The influences of certain contract elements and the role of
contracts in achieving preferred customer status
Master Thesis Supply Chain Management
Faculty of Economics and Business, University of Groningen
Jan 27, 2020
Chuming Lu Student number :S3497623 E-mail:C.lu.6@student.rug.nl
Abstract
The construction industry is now facing a shortage of capacities, and it is becoming more difficult for buying firms to acquire better resources from their subcontractors. Becoming a preferred customer could help buying firms to acquire better resource allocations from their suppliers. There are many approaches to achieving preferred customer status, but the effect of contracts is normally neglected by firms. Relational governance functions as a complement to formal contracts. Together, these factors have a significant influence on the buyer-supplier relationship. This paper explains how three main aspects of contracts (fairness and coordination, well-specified terms and relational governance, and provisions to promote longevity) can help buying firms achieve preferred customer status and explores the role of contracts in a buyer-supplier relationship.
Table of Contents
Acknowledgement ... 1
1.Introduction ... 2
2. Theoretical background... 5
2.1 Preferred customer status ... 5
2.2 Contracting ... 5
2.2.1 Fairness and coordination ... 6
2.2.2 Well-specified terms and relational governance ... 7
2.2.3 Provisions to promote longevity of exchange ... 8
3. Methodology ... 8
3.1 Sample and data collection ... 8
3.2 Interview protocol ... 10
3.3 Data analysis ... 11
3.3.1 How managers interpret the mechanism of preferred customer status ... 12
3.3.2 How manager interpret the effect of formal contract ... 13
3.3.2 How manager interpret fairness and coordination ... 13
3.3.3 How manager interpret well specified terms and relational governance ... 15
3.3.4 How manager interpret longevity of exchange ... 16
4.Results ... 17
4.1 Preferred customer status ... 17
4.2 The role of contracts in a buyer-supplier relationship ... 19
4.3. The influences of the three aspects of contracts ... 20
4.3.1 Fairness and coordination ... 20
4.3.2 Well-specified terms and relational governance ... 23
4.3.3 Provisions to promote longevity of exchange ... 25
5. Discussion ... 26
5.1 Discussion of the results ... 27
5.2 Discussions on the three main aspects of contracts ... 28
5.2.1 Fairness and coordination ... 28
5.2.2 Well-specified terms and relational governance ... 29
5.2.3 Provisions to promote longevity of exchange ... 31
5.3 Conclusion ... 32
5.4 Contributions and managerial implications ... 32
5.5 Limitations and future research ... 33
Reference ... 34
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Acknowledgement
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1.Introduction
In recent years, many managers in construction companies have found that it is more difficult for them to find subcontractors even though they are willing to build long-term relationships, and this is slowing their business down (Riddell, 2017). This phenomenon can be explained by the limited capacity of suppliers, in the case of the construction industry, subcontractors (Riddell, 2017). The capacities of suppliers are scarce, and thus, buyers need to compete for these scarce capacities (Schiele, Calvi, & Gibbert, 2012). Many customers thus invest in relationships with their suppliers in order to become preferred customers and thus acquire better resource allocations (Pulles, Schiele, Veldman, & Hüttinger, 2016). Researchers have offered various solutions, including long-term commitment and trust (Pulles, Veldman, Schiele, & Sierksma, 2014) and partnering (Beach, Webster, & Campbell, 2005). However, previous studies have focused mainly on the manufacturing industry, and there are significant differences between the construction and manufacturing supply chains, particularly that construction organizations are mainly project based with short-term relationships and one-off contracts (Fulford & Standing, 2014).
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a 3 layers of interaction framework to achieve long-term relationships. Previous research also did not explore the potential role that contracting plays in a relationship where it helps to achieve preferred customer status. This paper offers possible approaches to become preferred customer through formal contract.
This paper answers the following research question: What are the influences of fairness and coordination, well-specified terms and relational governance, and provisions to promote longevity of exchange on a buying firm to achieve preferred customer status, and what is the role of contracting in an exchange relationship in the construction industry?
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2. Theoretical background
2.1 Preferred customer status
A preferred customer can be defined as a customer who pays a lower price for goods or services than other customers or receives better resources from the same supplier (Schiele et al., 2012). Becoming a preferred customer in general means acquiring ideas, capabilities, and materials that build competitive advantages from suppliers that might not be achieved easily (Pulles et al., 2014). Due to the unique characteristics of the construction industry, preferred customer status also leads to better productivity, minimization of waste, improvements in operational efficiency, and better material flows and more information sharing (Beach et al., 2005). According to Pulles et al. (2014), customer attractiveness and supplier satisfaction lead to preferred status. Customer attractiveness refers to the distinction between expected value from a future relationship and the current perceived value (Pulles et al., 2014). Customers could be perceived as attractive or matured (Bemelmans et al., 2012) when suppliers expect more value from them. Thus, it is important that contractors are perceived as mature and attractive in relationships in order to obtain preferred customer status (Bemelmans et al., 2012). Supplier satisfaction refers to the perceived feeling of equity or fulfillment (Pulles et al., 2014). Pulles et al. (2014) indicated that supplier satisfaction has a significant and positive impact on preferential resource allocation. Supplier satisfaction is an outcome of an exchange relationship where the expectations of suppliers are met (Schiele et al., 2012). Hence, buyers need to meet more expectations of their suppliers in order to achieve preferred customer status. Other scholars have found that preferred customer status has a positive impact on satisfaction on both sides of an exchange relationship (Fulford et al., 2014).
