Dependent on one but vulnerable to another: opportunism threats and control solutions for customization providers
We thank the managers and workers of Adept Limited, Auckland, for permitting us to use their company name in our paper and providing invaluable information about their organization. We also thank the participants of the workshops at University of Auckland, University of Technology Sydney, La Trobe University, Monash University, University of Melbourne, and the sixth New Directions Conference in Management Accounting in Brussels for their comments and suggestions at various stages of this paper’s development. The financial support of the University of Auckland in conducting the field study is gratefully acknowledged.
Abstract
While economic theory suggests that identifying alternate customers is costlier than identifying alternate specialized employees for customization providers, substantial field research evidence indicates the opposite, where providers are reportedly more dependent on employees than customers. We inquire into this contrasting picture between theory and practice through an in-depth case study that suggests that what begins as customer dependence transforms into vulnerability to employees. While perceived vulnerability to customers is efficiently removed through ex ante controls, the physical asset specificity in each customer order generates task uncertainty, specialization and teamwork, which become the new sources of opportunism threat for the customization providers. Compounded layers of ex ante and ex post controls with frequent iterations suggest a need for continuous management (as against removal) of vulnerability to employees.
1. Introduction
There has been much examination of how vulnerability owing to opportunistic actions (such as hold-up or deliberate noncooperation) arises in a general context of economic dependence, and how control solutions such as vertical integration and incentive alignment are designed (e.g. Alchian and Demsetz, 1972; Williamson, 1975, 1981a,b; Ouchi, 1980; Jensen and Meckling, 1992; Wruck and Jensen, 1994). However, in the specific context of customization, although evidence highlights the customization providers’ economic dependence on (i) customers (e.g. Jassawalla and Sashittal, 1998; Stump et al., 2002; Athaide et al., 2003; Hoegl et al., 2003), and on (ii) employees (e.g. Merchant and Simons, 1986; Abernethy and Lillis, 1995; Bouwens and Abernethy, 2000), we still do not have explanations for the contrasting views between theory and field studies in regard to the source of vulnerability for the customization provider.
While economic theory suggests that dependence on customers is a source of vulnerability for customization providers, substantial field study evidence (e.g. Adler et al., 1997; von Hippel, 1998; Rosenbluth and Peters, 2002; Nayar, 2010) supports the opposite view, namely that providers report vulnerability to employee threats more than customer opportunism. Knowledge of the source of vulnerability in customization can help refine several future empirical research concerns such as the customer–response time implications, teamwork determinants, measurement of operational risks and, in general, the design of robust control solutions for opportunism problems in customization-led dependence relationships.
Transaction cost economics (TCE) theory predicts that when two parties invest in a specific transaction, a condition of bilateral dependence emerges.1 This is because each party is concerned about potential asymmetric information held by the other party which, in turn, instills the fear of losing the value of all investments if either party opts out of the transaction disregarding the other party’s interests (Williamson, 1981b; Jensen and Meckling, 1992). Consistent with the theory, a customization provider that makes unique products tailored (not merely altered) to individual customers’ requirements, is likely to have little opportunity to sell its products elsewhere without incurring significant alteration costs if a contract becomes void owing to a customer’s opportunistic actions such as refusing payment or disclosing the provider’s policies to competitors (Foxall, 1998; Stump et al., 2002; Athaide et al., 2003). Similarly, a customer may also lose the value of all resources invested with the provider in specifying product design parameters, if the contract is cancelled because of a provider’s opportunistic price rise or quality reduction (Walker, 2003).
Although this situation reflects ‘equal’ bilateral dependence between a customization provider and its customers, the customization literature (e.g. Pfeffer and Salancik, 1978; Morgan and Hunt, 1994) suggests that dependence, in general, is unequally or asymmetrically skewed against one party or the other (although the magnitude is difficult to quantify). The literature also clarifies that when providers enter into nonrepetitive contracts with customers for unique orders in a nonmonopoly supply market, which imposes a higher investment on the providers relative to buyers, the providers are likely to be more asymmetrically dependent on customers (see Heide and Miner, 1992; Stump et al., 2002). Examples of such providers include small independent customization firms (e.g. a make-to-order furniture firm), divisions in large firms (e.g. a custom fan division in an appliance firm), and service providers (e.g. a payroll processing agent). In this paper, we focus only on the customization providers specified earlier who face asymmetric customer dependence.2
We now move to examine employee relations within such provider firms. While customers hold higher bargaining power against providers because of their ability to get competitive bids from alternate customization providers, employees’ bargaining power is less because both the provider and the employees have recourse to the labor market (Bergen et al., 1992). The provider and employees, at least in theory, can ensure that neither party engages in opportunistic behavior.
In practice, however, the customization provider has less incentive to act opportunistically against employees (see Hirsch, 1991). Apart from the costs of initiating arbitration procedures associated with an employee’s alleged inappropriate use of skills in customization, the provider is likely to incur further nontrivial costs in replacing the existing employee and avoiding adverse impacts on the delivery performance of an existing order. Further, the potential loss of reputation also deters the provider from behaving opportunistically against employees (Williamson, 1996).
We now compare the providers’ level of dependence between customers and employees. As discussed earlier, the providers’ dependence on customers is high because customers hold greater bargaining power. In relation to employees, a provider holds the right of access to the external labor market as a control mechanism to protect itself from employee opportunism. Note, however, the labor market is not likely to be as widespread as for a standard product environment but would certainly be better than for a unique research and development context such as nuclear fission technology. A provider’s dependence on employees can, therefore, be considered neither high nor low but rather medium. Given that TCE (e.g. Datta and Chatterjee, 2008) argues that the level of dependence is a key determinant of the degree of vulnerability, customization providers are, in theory, likely to be more vulnerable to customers’ than employees’ opportunistic behavior.
Quite contrary to the theory, field study research offers considerable evidence for customization providers reporting vulnerability to employees’ rather than customers’ potential opportunism. von Hippel (1998) finds that a division of LSI Corporation, which sells customized circuitry (also called application-specific integrated circuits) offered its custom design software to customers not fearing the potential theft of proprietary rights, because the costs of putting in place powerful internal control systems to prevent employee manipulation of customer specifications far outweighed the loss of organizational benefits in allowing the software access to customers. Adler et al. (1997) document the potential for the opportunistic behavior of specialized workers (and not of customers) of three automobile transplants when making customized trucks. HCL Technologies, a global information technology company that provides customized software programming services, completely embraces the ‘employees first; customers second’ principle as they consider internal employee coordination concerns to be far more critical than customer relationship concerns (see Nayar, 2010).
Our research question is designed, therefore, to understand the reasons behind this contrasting picture: why customization firms are vulnerable to employees’ rather than customers’ opportunism. To address the question, we collect in-depth case data of a customization firm through (i) multiple interviews; and (ii) archives, including manuals, memos, and process charts, and analyze the data to build a theoretical framework. Yin (1994) argues that when there is a reason to believe that the existing theory either conflicts with or does not adequately explain practice, it is critical to construct a new framework from a triangulated case study research.
The remainder of the paper is as follows. Section 2 defines the constructs and provides an overview of the literature on opportunism and vulnerability for customization providers. Section 3 analyzes the case data of a customization provider, describes the research method and examines how the case firm organizes its management controls. Section 4 explains the case findings using a TCE theoretical lens and builds a framework. Section 5 concludes.
2. Construct definition and literature overview
Customization refers to the business strategy of building customers’ specifications into a product (Gassenheimer and Manolis, 2001). This strategy can be viewed as a continuum where one end provides minor customer-requested variations (such as options) to the existing product model called ‘mass-customization’ (Kotha, 1995); the other end reflects a more complete sense of offering fully customer-initiated product design, called ‘tailored customization’ (Kotler, 1989; used in Bouwens and Abernethy, 2000). We adopt the latter conception of tailored customization, in defining the scope of the term in this paper.
