CAPITALISM’S FUTURE LIES IN NETWORKS AND COOPERATION

By FAROK CONTRACTOR

Reprinted with permission from YaleGlobal Online(www.yaleglobal.yale.edu)

The global financial crisis has increased protectionism in some countries, raising questions about whether international business and global cooperation will recede. The past 25 years celebrated a culture of corporate triumphalism based on competition and profit-seeking. But, beneath the veneer of such a popular corporate ideology, a different economic trend has taken root -- one that makes a return to protectionism or isolationism unlikely. Cooperation, as much as competition, is slowly being recognized, by evolutionary scientists and behavioral economists, as an engine of progress.

Cooperation among companies is an integral part of the new model for business in a globalized economy. Today, the largest economic grouping is not the multinational corporation but the global industry network, consisting of companies that simultaneously compete and cooperate.

The new knowledge and service economy of the 21st century relies on a model of corporate "alliances" and "networks," by breaking down the sequence of research, production and distribution -- previously done in-house within the same company -- over separate enterprises that take joint risks and share rewards over longer periods of time.

Boeing used to build entire aircraft itself, with parts purchased from thousands of suppliers with whom its relationship was adversarial. Today it is a cooperative process. While Boeing guards proprietary technologies, the 787 "Dreamliner" is built with major inputs from partners in seven nations, all part of the research and development team from the beginning, sharing in development costs and providing specialist knowledge that Boeing did not have. Each network "partner" incurs research and development costs based on faith and trust, with no assurance of recouping these outlays for a decade or more.

Forgoing immediate gain, good ideas and technology are altruistically shared within the "network" of suppliers, even though there may be no immediate gain for that partner. However, the whole network gains. The altruistic member firm, sharing good ideas or incurring costs, does not demand immediate recompense, anticipating eventual reward because the other companies remember its contributions. The new network economy is based on forbearance and trust among cooperating firms, long-term memory and social networks, rather than formal contracts or directed hierarchies.

Cooperating networks range from strategic to operational to tactical, with hundreds of thousands of cooperative relationships worldwide.

For many industries, a global scale of operations is mandatory for efficiency reasons. The huge costs of R&D or production in high-tech sectors make it too difficult for a single company to develop the product or brand, bear the risk and span all segments of the value chain on a global basis.

The new alliance network economy provides more flexibility, lowers risk for each member company, and speeds response to changing markets or fashion conditions, more than is possible within a single firm. The value chain is outsourced over several companies, in different nations.

Consequently, the basic model of business is being revised. The predominant model today is for each firm to find its core competence while collaborating with partners occupying other parts of the value chain. Each partner specializes in a function it does best or cheapest. For example, Nike specializes in design and marketing, outsourcing the production of shoes to its partners.

Most outsourcing is not an arms-length transaction, but entails an intimate, cooperative relationship between the managements and engineers of the network firms. The better managed the relationship, the greater the performance of the alliance. The behavior, quality standards and reputation of foreign prospective partners is easily discerned in a connected world. While outsourcing in manufacturing is a 200-year-old phenomenon, business-services outsourcing has exploded recently, aided by reduced data-transmission costs and an increase in absorptive capacity in emerging nations.

The cooperative revolution is also being aided by sweeping changes in the global regulatory environment such as the liberalization of foreign direct investment rules, the international spread of intellectual-property enforcement, the harmonization of standards and the codification of business functions. Hence, ultimately, any business process or task that can be codified or digitized is amenable to outsourcing.

"Codification" simply means that companies make a concerted effort to document management processes and engineering techniques that formerly resided in the minds of their engineers and managers in the semiconductor, steel, chemical and many other industries.

Another form of cooperation involves partners pooling resources for the same business function or piece of the value chain. More diverse talent is thereby tapped, costs are lowered and good ideas are gleaned -- especially if the research is done abroad. Another motivation is simply to spread risk. The cost of a semiconductor fabrication factory being as much as $4 billion, few single firms can justify the investment. The entire pharmaceutical industry is evolving in that direction with ideas, costs, benefits and risk shared between large firms and their smaller biotechnology partners.

To a degree unimagined just two decades ago, development risks are driving more industries to recognize that global returns are mandatory for competitive survival. Budgets for Hollywood movies are never set without an estimate of the non-U.S. market profit potential. Few single companies can today market to all potential customers -- or all end-applications -- to maximize return on R&D.

Besides increased codification of corporate knowledge, the capacity to absorb technology better in emerging nations, and the IT revolution, a series of global institutional developments have also fostered international corporate alliances: Increased patenting makes technologies more visible to prospective allies. Better patent enforcement reduces fears that allies may engage in opportunistic behavior. Of course, several emerging markets are a long way from effective enforcement of intellectual property rights, but this is bound to improve. All in all, the global spread of intellectual property rights will increase cooperation.

The old industrial economy of objects emphasized mass production and ownership, control and vertical integration within a single company. An economy of ideas favors flexibility, customization, rapid response and risk, reward and idea sharing within networks of companies. Cooperating entities in a network attract more members into the network, which in itself increases value, reduces costs and promotes common standards.

Dr. Farok Contractor is a professor in the Management and Global Business department at Rutgers Business School and the author of several books on alliances and cooperation, including "Cooperative Strategies and Alliances."