2.2 Contracting
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the ordering, expediting, and evaluating phases of a procurement. This means that a contract could potentially help a construction firm become a preferred customer through emphasizing fairness and coordination (Poppo & Zheng, 2014), containing provisions to promote longevity of exchange (Poppo & Zenger, 2002), and providing well-specified terms and relational governance (van der Valk, Sumo, Dul, & Schroeder, 2016).
2.2.1 Fairness and coordination
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customer, fairness will increase the efficiency between the two parties, and a lack of fairness might lead to some opportunistic behaviors.
2.2.2 Well-specified terms and relational governance
According to Cox et al. (1999), incomplete or incorrect specifications often result in numerous problems in projects, such as the postponement of the project. The subcontractors might not completely understand the requirements. Based on the case study of Kadefors (2005), unclear terms may cause misunderstandings between customers and suppliers and thus lead to conflicts. Another issue related to unclear terms in the contract is that customers’ standard specifications might be placed low in the ranking of the contract. Subcontractors thus, would be sure they meet all these regular requirements, but they might avoid the trouble of adapting their standards documents to this unique project. Once the contract is signed, they might find problems that exist in the contract due to the not clearly specified requirements or terms. Subcontractors might underestimate the difficulties of terms when they are not well specified. Thus, terms should be very clearly specified in contracts in order to reduce the unclear information and improve the efficiency.
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developing an explicit strategy of commitment and communication (Yeung et al., 2011). In addition, commitment and trust in a strategic alliance should aim at long-term relationships and mutual gains.
2.2.3 Provisions to promote longevity of exchange
According to Poppo and Zenger (2002), contracts should promote longevity in exchanges, because it will help to improve the relationship between the two parties by preventing opportunistic behaviors. Managers should adopt a contract that promotes the longevity of relationships by specifying not only required actions and conditions of contractual breach but also a framework for resolving unforeseen disputes (Williamson, 1991). Similarly, expectations of longevity minimize the need for precise performance measurement in the short run, and conflicts between parties can be corrected in long-term relationships (Poppo & Zenger, 2002). Thus, specifying longevity in the contract could provide the flexibility to cope with the inevitable uncertainties that arise in an exchange. Furthermore, the specification in the contract should promote longevity, and the other party should behave cooperatively. In this way, unforeseen conflicts can be reduced, and the relationship can be enhanced.
3. Methodology
3.1 Sample and data collection
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To collect data, an email was sent to multiple construction organizations, because these construction companies have direct data on their relationships with their partners, and this would be appropriate to answer the research question. This email contained a request for a face-to-face interview with the supply chain managers. To encourage their participation, the managers were informed that the interview was for research purposes only, their responses were confidential, and a summarized report would be offered. Eight managers from five different construction firms agreed to participate, of whom five were interviewed on-site. However, one interview has been taken out because the manager mostly gave simple yes or no answers and it was impossible to interpret. The rest five firms are appropriate for this research because they are all in the construction industry, and they all have a great number of construction projects in Europe. They highly evaluate their relationships with their partners and they all have positive and negative experience with contracting. In addition, they all have large supplier networks. This could enable a rich data input. These five firms operate differently. Two are very powerful buyers in the industry and completely outsource construction work to various subcontractors in different regions in the Netherlands. The other three are relatively small firms. They admitted that they are in a supplier-dominant market, and they have put a great deal of effort into becoming preferred customers. Table 3.1 gives detailed descriptions of the selection criteria and information about each company. The different sizes of the companies enrich the range of the results of this research.
Company Number of respondents
10 infrastructure for electricity manager and region manager of Germany D 1 Cables for Internet Procurement manager and project team leader Buyer 4713 3895 E 1 Building construction Procurement, contract manager Supplier and buyer 5733 8126
Table 3.1 Selection criteria and generation of the company
The interviews were fundamentally walk-throughs of contracts that firms have with their partners. During the interviews, the informants provided examples of their contracts with their partners and explained the issues that exist in these contracts. Then, they explained how these issues influence their relationships with their partners. In addition, the informants provided other examples of contracts that they considered satisfactory and explained why they are satisfied with these contracts. Among the five companies, one provides construction services. The results from this company help to explain how suppliers evaluate the three aspects of the contract and what they consider attractive in a customer. This could provide a perspective from the supplier side.
3.2 Interview protocol
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found that complete information sharing is also a kind of fairness, and thus, information sharing was addressed during the interview. According to Steller (2019), the initial attitude toward contracts is another significant aspect of fairness. Hence, questions were asked about the managers’ initial attitudes when they signed the contracts. In the next part of the interview, the questions were about well-specified terms and relational governance. This part is developed from the study of van der Valk et al. (2016). According to Yeung et al. (2011), commitment and trust are two of the most crucial elements of relational governance. Asking managers to provide examples of contracts where these elements are missing or well established can give clear information about the influence of relational governance and well-specified terms. For provisions to promote longevity of exchange, questions regarding their willingness to build long-term relationships were asked. These answers provide insight into how these aspects in the contract influence the relationship between suppliers and customers. To examine the role of contracts in their relationships, the managers were asked directly to provide their evaluations of the effects of contracts in general.
3.3 Data analysis
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how managers evaluate the influence of formal contracts and the 3 main aspects of contract on their relationships with their partners. The full interview protocol and coding scheme are depicted in the appendix.