Several earlier studies examine customization’s impact on critical accounting and operations management variables such as control information (Bouwens and Abernethy, 2000), span of control, level of decentralization (Vickery et al., 1999), technology (Johnson and Ettlie, 2001), unit performance (Majumdar and Ramaswamy, 1994, 1995), assembly needs, product configuration (Salvador and Forza, 2004), and spare parts availability (Suomala et al., 2002). Although accounting and operations management disciplines examine little about opportunism in a customization context, the marketing discipline (Heide and John, 1988; Ganesan, 1994; Gassenheimer and Manolis, 2001; Stump et al., 2002; Athaide et al., 2003) fills this gap partially when it examines the level of asymmetric dependence between the providers and customers.3
A few studies look at supplier firms’ vulnerability in relation to customized product manufacture, particularly when there are more market alternatives for the customers relative to provider firms, and when customers do not intend to create a repetitive purchase relationship. A provider’s strategic decision to offer customized product innovations requires considerable product adaptations from one user site to another (Hallen et al., 1991). Such adaptations necessitate the provider firm and its customers to commit to idiosyncratic investments (Kumar et al., 1995; Stump et al., 2002). However, Stump et al. (2002) further state that the type and degree of uniqueness of the investments differ between the two parties. While provider firms invest in building contracts and altering their technology to fit customers’ specific requirements, customers invest time in building specifications, negotiating contracts, and planning procurement logistics.
Porter (1980) holds that such investments impose switching costs on both parties which, in turn, induce the parties to complete their transaction. However, Stump et al. (2002) argue that a customer’s investment is relatively less unique than a provider’s investment, because the customer’s investment can be modified at a relatively low cost to fit an alternate provider. Further, as the customer enjoys relatively more avenues of alternate supply sources, Stump et al. (2002) argue that the provider is asymmetrically more dependent on the customers. They conclude that asymmetric dependence leads to vulnerability to customers’ opportunistic actions.
Some early studies suggest that customization motivates customers to reveal their tacit and other operation-related information to the providers which, in turn, can help reduce the information asymmetry problem. For instance, Foxall (1998) argues that having prior customer relationships protects the provider firms against customers’ intentions to reveal confidential information about technological capabilities and innovative product attributes to competitors. Vyas and Woodside (1984) suggest that prior relationships help provider firms to reduce anxieties about customers’ trustworthiness and competence. However, more recent studies (e.g. Stump et al., 2002; Athaide et al., 2003), however, hold that customization does not always incentivize customers to fully reveal all the hidden information because of their less unique (easily alterable) investments and likely lower contributions than those of the provider firms.
Although the above-mentioned studies predict providers’ vulnerability towards customers, significant field evidence (e.g. Adler et al., 1997; von Hippel, 1998; Nayar, 2010) indicates that the providers are, in reality, vulnerable to employees. Typically, employee opportunism is described in terms of shirking (see Alchian and Demsetz, 1972; Jensen and Meckling, 1992) but in a customization context, the specialization of knowledge may induce other forms of opportunism such as hiding inefficiency to obtain undeserved rewards and withholding unique information to bargain for additional rent. The customization literature offers little insight as to why this contrasting picture exists between theory and practice in relation to vulnerability to opportunism. We believe that the reason for the lack of insight is that the accounting and operations management disciplines do not study opportunism issues in customization, while the marketing discipline focuses only on customers’ opportunistic behavior and not employees’. In summary, the extant customization literature holds no theoretical analysis that compares customers’ and employees’ opportunism. This analysis is important in organization research to advance our understanding of the link between dependence and vulnerability in an opportunistic environment.
In a positivistic economic approach, a recurring real-world event must have a reason for its existence, even if the event contrasts with extant theory (Watts and Zimmerman, 1978; Williamson, 1996). For instance, if von Hippel (1998) finds that LSI is vulnerable to employees’ manipulation rather than customer theft of its design rights, a rigorous case study analysis can help identify further theoretical extensions to what is already known.
3. Case study method, description and findings
3.1. Background and justification for the choice of the case firm
Adept Limited is an Auckland-based firm that manufactures plastic injection molds for customers from various industries. Founded by its managing director in 1971, Adept began its business as a small molding firm offering custom plastic products. Since the early 1990s, Adept has been differentiating itself against other firms by focusing on high-value customized products (e.g. taxi meters, battery switches and medical lens cases), instead of common plastic products such as coat-hangers and buckets. With more than 120 employees, Adept generates annual revenue of more than NZ$15 million. Although relatively small, Adept is one of the key players in the New Zealand plastics industry. Of the 440 firms making plastic products in New Zealand, there are only 14 firms that employ 100 or more people (http://www.plasticsnz.com). Adept welcomed our application to study their firm with interest. One main reason was that the company’s general manager was keen to know our analysis of the potential opportunism sources in Adept and our control suggestions.
In line with Eisenhardt’s (1989) suggestion, the case study firm was deliberately chosen to suit our research question. Our objective of examining the sources of opportunism and design of controls in an organization requires the study of a large portion of a small firm rather than a small portion of a large firm. We also targeted a professionally managed entity as against a family-firm as the latter may not always present the typical agency-related opportunistic threats that we sought to examine. Although Adept is headed by an owner-managing director (OMD), all the managers and employees were externally appointed professional engineers. However, following Yin’s (1994) caution, we were open to examining any unique situations that we might face owing to the presence of less common hierarchical positions such as the OMD.
Adept follows an ‘integrated-service’ approach in implementing its business strategy. Under this approach, Adept offers design, molding, and manufacturing services to its customers. The customers’ design specifications are built into high-precision molds, which are then used to make the end product. The products are made in a simple process where liquid plastic is poured into a heated mold in a blow-molding machine. The hot, solidified plastic that is ejected out of the mold assumes the shape of the mold. Although the end product manufacturing involves only one machine, Adept has 14 machines of varying capacities; each one is used to manufacture a specific range of molds and plastic products. The end product is made by a standardized process, but the mold-building process is fully customized. Each mold is created to suit the needs of a specific customer, thus mold building is the process that creates customization in Adept. We focus on the mold-building process, which has the mold as the ‘end product’.
Each customer’s specifications are designed and built into a unique mold. The design for each mold is developed only after entering into a contract with the customer. Although Adept knows how to build molds, the knowledge relating to the design, resources, task inter-relations and sequence varies for each mold. This is regardless of whether Adept builds new molds or improves existing molds for customers. The mold-building department manager confirms that:
[i1] ‘A job is a job… whether it is new or an improvement to the existing mold. It consists of x amount and just because it is an improvement to the existing mold, it doesn’t mean it is less hard than a new one. (Once) we have done our bit, we no longer have anything to do with it (the mold) until they (customers) ask for a change. We make, it is approved and then we forget about it. The mold is gone. We have nothing to do with it again. We might not see that mold for years (a feature of customization)’.
3.2. Description of the case study research method
The first author logged in a total of 78 hours at Adept in Auckland over three separate visits spread across 3 months. The first visit, for 9 hours, was to present the proposal (and not the model) of our research and to gain approval to conduct the case study. During this visit, we gained an overview of Adept’s functions. The second visit was for a period of 15 hours to gain a detailed understanding and mapping of the organizational structure and factory operations. This visit paved the way for identifying target interviewees, drafting the semi-structured questionnaire and determining the different types of evidence that needed to be collected. The third visit was for 54 hours to conduct interviews and verify corroborating documentary evidence. Table 1 lists the interview schedules.
