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Comparative Supplier Relationsin the U.S. and Japanese Auto Industries:An Exit/Voice Approach

Susan HelperCase WesternReserveUniversityIn 1980 Japansurpassedhe United Statesas the world's eadingproducerof automobiles. ot only doesJapannow produce he greatestnumberof carsof any country n the world [9], it introduces ew models

with the greatest requency 7], makes hem in factorieswith the highestproductivity 19], and dominatessurveysof customersatisfaction ndfrequencyof repair [8, 19]. Observershave attributedmuch of thisperformanceo Japaneseutomakers'ubcontractingystem,n arrangementbasedon long-term elationshipsith suppliers, greatdeal of informationexchange,oint problemsolving, nd governancey trust 7, 10, 30].While culturalpredispositionsre undoubtedlymportant n explainingthe structure f Japaneseubcontracting,n this paper will try to explaindifferencesn supplier elationssystems ased on economic actors andhistoricalevents. This is not to imply that cultureand historyare entirelydistinctcategories. or example,f historical ventshaveshownpeople heefficacy f trust,they are more likely to be trusting n the future.Hence,culturalnormssuchas trust can be the precipitateof history 11, p. 91].The first section f the paperoutlines conceptualramework asedon Albert Hirschman's istinction etweenexit and voice [16]. The secondsectionuses this framework to analyzebriefly the evolutionof supplierrelationshipsn the U.S. auto ndustry nd the third section xaminesevenmore briefly) the Japanese uto industry.ConceptualFramework

Many problemscan arise in a relationship etweencustomerandsupplier. or example, uppose ne partywants he otherparty o undertakea specific ction lower ts price, mprove ts quality),but the other partyrefuses, itherbecauset lacks he capabilitydecisionmakers n the firmdo not knowhow o implementhe proposedhanges), r becauset lacksthe incentivedecisionmakers aveother,moreprofitable, ourses f actionopen o them).Anotherpossibilitys that one partymay feel that there sa problem the customer ay indthat its productsren'tselling swell asit would ike), and believe hat changed ehavior y the otherpartywould

BUSINESS AND ECONOMIC HISTORY, Second eries, olumeNineteen, 990.Copyright c) 1990 by the Business istory Conference. ISSN 08494825.153

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contribute o its solution,but is not able to proposea specificcourseofaction.BorrowingHirschman'serminology,we can identifytwo types ofresponsesoproblemsrisingn a customer-supplierelationship:(1) exit,where the customerirm's responseo problemswith a supplier s to finda new supplier, nd (2) voice,where he customer'sesponses to workwith the originalsupplieruntil the problem s corrected.Where the exitstrategy ecuresompliancey useof the stick f threats o withdrawromthe relationship,he voicestrategyelieson the carrot f increased rofitsfor both partiesdue to improvedproducts.The key to the exit strategys makingcredible he customer'shreatto leave if its demands are not met. Therefore, the customer must haveaccess o many interchangeableuppliersand/or the ability to tool upquickly or in-house roduction. n contrast, n extensive ommunicationssystems necessaryo facilitate he rich flow of information eeded or thelet'swork thingsout approach f the voicestrategy. his informationlowboth requires and engendersa high degree of commitment o therelationship.Commitment etween uyerandseller s important or threereasons.First, t is costly o establish nd maintainextensive ommunicationystemswith multiplesuppliers.Second,here s a needfor trustwhenexchanging

proprietary information. Finally, customersand suppliers can reapsubstantialenefits rom knowledge f eachother'sproducts nd processesgainedby working ogetherover time. In contrast, n exit-based trategyrequires ow commitment, o as to maintain he credibility f the customer'sthreat to leave. Therefore informationexchange lso must be low.The customer's hoiceof methodof problem esolution exit orvoice) is an importantone because t affectsboth the customer's ndsupplier'selativebargaining ower and their propensityo introducenewtechnologiesf various ypes.The exit strategy ives he customer greatdeal of bargainingpower because t has little commitment o any one