3.3.1 How managers interpret the mechanism of preferred customer status
Cases Interpretations of customer attractiveness
Interpretations of supplier satisfaction
Benefits Interpretations
1.A “We have steady orders and workloads for them. I think this is very attractive for them.”
“Our suppliers are very satisfied with this strategy because our CEOs have never met before.”
“Our relationship is getting better.”
“They gave us their best teams as well.” Better resource allocation Better teams Stable relationships Workloads Stable orders 1.B “We are one of the biggest
customers in the market, and I think every supplier wants to work with us.”
“I think our suppliers really appreciate it because they feel they are equal and well respected.”
“Once we have this kind of relationship, they do our jobs faster and better for sure.”
Time saving Better quality
1.C “we are the only customer of this market in the
Netherlands..so they need us to get in the market” “we have a high amount of workloads”
“our suppliers really like this change(reduce the tendering) and they said this makes their work easier”
“...they think they are taken equally and seriously so they can poy more effort in to the project”
“..for us, we can get their best teams and we get our work done better. for them, we offer education programs and we educate people from the site ”
“we communicate more, and the problems can be solved faster”
“...so we have less negotiations and tenders because we have trust.”
Joint program Support
Education program Communication Problem solving
1.D “we are a good customer for them we always pay on time and we are very soft on the relationship”
“we always give our suppliers great value of work ”
“we can be seen as a high standard company and I think this is attractive to our suppliers ”
“..I think they are very satisfied with this, we ask them on a scale from 0 to 10 how satisfied are you and they said 8”
“They think this is a great idea and they are very happy about it ”
“..and the working processes can be easier.”
“we gave a lot of orders to them if they also give our their best materials and teams.”
“our communication has been improved a lot and we have less conflicts, when there are problems, we understand each other.”
Facilitate projects Better resource Stable workloads Less conflicts Support Mutual understanding
1.E “we always pay on time, and every time they have some issues we are always there for them”
“is this company profitable and does this company meet our standards.”
“when we have this kind of relationship, we always support each other when the market is not good.”
Support Mutual
13 “we can be satisfied when the communication is good and we can make a profit.”
Table 3.2 Interpretations of customer attractiveness , supplier satisfaction and the benefit of preferred customer
3.3.2 How manager interpret the effect of formal contract
Cases Contract Interpretations
2.A “something once you sign it, you just put them in the drawer and only look at it when you have problems”
“We have standardized contract and it saves a lot of costs. I do not have to start everything from scratch”
standardized contract little effect of contract
costly to build up new contract 2.B “Yes, most of our contracts are standardized, because we try to save
our costs on making new contract, our suppliers have been working with us for many years and they know what they can expect from our contract”
standardized contract cost saving
2.C “A contract is just a ticket, what matters is our interactions after we signed the contract and the best contract is a contract that you do not have to look at it when you signed it.”
“We have contract framework, under this framework, the number of tendering can be reduced and suppliers are very happy with this”
contract helps to enter the market contract framework
reduce tendering supplier satisfaction 2.D “Hard on contract but soft on relationship.”
“We have something called clustered contract, we cluster similar materials and processes ...We give our suppliers an abstract and clustered price”
clustered contract
2.E “We have standardized contract and we call it window contract. In the window contract, 90% of the context are standardized and the rest is project specific”
standardized contract and window contract
Table 3.3 Influence and interpretation of formal contract
3.3.2 How manager interpret fairness and coordination
Table 3.4 and 3.5 present how managers interpret fairness and coordination.
Cases Interpretations of fairness Interpretations
3.A “Contract can be fair and it is also always looking for balance.”
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“if this is not well solved, the whole partnership could possibly be
ruined.” Conflict
3.B “We are trying our best to achieve a balance and hopefully that would
help the project” Balance
3.C “In order to achieve a balance, we changed our contracts a lot in the past years.”
“we do it for our future together”
“We used to have a really high financial penalties in order to be more fair in addition, we will have less penalties and more risk sharing”
Balance Less penalties Partnership Risk sharing
3.D “we are working with them as a partner and that's the goal”
“Before we had a relationship where we make the principles and I tell them you do this and that and I always tell you how to do it.”
Partnership Make principles Conflicts
3.E “The fairness is about soft issues and also a matter of trust” Trust Table 3.4 Interpretation of fairness
Cases Interpretations of coordination Interpretations
4.A “If you started with a contractor that is always bad and always looking for my money”
“When you are doing the work itself. How do you coordinate. It's also a thing to communication.”
“if you have a good basic and positive attitude in start it will help through several projects.”
“When you are working on a project and you have to look at it above those projects.”
Attitude
Communication Above project level
4.B “This could be 2 things, either in the appendix in the contract or via service agreement”
“For the coordination, we specify what are the communication channels we specify about contract management, who has what role and contract management”
Communication
Specify risk and responsibilities
4.C “what we are trying to do is to make it easier for them through job. We still have the framework agreement and we will have less mini
tenders.”
“It is very challenging to change their mentalities” “we do it together for our better future”
“the communication plan should be in the appendix in the contract.”
Reduce processes
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4.D “We must not interfere into their processes also means contractors has to do the first things right”
“It is very challenging to change their mentalities”
“some companies have worked with us for 30 years and our CEOs have never met each other”
“They are not very good at communication and everything is black and white so you have to put this on the contract.”