| Interviewees/Informal discussants | Date | Visit | Nature of interaction | Purpose | Duration in hours† |
|---|---|---|---|---|---|
| Design manager | December 13, 2003 | First | Informal discussion | Discuss proposal and plant visit | 3 + 2† |
| Design manager and Molding manager | December 14, 2003 | First | Formal presentation; informal discussions | Gain approval | 1 + 3† |
| General manager; Design manager | January 19, 2004 | Second | Informal/document (Adept Manual) verification | Learning operations and structure | 8 |
| General manager, human resource manager, and two design workers | January 20, 2004 | Second | Informal/document (Adept Manual) | Mapping structures and operations | 7 |
| General manager | January 28, 2004 | Third | First formal interview | Overview and strategy | 1.5 |
| Design manager | –do– | Third | First formal interview | Design tasks and interactions | 1 |
| Production manager, one shift worker and two design workers | –do– | Third | Informal discussions/job descriptions | Understand roles and take observation notes | 3.5 + 3† |
| Molding manager | January 29, 2004 | Third | First formal interview | Molding tasks; interactions | 1 |
| Production manager or controller | –do– | Third | First formal interview | Production functions | 1 |
| Production shift manager | –do– | Third | First formal interview | Shift functions; role with PM | 1 |
| Two molding workers, and design engineers | –do– | Third | Informal discussions Job descriptions | Molding and design relations; take observation notes | 3 + 3† |
| Human resource manager | January 30, 2004 | Third | First formal interview | HR overview and roles | 2 |
| Project controller and one design engineer and molding manager | –do– | Third | Informal discussions/Adept Manual check | Project control roles with other divisions; take observation notes | 4 + 3† |
| General manager | February 10, 2004 | Third | Second formal interview | Clarification of earlier views | 1.5 |
| Human resource manager | February 10, 2004 | Third | Informal discussions/structure charts and Adept Manual checks | Cross-checking molding and design roles; take observation notes | 3 + 4† |
| Design manager and Molding manager | February 11, 2004 | Third | Second formal interviews | Clarification on earlier views; and take observation notes | 4 + 5† |
| Human resource manager | February 12, 2004 | Third | Second formal interview | –do– | 2 |
| HR manager, Mold-building manager, two molding workers | February 12, 2004 | Third | Third interview (HR); Informal discussions | Control theory; take observation notes | 4.5 + 3† |
| Total hours | 78 |
- †The duration includes the main data collection time plus the time required in our work bench at the case-site for analyzing the documents, matching evidence collected against theory and drafting interim theory statements that were later validated by Adept interviewees.
Table 1 identifies three main sources of evidence, (i) formal interviews; (ii) informal discussions and observations; and (iii) documents. The interview data were collected through semi-structured questionnaires (see Table 2) that were continually revised during the course of the interviews. Key questions were posed to different managers to cross-verify the interview responses. All formal interviews were recorded in Sony® digital device and stored in separate voice files on our hard disk. Observations and informal discussions were noted chronologically in separate worksheet files, which describe and elaborate or clarify the interview evidence. While interviews indicated what documents can be useful as further reference, informal discussions helped us explore and extract relevant pages of the documents that supported or triangulated the interview evidence (see McKinnon, 1988; Abernethy et al., 1999; Yin, 2003). We provide an example. Consistent with the general manager’s interview comment (see i4 in Section 3.4.1.) which indicated that surprise design reviews are conducted, we sought clarifications through informal discussions with two design workers, who reiterated the need to remain up-to-date with the detailed design intricacies to defend their position during surprise design reviews, conducted as part of the design policy. Taking a cue from their statement, we requested and obtained the documentary extract of Adept’s Design Manual (see d1 in Adept Manual) to understand the procedure for surprise reviews, which completes the chain of evidence.
| Mold-building Department: |
| How many employees work in your department? What is the hierarchical structure within your department? What are their broad responsibilities? |
| Every custom job requires separate mold (tool) to be made. I understand that you get the tool design from the design department. Is this the starting point for your tool work? |
| What is the average length of time it takes to make a tool? Can you elaborate? |
| How frequently do toolmakers report (both formally and informally) to you? What are their decision-making powers? Any restrictions on their rights? That is, when do they have to check with you and why? |
| Do you interact with customers? Who else in your department? How do they interact? At what stage? And for what purposes? |
| How do you interact with other departments? Who first? Why and when? |
| On the molds that are already manufactured: Who owns them? Adept or the customer? If it belongs to customers, then why do you retain them even after the completion of production? |
| If Adept decides to produce only its own proprietary products, what would be the future of the mold-building department? |
| Do you evaluate your employees’ performance? How? What kind of measures? How frequently? Why? Would your employees know about their performance? |
| Is it easy to evaluate employee performance? Any special circumstances worth mentioning that are difficult? |
| Finally, on motivation: How do you motivate your employees to improve their performance? How do you make it acceptable to them? What are your plans? Do you have complete authority on your plans for motivation? |
| Design Department: |
| How many design engineers work in your department? What is the hierarchical structure within your department? |
| How is a customer request for a product design processed in your department? Who takes a first look? Who reviews it? What happens after that? |
| Does the customer come into the picture? When and how often? |
| Once the design work is allocated to a designer, how does he or she carry out the planning, initiating and the actual design? |
| How frequently do your designers report to you? When and why? |
| How do you interact with other departments within Adept? Why and when? |
| Do you evaluate your employee performance? How? What measures? When and do your employees know of their performance? Any difficult issues in measurement? How do you overcome the difficulties? |
| How do you motivate your designers’ performance? Do you have any plans to initiate a different motivation plan for your department? |
| Human Resource Department (we had to alter this questionnaire to make it more detailed even at the first time use (unlike the earlier two questionnaires) because we had the advantage of a long informal discussion with the HR manager even before the formal interview) |
| When was the Adept Manual and Procedure Manual first issued? Why was it issued? Rather, what are the compulsions for the issue of a detailed manual such as this? |
| With regard to the detailed position descriptions mentioned in your Manual, do you need such great detail? Why? We guess while job descriptions define the purposes, procedures lay down the boundaries. Would you clarify your views with an example from Adept? |
| This is with regard to the boundaries problem in Adept. We will pick an example. Design uses Maintenance to place orders for design materials. Why can’t they place the order themselves? What is the advantage in operating through the Maintenance? |
| In response to your view on team work, I understood your rationale: the constraints of a small company culture that is used on a growing company. As we see it, there could be another reason for the above-mentioned boundaries problem. When companies produce highly customized products, departments become highly inter-dependent to act and resolve problems (Maintenance manager agreed to our views. But we do not reveal this information because we do not want to pre-empt the HR manager). What is your opinion on this? |
| Provide your views on the performance measurement (not the annual performance reviews) that take place more regularly within departments in Adept. What kind of measures are they looking at? What should they be looking at taking the overall objectives of Adept? Regarding the ways of measurement and the frequency of measurement? |
| Finally, what are your views on the employee motivation schemes within Adept? Do you think any other scheme other than the present one would serve better? |
| General Manager: |
| Brief history of the company: the start; objectives, then and now; major constraints and milestones in the company’s progress |
| Adept’s overall structure: the reasons for its thin or flat hierarchy; the roles of each of the different managers |
| Product structures within Adept: the roles of customization on the work among the different departments |
| What is the nature of teamwork in Adept? What is the role of culture such as the open-door policy and the policy documents such as the Adept Manual and Procedure Manual? |
| How is performance evaluated in Adept? Any changes since the beginning? Why? |
| What is Adept’s policy on employee motivation? What kind of incentive schemes would suit a company such as Adept? Why? |
- We used the second (and in some cases third) round of interviews to seek clarification on the interviewees’ earlier responses.
Each time a major chain of evidence is completed, we took time on our work bench at the case-study site to examine whether and how the evidence matched with our TCE theory. Using the theory, we drafted an explanatory statement and got it validated from Adept executives during the second round of interviews. While the executives generally concurred with our explanations, there were occasions that we got alternate explanations (for example, paragraphs 1 and 2 of Section 4.2.1 describes alternate reasons for the existence of teamwork). When alternate explanations arose, then we examined whether we could ‘rule-out’ such explanations. In some practical circumstances, we could not find any valid theoretical explanations (for example, the last paragraph in Section 4.2.3 illustrates how OMD’s behavior defies theoretical generalizations).
