| This paper provides an economic theory of the degree of formality in industrial procurement. The argument is based on a tension between two procurement goals: imposing cost discipline on the supplier, and creating the conditions for cooperative innovation. In this model, a contract can solve the cost discipline problem, but only by discouraging cooperation; a less formal arrangement provides cooperation but poor discipline. The attractiveness of contracts is smaller, the less vertically integrated the industry, because a thick market for inputs provides its own discipline incentives even without a contract. Thus, in highly integrated industries, contracts are used, while in less integrated industries business is done on handshakes. This theory of the role... |
