Supply chain partners often prefer to get their agreements in writing. But over time an informal arrangement may be better than a contract.
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Imagine that your company has an idea for an innovative new product. Manufacturing it will require your supplier to invest in capacity. But with the product still in the development stage, it will be difficult to write a contract specifying the price or production quantity. Without incurring excessive risk, what kind of commitment should you make to induce your supplier to produce the component?
In such a case, an informal agreement can be better than a contract, new research by Professor Terry Taylor shows. He found that supply chain partners that expect to collaborate in the future can develop the trust and cooperation that make informal agreements work. Yet if economic circumstances change or the relationship sours, the firms may want to call off their arrangement. Taking a game theory approach, Taylor determined how supply chain partners should structure informal agreements.
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