We perused several key documents including job descriptions, manuals, organization charts and cost estimates but could not access a customer contract, which according to Adept was a sensitive document. Although the customer contract could have provided us useful information, we believe that the materiality of our findings was not significantly affected because we understood the significance and content of the contract through multiple interviews. We then spent about 33 hours (outside of the firm) over the succeeding months to transcribe, codify and draft the case report. While transcription was done by an independent transcriber based at Auckland, the first author cross-verified samples from each voice file to ensure that the transcribed word files were complete and satisfactory. The first author then coded the whole data manually because of the need to read the entire set of word files, identify key points, correspond with other evidence sources and develop an economic model of the case facts. The model then became the basis for the draft case report which was presented to Adept General Manager and other executives. An email confirmation was obtained from the design manager which indicated that the report reflected a true account of the company’s processes.
The methodological issues are now summed up according to Yin’s (1994) scientific case-study terminology. We realized that repeating key questions to multiple interviewees helped us improve the way we communicated the overarching economic concepts. The improvement in our communication and the similarity in the interviewees’ understanding reflected the presence of not only the reliability of our questionnaire items, but also our concepts’ relevance (construct validity). Further, the chain of evidence collected helped improve our explanation-building ability, a measure of internal validity. A threat to internal validity in a case study arises when researchers provide only that evidence which supports the theory and ignore the rest (Yin, 1994). To overcome this threat, we presented our case study report to Adept executives and obtained their confirmation or approval of the study details.
The focal transaction in this study is the building of the molds. The parties involved in this transaction are Adept’s mold-building manager and his workers. However, owing to the inter-related nature of molding with upstream activities, we also included the design manager and his workers as parties to the transaction. The downstream functions, although important, are not directly involved in building the molds and hence are not considered parties to the above-mentioned transaction. The manufacturing department acts as a testing center for the molds produced in the mold-building department, while the maintenance, assembly and project control departments provide technical support to the design and molding departments.
3.3. Sources and control of customer opportunism in Adept
Design, the first operation in Adept, is structured as an independent department. The design function starts when a customer brings in a product idea and overall specifications and discusses it with the design manager, who is the first contact point with the customer. Each potential customer order generates a separate stream of activities within Adept. The design manager compiles the brief to ensure that the customer order is tenable. The aim of the brief is to check whether the customer has considered different product features, application levels and potential benefits.
However, the design department may perceive an opportunistic threat if the customer intends to use the firm’s advice free of cost to bargain for cheaper services from another molder. As a control mechanism (to avoid perceived threats from turning into reality), the design manager does not provide the design brief to the customer but rather uses it to elicit more precise customer responses relating to the specifications. The process of eliciting such responses enables the design employees to build unique customer-relevant technical data which are not readily comprehensible to the customer. The design manager claims that the magnitude and the high costs of acquiring technical proficiency at this stage can deter the customer from opportunistically ‘walking-away’ to another mold building firm. The following comment by the general manager reflects the ‘perception’ of customer opportunism:
[i2] ‘If we (Adept employees) have designed and developed a product (from the beginning) for a customer, and (also if) he or she does not know everything about the product design, then he or she is more reluctant to walk away to an alternate molder in town. This is because if things go wrong, then the alternate molder will be in a poor position to fix it up immediately and cheaply’.
Once Adept is able to deter the ‘walk-away’ threat, the design manager feels that the customer is more securely locked into the contract with Adept. However, the manager does not preclude other potential sources of opportunism problems such as ex post denying, canceling or not paying for full or any part of the order. To control the ‘ex post-denial’ threat, the design manager uses the design employees’ technical knowledge data to prepare a detailed revised brief (called ‘release brief’) along with a price quotation and a payment schedule relating to the order. These documents are signed off by both parties, namely, the design manager and the customer.
The signing-off implies that the customer has approved the contract specifications, including the expected time plan and the payment agreement. The signing-off implicitly reduces the firm’s potential loss owing to the customer’s opportunistic behavior relating to the order.4 Thus, Adept’s employees build and document specialized knowledge that enables customers to obtain their specifications and helps shield the firm against potential customer opportunism.
3.4. Sources and control of employee opportunism in Adept
3.4.1. Uncertainty and specialization-led teamwork
Upon getting the customer’s approval, the design manager uses the signed release brief as the referendum for the customer order. In Adept, as the requirements in each design task (specifying, drawing, testing and prototyping) vary according to the information contained in the release brief, there arises considerable task uncertainty prior to execution. Although the design manager depends on the specialized design engineers to resolve the task uncertainty, he still considers that no single design engineer holds all the design-specific knowledge to carry out a whole customer order. This is because the tasks are highly inter-related wherein a small unexpected change in one task can affect others. This view is similar to the case example documented in Wruck and Jensen (1994), which suggests that specialized knowledge required for one complete transaction is typically dispersed in bits among different individuals. To overcome this individual limitation, the design manager acknowledges that teamwork is inevitable to build, test, verify and re-align design solutions for any customer order.
The manager identifies a team of design engineers who hold the technical proficiency relating to any order. The team size varies between two and ten employees depending upon the order size and the skill-sets needed for the order. The design manager then asks the team to draft detailed design task schedules and identify the procedures required to carry out the commitments stated in the release brief. The procedures are specific for each job, involving one-time development of specialized skills, such as simulating order specifications. The team then determines how they will develop the design drawings for the job. According to the design manager:
[i3] ‘Every job is different. Our people understand this … and many of their jobs involve a lot of research (planning) and testing (of the designs), and you do not know that you can even do it without doing that work first’.
One of the concerns of the design manager is the scope of on-going opportunism in teamwork. Although economic theory predicts that teamwork gives rise to opportunistic behavior such as shirking because individual output cannot be readily observed, the case evidence (interview i3; document d1) suggests that the manager’s concern stems from reasons beyond just unobservable output. The teamwork in Adept carries the unique features of customization namely, task uncertainty and knowledge specialization. Managers may find procedures used by some design engineers to carry out some tasks incomprehensible which, in turn, may motivate opportunistic behaviors such as hiding inefficiency and disowning responsibility. To control such opportunistic behavior, the design manager holds the right to monitor the progress and quality of work done through ‘surprise design reviews’ of engineering drawings called ‘concepts’ (see d1 in Adept Manual). As the general manager stated:
[i4] ‘We don’t want people thinking, oh, it is review time now and I will work really hard for a month and as soon as the review is over, I can relax (without anyone noticing)’.
At the end of each job, a formal review is undertaken. At any time during the job, if a team poses any constraint that does not have clear solutions, the manager exercises a discretionary solution to amend the team structure (say, remove a worker and add another) to help resolve the constraint. This solution may be to either promote efficiency (rectify genuine constraints) or to control any opportunism tendencies. Williamson (1996) argues that it is difficult to segregate the two (efficiency and opportunism) in reality because they co-exist and feed on each other. Consistent with this view, Adept indicates that both perspectives are equally applicable. For instance, the design manager asserts that, generally, the right choice of team members often provides great synergy for increasing the overall team output. The human resources manager, on the other hand, emphasizes the role of peer evaluation in controlling opportunism in teams:
[i5] ‘We had a worker who was not contributing as a team player. Even though I could not find him out (myself), I got told by most of his team-mates in confidence’.
The Adept Manual supports all the above-mentioned interview evidence, as follows.
Adept Manual A15-2-3 Design Process Controls
[d1] ‘The first element of any design will be the creation of a written product/mold development brief … Once the product development brief is approved by the client, a quotation will be supplied to the client. Once the quotation is accepted by the client, specific tasks for the development of the design will be allocated by the design manager to an appropriate team of designers. During the process (i.e. as the designs are being developed), surprise internal reviews of the concepts can be carried out any time at the discretion of the design manager. However, at the completion of each design, a formal design review will be carried out’.
The mold building begins, generally, at the end of the design function where the design manager approves and passes the design reviews to the mold-building department. However, in Adept, the design and molding functions have many common tasks, such as molding design. The mold-building manager reiterates that he gets involved at different stages of the product design, along with a few of his programmers and mold makers, to avoid unexpected difficulties later during mold-building. The manager claims that if he were not to participate in the design reviews, the design engineers could release a drawing that is ‘theoretically design-perfect’ without even worrying whether the design is amenable for building the mold. According to the mold-building manager:
[i6] ‘I get involved where possible in the actual design of the product right at the very start and tailor it right from there, so that is the start of the mold-building process. Then it goes to the mold design…And they don’t realize this because they don’t do it…What is seen as simple and cost-efficient by a designer is not so when it comes to molding, so every mold needs to be reviewed’.
