Co-evolution Alliances in Vertical Relationships: The Knowledge Economy Perspective
Date Issued
2012
Date
2012
Author(s)
Hung, Der-Fang
Abstract
This research emerges from a phenomenon which occurs in knowledge-intensive industries where equipment companies collaborate unceasingly with their customers. Scholars refer to it as co-evolution (Koza & Lewin, 1998; Levinthal & Myatt, 1994; Sturgeon & Lee, 2001; Volberda & Lewin, 2003; Wilson & Hynes, 2009). I ask a fundmental question, why the co-evolution phenomenon exists in a vertical relationship. From the viewpoint of economists, a co-evolution alliance could be a different source of economic rent, such as relational rent (Dyer & Singh, 1998). For strategists, a co-evolution alliance could be a different source of competitive advantage, such as foreclosure (Allen, 1971; Hart et al., 1990; Rey & Tirole, 2007). However, from the viewpoint of knowledge economy, the reason why the co-evolution alliance emerges is the transaction cost derived from knowledge characteristics, that is, knowledge complexity, knowledge specialization, knowledge asymmetry and knowledge noncontractibility. This thesis is concerned with the firms’ strategies in a vertical relationship and defines a co-evolution alliance as a cooperative arrangement in which the knowledge change of one firm will influence the knowledge change of its counterparts over time. According to the definition, it is obviously belong to a firm-level study. In addition, this research regards a co-evolution alliance as a strategic choice for a firm pursuing its best performance according to the rule of maximizing profit. Moreover, governance cost in this thesis is viewed as the aggregation of the cost induced by knowledge complexity, the effect contributed by knowledge specialization, and opportunistic cost. Accordingly, how to prove the governance cost of a co-evolution alliance is less than the cost of market and the cost of a firm becomes the core research question. Hence there are three hypotheses which need to be supported. The first hypothesis is that the governance cost of the market is greater than that within a firm under high knowledge complexity. The second hypothesis is that the governance cost within a firm is greater than that of a hybrid mode under high knowledge complexity. The third hypothesis is that considering opportunism cost, the co-evolution alliance is the optimal hybrid mode under high knowledge complexity.
In reasoning, I argue that the relational rent which is proposed by Dyer and Singh (1998) is one of the sources for maximizing profit. But that raises another question: why does a firm not integrate the counterpart if their cooperation is frequent and profitable? The core of this question could be viewed as an issue of vertical control, that is, the decision of trade-off between vertical restraints and vertical integration.
The distinction between vertical restraints and vertical integration is the consideration of transaction costs, in particular contracting costs. Without transaction costs, the advantages that result from vertical integration can be replaced by vertical restraints (Chen & Hylton, 1998; Mahoney, 1992). In fact, transaction costs can be discovered in most of exchange relations and can vary with the characteristics of transacted objects. In knowledge-intensive industries, knowledge is the important resource and the core transacted object. Hence, knowledge characteristics influence the transaction cost and the choice of vertical control mode.
According to Fransman’s (1998) research, knowledge can be defined as processed information with a tacit and context-dependent nature. It has two important characteristics: knowledge complexity and knowledge specialization. Knowledge complexity originates from the interactivity of knowledge (Goldwasser, Micali, & Rackoff, 1985). In other words, knowledge that can be accessed without any interaction has zero complexity (Goldreich & Petrank, 1991). Knowledge specialization, derived from the undiminished feature of knowledge as it is used (Foss, 2005), could be defined as the applied cost of knowledge that is reduced by deploying frequently. Hence, the transaction cost of a firm is related to knowledge complexity and knowledge specialization. The transaction cost will increase as the knowledge complexity is growing; contrarily, the transaction cost will reduce as the knowledge specialization is deepening.

The knowledge cost function can be derived by combining the two transaction costs and the cost of possessed resource into the knowledge production function. As a result, the knowledge cost function has maximum cost when a firm owns two knowledge varieties simultaneously. Furthermore, if the rate of coordination cost of the market to governance cost of a firm is greater than 1, it means that the governance cost of the market is greater than that within a firm. Otherwise, it means the governance cost of the market is less than that within a firm. As a result, the rate is greater than 1 when knowledge complexity gradually increases. Accordingly, this result supports hypothesis 1, which suggested that the coordination cost in the market is greater than that within an organization as knowledge complexity gradually increases.

Similarly, if the rate of coordination cost of a firm to governance cost of a hybrid mode is greater than 1, it means that the governance cost of a firm is greater than that within a hybrid mode. Otherwise, it means the governance cost of a firm is less than that within a hybrid mode. As a result, the governance cost within a firm is greater than that of a hybrid mode as knowledge complexity gradually increases. In other words, a firm is not an optimal governance type when a new production process needs to integrate two different knowledge sets. This implies that cooperative co-specialization has its economic value. Hence, this result supports hypothesis 2, which stated that the governance cost within a firm is greater than that within a hybrid mode as knowledge complexity gradually increases.

Considering only knowledge complexity and knowledge specialization, I directly prove that the hybrid mode is an optimal choice in the case of co-specialization. In the next step, I consider opportunism costs, which stems from knowledge asymmetry and knowledge noncontractibility, and put it into the knowledge cost function to prove that the co-evolution alliance is the optimal governance mode among three hybrid modes: strategic alliance, alliance portfolio and co-evolution alliance. If the same calculative technique is applied, the rate of governance cost of strategic alliance (or alliance portfolio) to governance cost of co-evolution alliance shows that the governance cost of the co-evolution alliance is the least among the three hybrid modes. This result implies that a co-evolution alliance is the optimal governance mode when considering opportunism costs under high knowledge complexity, which supports hypothesis 3.


Subjects
Co-evolution Alliance
Strategic Alliance
Alliance Portfolio
Knowledge Complexity
Scope Economy of Knowledge
Opportunism Cost
Type
thesis
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