The Significance of Relational Contracts

Question 1
Background:
A relational contract can be described as “informal agreements and unwritten codes of conduct that powerfully affect the behavior of individuals, clearly emphasizing the informal nature of contracts.” (Ho?hn 35) They help businesses overcome obstacles typically faced in formal contracting. Formal contracts must be written in a manner that allows for easy verification by any third party, therefore must be self-enforcing. (Ho?hn) The basis for relational contracts is self-enforcement, especially when relationships are finite. When relationships remain open-ended, the situation changes. Meaning, inclusion of extensions with information self-enforced provisions. When these changes happen, such contracts become self-enforced relational contracts. (Ho?hn) Thus, begins the ‘trust game’.
The trust game is simple, player 1 must choose to ‘trust’ or ‘not trust’ player 2. If player 1 ‘trusts’ player 2, player 2 can have the opportunity to betray or honor player 1. Should both parties not betray each other, they each get a payout. However, when one party betrays they other, they may get a payout of two, rather than one. (Ho?hn) It is important to explain the concept of relational contracts and the ‘trust game’ because of the inherent aspect of trust within the partnering terms. “The Partnering team members shall work together and individually in the spirit of trust, fairness and mutual cooperation for the benefit of the project, within the scope of their agreed roles, expertise and responsibilities as stated in the partnering documents”. When companies or parties aim to trust each other, their expected payouts are one, but allow for an open-ended relationship that can grow and expand to suit the needs of both parties. Such flexibility could be crucial in proper development of the desired aims within a new or existing relationship between two or more parties, potentially leading to positive outcomes.
PPC 2000:
The key factors of partnering are:
1. Collaborative working
2. Selection of advisers and partners
3. Maximization of effectiveness related to resources
4. Specific and concise aims/objectives
5. Teamwork and commitment
6. Ongoing improvement/performance measurement (MacRoberts)
These areas when performed correctly lead to proper partnering and improved outcomes for both parties. For example, collaborative working is a time-intensive endeavor that requires extensive communication between both parties and compromise regarding what each party can get from the other or from the overall objectives. However, when executed correctly, collaborative working allows for a cohesive, effective, and functioning effort that can last long-term. (MacRoberts)
What is PPC 2000? “PPC is a multi-party contract: not only do the client and the contractor enter into the contract, but also the client’s representative and any consultants appointed by the client, and possibly certain specialists.”(MacRoberts 19) PPC 2000 encourages partnering relationships with specialists that may become full members of partnering teams allowing for the execution of a joining agreement. Additionally, PPC 2000 offers establishment of a core group comprising of key people who undertake and make decisions related to regular previews, performance and progress. (MacRoberts)
When partnering is involved, the likelihood of incorporating other best practices like good communications, fair allocation, risk analysis and management, and strong project programming and management increases. See diagram 1 for the various potential parties involved. When it comes to mutual cooperation or good faith, there are duties to disclose latent defects, carry out the work with care and skill, and cooperate as needed to permit contractors to perform designated tasks. (MacRoberts) The PPC2000 is designed to cover the entirety of the process from design, supply, and construction. To pursue a mutual cooperation, parties must fulfill specific duties and integrate everything under a single multi-party contract.
When it comes to assessment of performance within these kinds of contracts, one must examine the agreed financial sanctions or benefits and against agreed KPI’s. By looking at incentives and profit and overhead, parties can manage potential hurdles that naturally arise in these kinds of partnerships. The Problem-Solving Hierarchy involves period to resolve, the Core Group, mediation, conciliation or other forms of ADR, and litigation or arbitration (MacRoberts).