Not interfere Conflict
Hard to adopt the change Meeting on different levels
4.E “The most important topic is always communication, also you should
have communication on different levels and finished the expectations” Communication on different levels Table 3.5 Interpretation of coordination
3.3.3 How manager interpret well specified terms and relational governance Table 3.4 and 3.5 present how managers interpret well specified terms and relational governance.
Cases Well specified terms Interpretations
5.A “A poorly written contract is a bad beginning”
“Sometimes, it cost us a lot if we made a mistake in the contract.” Bad start High cost
5.B “Not well written is really not the case with us because most of the time we use model for contacts and standardized. So sometimes there are some articles in the contract does not apply for specific the service of the working and the whole project is messed up”
Conflict
Unsuccessful project
5.C “We have some contracting discussion about some interpretations of the terms”
“it could be how you explain it then you have discussion it can be how do you interpret these words; we even had a lawsuit on brackets .”
Discussion before contracting conflict
5.D “It's very important before you have a contract you specify your needs”
“If you make things complicated then it’s a lot of work for both sides and you have to have 5 people to check the balance and that's a lot of cost”
“To specify is good but after specify you can group them”
Discussion before contracting
5.E “If the contract terms are not well specified, the contract will be messy and the project will be messy”
“The terms are based on common sense, common understanding and also know your partners.”
“Normally we have the contractual discussion in up front. And also, to emphasis on the project level.”
“...the Bonus structure is not written down very smart. So, it was bad in the beginning.”
“Safety is always important and it should be very well written. We do not want any accident”
Unsuccessful project Communication
Discussion before contracting Safety
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Cases Relational governance Interpretations
6.A “It comes by foot but leaves on a horse (komt te voet en gaat te paard)”
“There will always be problems that nobody can predict, we need to trust each other and we come to the solution together. The problem itself is not a big deal, what matters is we have trust in each other and we help each other so we have a solution.”
“yes (informal contacts). for the most contractors. I think it's always very important to know the person behind it.”
“I really have to make sure if they have the right attitude in the very beginning, do they really want to work with us or they just want my money.”
Hard to gain trust Unforeseen problems Obey the rules Attitude
6.B “Depends on the subject. some subject’s suppliers you don't need to have a long-term relationship. Some you do. I think most of the time you have a year contract. So, you need to invest the long-term relationship”
Long relationship
6.C “If your partner has a positive attitude with you and they want to build a good relationship, we would definitely do the same. This will for sure give us better relationship.”
Attitude Trust 6.D “It takes a very long time to build trust and parties should always do
what say in the contract. For instance, we always pay on time and we also expect our suppliers could do what they have promised.”
Hard to gain trust Attitude
Obey the rules 6.E “works could be easier when you know each other and you have the
trust in each other)” “do what you say”
“...trust cannot be written on the contract terms are mostly the normal standard framework then again you have to work together. Because the project is people's work not only contract work”
“Which one is more effective? Informal or formal? Both, the formal part is mostly covered by the contract and the informal part is a matter of trust.”
“Trust is important for both sides. If you do a negotiation you make a deal and keep it”
Communication Obey the rules
Trust cannot be written on Contract
Trust
Table 3.7 Interpretation of relational governance
3.3.4 How manager interpret longevity of exchange
Table 3.6 presents how managers interpret provision to promote longevity of exchange.
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6.A “We have our own method to achieve long relationships ...and this is very important because in this way suppliers would think we want a closer relationship and they would do the same.”
“I know they need this to have a steady flow. If we can offer them this, we can also offer them good margin”
own method risk reduction trust
6.B “Depends on the subject. some subject suppliers you don't need to have a long term relationship. Some you do. I think most of the time you have a year contract. So, you need to invest the long-term relationship”
long-term relationship
6.C “we definitely get better resources from our contractors if we sign the contract for 5 or years instead of one years. Because when you have a short contract, your supplier just wants to get the work done and get the money. They do not put too much effort into our relationship”
“The duration of course. The longer the period the more willing you show your willingness. So long terms show also trust”
better resource
long duration contract
6.D “We do not have a very good negotiating position. So, it's very smart to have a long contract with contractors. So, it's very smart to realize that a long duration contractor can secure your capacity.”
“It's a supplier market not a buyer market”
communication support
risk sharing 6.E “it is important to have long term relationship not one of a kind because this
will give us a better relationship” better relationship
Table 3.8 Interpretation of longevity of exchange
4.Results
The structure of this chapter is as follows. Section 4.1 explains the benefits of preferred customer status for both customers and suppliers. It also explains the approaches that companies adopt to achieve this goal. Section 4.2 demonstrates the effect of contracts on the buyer-supplier relationship and how companies could use contracts to achieve a better relationship. Section 4.3 gives explanations of what the three aspects (fairness and coordination, well-specified terms and relational governance, and provisions to promote longevity of exchange) of a contract influence together with relational governance on buyer-supplier relationship.
4.1 Preferred customer status
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construction industry means that they have joint programs that bring more profit for both sides, and they support each other when the market is shrinking. In cases 1.A and 1.B, preferred customers can obtain better quality and better work from their suppliers. The suppliers assign more experienced and elite teams to execute project for their preferred customers. According to case 1.C, another benefit of preferred customer status is that the contracting process is reduced. For instance, the number of tenders is decreased. Suppliers are thus able to put more effort into their actual projects. The manager in case 1.C explained “there is less tendering, our suppliers are very happy about this, and they can focus more on the project instead of loads of paperwork.” In addition, the relationship is more stable because suppliers are willing to have long-duration contracts with their customers. This leads to stable risk sharing.
