CUSTOMS AND BORDER PROTECTION LIE ON A TABLE

    New CBP Regs Call for Greater Diligence by Brokers in Reporting Security Breaches

    Freight Forwarding/Customs Brokerage
  • A WORKER IN A WAREHOUSE, SUPERIMPOSED WITH GRAPHICS SHOWING SUPPLY NETWORK

    Enabling Intelligent Visibility With Supply Chain Analytics

    Data Management (Big Data/IoT/Blockchain)
  • GSCMS-Promo.png

    Watch: Introducing the Global Supply Chain Marketing Summit

    Education & Professional Development
  • A HAND TURNS A LARGE, LIGHTED DIAL WITH THE WORD RISK ON IT iStock-NicoElNino-1364371014.jpg

    Measuring KPIs and KRIs for Comprehensive Supplier Performance Management

    Technology
  • DEEPLY CRACKED EARTH UNDER A BLUE CLOUDY SKY

    Why Maritime Supply Chains Must Adapt to Sustainability Regulations

    Ocean Transportation

Digital Edition

Scb nov 2022 sm

2022 Supply Chain Innovator of the Year

VIEW THE LATEST ISSUE

Case Studies

  • New Revenue for Cloud-Based TMS that Embeds Orderful’s Modern EDI Platform

  • Convenience Store Client Maximizes Profit and Improves Customer Service

  • A Digitally Native Footwear Brand Finds Rapid Fulfillment

  • Expanding Apparel Brand Scales Seamlessly with E-Commerce Technology

  • How a Global LSP Scaled its Security Program and Won More Business

Visit Our Sponsors

Orderful Yang Ming Alithya
Barcoding Blue Yonder BNSF Logistics
CoEnterprise Data Capture Deposco
E2open GAINSystems Generix
Geodis GEP GreyOrange
Here Honeywell Intelligrated IFM
Infor Inmar Keelvar
Kinaxis Korber Lean Solutions Group 2H
Liberty SBF Locus Robotics Logility
LogistiVIEW Lucas Systems MCA Connect
MPO Nvidia Old Dominion
OpenText ORTEC Overhaul
Parsyl PMMI QIMA
Redwood Logistics Ryder E-commerce by Whiplash Saddle Creek Logistics
Schneider Dedicated Setlog Holding AG Ship4WD
Shipwell Tecsys TGW Systems
Thomson Reuters Tive Trailer Bridge
Vecna Robotics Verity
Verusen
  • More From SCB
    • Featured Content
    • Video Library
    • Think Tank Blog
    • SupplyChainBrain Podcast
    • Whitepapers
    • On-Demand Webinars
    • Upcoming Webinars
  • Digital Offerings
    • Digital Issue
    • Subscribe
    • Manage Your Subscription
    • Newsletters
  • Resources
    • Events Calendar
    • SCB's Great Supply Chain Partners
    • Supplier Directory
    • Case Study Showcase
    • Supply Chain Innovation Awards
    • 100 Great Partners Form
  • SCB Corporate
    • Advertise on SCB.COM
    • About Us
    • Privacy Policy
    • Contact Us
    • Data Sharing Opt-Out

All content copyright ©2023 Keller International Publishing Corp All rights reserved. No reproduction, transmission or display is permitted without the written permissions of Keller International Publishing Corp

Design, CMS, Hosting & Web Development :: ePublishing