Contractual Diversification Advantage: A Relational View of the Link Between Supplier Diversification and Performance

Abstract

The purpose of this research is to examine the effect of diversification on interfirm relationships. Given how extensively firms develop key relationships with customers, suppliers, and other stakeholders, understanding the role that interfirm (relational) strategies are affected by diversification likely will be quite informative. This is particularly true of small businesses, which are not as frequently studied by strategy scholars. A relational perspective suggests that investments in relationship-specific assets, substantial knowledge exchange, combinations of complementary resources and capabilities, and effective governance structures between supply/buyer firms in a partnership dyad can generate relational rents. A foundational predication within our research is that firm diversification will lead to more advantageous relationships with business partners, a hypothesis that we test through contract performance. In our study, we review 240 Research & Development and New Product Development contracts with supplier firms and the US Department of Defense that incorporated some form of risk-sharing between the buyer and supplier. We find that diversified firms engage in contracting with suppliers in a way that provides an advantage over their single-segment competitors in terms of total contract cost, the number of change proposals by engineers in contract work, and longer durations of government contracts. We also find that diversified small firms receive more of a benefit than their larger counterparts in terms of contracting advantage. Based on our findings, it is evident that managers of diversified firms provide advantage to their firms by being more accustomed to complex contractual arrangements than their single-segment firm counterparts. Our findings also suggest that enhanced opportunities for organizational learning are available to diversified firms who engage in contractual relationships. Relational contracts that feature risk-sharing between buyers and suppliers provide space for joint-learning, and it is likely that managers of diversified firms have more experience navigating these risk-sharing relationships. This is particularly influential in a dynamic marketplace as firms prioritize innovation and adaptability in order to thrive.