For suppliers, having preferred customers means they have stable orders and workloads from their customers, and this guarantee their profits. The manager in case 1.A mentioned that “when we have a close relationship with our suppliers, we can make sure our suppliers get stable orders and workloads from us.” In addition, the contracting process with preferred customers is easier (case 1.C). Most of the managers are trying to change the terms and processes of contracting to become more attractive. There are two main approaches they are taking. First, in cases 1.C, 2.C, 2.D, and 2.E, the managers tried to reduce the terms in the contracting process, including the number of tenders and the terms in the contract. The second approach is patterning. In cases 2.C and 2.D, buying firms offered joint programs, such as joint education program for site workers. This is a new method for both suppliers and buying firms. According to the managers, this approach is slow, because it requires a number of changes in the organizational culture and mindsets of leaders.
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treated equally and taken seriously. Previous literature indicates that unclear terms can cause a great deal of problems. The managers explained that these problems can be a delay of material or project or extra cost, and sometimes suppliers cannot finish the project. They are very dissatisfied with customers like this because of the unclear terms in their contracts. According to Yeung et al. (2011), commitment and trust are the most basic elements of relational governance. This research similarly found that trust and attitude are perceived as the two most important factors in relational governance. In case 3.A, the manager stated that “we have to make sure that our suppliers have the right attitude. Do they just want money from us, or do they really meant to cooperate with us?” Relational governance can enhance the relationship behind the contract and reduce conflicts (case 1.D). This makes suppliers more satisfied, because problems can be solved behind the contract and in a more informal way. However, trust is intangible and cannot be presented on the contract. In case 5.C, the manager explained that “trust cannot be written on the contract, and it can only be gained behind the contract.” Firms have many approaches to gain trust, including communication, partnering, long duration of cooperation, and joint programs. These methods help to reduce disputes between the two companies. A contract that has provisions to promote longevity of the exchange relationship is positively related to customer attractiveness because this means steady workloads and more profits for suppliers. Moreover, as the managers mentioned, a long relationship enhances risk sharing and prevents opportunistic behaviors, because the parties have known each other for a long time, and trust has been built. Fairness and coordination have significant influence on both supplier satisfaction and customer attractiveness.
4.2 The role of contracts in a buyer-supplier relationship
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contracts with relationship management, because the attitudes, behaviors, and interactions are perceived as more important than contracts. On the other hand, a contract is also a powerful support when the two parties have disputes. All cases indicated that all the buying firms they deal with have standardized contracts, even though each project they have is different. In cases 1.A and 1.C, firms have model frameworks for contracts, because writing a new contract takes a very long time and involves many departments. Standardized contracts save a great deal of cost. In addition, the materials they need and the procedures of these projects are similar. The managers normally adjust the contracts with suppliers together through the tendering process. During this process, each party raises questions and doubts, and the contracts are changed accordingly.
Even though the managers do not recognize the effect of contracts in their relationships, they still try to achieve better supplier-customer relationships through various methods involving contracts. In case 1.C, they have reduced the terms and requirements in the contract to make it simpler in order to attract more suppliers, and their suppliers are very satisfied with this approach. In this way, they developed a contract framework with different requirements including auditing, materials, and processing. With this contract framework, they require less tendering, and the tendering process has become less complicated. Suppliers are thus more willing to work with them, because their work is easier. In cases 1.D and 1.E, buying firms developed “clustered contracts” and “window contracts.” These two types of contract are explained in the following section.
4.3. The influences of the three aspects of contracts
4.3.1 Fairness and coordination
In general, most managers perceive fairness as a balanced way of working together (see cases 3.A, 3.B, and 3.C). In addition, shared risk, fewer financial penalties (see case 3.C, 3.D, and 3.E), and working together equally are perceived as fair.
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involved, because company C imposed significant financial penalties on their suppliers. This led to heavy financial burdens for their suppliers. As a result, their relationships with suppliers were negatively influenced, and suppliers did not assign their best resources to this firm. The manager in this case said “we had a lot of fights with our suppliers because they have too much financial pressure, and we always demand the best work.” To resolve this situation, this company introduced a new approach to contracting. The new contract they have now is more fair, because they share the financial burden and specify that the responsibilities and risks are shared by both parties. To share the risk, they decided to pay the extra costs caused by their side, for instance because of a delay in materials, which used to be a risk of the suppliers alone. In this way, the suppliers thus have less financial burden, and they are more willing to put their best work toward this company. Consequently, company C claimed that suppliers are very satisfied with this approach, because it makes them more secure and equal. The manager in the case said “our suppliers really like this approach because they think they have been taken seriously and equally.” Their relationships with their suppliers have been improved significantly, and they perceived themselves as a preferred customer.
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working in the old way for more than 30 years, and they are quite unsure about this new approach. The managers from these two buying firms consider the biggest challenge is to change the mindset of suppliers.
All the managers interpreted coordination as communication and understanding each other. For instance, in case 4.A, the manager claimed that “communication is the key to successful coordination.” The manager in case 4.E said that buying firms should not interfere with the processes of buying firms. They believe that good coordination enhances their relationships with their suppliers, and they can get better resources from their suppliers. The means of communication are explained in the appendix (see case 4.C).
