Pragmatic Collaborations: Advancing Knowledge While Controlling Opportunism.

Abstract

This paper starts from the observation that firms are increasingly engaging in collaborations with their suppliers, even as they are reducing the extent to which they are vertically integrated with those suppliers. This fact seems incompatible with traditional theories of the firm, which argue that integration is necessary to avoid the potential for hold-ups created when non-contractible investments are made. Our view is that pragmatist mechanisms such as benchmarking, simultaneous engineering and "root cause" error detection and correction make possible "learning by monitoring"--a relationship in which firms and their collaborators continuously improve their joint products and processes without the need for a clear division of property rights. We argue that pragmatic collaborations based on "learning by monitoring" both advance knowledge and control opportunism and thus align interests between the collaborators. Copyright 2000 by Oxford University Press.

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Pragmatic Collaborations: Advancing
Knowledge While Controlling Opportunism
SUSAN HELPERa, JOHN PAUL MACDUFFIEband
CHARLES SABELc
(aDepartment of Economics, 400 Wickenden Hall, Case Western Reserve
University, Cleveland, OH 44106. Email: sxh23@cwru.edu,
b2000 Steinberg-Dietrich Hall, Wharton School, University of Pennsylvania,
Philadelphia, PA 19104-6370. Email: macduffie@wharton.upenn.edu and
cColumbia Law School, 435 West 116th Street, New York, NY 10027, USA.
Email: cfs11@columbia.edu)
This paper starts from the observation that firms are increasingly engaging in
collaborations with their suppliers, even as they are reducing the extent to which they
are vertically integrated with those suppliers. This fact seems incompatible with
traditional theories of the firm, which argue that integration is necessary to avoid the
potential for hold-ups created when non-contractible investments are made. Our view is
that pragmatist mechanisms such as benchmarking, simultaneous engineering and ‘root
cause’ error detection and correction make possible ‘learning by monitoring’—a
relationship in which firms and their collaborators continuously improve their joint
products and processes without the need for a clear division of property rights. We argue
that pragmatic collaborations based on ‘learning by monitoring’ both advance
knowledge and control opportunism and thus align interests between the collaborators.
1. On the (Im)Possibility of Collaboration:
Two Views of the Firm
It is now widely observed that firms more and more collaborate with their
suppliers, even as they reduce vertical integration with them. This observation
seems incompatible with the standard theory of the firm, which argues that
integration is necessary to avoid the potential for hold-ups created when
non-contractible investments are made. In this paper, we start with this
apparent paradox (documented with examples both current and historical) in
order to describe a non-standard type of firm—a novel organizational form,
© Oxford University Press 2000
Industrial and Corporate Change
Volume 9
Number 3
2000
443

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neither market nor hierarchy, that addresses the problem of opportunism
while at the same time advancing learning and innovation. From this
juxtaposition of two views of the firm, we draw theoretical explanations of
the behavior of the non-standard firm, explore the implications for the
governance of such firms and identify the limits of traditional organizational
building blocks such as contract and property.
The standard theory of the firm, albeit a stylized portrait, refines and
generalizes a picture of economic activity sketched by Adam Smith, realized
in the mass production US economy starting in the late 19th century and
rendered as history by Alfred Chandler Jr (Chandler, 1962, 1977) and others.
Its central theme is that the firm, and property in general, exist to reduce the
hazards of collaboration that could not efficiently be overcome in market
exchange. The hazards arise typically whenever (potential) partners can use
their control over resources indispensable to the joint venture to extort
benefits in excess of those provided in the partnership agreement or where
some can play on the ignorance of others to claim the benefits due for having
performed their obligations without actually having done so.
These problems are pervasive because humans are by nature ignorant and
guileful and they use their guile to extract advantage from one another’s
ignorance. At the limit they exchange information only when bargaining over
the distribution of the potential benefits, tainting what they say and the
bargains they strike. Ownership of assets (understood as the exclusive right
to determine their use unless otherwise contracted), combined with the legal
rights linked to asset ownership, provide powerful instruments for limiting
the extortion and deception that daunt cooperation (Holmstrom,
1997).1Examining collaboration across firm boundaries is an indispensable
method for discovering just what these instruments are and when and how
they work, and don’t work. The key is learning how to understand economic
behavior under circumstances when self-interest threatens to trip itself up and
deprive the parties of the gains of cooperation.
The non-standard theory arises from observations of the inherent sociability
of human behavior and the development of reciprocity norms between and
among individuals and groups. Its empirical inspiration is twofold: (i) the
(Japanese-inspired) ‘lean’ firm that successfully challenged the dominance of
mass producers in the automobile and other industries starting in the
mid-1970s; (ii) the (primarily US-based) high tech start-ups in computers,
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444
1By ‘standard’ theories of the firm, we mean to include such works as Williamson, Hart and Chandler
(Chandler, 1977; Williamson, 1985; Hart, 1995). For an analysis of differences between transaction cost
and property rights theories see Whinston (Whinston, 1997). For a discussion of other incentive
mechanisms besides ownership see Baker and co-workers and Holmstrom and Roberts (Baker et al., 1998;
Holmstrom and Roberts, 1999).