Although the above-mentioned comment [i6] does not clearly bring out the opportunistic intentions of the design department, we observed that Adept has instituted a project controller position not just for managing the project timelines but also to mediate conflicts between design and mold-building departments. Our observations are confirmed by the HR manager as follows.
[i7] ‘He (the project controller) is not a decision-maker. He (as Adept’s spokesperson) technically pulls together the entire project for the customer. What he makes sure is that all parties (different departments) talk and they do not talk at cross-purposes (or in self-interest) to each other’.
The Procedure Manual corroborates the evidence on intra- and inter-departmental teamwork.
Design Process Controls Mold Design Review 5.7
[d2] ‘The review will be carried out by the tooling review and approval team. The team will consist of (or their designees), but not be limited to the following: design manager; tool room (mold-building) manager; a manufacturing department representative (day shift manager or plastics technician). Where appropriate, the client may also be included in the team. … Once all reviews have been carried out and issues exposed by reviews have been corrected, the mold design shall be approved by both design and mold-building managers’.
Once the mold design is complete, the mold-building function begins. The mold-building manager organizes his department in ways that are similar to the design department. The mold-building manager meets with his workers and discusses ways to make the mold. Together with his workers, the manager prepares a schedule of tasks and the time involved in doing the tasks, which include programming, die-setting and tool-making. The mold-building department workers hold specialized skills in these major tasks, wherein the tasks are not standardized because each mold is distinct. Each job requires a separate plan to determine the tasks, type and quantity of materials, estimated processing time and allocation of the tasks. In the words of the mold-building manager:
[i8] ‘Each job requires new programming, requires new cutters, analysis of the approach, namely, a strategy. (We must) know where the cutters are positioned in the machine, take rough cuts and finishing cuts and measure them. (Each job) requires an analysis of how they (workers) are going to approach (the strategy). It is not so much of an automated (standardized) process’.
Once the mold-building manager and workers plan the task schedule, the manager allocates the respective portfolio of tasks to different task groups such as programmers, die-setters and mold-builders. The individual employees identify their own tasks. However, they do not have complete control over the individual tasks as their decisions can affect other workers in the department. The inter-related tasks, although coordinated by the manager, are a potential source of opportunistic work execution. According to the mold-building manager:
[i9] ‘How they (the mold-building department employees) go about their individual parts is entirely up to them. It is a complex line of the business and there are a lot of ways a mold can be done … They have their own decision-making to take care of but it has got to fall into the basic plan that we had worked out, otherwise I can’t keep up with it (the plan) and since the job is so inter-connected, I have to make sure the guys do their job sincerely; you know what I mean (indicating the potential for opportunistic behavior such as disowning responsibility e.g. ‘that is your problem-not mine’)’.
In summary, we find that Adept controls the task uncertainty of its customization orders with the help of its employees’ specialized expertise. As any single individual’s expertise is generally insufficient to execute a whole order, different working teams are identified (with a careful grouping of individual experts) to execute different orders. Although Adept is concerned about opportunism in teamwork, which is consistent with theoretical predictions, Adept’s concerns reveal the unique effects of teamwork opportunism associated with customization. Adept realizes that most of its opportunism concerns (e.g. hiding inefficiency) are owing to the low degree of comprehensibility of the problem for which precise solutions cannot be determined in advance. Solutions such as surprise design reviews, inter-departmental managerial oversight, and peer reviews are merely overall structures, whose micro-details can be drafted only after a problem is identified and understood. The theoretical analysis of such solutions is carried out in Section 4.2.
We also find that the above-mentioned controls do not exist in isolation. Throughout the company, an ‘open-door’ culture is actively adopted, which enables each worker to freely interact with co-workers from other work centers, observe practices and offer feedback. As interaction is required within a department (say, programming and die-setting work centers within the mold-building department) and across different departments (programming of mold-building and testing of design), Adept follows this culture on a company-wide basis. Our observations suggest that workers interact whenever they need support from other work centers. For instance, when a die-setter is unsure of setting parameters, he goes to the programming work center and analyzes the program results (from a user perspective) along with programmer and suggests feedback to the process. Although this culture is an unwritten practice, its existence and usefulness for Adept’s custom molding is reiterated by almost all the interviewees. In the words of the general manager:
[i10] ‘you encourage cross-functional communication (through open-door culture) to produce decisions made by consensus …and then hopefully there are less problems and less mistakes’.
Further, informal discussions with two molding workers indicate that the open-door culture prevails because the reporting structure in Adept’s flat. According to the general manager:
[i11] ‘if you look at our guiding principles, you will see one about experimentation and tolerance for mistakes. A flat structure helps us in that regard. We want people to make decisions for themselves and liaise with other departments not in a hierarchical (command-and control) way but in a simple cooperative way. So no one department has formal authority over the other…’
This nonhierarchical flat structure is also evident from our analysis of Adept’s manual.
Adept Manual A6-2-1 Organizational Structure
[d3] ‘The General Manager (GM) reports directly to the owner-managing director (OMD). The GM, in turn, oversees all the twelve functional departments: design, mold-building, production control, production, warehouse, project control, business development, maintenance, assembly (parts), office administration, information systems, and human resources. Each of these functional departments is headed by a manager. The individual departments run as homogeneous teams with no further hierarchies. It is expected that this structure will facilitate interactions both within (intra) and outside (inter) functional departments’.
Whether open-door culture precedes or succeeds flat organization structure is not clear from our analysis but our evidence suggests that these governance structures support the implementation of overall controls such as surprise design reviews, inter-departmental managerial oversight, and peer reviews. However, although the objective of these governance and control mechanisms is to prevent the motivation for opportunistic behavior in customization-related teamwork, achieving the objective is a continuous managerial problem because the detailed specifications of the control mechanisms (for example, who would conduct the surprise review, what areas to focus and how frequently) need to be planned differently for each new customer order.
3.4.2. The suitability of overall job-based performance measures
The design manager uses an overall job-based measure, ‘charge-out time’, to ascertain whether the design function contributes to Adept’s profitability. Derived from the release brief, ‘charge-out time’ captures the time consumed on a job against the time quoted for the job to the customer. An example the design manager used to clarify this is as follows.
[i12] ‘If we quote a job for $5,000 and our charge-out rate is $100 per hour, we have 50 hours to do the job. It is a simple equation. And so, when I look at the design job, if I see that we have spent only $2,000 worth of time (i.e. 20 hours) and we are (about) half-way through the job, I would think that things are looking good. For instance, if we have spent $4,000 worth of time (i.e. 40 hours) and we are only half-way through, then there is a problem’.
As each job is different, the design manager considers his department to have planned and executed a job well if the number of actual hours falls within +/−10 per cent of the quoted hours.
The mold-building manager uses the measure ‘total hours quoted for a job’ which is derived from a document called the ‘tool costing estimate’, which is presented below.
Tool Costing Estimate Mold Building Documentation 2004
According to the mold-building manager, the tool-costing estimate is similar to a job-plan that specifies all the detailed activities involved in the process of building a mold. When a customer order is received, the mold-building manager and his employees plan the expected hours for each activity necessary in building the mold. When more than one machine is in use, the number of hours (column 4) is multiplied by the number of machines to be used (column 6) and notes (column 7) will be recorded with the number of machine hours for the specific activity. The total hours planned is multiplied by the hourly rate to provide a mold-building quotation to the customer. Internally, the tool-costing estimate is used as a budget in making the specific mold.
The mold-building manager compares the actual total hours logged by all his workers in the job against the tool-costing estimate. The total hours actually logged in the job are calculated from the individual timesheets filled in by each worker during the course of the job. In effect, the mold-building manager can compile information on efficiencies of individual tasks and identify the trends in the execution of each task which, in turn, enables the manager to plan any ex post changes in the tasks.