Partnering Terms:
As previously stated, a core aspect of partnering is trust. Therefore, there must be some level of assurance that both parties or however many parties involved, take on specific responsibilities and put forth a collaborative effort. “Early involvement of key parties, transparent financials, shared risk and reward, joint decision-making, and a collaborative multi-party agreement are some of the features incorporated in all the arrangements to a varying degree.” (Lahdenperä 57) By agreeing to joint decision-making and having for example, transparent financials, such efforts provide an environment from which partnering team members can build trust and therefore, commit to a long-term endeavor. While project partnering allows for growth of trust and communication, there is another more extreme mode of operation called partner alliancing. “Similarly, project alliancing takes relational contracting to the extreme compared to the current forms of integrated project delivery and, especially, project partnering.” (Lahdenperä 57)
What is project partnering and project alliancing? Project partnering “is a single project application of a management approach used by two or more organizations to achieve specific business objectives…(Lahdenperä 58) Project alliancing describes the approach of “delivering major capital assets where owner and non-owner participants work together as an integrated, collaborative team in good faith, acting with integrity and making unanimous, best-for-project decisions, managing all risks of delivery jointly, and sharing the outcome of the project.” (Lahdenperä 58) Integrity is a key aspect of project alliancing and something that should be considered regarding partnering terms. When parties involved in the relational contract all have a good sense of integrity, rule-breaking and underhanded behaviors are less likely to occur. Relational contracts then become the sign post from which interested parties who wish to work together may use to achieve shared and individual objectives.
From the viewpoint concerning relational contract theory, “all contracts have a relational element in the sense that all economic exchanges happen in a relational context.” (Gil 145) Examining things at one end is the subject of discrete contracts and the emphasis on planning, precision, wholeness, and tight measurements of performance. These kind contracts suit situations where there is limited personal interaction and involve short-term transactions. (Gil) Whereas at the opposite end are intertwined or relational contracts with emphasis on reciprocity, cooperative behavior, and mutual dependence. Relational contracts are useful for long-term transactions in need of adaptability and flexibility. Considering relational contract theory puts on full display the variety and complexity of contracts, it reinforces the realization that contracts require cooperative social behavior within a team setting.
That is why relational contracts are so important for the proper integration of positive values within a partnership. For example, the T5 Project concerning the Toyota production system allowed for an analysis on the business infrastructure and technical processes involved in long-term cooperative relationships among suppliers and assemblers. (Gil) “In this system, first-tier suppliers are not selected on the basis of bids, but rather on the basis of past relationships and a proven record of performance.” (Gil 150) By observing past relationships and witnessing a good track record, that all important trust building begins. To recap, trust, integrity, communication, and use of relational contracts allows for the growth and positive interactions between parties interested in a long-term functional business relationship.
The Importance of Relationships:
In the present day, firms and organizations pay more attention to the management of relationships than to maintaining contractual terms. Although things like litigation and arbitration can and are used if conflicts arise, the need to spark a casual, non-formal arrangement allows for growth of esteem, trust, and communication. (Seshadri) Neoclassical as well as arm's-length contractual relations decrease “lean” working ensuring the opposite of desired outcomes like defensive behavior and mistrust, potentially adding to transaction costs leading to a prioritization of maintenance of trust. (Seshadri) Antagonistic methods to contracting as seen in the construction industry, have led to diminished effectiveness with lower productivity levels. The opposite is seen with relational contracting as companies and organizations see an increase in efficiency and trust through sound development of partnering agreements, reviews, and joint team goals, enhancing financial returns and minimizing conflicts and accidents. (Seshadri)
Relational contracts and the focus on relationships strips down the past reliance on formality. While there is room for formal contracts such as the case in royalties and so forth, for partnerships, especially long-running partnerships, management of relationships remains key in acquiring and accomplishing shared and individual goals for all parties involved. As businesses expand to become multi-national corporations, these strategies to manage relationships allows for positive outcomes in various situations. Because companies then prioritize trust building above formalities.
In conclusion, partnering terms should focus on relationship management. Things like trust building, communication, and even removal of some formalities, allows for the growth of parties regarding shared objectives. Relational contracts are the foundation from which relationship management can begin. A key aspect of relational contracts is integrity. When both parties have a high sense of integrity, there is more fairness within the interactions and a greater sense of duty.
Question 2
Some partnering terms that may be problematic for the Partnering Team Members are: integrated design/supply/construction process and supply chain partnering. If one looks at the guidebook on pages 65-68 it explains the ten common pitfalls. When problems arise, they may result from common issues that occur through any partnering process. For example, the integrated design/supply/construction process. 10.2.1 describes when a client is not actively involved as a Partnering Team member. When looking at the various roles and responsibilities of the members, PPC2000 does not mandate clients to take over duties or roles not assigned to them. If one person or party fails to do their assigned task within the integrated process, issues may occur leading to ineffective action and diminished effectiveness. Although the client is not required to invest time in the inner workings of the process, not doing so can in turn discourage or limit openness and trust. The process is often so complex, involving multiple parties aside from the core group, that active participation from the client may often be warranted in order to produce positive outcomes.
