(1997-10-31) A General Theory of Network Governance: Exchange Conditions and Social Mechanisms

A General Theory of Network Governance: Exchange Conditions and Social Mechanisms; Author(s): Candace Jones, William S. Hesterly and Stephen P. Borgatti. A phenomenon of the last 20 years has been the rapid rise of the network form of governance. This govemance form has received significant scholarly attention, but, to date, no comprehensive theory for it has been advanced, and no sufficiently detailed and theoretically consistent definition has appeared. Our objective in this article is to provide a theory that explains under what conditions network governance, rigorously defined, has comparative advantage and is therefore likely to emerge and thrive. Our theory integrates transaction cost economics and social network theories, and, in broad strokes, asserts that the network form of governance is a response to exchange conditions of asset specificity, demand uncertainty, task complexity, and frequency. These exchange conditions drive firms toward structurally embedding their transactions, which enables firms to use social mechanisms for coordinating and safeguarding exchanges. When all of these conditions are in place, the network governance form has advantages over both hierarchy and market solutions in simultaneously adapting, coordinating, and safeguarding exchanges.

Many industries increasingly are using network governance-coordination characterized by informal social systems rather than by bureaucratic structures within firms and formal contractual relationships between them-to coordinate complex products or services in uncertain and competitive environments (Piore & Sabel, 1984; Powell, 1990; Ring & Van de Ven, 1992; Snow, Miles, & Coleman, 1992). This type of governance has been observed in such industries as semiconductors (Saxenian, 1990), biotechnology (Barley, Freeman, & Hybels, 1992), film (Faulkner & Anderson, 1987), music (Peterson & Berger, 1971), financial services (Eccles & Crane, 1988; Podolny, 1993, 1994), fashion (Uzzi, 1996, 1997), and Italian textiles (Lazerson, 1995; Mariotti & Cainarca, 1986). Although network governance is widely acknowledged and is seen as producing important economic benefits, "the mechanisms that produce these benefits are vaguely specified and empirically still incipient" (Uzzi, 1996: 677). This vague specification lacks clarity on what network governance is, when it is likely to occur, and how it helps firms (and nonprofit agencies) resolve problems of adapting, coordinating, and safeguarding exchanges.

The article is organized as follows. First, we review the literature defining network governance and provide our own definition. Second, we identify conditions for network governance and explore why networks, rather than markets or hierarchies, are employed. Third, we explain how structural embeddedness arises out of exchange conditions and provides the foundation for social mechanisms used in network governance. In addition, we specify how key social mechanisms enhance coordination and reduce behavioral uncertainty among exchange parties. These social mechanisms in network governance reduce transaction costs, gaining comparative advantage over markets and hierarchies, which enables network governance to emerge and thrive. Finally, we suggest future directions for research on network governance.

WHAT IS NETWORK GOVERNANCE?

Definitions in the Literature

Proposed Definition of Network Governance

Network governance involves a select, persistent, and structured set of autonomous firms (as well as nonprofit agencies) engaged in creating products or services based on implicit and open-ended contracts to adapt to environmental contingencies and to coordinate and safeguard exchanges. These contracts are socially-not legally-binding.3

TABLE 1 Differing Terms and Definitions for Network Governance

Many scholars commonly cite the film industry as an example of network governance (Hirsch, 1972; Meyerson, Weick, & Kramer, 1996; Miles & Snow, 1986; Powell, 1990; Reich, 1991). Here, film studios, producers, directors, cinematographers, and a host of other contractors join, disband, and rejoin in varying combinations to make films. Network governance comprises a select subset of film studios and subcontractors. The seven major film studios repeatedly use and share among their films an elite set of subcontractors who constitute 3 percent (459 of the 12,400) of those registered in guilds

EXCHANGE CONDITIONS FOR NETWORK GOVERNANCE

In the TCE (transaction cost economics) perspective three exchange conditions-uncertainty, asset specificity, and frequency-determine which governance form is more efficient.

Many of our arguments are based on TCE logic. For a governance form to emerge and thrive, it must address problems of adapting, coordinating, and safeguarding exchanges more efficiently than other governance forms

However, we move beyond TCE in three ways. First, we identify the specific forms of uncertainty and asset specificity that give rise to network governance. Second, we extend TCE by incorporating task complexity (Powell, 1990; Powell, Koput, & Smith-Doerr, 1996) into the explanation of governance form; this is important because it moves the theory beyond a dyadic focus. Third, we show how Williamson's notion of frequency, which is underspecified and underdeveloped in TCE, provides a link with social network constructs of relational and structural embeddedness

we identify four conditions necessary for network governance to emerge and thrive (see Figure 1): (1) demand uncertainty with stable supply, (2) customized exchanges high in human asset specificity, (3) complex tasks under time pressure, and (4) frequent exchanges among parties comprising the network. We discuss these in greater detail next.

Product Demand Uncertainty with Stable Supply

Understanding the sources of uncertainty is important, since these influence what governance form is used to coordinate and safeguard exchanges.

We find network governance in industries with high levels of demand uncertainty but a relatively stable supply of labor; these include the film, fashion, music, high-technology, and construction industries.

Demand uncertainty also is generated by rapid changes in knowledge or technology, which results in short product life cycles and makes the rapid dissemination of information critical

Finally, demand uncertainty is generated by seasonality,

Customized Exchanges High in Human Asset Specificity

The customization of products or services increases demands for coordination between parties. It also raises concerns about how to safeguard these exchanges, since customizing products or services makes both seller and buyer more vulnerable to shifts in markets

Complex Tasks Under Intense Time Pressure

Network governance facilitates integrating multiple autonomous, diversely skilled parties under intense time pressures to create complex products or services.

Frequent Exchanges Among Parties

frequent exchanges not only justify but enable using interfirm networks as an alternative governance form. Frequency allows human asset specificity to develop from learning-by-doing (Williamson, 1991: 281) and to "deepen" through continued interaction; this creates exchanges where the "identity" of the other matters (Williamson, 1991: 282) and enhances the transfer of tacit knowledge among parties.

Repeated personal contacts across organizational boundaries support some minimum level of courtesy and consideration between the parties [and] discourage[s] efforts to seek a narrow advantage in any particular transaction

Interaction Effects of Exchange Conditions

No single exchange condition propels the emergence of network governance; rather, a combination of specific conditions is required for network governance to emerge and to thrive as an organizational form, offering comparative advantages over markets and hierarchies. These conditions involve high adaptation needs, owing to changing product demand; high coordination needs, owing to integrating diverse specialists in complex tasks; and high safeguarding needs, owing to overseeing and integrating parties' interests in customized exchanges.

STRUCTURAL EMBEDDEDNESS AS A FOUNDATION FOR SOCIAL MECHANISMS

NETWORK GOVERNANCE: SOCIAL MECHANISMS AS SOLUTIONS TO EXCHANGE PROBLEMS

Since social mechanisms in network governance are poorly understood, we focus on identifying them and explaining how they facilitate adapting, coordinating, and safeguarding exchanges, as well as their boundary conditions (see Table 2).

TABLE 2 How Social Mechanisms Influence Exchange Behavior

Restricted Access to Exchanges in the Network

Macroculture

Collective Sanctions

Reputation

Interaction Effects of Social Mechanisms

IMPLICATIONS FOR RESEARCH AND PRACTICE

Contributions and Challenges

Directions for Future Research