In case 4.C, the buying firm tried to eliminate redundant processes and offer partnership for their suppliers. For example, they reduced the number of tenders to help suppliers focus more on their actual work. In return, suppliers are supposed to be more motivated to put their best work forward. To achieve the process reduction, this company developed a contract framework that helps to reduce the number of tenders. In the past, suppliers had to go through a funnel-shaped selection process that was very time consuming and costly. With this new contract framework, if suppliers are qualified in one category, they start the process immediately. As the manager explained, “I think our contract framework worked really well, and we do not have that many tenders anymore. I believe our suppliers will appreciate this.”
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it will be easier to find a solution to our problems.” For instance, when there is a problem in a specific project, both companies should look outside this project itself and coordinate on the relational level. This strategy would influence the relationship strategically, with suppliers feeling that they are being taken seriously and both sides feeling more connected. In all cases, the managers believe that communication is the key to coordination. Furthermore, they think many problems are caused by lack of communication and misunderstanding.
4.3.2 Well-specified terms and relational governance
All the participating companies have standardized contracts to ensure that there are no mistakes in contract terms. The managers believe this can help increase clarity. Unspecified terms in the contracts might mislead parties and cause opportunistic behaviors. For instance, in case 5.C, the buying firm received an unexpected invoice from their supplier because they did not specify it clearly in the contract. This lack of clarity can cause extra costs for buying firms.
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because a clustered contract does not provide all the details of the price, and suppliers only pay attention to the project-specific context in a window contract. One manager explained that “we developed this clustered contract. In this case, we only give our suppliers an abstract price instead of a list of 300 prices, and they said this makes their work easier.” In this way, the contracting process becomes less complicated and reduces the workloads for suppliers. Buying firms believe that suppliers can thus focus more on the projects instead of the paperwork. This will also positively influence the resource allocation of suppliers toward them. Paradoxically, this makes a contract extremely complicated and very difficult for workers at the site to understand. Thus, companies normally have a “translated” version of the contract for workers to ensure that they understand the requirements. Specified terms are also related to trust. When terms are not clear, mutual trust is necessary for companies to behave rationally and fairly.
According to the managers, trust and attitude are the two most important dimensions of relational governance. They believe that trust cannot be written into the contract and is built beyond the contract. For instance, in cases 6.A and 6.E, the managers explained that they critically evaluate the attitudes of their partners. One manager stated that “I really have to make sure they have the right attitude in the very beginning. Do they really want to work with us, or do they just want my money?” Buying firms have put a great deal of effort into gaining trust by working as partners and providing support. A good attitude makes both of them more comfortable, and communication is easier. In addition, trust should be built beyond the project level. When this occurs, problems can be solved faster because they already have a stable relationship and they know each other better.
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suppliers better and enhance their relationships significantly. Informal communication goes beyond the project. The managers believe that informal communications help them to build strong bonds with their partners on the personal level.
According to cases 6.A and 6.D, building trust is a slow process, as it takes a long time for firms to build trust, and it can be fragile. One manager described trust by saying “it comes by foot but leaves on a horse (komt te voet en gaat te paard).” A single opportunistic behavior can ruin trust that has been built for years. In case 6.A, the manager wanted to reduce the processes for their suppliers, so a monthly report is not required from the supplier, even though it is mandatory according to the contract. However, they did not add this in the contract, and the manager only informed the supplier orally. This manager trusted their supplier. However, at the end of the project, the supplier sent an invoice for monthly reports. The manager became very indignant, and they stopped their partnership right after.
4.3.3 Provisions to promote longevity of exchange
According to case 7.D, construction is a suppliers’ market, not a buyers’ market. Thus, it is very important for buying firms to keep long, stable relationships with their suppliers in order to secure capacity. The managers believe that a long-duration contract helps to achieve better relationships with their suppliers. To achieve this, buying firms can offer joint programs, like education. Most importantly, trust should be built and parties should have common understanding.
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In case 7.C, the buying firm tries to extend the duration of relationships to keep their suppliers satisfied, and they believe that buying firms need to take the first step to promote long relationships. They also motivate suppliers to become involved in long-term relationships by offering education and other supports for workers. They believe that a short contract duration does not guarantee them the best work from their suppliers because suppliers will just execute the project without investing in the relationship if the contract is only for one year. Instead, a long duration contract, normally 8 to 11 years, will motivate their suppliers to put effort into their relationships. They claimed that “when you have a contract for one year, the supplier just wants to finish the job, and they will not invest in our relationship.”
In cases 7.A, 7.C, and 7.E, buying firms developed a new method to attract suppliers to a long relationship by setting a certain fixed margin for suppliers in the contract. If a subcontractor is not able to achieve this margin, these firms will compensate them to the fixed margin. For instance, they set a fixed margin of 8 million euros in the contract. When suppliers cannot reach the margin, these buying firms compensate them up to 8 million euros. On the other hand, when the margin is above the 8 million euros, they share the excess with their suppliers. In this way, they both share the risk, and suppliers have less concern about the margin. Suppliers are expected to be more satisfied and to allocate better resources toward these firms. One manager explained that “our suppliers are very relieved with this, because they know they can make money from us, and I think they will be satisfied with this as well.” However, this method is extremely complicated because it requires strong trust and transparency. Each party has to be aware of where exactly the money goes. The buying firms believe that long relationships also boost trust and communications with their suppliers.
5. Discussion
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We first discuss the influence of the contract on the buyer-supplier relationship. Afterward, we discuss how the three main aspects of a contract influence the buyer-supplier relationship. In addition, we give our suggestions for buying companies to achieve preferred customer status through the three aspects of a contract.