One must also take into consideration local problems that can affect efficacy of individual actions. For example, if the process involves different locations, different cultures, and thus, different laws, there may be actions certain parties cannot complete. “…the rapidly increasing burdens of local liability are largely the result of the confluence of political economy incentives and policy imperatives amplified by central-local relationships and unbalanced economic development.” (Xiao 163) It is then the responsibility of other parties and in particular the client to assess the situation and be responsible for the results. Frequently a myriad of problems could arise, and it is up to the client to decide to take on more responsibility to fulfill objectives. While the PPC2000 facilitates relationship management, it does not enforce responsibility past assigned duties. Therefore, emphasis should be placed on handling one or more duties should the need for it transpire.
Another key aspect to manage is supply chain partnering. One pitfall that could happen is discussed in the guide on page 66, 10.2.3, failure to select the constructor and specialists early. While PPC2000 is innovative in its ability to allow for establishment of an integrated set of contractual processes and relationship early on in the ‘pre-construction’ phase, postponing signatures can shorten this phase and delay involvement of key specialists and constructor. Constructors for example, need to be appointed in the beginning to make major design contributions. The same can be said for specialists and their contribution to design development before or after formal selection.
When actions are postponed and thus leading to a chain effect of further delays, this can turn a small issue into a significant one. A potential solution when applied to the supply chain partnering aspect is traceability. “Traceability is another requirement to many remanufacturers. Due to product liability and configuration control, the enterprise may wish to link the parts that come off on assembly directly back to the original assembly.” (Ptak and Schragenheim 388) By tracing back where the parts were originally assembled, it removes some of the guesswork related to inputs during preconstruction phases. The aim is to reduce liability and to do so means to connect and understand where certain processes began and linking them to the appropriate situation. The supply chain is often a complex process especially when deciding to partner up with other manufacturers. The quality of items may be different than desired and can lead to issues along the way.
A key example of this is Mattel. Mattel contracted a Chinese manufacturer who then contracted another Chinese manufacturer to paint specific toys. The quality of the paint was not known to Mattel or even the initial Chinese manufacturer, leading to an oversight problem and lead painted toys. “Mattel, the maker of Barbie dolls and Hot Wheels cars, is recalling nearly one million toys in the United States because products are covered in lead paint. According to Mattel, all toys were made by a contract manufacturer in China.” (Story) Because Mattel did not investigate the origin of the manufactured toys, they experienced a liability problem with their merchandise. If kids became exposed to lead due to the lead painted toys, the company could face multiple lawsuits. Therefore, it is important to understand where products and parts come from and choose constructors and specialists early to avoid the frequent pitfalls associated with the supply chain. Many problems may come from lack of knowledge and lack of communication often seen in these scenarios.
Question 3
Limiting supplier liability is a great solution to the issues found in supply chain partnerships and so forth. There exists a three-part methodology aimed at covering liability protection for a supplier. Although not an exact science, it offers a potential answer to the question of quality control and management of issues or obstacles. Ultimately, how a supplier limits liability depends on various factors like kind of service or product or size of company. The first part is “limit supplier obligations to the customer”. By committing to explicit and clear obligations, a business eliminates any additional problems through uncertain or unclear responsibility to the consumer. (Pecht) For instance, one must exclude common or statutory law implied obligations by defining excuses through analysis of supplier performance. Lastly, to limit liability for this section, the business must restrict impact of precontract statements created by the supplier to customers, as well as include whole agreement/non-reliance clause. (Pecht)
The next step is to limit procedure remedies and specify and clarify procedures to bind to customers. One does this by imposing a time limit regarding customer claims. (Pecht) Additionally, there may be exclusion of a customer’s right of set-off and placement of conditions on claims by customers. By limiting the claims not just for customers, but also third parties, there is automatic reduced liability. Something subtler could be treating customers ‘acceptance’ as waivers for any future customer claims. (Pecht)
The third and final step in the methodology is limiting supplier’s lability for loss and damages to customer. By excluding outright, specific types of customer loss and accepting other losses of customer with a financial limit, suppliers then provide some relief for customers while removing the burden of complete financial liability should a product or service fail. (Pecht) Also, being vigilant if customers cap their own liability can lead to increased quality of assessment and decreased liability.