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semiconductors,softwareand biotechnologythatin thissameperioddeveloped
andcommercializedwholenewtechnologies.Itscentralthemeistheambiguity
and provisional nature of all understanding, from the simplest verbal exchange
to the most complex co-development project. As a consequence, interlocutors
and partners must cooperate in pursuit of mutual intelligibility as a condition
for self-understanding. In this view, because of the mutual vulnerability
resulting from their ignorance of the world, humans are by nature at least as
disposed to be cooperative in order to learn as to be guileful. Once the
cooperative exploration of ambiguity begins, the returns to the partners from
further joint discoveries are so great that it pays to keep cooperating.
Certain corporations, of various stripes and drawing on multiple sources of
inspiration, have formalized and developed this potential for learning through
cooperation. They do so by introducing what we call ‘pragmatic mechanisms’:
disciplines that reveal the ambiguities of current product designs, production
processes and organizational boundaries. At the same time, they orchestrate
joint inquiry, among collaborating individuals, groups and organizations, of
these ambiguities. In the process of inquiry, each collaborator can con-
tinuously monitor the performance of the (relevant) others, while learning
from them and acquiring skills that can be redeployed in other joint ventures.
The overall result, which we will call learning by monitoring, becomes the
basis for pragmatic collaborations.2
From the perspective of the non-standard view, the significance of these
pragmatic mechanisms is that they relax constraints of endemic ignorance
(the systematic incapacity to learn enough to be invulnerable in exchange)
that the standard view regards as constitutive of human nature. Firms exist
in this non-standard world because it is necessary to fix the points of view,
expectations and responsibilities of the collaborators in order to evaluate and
revise them through collaboration.3The exploratory results from any one
collaboration become the basis for adjustments as necessary to facilitate the
next joint activity. Put differently, the de facto joint residual control over assets
deployed in the common project becomes the basis for deliberation over the
shape of the next project, rather than a source of unproductive haggling.
The non-standard firm uses a number of pragmatic mechanisms to create
and maintain the conditions under which two or more firms can sustain
collaboration. These mechanisms, including benchmarking, simultaneous
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445
2For related views in the organizational theory literature see Schon and Weick (Schon, 1973; Weick,
1995). The roots of the pragmatist perspective, as we use it here, lie in philosophical writings by von
Humbolt, Hegel and Dewey and in the anthropology of Mauss and the early Bourdieu (Bourdieu, 1977).
Also, see Sabel for an earlier exposition of ‘learning by monitoring’ (Sabel, 1995).
3See Kogut and Zander for more on the firm as a source of identity that guides the coordinated action
of its members (Kogut and Zander, 1996).