The structure of this chapter is as follows. Section 5.1 gives a brief summary of the previous findings. Section 5.2 discusses how the three aspects influence the buyer-supplier relationship and provides strategies to achieve preferred customer status through the three main aspects. Section 5.3 lists the contribution to the literature and advice for managers. Section 5.4 explains the limitations of this study and provides insights for future research.
5.1 Discussion of the results
Similar to other industries, being a preferred customer in the construction industry means lower prices, more profits, more support, and better resource allocations. This close relationship also facilitates risk sharing and reduces redundant processes. Beach (2005) found that preferred customer status could lead to more open cooperation and more information sharing. This research found the same results. In addition, this research found that preferred customer status also benefits suppliers. When suppliers have preferred customers, they are more likely to receive stable orders and fixed margins. According to the literature, most construction companies are project based, and each project is unique, which means each project can have different requirements and conditions. However, most buying firms have standardized contracts, and most managers neglect the effects of these contracts. Nevertheless, contracts play an important role in the buyer-supplier relationships. When buying firms emphasize fairness and communication, suppliers feel more equal, and this increases their satisfaction. In addition, contracts that have decent margins and promote the longevity of relationships are perceived as attractive by suppliers. Thus, a well-built contract can help a buying firm to achieve preferred customer status.
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of Thomas et al. (1998) who found that effective coordination and communication are critical factors of success in projects and relationship development. Well-specified terms and relational governance also contribute to achieving preferred customer status. Most firms use standardized contracts to ensure terms are well specified, and they interpret relational governance as attitude and trust. Similar to the findings of Poppo et al. (2002), relational governance acts as a complement to a formal contract. Together, they enhance the bond between parties. Longevity of exchange can be achieved through in-depth interactions and trust. In general, trust is the key to achieve better relationships. Once trust is established, the other aspects follow.
5.2 Discussions on the three main aspects of contracts
5.2.1 Fairness and coordination
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perceived as attractive when they compensate incurred costs, as in case 3.C (Kadefors, 2005; Kahneman et al., 1986). When buying firms impose fewer penalties and include margin sharing, they become more attractive, and supplier satisfaction increases (Pulles et al., 2014). Hence, fairness can help a buying firm achieve preferred customer status and can serve as one of the cornerstones that foster interfirm cooperation on a long-term basis (Luo et al., 2008).
Communication plans in the contract help to achieve better coordination and lead to a better relationship (Pavlov et al., 2011; Popp et al., 2014). We found similar results. When buying firms offer additional partnership coordination, communications become better. This might increase their reliability and validity, which increase supplier satisfaction. Based on the study of Saram et al. (2001), a communication framework should be introduced, including conducting regular meetings and project reviews and communicating project progress, financial/commercial status, plans, schedules, changes, and documents to all relevant participants. This can be achieved through three different levels of communications: strategic, tactical, and operational. On the strategic level, the CEOs from both sides should meet once or twice a year to discuss their relationship and make future plans. On the tactical level, project managers should meet monthly to discuss processes about the project. On the operational level, construction workers should meet frequently to discuss the execution of the project.
5.2.2 Well-specified terms and relational governance
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Conciseness: the conditions avoid unnecessary information. 3. Fairness: conditions emphasis on risk and margin sharing instead of financial penalties and unrealistic expectations. 4. Effect on quality: construction firms have very high standard with qualities, and terms should thus promote the meeting of the project’s established requirements for materials and processes. 5.Effect on cost: budgets and prices can also be clustered together and it would be easier to account for both parties. 6. Effect on schedule: conditions should emphasis on the communications and information sharing.. 7. Effect on safety: firms should ensure a safe working environment especially in the construction industry.
Attitude and trust are the two main dimensions of relational governance, which comprises the attitudes and actions suppliers and customers take to control, influence, or regulate the coordination of their supplier-customer relationships and influence resource allocation (Steller, 2019). We also found that managers believe that a good attitude helps them get resources from their suppliers. In Steller’s (2019) findings, customers either take a dominant or “as equal” initial attitude, and suppliers choose an opportunistic or an “as equal” initial attitude. Table 5.1 illustrates the four types of relationships based on the buyer’s and supplier’s attitudes.
I: dominant customer, opportunistic supplier II: dominant customer, “as equal” supplier
III: “as equal” customer, opportunistic supplier
IV: “as equal” customer, “as equal” supplier
Table 5.1: Attitude matrix. Source: Steller (2019)
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responses and offers, in addition, it supports the bonding between parties. As a result, suppliers would feel satisfied because they are treated equally. In this way, customers could achieve preferred customer.
In addition to attitude, trust should be embedded in the relational governance. Poppo and Zenger (2002) found that informal, trust-based agreements act as complements, because contracts provide basic guidelines for the social relationship to cooperate. This research found similar results. Trust is seen as a key to build relationships, and managers believe trust cannot be gained from a formal contract. The managers interviewed also pointed out that trust should be combined with formal contracts. According to Pulles et al. (2014), trust is positively related to physical resource allocation, and it helps a buying firm become a preferred customer. This paper shares the same finding, that managers believe trust ensures capacities and better teams from their suppliers. Studies by Poppo et al. (2011) and Yeung and Chan (2012) found that significant formal and informal communications are required to develop relational trust. Communication, especially on the strategic level between CEOs, is most helpful in gaining trust (Rapert et al., 2002). In case 3.A, the CEOs of their suppliers had not met with their CEO for more than a decade. When they introduced CEO meetings, they found that their relationships improved significantly. On the contrary, de Blois (2011) found that informal and oral communication does not contribute to the appropriate goals. However, this paper is against this claim, finding that trust can be gained through both informal and formal communications and obeying the rules. Thus, companies should adopt the communication framework discussed in the previous chapter to build trust and achieve preferred customer status.