1Theermsexit ndoice riginatedn 16].haveeneralizedhis nalysiso ncludecases where the resolution of problems requires not only more effort by the partiesinvolvedbut also irreversible nvestments n physicaland organizationalcapital [13, 15].2A upplieras commitmentrombuyerhenhe uppliernowshathe uyerillcontinue to purchase its products for some length of time. This assurance can beprovided n severalways, including inancial ies such as equity investmentor long-termloans, long-term contracts, and parties' concern for their reputations or fair dealing.Commitment also can be provided involuntarily, s when a buyer faces an oligopolisticsupplier industry. That is, if a firm can obtain an input from only a few vendors, thefirm's ability o exit from a relationshipwith them is very weak. Contrary o the implicitassumptionof much of the literatureon vertical integration,equity investment n adownstreamprocess i.e., a decision o make rather than buy) is neither necessarynorsufficient or administrative oordination. For example, a financially ndependent buyerand supplier who have had long-term dealings may have oloser administrative elationsthan would two divisionsof the same holding oompany.

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supplier.Conversely,he voice strategy educes he customer's argainingpowerby increasingts costof switching etweensuppliers. On the otherhand, where significantnvestments required either to communicateheexistence f a technical roblemor to implementa solution o that problem,voice is likely to be superior. The reason is that without the detailedinformation nd ong-term ommitment haracteristicf a voice elationshipa supplier'snnovationmay well be inapplicableo the customer's eeds.Even if it is applicable, supplierwithoutsome ype of marketpowerwillhave trouble raising capital to introduce the innovationex ante andappropriatingentsromt expost13,14].I have argued that while the exit strategymaximizescustomerbargainingpower, the voice strategymaximizesmost types of technicalchange.Therefore, there existsa tradeoff between customerbargainingpowerand industryechnical hange.What determines hichpointon thistradeoff s chosenat a particularpoint in time?The driving forces n this model are the conceptsof strategyandirreversibility.trategy nters ecausearmswithmarketpower n their inalproductmarketcan use that power o change he structure f their inputmarkets.Such irms can not only act to minimize he costof inputson agivencostcurvebut theycan alsoaffect he locationof the costcurve tselfbyalteringarrierso entryn their upplierndustries.By heir hoicefsupplier elationsstrategy, ustomerarmsaffectnot only the prices heypay or inputs, ut also he potentialor technical rogress y suppliers ndby the downstreamirms themselves.A customer's trategys irreversiblen the shortrun becauset leadsboth supplierand customer irms to developparticularcapabilities ndexpectationsn a mannerwhich tends o be self-reinforcing.he feedbackmechanismsmong he forcesof technical hange,nput marketstructure,and Final-product arket structure ouldmake a supplier elationssystemquiteunstable.A cycleof supplierelations ystemsouldbe generatednwhich ach ystemarriedheseedsf tsowndestruction.

While the expectationsnd capabilitiesenerated y a givensupplierrelationssystem end to be self-reinforcing,he changesn final-productmarket structure esulting rom that supplier elationssystemmay be de-stabilizing. The scenario s that a farm would gain final-productmarketpower at least in part through ts ability to managea voice supplierrelations ystem. owever,due to the highbargaining owerof suppliersn

30fcourse,omenventionssuchs he ersonalomputer)equiredeitherery uchcapital nor very much customers specific nformation xchange. Such cheap innovationsare less likely to be feasible in an industrysuch as autos, in which huge investments nphysicaland organizationalcapital specific o a particularway of doing things have beenbuilt up overtime [1].4Formoren he bilityfdominantirmsoalterhe osturvesheyace,ee 25].5ThanksoKim larkndAlbertirschmanordiscussionf his ossibility.

