How the wrong contracts destroy value

I have been reading an excellent research paper (see reference below) based on a study of the US automotive industry and in particular how General Motors went from a dominant market position to bankruptcy in less than 30 years.

The research paper challenges the long-held view that US manufacturers lost share due to an uncompetitive cost base and suggests instead that it was their inability to develop high performing relationships – a capability that was integral to the management style of their Japanese competitors.

The study says: “GM’s (practices) were predicated on a view of workers, suppliers and even white collar employees as commodities whose work could be fully controlled by experts through the use of careful specifications and the spot market, while Toyota’s practices were critically dependent on joint problem solving across boundaries of all kinds, and thus on the existence of strong relational contracts”.

It observes that US industry focused strongly on process and very narrowly defined ‘division of labor’. Employees had little sense of what came before or after; this was a model driven by rigorous cost control over individual steps in the process. It created a ‘blame for problems’ culture versus an ‘accountability for success’ culture. (As someone who worked in the auto industry during this period, I can relate to these findings, having colleagues who moved into the US industry and promptly left when they encountered working practices).

The researchers cite examples where US management concentrated on methods – such as Just In Time manufacturing – rather than understanding the management practices that enabled them. Thus they could not replicate these methods because much was intangible. For example, GM management sent teams to take photos so they could copy Japanese working methods; but how do you take photos of a good and collaborative relationship?

Throughout this era, design of new vehicles in the US took double the number of hours. The percentage of faulty parts massively exceeded those of Japanese competition and improvement rates were only half as good. It was factors such as these that undermined quality. Japanese firms were focused on constructive approaches to problem solving; their US counterparts were not.

Many of these findings resonate today. Procurement practices in many companies have not adjusted to delivering and sustaining high-performing relationships. IACCM’s work on value-based contracting methods addresses these issues, but management must set the scene for collaborative working practices.

For those who claim that contracts and contracting practices do not matter, this report should make sobering reading. Today especially, with increasingly complicated supply networks and global trading relationships, the right contracting strategies can result in sustainable competitive advantage.

MANAGEMENT PRACTICES, RELATIONAL CONTRACTS, AND THE DECLINE OF GENERAL MOTORS by
Susan Helper and Rebecca Henderson, published by the National Bureau of Economic Research