This evidence appears to support the theory that individual molding tasks are evaluated rather than the overall job performance. We clarify this contradiction. The mold-building manager builds the ‘total hours quoted for a job’ by planning the hours for individual tasks that make up the job. However, the mold-building manager does not use the hours planned for each task as a standard to evaluate each individual worker. Although the jobs are executed by individual workers (and in some cases by two or three workers from a specific task group (programming, die-cutting or tool-making), the job is initiated and planned by overall team comprising all task groups and the manager. The manager believes that the actual performance on any individual task is a reflection of the team’s (rather than an individual’s) overall performance. In the words of the mold-building manager:
[i13] ‘People (workers) give me feedback saying – I had trouble doing this or that. I (then) print out their actual hours from reports which tell me how the job went. This job went well, that job did not. The one that did not, OK, did I under-quote it? Did the worker or (task) group miss something? Or was it a mold design problem? There is so much in there that evaluating whether a worker is actually getting better or not is not a simple (comparison of actual hours against planned) issue’.
When individual performance is not identifiable, some workers may engage in opportunism. The mold-building, human resource and the design managers confirm cases of shirking in the past by workers, particularly when tasks are not clearly observable. The managers complement the team evaluation process with subjective measures (attitude to work and team spirit) to identify individual workers’ performance. To collect data on the subjective measures, managers depend on co-worker reviews because the co-workers hold more information on team mates than the managers. This indicates that the manager shares the monitoring right with the worker teams. According to the human resource manager:
[i14] ‘We had a worker who was not a team player, who was not performing his duties. He was ripping the company off, time-wise (by enjoying leisure and passing the costs on to others). I got a clear, detailed picture about this worker from 10 other operators in a group. I started focusing on his (subjective) performance issues and managed to get him out (of Adept)’.
The mold-building manager, who regularly assesses subjective performance of workers, states:
[i15] ‘I do a bit of a wander around in the mornings, just to say hello to the guys, make sure they are happy in their work, give them an opportunity to ask questions and also to discreetly collect information about the (behavior of) other guys in their group. That is an informal (subjective) way of performance evaluation …’
In conclusion, the performance evaluation process at Adept suggests that managers use overall job measures (charge-out time and quoted job hours) as these measures help in evaluating team performance. Further, Adept uses subjective measures to evaluate individuals within teams to control potential opportunism. Along with their own judgment, managers also use the feedback gained from co-workers for subjective evaluation. Note a caveat here, however. When managers use overall job-based measures, they partly assess their own performance as they also take part in the selection and planning of the different orders. We find that managerial self-assessment arises as part of the workers’ performance evaluation process in a customization context, and can be a future empirical question.
3.4.3. The relevance of ad hoc incentive compensation
All the interviewees confirmed that there is no planned incentive compensation system at Adept. The OMD retains discretion to declare a bonus on a random basis, either as a fixed sum (say, $1,000) for all employees, or as a percentage (say, 3 per cent) of the salary of each employee. The total amount available and the basis of distribution are also subject to discretion. As stated by the design manager:
[i16] ‘We have had a bonus that says, ‘we are going to pay out a week’s pay’, (and) so obviously that is reflected in what salary or wage the person is on. We had a bonus about two months ago and it was $600 for every staff member in the company, no matter what salary they were on, unless the member had clearly not been contributing to the company, as found through our informal (subjective) evaluations. Bonus, in this company, is very much a surprise when it happens’.
Note that the bonus is based on the firm’s overall performance. In response to our question on why incentives are informal and based on overall performance, we obtained two related reasons. The first one relates to OMD’s experience-led beliefs. According to the general manager:
[i17] ‘The OMD does not like any formal (individual-based) incentive schemes because he has tried them three or four times over the last 30 years and he says all of them produce some improvements and then they (the schemes) become counter-productive. They (the schemes) actually produce negative effects because people do things that will get them the bonus even if that is not in the best interests of the company (indicating opportunistic behavior)’.
In a separate interview, the design manager also confirmed that:
[i18] ‘If anything, it is probably (attributable to) the ownership of the company. All the decisions he makes goes and it is the culture of the company. The company has in the past tried to develop bonus schemes and those are formal (individual-based). Generally, they wear off. They are very much a good motivator for a start but then it becomes an expected part and, therefore, it is not a motivator anymore’.
The second reason relates to the complexity of Adept’s business. As tasks of any one person are invariably linked to many others and are hard to distinguish, incentive compensation for individual workers is difficult to identify. According to the general manager:
[i19] ‘If an individual is the production manager, his or her performance will be affected by how well the factory (headed by the shift manager) does its job. So, the problem was you had a measure that was supposedly measuring the performance of a given person, while the person did not have a complete influence over that performance’.
From the available evidence, we gather that both the above-mentioned reasons are likely to feed on each other to increase the scope for potential opportunism. In Adept, the design brief affects the molding job plan for each new mold and hence standards are difficult to set for different tasks. If individual incentive compensation were enforced based on standards in such a situation, then workers are more likely to engage in actions that get them the bonus (in line with interview quotation i16). This firm-value reducing behavior is perhaps the reason why the OMD had introduced and withdrawn three individual bonus schemes in the past (quotation i16).
Theoretical lens to explain case findings
4.1. Theoretical analysis of customers’ opportunism and control
Transaction cost economics suggests that the choice between two governance structures to mediate a transaction depends on the relative transaction cost economizing ability of the two structures. Williamson (1981b) also holds that investment in assets specialized to a transaction is a key reason for dependence and potential opportunism problems between two parties. In a customization context, a firm produces customer-specified products, for which it may need to invest in specialized assets (such as molds), described in terms of ‘physical asset specificity’.
When a firm’s contract with its customers involves physical asset specificity, TCE holds that both parties are likely to make idiosyncratic investments, whose value outside of the joint contract is little. TCE further holds that idiosyncratic investments create a bilateral dependence condition, which suggests that both parties have incentives to continue with the contract. However, each party is suspicious of the other’s private value-enhancing asymmetric information. To counter the other party’s potential opportunistic moves, each party invests in self-protecting, ‘dead-weight losses’ (such as a firm initiating a costly search for another worker) which ultimately reduces the overall cash flows available to both parties under the contract (Klein et al., 1978; Watts, 1992).
Although bilateral dependence arising with physical asset specificity can render both parties equally dependent on each other, the extant customization literature (Pfeffer and Salancik, 1978; Morgan and Hunt, 1994) clarifies this problem when it identifies that, in specific circumstances, the provider is often more vulnerable to customers’ opportunism. For instance, in the presence of nonmonopoly supply sources that impose a greater investment burden on the provider (e.g. Stump et al., 2002), the customer’s intention for repetitive contracting is likely to be less as the customer holds relatively more market avenues than the provider (Heide and Miner, 1992; Gassenheimer and Manolis, 2001). In the event a contract is cancelled for whatever reason, the customer holds recourse for accessing another provider, but the original provider may have to incur nontrivial product variation costs before finding another customer. To avoid such costs, the provider is likely to honor its existing customer’s contract.
To begin with, the physical asset specificity of an asset (such as the mold), which is required in making the final product demands that the provider generates at least some new knowledge (see Zhao et al., 2004) such as in design drawings for each order. As a consequence, the uncertainty that arises is in (i) new knowledge creation such as identifying product strategies (applications, potential benefits, and design options) and micro-level tasks (adding, deleting, or re-sequencing tasks); and (ii) potential customer behavior to exploit the uncertainty in knowledge creation for his or her benefit by passing the costs on to the provider (Williamson, 1996, p. 60).
As previously mentioned, Adept customers have the scope to engage in two types of opportunism, namely, walk-away and ex post-denial. Thus, Adept develops the design brief to examine the robustness of the product strategies in relation to the customer order. In developing new products, Davila (2000) argues that the main purpose of a robustness check is ‘uncertainty reduction’. As the design brief reduces the customer’s knowledge uncertainty, they may be tempted to take advantage of the clarity offered by the design brief without paying the existing provider and walk away to an alternate provider to bargain for a cheaper deal. In such a case, the opportunistic customer causes harm to the existing provider not only in terms of lost time but also lost sales.