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sale frequentlyook less ime than the 30 to 90-daycreditprovidedby thesupplier 24, 27]).An important xampleof supplier echnical roficiency asprovidedby the Leland, Faulconerand Norton Company.The companybegan n1890 as a machine ool company. t made an important nnovationn themanufacture f bicyclegearsand brieflybuilt motorboat ngines. he firmenteredauto productionn quantityn 1901,making ransmissionears orthe Olds curved-dashunaboutafter Olds's actorywas destroyed y fire.Entirely as a result of greaterprecisionn machining, enry Leland wasable to increasehe horsepower f the engine rom 3 to 3.7. When furtherimprovements ielded 10.25 hp, and Olds refused o accept hem becausethey would have required adical change n the rest of the car's design,Leland went into the auto businessor himself n 1902--andchangedhisfirm's name to the CadillacAutomobileCompany 34, 36].Many other important nnovations ere made by parts suppliersnthisperiod. Somewereoriginally imedat otherpurposes.Hyatt inventedthe flexible oller bearing n an attempt o perfecta sugar-canerindingmachine; imken nvented he tapered oller bearing n 1899 o reduce heneed for lubricationof carriages nd wagons 3, p. 15; 28, pp. 9, 60].Others, while automotive-specific,ere largely the work of individualswithoutsponsorshipy an automaker, uchas Bendix's tarterdrive n 1912[12]. Due to the rapid growthof the industry, utomakers nd supplierssoonbegan o make nvestmentspecifico automobile roduction. t firstthese investments were carried out in what could be characterized as avoice relationship etween inancially ndependent ustomer nd supplierfirms.According o Seltzer,Mincontrastwith its more recentpolicy, he[Ford Motor] Companywasnot thenaverse o purchasingirtuallyall of itsmaterialsand partsfrom independent roducers n the 1909-1914 eriod.The automaker hared ts growingmanagementxpertisewith its suppliers:

The Ford Motor Company purchasedmaterials for itscomponents-makers,eorganizedheirmanufacturingrocesses,supervisedheir argerpolicies, nd, n somecases, ided hemin financing roduction.he Company ecame o dependentupon the production f its specialized uppliershat its ownoperations ere requently ithin hirtyminutes f suspensionbecause f tardydeliveries f partsor materials 27, pp. 89-90, 100].The reduced nventories,made possibleby this just-in-time pproach,helpedFord keep his prices ow.In a similareffort to ensure upply, urant persuaded artsmakerssuchas Weston-Mott n Utica and Alfred Championn Boston o movenear his operationsn Flint [5, p. 118; 28; 29]. Smallerautomakers ereevenmoretightly inkedwith their suppliers;heir componentsesigns ereso specializedhat the bankruptcy f one firm couldmean he bankruptcyof the other as well [31].

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This voice-based rrangementwith outsidesupplierssoon provedunstable. rom the partsmakers' tandpoint,he combination f fast growthand industry onsolidation eant hat they soon ound hemselvesoldinglarge nvestmentshat were specifico one or two customers. or example,Alfred Sloanwroteproudlyn his autobiography29, pp. 92-93]of the largeinvestmentsis firm, the Hyatt Roller BearingCompany, ad madeby 1916:an 80% expansion f floor area (to 750,000 square eet) in three years;three private ailroadsidings;heir ownfire department; staff of chemistsand metallurgists ho sawto it that every tep n the development f rawmaterial into antifrictionbearingswas checkedby scientificmethods.But this investment as highlyvulnerable:One dismal act was revealedby our accounting: ore thanhalf our businessame rom Ford, and our otherbig customer,General Motors, dwarfed the remainder. If either Ford orGeneralMotors shouldstartmaking heir own bearings r usesome other type of bearings,our companywould be in adesperate ituation.

When W. C. Durant invited he youngcompany resident o luncheon odiscussproposalo buyhimout,Sloan as eadyo listen?Supplierswho did not make suchspecific nvestmentsoon foundthemselveso be high-cost roducers. s Ford gainedcapital,he graduallybegan o make parts he had previously ought;his company alwaysmadethem cheaperthan the former makers becauseFord would constructmachinery to do just that one ob, whereas he outsidemanufacturersadto considerther roductsith hesamemachine.7For the automakers,he combination f fast growth and industryconsolidation ave them both the desireand the wherewithal o use voicewithin their organizationswhile moving toward exit relationshipswithoutsidesuppliers. ast growth eft Ford and GM shortof trainedmanagers.

One important ource f managers as he parts ndustry, hichwasmoreestablished nd better managed.Sloan, Charles Kettering, the Fisherbrothers, nd S. L. Mott all became mportant o the success f GM; theyjoined the firm when their making businesses ere boughtout byDurantrhe uPonts29].arts6The wnersfDaytonngineeringaboratorieslater M's elco ivision)ad imilarfeelings [29, pp. 98-99].7Dodge.Ford otor ompany,070Mich up. t.BriefsndRecords27, .101;1].8Chandlernd alisbury6]citeGM'sesireogain ccesso heFishers'anagementskillsas the reason or GM's increaseof its ownership f FisherBody from 60% to 100%in 1924. In contrast o Klein, Crawford,and AJchian's [18] celebrated reatment of thisincident, Chandler and Salisburydo not mention asset specificityas a consideration.

