Styles of Hybrid Contracting

"I'm offering you a three-year contract at twenty thousand dollars a year, starting today."
--Potter (It's a Wonderful Life)

Once again, from Williamson (2008). For Node C transactions, there are three primary styles of mediating the contractual interface for hybrid transactions.

Muscular contracting involves a large, powerful entity that dictates contractual terms in a one-sided manner. "Here are my specifications, give me your best price or I will go elsewhere..." While workable for contracting generic goods and services, Node C involves transactions where specific investments are required. Smaller, less powerful participants understand that their investments will be at risk if things go wrong. They will therefore either ask the powerful entity for contractual safeguards, raise prices to reflect the added risk they are being asked to assume (a la Node B), or decline to contract. It should be apparent that the muscular approach to contracting is likely to be inefficient and myopic over time.

Benign contracting assumes that cooperation for dealing with unforeseen contingencies will be forthcoming. Trust supplants power as the key concept. "I trust that you'll do the right thing if the situation changes..." Because of self-interest, however, as outliers arise and stakes increase, temptation to defect from the spirit of cooperation grows. The proposition is that when 'lawful' gains to be had from insistence upon the literal terms of the contract exceed the discounted value of continuing the exchange relationship, defection from the spirit of the contract can be projected.

Credible contracting differs from benign contracting in that it does not project benign behavior when outliers appear. It also differs from muscular contracting in that it is not mean-spirited. Instead, the parties involved exercise feasible foresight out of awareness that all complex contracts are incomplete and thus pose cooperative adaptation needs. The parties look ahead, project potential hazards, work out coping mechanisms, and write them into the contractual design. Credible commitments are thus introduced to effect hazard mitigation.

Reference

Williamson, O.E. 2008. Outsourcing: Transaction cost economics and supply chain management. Journal of Supply Chain Management, 44(2): 5-16.