To protect the firm from the walk-away threat, the design manager does not provide a copy of the design brief to the customer but instead uses that document as a basis to elicit detailed responses from the customer and accrue unique technical knowledge relating to the customer order. As a consequence, substantial information asymmetry rests with the provider firm at least until the customer gets a copy of the design contract. Until then, in accordance with the theory (see Williamson, 1996), Adept holds information asymmetry as a restraining control against the customer’s walk-away threat.
Once the release brief is drafted, the design manager bundles it along with the time and payment schedules (together called the design contract) and provides a mutually signed-off copy of the contract to the customer for their record. Although the information asymmetry is reduced at this stage, the provider is now covered by the legally tenable design contract against other contractual hazards such as the customer’s potential denial threats. Furthermore, there is less incentive for the customer to walk away at this stage because the provider can access legal action.
In summary, the case evidence suggests that although customization firms are dependent on customers, the firms directly control their resultant potential vulnerability from customers’ walk- away and denial threats by building credible commitments through information asymmetry and legal rights. These two control solutions are ex ante controls designed to remove the scope for customer opportunism. Applied at the beginning of a contract, these controls function as one-time solutions, without the need to be invoked multiple times or even be assessed further through ex post controls. In addition, these controls do not require continuous monitoring. Customization firms manage their dependence on customers through simple but efficient controls, which remove the potential for vulnerability. The first part of Figure 1 summarizes this analysis.
Relations among customization providers, customers and employees.
4.2. Theoretical analysis of employee opportunism and control
4.2.1. Teamwork, related opportunism and control
Williamson (1996, p. 41) extends the application of TCE to a firm’s internal management control processes that are aligned with the firm’s internal transactions in ways that economize overall transaction costs. Knowledge specificity is one critical internal specific asset that poses complex governance problems within firms (Williamson, 1981b). In preparing the release brief and, thereafter, in developing drawings and prototypes, the design manager depends on the specific expertise of his employees to reduce uncertainty in both product strategy and micro-level task knowledge. In most situations that demand knowledge specificity, Wruck and Jensen (1994) find that the overall knowledge needed to conduct a transaction is typically dispersed among several employees.5 Teamwork helps collate all such knowledge, which explains why all the managers in Adept find teamwork inevitable.
To ensure that there is no other omitted cause or reason for teamwork, we checked with all Adept managers. The responses of most managers point to the same explanation of knowledge specificity, with the exception of the human resources manager who cited another reason, ‘small company culture’, which can also drive Adept’s teamwork. Her argument is that, in a small firm, employees tend to have a close relationship with each other and, therefore, are more likely to help each other intra- and inter-departmentally to achieve the firm’s goals.
According to the human resources manager:
[i20] ‘In the past two years, the company has grown from 65 to more than 100 staff; in terms of sales (revenue), from $9 to $11 million. The company was initially small… the small company culture (where everyone helps others willingly) is still continuing in a growing company’.
In our analysis, we find that it is not possible to completely rule out this alternate reasoning, given the firm’s small size (even if one takes the recent growth into account). However, we argue that the ‘small company culture’ and ‘knowledge specificity’ may not be competing explanations, as both are endogenous to the nature of Adept’s business. The design and manufacture of molds requires specialized knowledge that is dispersed throughout the firm, and a strong teamwork culture that is more naturally present in a small firm. Both explanations are plausible and likely to be synchronous.
We now explain the opportunism sources and control in terms of the theory. We reiterate the design and mold-building managers’ concerns about the scope for employees’ opportunistic behaviors such as hiding inefficiency, and working just prior to reviews. Jensen and Meckling (1992) argue that such behaviors arise with the information asymmetry that exists in teamwork. Alchian and Demsetz (1972) predict that as individual members’ inputs or efforts are not costlessly observable, a member can shirk so long as other team members compensate for the loss of overall team output or so long as the share of profits from the teamwork is higher than the value of leisure.
To overcome shirking, Alchian and Demsetz (1972) suggest that the team leader be vested with monitoring rights to oversee members’ contributions to the team, along with the right to share in the excess proceeds that remain after paying all the team members. In effect, Alchian and Demsetz advocate the role of decision rights to monitor performance and compensation to motivate improvement.
Fama and Jensen (1983, pp. 303–304) identify a more structured set of four decision rights: (i) initiating alternate investment projects; (ii) approving a specific project; (iii) executing the project; and (iv) monitoring the project decisions. They classify initiation and execution as decision management and approval and monitoring rights as decision control rights to oversee decision management tasks.
Delegation of decision rights for a transaction depends on where the specific knowledge resides (Fama and Jensen, 1983; Jensen and Meckling, 1992). In Adept, we find that the design and mold-building workers take part in decisions such as initiating and planning different design and mold-building tasks for each job. However, the evidence suggests that the design and the mold-building managers do not completely decentralize the initiation rights to their workers, but share them with the workers of both departments. We also find that while design and mold-building managers delegate the execution rights fully to worker teams within their respective departments, the managers share the monitoring rights with workers when they involve their department workers to oversee co-workers’ contributions to teams. In short, the managers delegate only execution rights to worker teams but share all other decision rights (initiation, approval and monitoring) with different teams. The evidence suggests that Adept managers carefully divide different areas of expertise and align (i) fully delegated or shared decision rights with (ii) intra- or inter-departmental teams. The need for such large-scale sharing and inter-departmental teamwork explains why Adept encourages an ‘open-door’ culture together with a flat organizational structure.
We find that decision right allocations in Adept are consistent with the underlying theoretical rationale. While managers hold specific knowledge in relation to the identification of how a particular customer order matches the firm’s objectives (strategic fit), workers hold expertise in determining the feasibility of making the order. Both these areas are important during the initiation and planning phase, therefore, the manager shares the initiation right with their worker teams. In regard to the approval right, the design and mold-building managers find that while the customer guides the product specifications, the production manager is the expert when it comes to the manufacturability of the design, hence the approval process is shared with a team comprising the production manager and the customer.
Although decision rights are clearly allocated, TCE suggests that teamwork-related opportunism, such as hidden inefficiency and work postponement, will continue to exist so long as performance is not measured. The problem of performance measurement in customization, how it exacerbates the teamwork opportunism, and how the performance problem is controlled, are now examined.
4.2.2. Performance measurement problem and opportunism
Just reiterating, the performance evaluation process in Adept involves managers using only job-related measures (e.g. charge-out time and quoted job hours) for two reasons: job-related measures capture overall team performance, and individual performance is not costlessly measurable. We also find that when managers use overall measures, they partly evaluate their own performance as they also take part in the initiation and planning of the jobs.
In theory, one can segregate managerial activity (e.g. determining strategic fit) from the worker teams’ activity (e.g. deciding manufacturability) within the decision management right. Observations, however, suggest that it is practically difficult in a customization context to segregate the performance of managers and worker teams, let alone the performance of different workers within a team. Some managerial self-evaluation seems likely in a customization context, although this is a future empirical question. Fama and Jensen (1983) suggest that initiation (being part of decision management), and monitoring (being part of decision control) must not be vested in the same person because of the scope for opportunism. Hence, questions as to whether managers engage in opportunism and how CEOs control managers’ performance, fall outside the scope of our paper and are, therefore, left unexplored.
As the second reason, unobservable individual performance, accentuates the scope for opportunistic behavior, Adept managers use subjective measures to evaluate individuals within teams to control potential opportunism. Along with their own judgment, managers also use the feedback gained from co-workers for subjective evaluation because the managers believe that they have better information about a worker’s team contribution.