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Industryconsolidation eant that Ford and GM were able to seeksupplier elationshipshat left them n a favorable argaining osition venat somecost o efficiency. ver the next severaldecades, .S. automakerscreated a fiercely competitive omponentsndustry.They did this byreducing arriers o entrythroughsuchmechanismss takingcomplexfunctionsike engineering nd R&D almost completelyn-house.Theyemployed everal six o eight)competinguppliersor eachpart, offeredonlyshort-termone-year) ontracts,ndrequired upplierso licensemajorinnovations.hey alsodividedparts nto small,easy-to-produceieces, ndhired managerso coordinatehe assembly f thesepartscentrally 13, 15].Growth and consolidationlso provided he dominantautomakerswith the money o buy out suppliers n generouserms and to expandinternal capabilitieso produce,design,and subassemblearts.At Ford,these undswere nternally enerated;t GM theycame rom the externalcapital market. Ford was able to use these funds to gain control of hiscompany.n particular,he was able to reducecontractingo the Dodgebrothers,who initiallyhad respondedo their problemof assetspecificityna differentway romSloan whohadallowed imselfo be bought ut); heDodges ecame ord'sdirectcompetitors,nteringhe automotive usinessin 1914 [21, pp. 279-83;21, pp. 104-06;25, p. 11].This dual system f vertical ntegration nd exit-basedelationswithoutsidesupplierswith subsequent odifications)elped o protectFordand GM againstsuccessfulntry by domesticproducersbut left themvulnerable o the Japanese n the 1970s. do not mean to imply thatvertical integrationby itself is necessarilynefficient; the customercommitment xpressedhroughvertical ntegrationmay make possiblesignificant roductivenvestment. owever, he mix of vertical ntegrationand exit chosenby US automakersin differentproportions, ut withbroadly imilar ffects)was nefficientn twoways. irst,verticalntegrationfacilitatedhe useof the exit strategywhich ostered xcessiveompetitionamong uppliers)y giving he automakers crediblehreat o tool up forin-houseproduction. econd, ertical ntegration ecame nefficientbecausethe divisionswere excessivelynsulated from competition: hey wereinsulated othby their privileged argaining ositionwithin he corporationand by the market power of the corporations ithin the U.S. economy 13,15]. Domesticautomakers ow are trying o switchback to a more voice-basedsystemooaifficult ask given the exit/vertical ntegration ystem'slegacyof mistrust, omplacentutomaker ivisions,nd weak ndependentsupplier irms.The JapaneseExperience

Like their US counterparts,apanese uto suppliersn the earlydaysof their industry 1925-45),usedgeneral-purposequipment nd soldonlya smallportionof their output o the auto ndustry 30]. Japanese uppliersgraduallydeveloped nowledge nd equipmentspecializedo the autoindustry;n so doing hey receivedinancial nd technical ssistancerom

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their customers22, 23, 30]. In Japan, his secondstagehas proven o bea stablerrangement?Three factors seem important n accountingor the differentevolutionof U.S. and Japanese utomotive upplier elationssystems.Relative o their U.S. counterparts,apanese utomakersad essaccessocapital,a more slowlygrowingmarket,and lower discount ates.Twoadditionalactors hat need urther nvestigationre the role of governmentpolicy and the differentialeffectivenessf organi:,ationaloundariesngainingaccesso a dual labor market.Capital was perennially hort n the Japanese uto industryof the1950s 9, 30]. Although he industrygrew quicklyby normal standards,neitherToyota nor Nissancouldmatchthe boomingsales hat gaveHenryFord the power o buyout the Dodges ndestablishhe greatRiverRougeplant. It is instructiveo comparehe turn-of-the-centuryS auto ndustrywith the Japanesendustryof the late 1930s. n 1903 the US produced11,000cars and trucks--not ery different rom the 12,186producedbyJapan n 1936.However,US productioneached earlyonemillion n 1915,only 12 years ater. Japandid not approach ne millionuntil 1962,or 26years ater.The Japanesewere not able to raise massive mountsof capitalthrough he stockmarket or bondmarket,as did Durant and the DuPontsat GM. Using externalsuppliers ave he industrymore accesso capitalthan vertical ntegrationwouldhave,becauset brought n more relativesandother nformal ourcesf funds.By the time the automakers ereableto generate significantamountsof internal funds, they had alreadydevelopedkillsand attitudes ecessaryo manage system f governanceby trust ; he benefits f verticalntegration ere correspondinglyeduced[30]. However,competition, rowth s most beneficial o voice when itoccursn moderation.While fastergrowthwouldhave reduced he timeavailable or developing rust, no or slow growth would have forcedsuppliers nd customerso dividea shrinking r stagnant ie.