5.2.3 Provisions to promote longevity of exchange
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activities to transcend organizational boundaries through multiple projects. In other words, companies should interact above the project level and build trust. Based on the results and model of Havenvid et al. (2017), this paper provides three layers of long-term relationship development: actors, resources, and activities. In the actors layer, actors in both buying firms and suppliers from bottom to top should establish formal and informal communication and trust. In the resources layer, this paper has a unique finding that both firms can set an agreed margin. When suppliers do not achieve this margin, the buying firm can compensate them, and when the margin is exceeded, both sides can share the excess. In this way, suppliers are more secure and more willing to put forward their better resources in an effort to achieve the bonus. In the activities layer, buying firms should not interfere with the processes of suppliers, and they should establish common goals and schedules.
5.3 Conclusion
To answer the research question, the contract does have an influence on buyer-supplier relationship. When the contract is flexible and fair, it might help a buying firms to become preferred customers. However, this effect is neglected by most of the firms. Fairness and good coordination could also help a buy firm achieve because a fair contract might make supplier feel equal and they are taken seriously. This might increase their satisfaction. In addition, good coordination increase trust between parties which also contributes to achieving preferred customer status. Well specified terms reduce the unnecessary workloads for suppliers and they are more willing to put more effort into the project. Relational governance as a complement to formal contract facilitates the trust and interactions between parties which has a positive influence on acquiring preferred customer status. Contracts with provision of long exchange are perceived as attractive. It increases customer attractiveness and thus leads to preferred customers.
5.4 Contributions and managerial implications
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aspects of contracts: fairness and coordination, well-specified terms and relational governance, and provisions to promote longevity of exchange. In addition, it fills the research gap between preferred customer status and contracting by examining how these three aspects can help firms achieve preferred customer status. Previous studies have mainly focused on the benefits of preferred customer status for buying firms. This paper found some benefits for suppliers in having preferred customers.
Empirically, this research provides guidance for managers to build contracts and help buying firms acquire better resources through contracts. First, managers should recognize the importance of formal contracts. Specially, contracts should emphasize fairness and communication on different levels. This paper offers a communication framework that can be used to achieve better coordination and gain trust. Second, managers should choose “as equal” attitude. Buying firms should treat all prospective suppliers equally. Only customers with an ‘as equals’ attitude towards the suppliers can build a strong relationship. In addition, customers should offer a long-term relationship because this could insure them capacities. This paper provides a three-layer framework to achieve long-term relationships. Contracts should be as clear as possible because it reduces the workloads for suppliers and gain buying companies better resource. A list of attributes that help firms specify terms and conditions in the contract,
5.5 Limitations and future research
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this change, so this is an area for future research. Furthermore, the three aspects of contracts explored are in some ways interrelated. For instance, fairness helps to build trust between parties, which leads to long-term relationships. How these aspects are related needs to be better examined.
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Appendix:
Interview protocols
39 General
questions
Could you please briefly introduce your company and tell me about your role in your company?
How many customers and suppliers do you have?
As a supplier, do you have any preferred customer? If you do, how do you treat them differently than other regular customers?
As a customer, have you ever tried to develop a better relationship with your suppliers? If you have, what is your purpose?
Is your company project-based? By which I meant most of your orders are individual and different projects.
How does this influence your contracting process ? Can you describe the challenges you have encountered and how you dealt with them?
If you are project-based firms, do you have standard contracts or each contract is different?
Fairness & coordinatio n
What kind of information do you normally provide on the contract?
Please be honest, what was your initial attitude towards the contracting? Are you trying to make it “as-equal” or you tried to take advantage.
I would now like to talk about fairness: Can contracts be fair or unfair?
Can you give me some good examples of fairness in the contracts with your customers that you are satisfied?
Can you give me some good examples of fairness in the contracts with your suppliers that they are satisfied?
Why do you find these contracts fair?
How these fairness in the contract change your relationships with you customers?
How these fairness in the contract change your relationships with you suppliers?
Can you give me some negative examples of unfair contracts with your customers that you are not satisfied?
40 Why do you find this contract unfair?
How do these contracts change your relationships with your customers?
How do these contracts change your relationships with your suppliers?
Do you provide all the information on the contact which tries to reduce the misunderstandings?
How do you specify your coordination with your partners ? For instance, the distribution, communication?
Can you give me some examples of bad coordination that are in the contract that you are not satisfied?
Can you give me some examples of bad coordination that are in the contract that your suppliers are not satisfied?
Why are you not satisfied with these coordination on the contract?
What do you think is the reason that your supplier is not satisfied with this?
How your relationship this customer has changed because of this?
How This change your relationships with your suppliers?
What was the solution towards these bad coordination on the contract?
Can you give me some examples of good coordination presented in the contract that you are satisfied and can you please explain why they are good?
Can you give me some examples of good coordination presented in the contract that your suppliers are satisfied and can you please explain why they are good?
Why do you think they are good coordination?
Does this change your relationship with your customers and how?
Does this change your relationship with your suppliers and how?