Transaction cost economics suggests that opportunistic actions typically increase costs or delay the time taken to complete a customer order, unless the noncompleted work of the opportunist worker is compensated for by co-workers. If this work is performed by other workers, the opportunist worker is said to be ‘free-riding’ at the cost of other co-workers’ efforts (Brickley et al., 2001). If the work is not completed because either the other workers are already working at optimum capacity or the work is too specialized, the team is unlikely to achieve its cost and time targets. In this case, the opportunist worker is considered to be ‘free-riding’ at the expense of team objectives (Alchian and Demsetz, 1972). Whichever way free-riding occurs, Adept’s use of subjective measures is consistent with Alchian and Demsetz’s (1972, pp. 790-91) view that managers can control free-riding with the ‘use of subjective indices such as team spirit and loyalty’ to evaluate an individual’s contribution to the team.
What if all the team members collude to boost each other’s subjective scores in a bid to cover up free-riding? To reduce the chances of collusion among team members, Brickley et al. (2001) argue that a link between incentive compensation and team performance (e.g. the team does not get a bonus if the overall team goals on cost and time schedules are not achieved) is necessary. We now move to examine Adept’s incentive compensation practices.
4.2.3. Ad hoc incentive compensation problem and control
As previously mentioned, Adept distributes incentives based on the overall firm’s performance either as a fixed equal amount or as a percentage of the salary of each employee at the discretion of the OMD. The OMD also has the discretion to deduct or withhold the incentive payment to any particular employee if his or her subjective evaluation is deemed not to be sufficient.
Transaction cost economics suggests that team-based measures are instituted in customization as individual worker performance is hard to identify. Generally, teams can be rewarded based on their own performance if they undertake jobs with a project focus from start to finish. In Adept, although the design and mold-building departments mainly form teams with members from their respective departments, they also interact with each other for many types of decisions such as mold designs, and with other support departments such as maintenance and project control. The inter-departmental interactions render the determination of the performance of any individual department difficult, hence, Adept considers the whole firm as one team for the purposes of incentive compensation.6
The OMD generally uses Adept’s overall performance results, such as ‘revenue’ and ‘profit’, as the criteria for declaring a bonus for all employees. The OMD’s discretion in determining what constitutes good overall performance (in revenue and profit), and the surprise element in declaring bonuses, are inter-related factors. As the OMD neither sets a clear overall performance goal nor determines the amount appropriable as the overall annual bonus pool, the surprise element exists. This element, however, may not always encourage better performance because a worker seldom knows whether (and when) he or she will get a bonus.
To the best of our knowledge, there is no literature evidence or theoretical reason to believe that discretion and surprise elements are particularly relevant to motivating performance in customization. On the contrary, there is reason to believe that when the overall performance goals and bonus pool are set ex ante, workers are more likely to be motivated to achieve targets for every custom order, which together can help the firm achieve its overall goals (see real-life examples in Merchant and Van der Stede, 2007, p. 89). This is likely to be possible when a firm implements an open-door culture and meets workers regularly to convince them that everyone plays an important part in delivering a custom order.
Therefore, we believe that the presence of discretion and surprise elements in Adept defies theoretical generalization except to say that this unusual observation or anomaly merely reflects the individual preference of the OMD. In our study, we find that this is the only area within Adept that was not theoretically generalizable, and therefore, we have excluded this from our refined theoretical model. Although we attribute this anomaly to the less common hierarchical positions such as the OMD, one may argue that we could hit upon such inconsistencies even in public limited firms. Having said this, we still believe that we know precious little on the elements of discretion and surprise in incentive schemes and therefore they are potentially rich areas for future research.
4.2.4. Summary of theoretical analysis of employee opportunism and control
In order for a customization provider to efficiently collate the dispersed specific knowledge, managers institute ex ante controls such as sharing the initiation right with worker teams, sharing the approval right with inter-departmental teams, and fully delegating the execution right to worker teams. As individual performance in teamwork is not easily observable, the scope for opportunism increases. To reduce opportunism, managers institute ex post controls including combining team performance with subjective assessment of individual team members. As workers have more specific knowledge about co-workers’ subjective performance, managers also share the monitoring right with the teams. To control the consequent scope for collusion among workers to boost each others’ subjective scores and reduce the overall team output, incentives are based on the teams’ overall performance (and the whole firm’s overall performance, in case there is inter-team involvement) and are distributed to individual members based on their subjective contribution scores. As the manager also plays a role in initiating the tasks, the worker team’s execution performance is also partly a reflection of the managers’ own performance. We do not examine the potential for managerial opportunism as it is outside the scope of this paper.
Note that, in Adept, the evidence that most decision rights (except execution) are shared among managers and workers matches the further evidence that managerial self-evaluation is inevitably mixed with workers’ performance evaluation, which again agrees with the evidence that incentive compensation is based on firm-level rather than individual or team-level performance. This chain of evidence offers increased confidence, not only in the presence of links among different control elements but also in building a theoretical explanation that uncertainty and knowledge specificity necessitate teamwork. Figure 2a clarifies the theoretical expectation of opportunism in teamwork and Figure 2b captures how teamwork in customization leads to opportunism with different set of control solutions. Customization providers require a series of compounded layers of both ex ante and ex post controls that require iterative changes to control employee opportunism in provider firms.
(a) General economic theory expectation. (b) Specific economic effects of customization.
5. Conclusions
Each customized product is likely to have unique product attributes. In a customization provider firm, the design department originates a series of activities within the firm as it is at the first contact point with the customer. As the design manager works with his or her employees to verify the customer order and build a design contract, the firm seeks to reduce knowledge uncertainty for the customer. In a contract of equally bilateral dependence, both parties are likely to continue the contract because both parties would lose if they opt out of the contract. However, in the case of a customization provider firm which has few market avenues but a higher investment burden in the order relative to the customer’s investment in the firm, the customer holds the first opportunity to use the knowledge at the cost of the provider and walk-away to bargain with an alternative provider. Further, once the provider firm commits its investment, it is more susceptible to customers’ denial or order cancellation threats. Consistent with the theory, the Adept general manager attests to perceived threats of customer opportunism. While the potential for payment denial threats is managed through legal protection, the cancellation threat is managed by withholding design information and creating information asymmetry. Although the dependence is high, the ex ante controls that Adept institutes help resolve Adept’s perceived vulnerability to customers.
However, in the process of withholding specialized design knowledge, the firm becomes more vulnerable towards its employees. The design knowledge that is created and withheld is obviously not general knowledge that is widely understood by one and all in the firm but very specialized knowledge that is dispersed only among a few expert design engineers (e.g. Jensen and Meckling, 1992; p. 260; Wruck and Jensen, 1994). Effectively, in relation to specific customer orders, these engineers are the only resource in Adept that hold the specialized knowledge. Adept’s managers are therefore dependent on these engineers to pool their knowledge via teamwork to execute a specific customer order. In teamwork, however, TCE (Alchian and Demsetz, 1972; Jensen and Meckling, 1992; Watts, 1992) states that objective evaluation of an individual member’s performance is not easy and, therefore, information asymmetry is likely to increase when one party transacts with a team rather than an individual.
In turn, increased information asymmetry promotes unique problems employee opportunism in customization context. For instance, the specialized engineers may use their knowledge to hide their inefficiency or disown responsibility (e.g. Adler et al., 1997). As this problem keeps recurring for each specific customer order, the solution-finding becomes an on-going exercise of management of vulnerability towards employees. In summary, while the need to withhold the design knowledge protects the firm against perceived customer vulnerability, the same withholding increases the firm’s vulnerability towards employees.
Adept manages teamwork with appropriate allocation of decision rights, including sharing of monitoring rights with worker teams for assessing the subjective contribution of coworkers. To avoid collusion among team members, Adept links the overall team-based compensation to the required overall target performance criteria. In sum, Adept adopts a series of both ex ante and ex post control mechanisms that are continually managed to ensure that employee opportunism is mitigated.
What begins as asymmetric dependence with customers turns into information asymmetry with employees because of task uncertainty, need for specialized knowledge and teamwork which, in turn, create vulnerability with employees. While perceived vulnerability with customers is removed by ex ante controls, employee dependence requires compounded layers of control to manage each specific customer order and, therefore, becomes an on-going exercise of control of vulnerability. We offer this as the theoretical explanation behind why customization providers are apparently more vulnerable to employees than to customers.