Aside from reducingautomakerearnings,moderategrowth hadanother mpacton the development f governancey trust : t meant thatthe return o investmentsn specific ssets lsogrew elatively lowly, ivingautomakersime to buildcommitmentasedon reputationor fair dealingwithout ncurring largecostpenalty. In contrast,n the US caseoutsidesuppliers ereveryquickly amnedf theydid nvest asSloan's bove-citedworriesattest)or if they didn't nvest as thosewho lost Ford'sbusinessbecauseheir general-purposequipment oon ed to highercosts han hisspecializedesigns).Despite he scarcity f capital, apaneseiscountates emainedow.This was not entirelyan exogenousulturalphenomenon;n part it was aresultof the social elationships hichproducedrust.That is, a virtuouscycledevelopedn which a traditionof sharinggains albeit unequally)

9In hisshort iscussion,willoverlookmportantistinctionsmong apaneseautomakers' subcontracting rrangements,For more detail, see [9, 22, 23, 30],

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among hosewho helped produce hem led to a willingnesso make long-term investments mongvarioussectorsof society,which createda largerpie to share,which einforced he tendencyo invest.The traditionof trustthat investment ouldbe rewardedproduced low risk premium, esultingin a low valuation of present relative to future returns--oneof theconditionshownboveo promotehecontinuousseof voice.oToday there are ten Japanese utomakers, haringa total output(including xports)not much arger than the U.S.'s Big Three. A voicesystem f supplierelationss both effectand causeof this marketstructure.While Toyota and Nissanhad enoughmarket power that theycouldoffer credible ong-termcommitmentso their suppliers,hey did nothave so much that they could afford to give less weight to efficiencynpursuit of bargainingpower, especiallyafter they set their sights onbecomingglobalcompetitors. he voicesystem erpetuateshis moderatelyconcentratedmarket structureby providingan infrastructureof capablesupplierswhichsmallerautomakers an draw on.Conclusion

This paper has soughteconomic nd historicalexplanations f thedifferencesn structure nd performance f U.S. and Japanese utomotivesubcontracting.n particular,t hasexploredhe impactof linkages etweenmarkets for final products,components, nd capital. The greater finalproductmarket power, faster growth,and better accesso capital of U.S.firmsmadepossiblehe useof exit-based upplier elations.Conversely,hesloweradventof massproduction romotedhe development f voice-basedrelationshipsn Japan.In its focuson the assetspecificity f U.S. suppliers'nvestments san impetuso verticalntegration y U.S. automakers,he foregoing nalysisis similar o that of transaction-costheorists18].An importantdifference,however, s the historicaland developmental erspective f the presentpaper.Voice elationshipsndotherdeparturesrom he competitive-marketmodel are not seenas necessarilysecond-bestesponseso the presenceof human railty n the form of boundedationality r opportunism;nstead,such nstitutional rrangementsanplaya key role in promotingnnovationand economicdevelopment.

10AIthoughhis apermphasizesrust,t shoulderememberedhat elationshipsbetween Japanese firms and their subcontractors est on a fine balance betweencooperation and exploitation. Japanese automakers use tiers of subcontractorsnot onlybecause decentralization s an efficient way to focus attention on the myriad tasksinvolved n producing car, but also becauseestablishing uchorganizational oundariesallows hem access o cheaper managementand labor [4, 11, 22, 23].

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