Asst. Prof. Karen Zheng: When a handshake is enough–the role of trust in supply chain management

MIT Sloan Asst. Prof. Karen Zheng

Trust is important to our relationships with friends, family, and acquaintances. Less understood, though, is the role trust can play in business relationships. When businesses deal with each other, their first impulse often is to summon their lawyers. But I have found in my research that there are many situations in which trust can be an effective replacement for costly and time-consuming contract negotiations.

To understand the role of trust in business, I and two colleagues, Ozalp Ozer of the University of Texas at Dallas and Kay-Yut Chen of Hewlett-Packard Laboratories, conducted a series of computer laboratory experiments that simulated one of the most vexing problems in supply chain management: The tendency for manufacturers to issue overly optimistic forecasts.

Manufacturers want to be sure they have abundant supply to satisfy customers. But inflated forecasts can prompt suppliers to overproduce, which can lead to costly losses. In 2001, the networking equipment supplier Cisco had to write off $2.1 billion in excess inventory because of inflated customer forecasts. In our experiments, we hoped to discover and determine the conditions under which partners in a supply chain can exhibit sufficient trust and trustworthiness to avoid such outcomes.

For the experiments, we recruited graduate students, all of whom were in business related fields. The participants were familiar with how manufacturers and suppliers interact. Some of the participants were assigned the role of suppliers and others manufacturers, and we placed them in situations in which they interacted in forecast communication.

With the software we varied two conditions—the cost of the product the supplier was making and the degree of uncertainty in the market demand for the finished product. Then we observed how these variations affected trust between the parties and the decisions they made in the market.

We found that when the cost of the product was low and the manufacturer’s market was stable, trust was high, and the businesses cooperated. This finding makes sense because businesses would cooperate when risks to both sides are reduced due to lower costs and stable markets.

We also found that when the supplier’s product cost was high and the manufacturer’s market uncertain, trust was low and cooperation broke down. Intuitively, trust is hard to establish when the stakes are raised by high costs and volatile markets. In these situations, companies are wise to sit down and work out contracts to manage their potential conflicts.

However, some results were surprising. When the cost of a product was low and markets were uncertain, trust still remained sufficient for cooperation. Similarly, when the product cost was high and markets stable, individuals still trusted one another and cooperated. These results indicate that trust is a powerful force which, under the right conditions, can override both market uncertainty and high costs.

The conditions tested in the experiments represent real-world situations. For example, ink cartridges are sold in stable markets and made at low costs. Laptop computers are costly to make and sold in volatile markets. Washing machines involve high production costs but face low demand volatility, and DVD movies incur low costs but high volatility.

Trust is too often overlooked as a factor in supply chain management. Most of the academic research in this area has assumed the parties have either complete trust in each other or absolute mistrust. A more accurate view would be that the decisions people make fall in between these two extremes, showing a continuum of trust and trustworthiness. Trust can also grow over time as businesses interact with each other and learn from these interactions.

As we learned in our experiments, there are times when trusting another business is not advisable. But under certain market conditions, trust can be a valuable resource that can enhance relations between companies, reduce conflicts, and save time and money.

Karen Zheng is Assistant Professor of Operations Management at the MIT Sloan School of Management

This post also appeared in Material Handling and Logistics and Mass High Tech 

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One Comment

  1. gatot siswanto
    Posted December 9, 2011 at 10:38 pm | Permalink | Reply

    Trust is the most fundamental aspect of business. there is no business without trust. but trust without control is like giving a lot of money to someone who does not know what a money for

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