Chi, Tailan (1994), Strategic Management Journal, 15 (4): 271-290.

1. Trading in Strategic Resources: Necessary Conditions, Transaction Cost Problems, and Choice of Exchange Structure Chi, Tailan (1994), Strategic Management Journal, 15 (4): 271-290. Slides Prepared By Wenxin GUO

2. Themes • The paper develops a theoretical framework for analyzing the exchange structure in the trading of imperfectly imitable and imperfectly mobile firm resources. • What is strategic resource? • Conditions for strategic resources to be gainfully traded • Barriers to imitation and impediments to trading (4 primary transaction cost problems) • Remedies: residual claimancy & residual control • Transaction modes & Implications

3. What is strategic resource?

4. Nature of Strategic Resources • Imperfectly imitable • Other firms face uncertainty in replicating the resource on their own (Lippman and Rumelt, 1982) • Imperfectly mobile • Other firms encounter difficulty in acquiring the resource from its present employer (Peteraf, 1993). • Sustainable competitive advantage • It provide rents that are more than temporary and have no substitutes (Barney, 1986b, 1991; Hill, 1991)

5. Components of Strategic Resources

6. Related Concepts • Complementary strategic resources • Strategic resources are by definition idiosyncratic (Barney, 1991), • Two sets of strategic resources that exhibit some complementarity have mutual dependence on each other and are thus co-specialized (Teece). • Normal resources • Resources that are easily imitable or mobile • Receive normal returns only (with no rents)

7. 2. Conditions for strategic resources to be gainfully traded

8. Modes of Trading • Acquisition of the whole firm or the part of the firm • Purchase of the resource's service • Transfer of the skills and organization routines

9. Conditions of Gainfully Trading • Condition 1: • Two firms that possess complementary strategic resources will have an incentive to trade their strategic resources when neither of them expects to be able to exploit the complementarity more profitably by trying to replicate the resources of the other

10. Conditions of Gainfully Trading • Condition 2: • When there exists complementarity between the strategic resources of one firm and the normal resources of another firm, the two firms will have an incentive to trade the strategic resources: • (a) if the former does not expect to be able to exploit the complementarity more profitably by acquiring the normal resources on the open market • (b) if the latter does not expect to be able to exploit the complementarity more profitably by trying to replicate the strategic resources of the former on its own or acquire imperfect substitutes on the open market.

11. 3. Barriers to imitation and impediments to trading Four primary transaction cost problems: • Adverse Selection • Moral Hazard • Cheating • Holdup

12. Sources of Imperfect Imitability • Three characteristics (Reed and DeFillippi (1990)) • Tacitness • Skills & organization routines whose creation and replication heavily rely on learning by doing (Penrose, 1959; Polanyi, 1967). • Complexity • It arises from the existence of different and interrelated skills and organization routines within a firm (Nelson and Winter, 1982). • Specificity • It refers to the condition that a resource is specialized to the needs of specific transactions (Williamson, 1985).

13. Relationships Sources of Imitability: tacitness complexity specificity causal ambiguity information asymmetry Shirking adverse selection cheating holdup Value creation Appropriation of value Transaction Cost Problems (Trading Difficulties): 13

14. Sources of Imperfect Imitability • Causal ambiguity(Lippman & Rumelt (1982)) • Uncertainty about what resource attributes are responsible for superior performance and how a firm can build resources with the right attributes. Tacitness Complexity Specificity Causal ambiguity

15. Causal Ambiguity & Adverse Selection • Adverse selection is due to the difficulty that a prospective acquirer faces in assessingthe skills and capabilities of the supplier. (e.g. :chemical compound bid) Causal Ambiguity divergent beliefs & expectations onerous negotiation Adverse Selection

16. Tacitness & Moral Hazard • Moral hazard is due to the difficulty that the acquirer faces in ascertaining the supplier's effortin providing its skills and capabilities. • Polanyi (1967), tacit knowledge is difficult to articulate and can not be fully coded in technical manuals. • Deficient performance measurement with a positive opportunity cost for the provision of the service will induce the supplier to shirk • Loss of high-powered incentive (Williamson, 1985) of managers of the acquired firm can cause a significant degradation in their performance.

17. Complexity, Specificity & Cheating, Holdup • Resource interdependency • When a firm's resources consist of many different and interrelated skills and organization routines, co-specialization arise. • Need for coordination • Hazard of Cheating • Hazard of holdup

18. Cheating in ex ante contractible aspects of coordination • The temptation to cheat is due to: • the existence of gain from cheating under imperfect price constraints (Hennart, 1993). • the absence of effective punishment for cheating under imperfect behavioral constraints (Hennart,1988; Teece, 1986). • Hazard of cheating is the primary transaction cost problem hindering coordination.

19. Holdup in ex ante non-contractible aspects of coordination Coordination Frequent joint decision making Negotiations Bargaining Cost mismatch of negotiation strategies uncertainty about each other's preferences asymmetric information about contingencies

20. 4. Remedies: • Residual claimancy • Residual control

21. Measurement problems & Residual Claimancy • Residual claimancy • Refers to the extent to which an input contributor bears the variation of the outcome from the production process it participates in (Barzel, 1989). • It can be used to alleviate both the problems of adverse selection and moral hazard. • Different forms: profit, sales, output, productivity and quality • Rule: to make the input contributor's payoff contingent upon a variable (or variables) that most closely measures its contribution (Holmstrom, 1979)

22. Coordination Failures & Residual Control • Integration • Exclusive control (horizontal integration): • Used when the firm's own strategic resources exhibit the property of non-exclusion in use • Unified control (vertical integration) • Used when specialized assets are required in an adjacent stage of production that is not presently under the firm's control • Quasi-integration • the extension of a firm's control rights cover a subset rather than all of the resources

23. Coordination Failures & Residual Control • Deterrence building • Used when it is too costly to eliminate the conditions of resource interdependency • E.g.: punishment (withholding cooperation or reducing level of cooperation); Joint Ventures

24. Remedies for Trading Difficulties Transaction Problem Remedy 24

25. Overview of four primary transaction cost problems and two principal remedying mechanisms

26. 5. Transaction Modes & Implications

27. Transaction Modes • Acquisition • Aim to effect the transfer of residual claimancy and residual control • The hazards of cheating and holdup can basically be removed • the acquirer may still face difficulty in assessing the value of the resources in the acquisition process and encounter a degradation of performance of the acquired personnel after the acquisition

28. Transaction Modes • Collaborative venturing (CV) • CVs are subject to both measurement difficulties and coordination failures. • The potential advantage of a CV over the complete acquisition is primarily due to the fact that both firms involved in the exchange can be apportioned some residual Claimancy. • A necessary condition for CVs to be the optimal choice is the presence of high transaction costs (Hennart, 1988, 1991; Shan, 1987, 1990). • significant adverse selection or moral hazard, • resources specialized to the rest of that firm or engender significant measurement difficulties

29. Interactions between Two Structural Dimension • The two dimensions of the exchange structure are not only distinct but also interrelated. • Conclusion: A broader definition of trading is needed to conduct a full analysis of the exchanges involving imperfectly imitable and imperfectly mobile firm resources

30. Thank You!