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engineering and systems of error detection and correction (as described
below), help overcome both the problems of bounded rationality and of
opportunism.
In the rest of this paper, we use the example of the automobile industry to
argue that collaborative development is now (and has been for crucial his-
torical periods) much more central to the activity and organization of firms
than the standard view allows. We then deepen and extend the non-standard
view to account for the institutionalization of ongoing incremental (and
cumulatively radical) innovation among collaborators. Our project is both
positive (we show evidence that firms have in many cases adopted these prac-
tices) and normative (we argue that more firms should adopt these practices).
The argument is organized in four additional sections. The second section
presents three examples of collaborative supplier relations, all drawn from the
automotive industry: (i) Japanese keiretsu from the post-war period to the early
1990s; (ii) current subcontracting trends in the US; (iii) a reinterpretation of
the purchase of Fisher Body by General Motors in 1926, often cited as the
paradigmatic example of the emergence of the modern, vertically integrated
firm.
The automotive industry is a logical choice for multiple reasons. First, we
can draw upon our extensive fieldwork in the industry for a detailed account
of collaborative processes and pragmatic mechanisms.4Second, the
make-or-buy decision in this industry has been the locus classicus of empirical
and theoretical work on the nature and boundaries of the firm since Coase
(1937). We believe it is especially powerful to find evidence of collaboration
in the setting where vertical integration is understood as the archetypal
response to the hazards of collaboration.
The third section presents a systematic explanation of such collaborative
innovation by sharpening the contrast between the two types of firms,
standard and non-standard. We emphasize how, for each type, the division of
labor and governance structure are linked to a particular notion of cognitive
possibilities, i.e. a distinct view of the relationship between the context of our
problems and the activities we should undertake to solve them. Put
differently, we contrast a familiar class of (standard) firm that resigns itself to
operate within routines as a condition for efficient action and an unfamiliar
(non-standard) one that achieves efficiency precisely by systematically
questioning routines without vitiating them as guides to action.
This section also explores in more detail the advantages of pragmatic
collaborations. We consider both the efficiency and effectiveness of these
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4This paper draws on (but for space reasons does not repeat) extensive field work by the authors in the
auto industry (e.g. Sabel, 1995; MacDuffie, 1997; MacDuffie and Helper, 1999).

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collaborative arrangements, particularly with respect to the production of
useful knowledge, and we also describe how the arrangements control
opportunism by aligning the interests of the collaborators.
In the fourth section, we look at issues of dynamics: how a pragmatic
collaboration gets started and what can undermine it. We argue that the claim
that the non-standard firm can thrive only under certain institutional con-
ditions (e.g. manufacturing in Japan) has been undermined by the successful
diffusion of the non-standard approach to a wide variety of contexts. We
conclude that the process of disciplined joint inquiry, using the pragmatist
mechanisms, can actually generate the conditions necessary to maintain and
nourish a collaboration, even where the institutional environment appears
highly prone to concerns about ‘hold-ups’.
In the same section we address open questions in the non-standard view
regarding the boundary of the firm and its determination of strategy.
Notwithstanding the experimental character of the new collaborations, there
are emergent answers to these questions. We find that non-standard firms
make strategic choices using the same disciplined scrutiny of assumptions that
is brought to bear on the choice of products, production processes and
organization design. The non-standard firm develops a series of institutional
devices, ranging from novel metrics connecting the performance of operating
units and corporate wholes to new ways of linking managerial career paths
and corporate reorganization, to support the definition and investigation of
strategic choices though collaborative problem solving. Thus strategy, and
boundaries, can be seen as joint products of the operation of the non-standard
firm.
The fifth section provides a summary and conclusion. Note that in this
paper we take the ‘standard’ view of the firm from economic theory as a
starting point. We identify challenges to that view from observations of
current business developments and reinterpretations of business history, and
advance a ‘non-standard’ view of the firm as a better way to explain those
observations. In addressing a central question about bilateral collaboration
between firms, e.g. why don’t concerns about ‘hold-ups’ prevent collab-
oration?, we choose not to address another set of questions, drawn from
economic sociology, about the role of networks of firms in the production of
knowledge and the generation of rents (Powell et al., 1996; Dyer and Singh,
1998; Gulati, 1998; Kogut, 1998). In the concluding paragraphs of the paper
we suggest how our future work could address these latter questions.
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