One book highlight how to limit liability through the use of information technology (IT) as a means of an ongoing assessment of circumstances that could lead to negative outcomes.
To limit liability and negligence claims, a company may choose to implement strict risk reduction mechanisms. To this end, IT can be used to continuously evaluate the impact on the environment from industrial processes. This can be done by monitoring emissions from facilities, tracking the transportation of goods and services, collecting information about the effects of certain chemicals, and monitoring the use of products by customers and throughout the product life cycle. (Bevilacqua, et al. 144)
One aspect covered like tracking the transportation of goods and services may be a great way to assess quality. Going back to the Mattel example, if they tracked where their supplier got their goods from, they could have potentially identified the faulty products used (lead paint) before costly problems arose. Avoiding a recall should be the chief desire of any supplier. As Mattel is a toy supplier for children’s stores and their customers are mainly children, having lead painted toys could cause serious liability issues for the company. Simply putting more effort in tracking products and their origins could result in reduced liability and reduced negative outcomes. These are things to pay attention to when acting in the role of supplier and attempting to deliver a quality product to consumers or a supply partner.
In conclusion, there are many possibilities to decrease and successfully manage liability. From decreasing claim times for customers to changing or limiting the conditions for claims for customers and third parties, suppliers can do what is needed to avoid potentially devastating financial losses due to limited liability. While the approach to decreasing or minimizing liability is limited, such a solution is just one of many available to combat the common issues regarding liability. It is a complex problem and often warrants several approaches or methodologies to successfully resolve. However, reduction of liability is a great first step that can lead to even more effective solutions and approaches.
By tracking products or services and tracing back their origins, that can also be a great method to reducing liability. Suppliers and manufacturers may contract to other suppliers and manufacturers, derailing the quality control assessments made from the initial company. But through communication with suppliers and manufacturers and performing origin and quality control checks on an ongoing basis, liability greatly reduces. Quality is a hallmark of an effective supply chain. When the quality diminishes, liability increases due to problems in products or services and customer satisfaction. Customer satisfaction should be at the forefront of the supply chain.

Works Cited
Bevilacqua, Maurizio, et al. Design for Environment As a Tool for the Development of a Sustainable Supply Chain. Springer, 2012.
Gil, Nuno. "Developing Cooperative Project Client-Supplier Relationships: How Much to Expect from Relational Contracts?" California Management Review, vol. 51, no. 2, 2009, pp. 144-169, doi:10.2307/41166484. Accessed 26 Aug. 2018.
Ho?hn, Michaela I. Relational Supply Contracts: Optimal Concessions in Return Policies for Continuous Quality Improvements. Springer-Verlag Berlin Heidelberg, 2010.
Lahdenperä, Pertti. "Making sense of the multi-party contractual arrangements of project partnering, project alliancing and integrated project delivery." Construction Management and Economics, vol. 30, no. 1, 2012, pp. 57-79.
MacRoberts. Macroberts on Scottish Construction Contracts. John Wiley & Sons, 2014.
Pecht, Michael. Parts Selection and Management. John Wiley, 2010.
Ptak, Carol A, and Eli Schragenheim. ERP: Tools, Techniques, and Applications for Integrating the Supply Chain. 2nd ed., CRC Press, 2016.
Seshadri, Sudhi. Sourcing Strategy: Principles, Policy and Designs. Springer Science+Business Media, Inc, 2005.
Story, Louise. "Lead Paint Prompts Mattel to Recall 967,000 Toys." The New York Times - Breaking News, World News & Multimedia, 2 Aug. 2007, www.nytimes.com/2007/08/02/business/02toy.html. Accessed 26 Aug. 2018.
Xiao, Kezhou. "Managing Subnational Liability for Sustainable Development: A Case Study of Guangdong Province." Fiscal Underpinnings for Sustainable Development in China, 2017, pp. 163-187.