Relationships as Capital

We’re all familiar with the adage it’s not what you know, it’s who you know. And specifically, relationships give us access to knowledge, resources, and systems that wouldn’t otherwise be at our disposal. Additionally, unhealthy relationships consume a significant amount of resources. One estimate I heard from a representative at the Air Force Negotiation Center was that over $200 billion are consumed annually by US federal workforce litigation, complaints, and arbitration (working from memory here, so I could be wrong about this quote). Thus, unhealthy relationships create a huge draw on resources, and healthy relationships should be more beneficial and less costly.

While we in economics frequently focus on the costs of production (usually something like: land, labor, capital, and entrepreneurship), to fully capture costs within a system, we must also consider costs of distribution to get the goods and services produced to the individuals who will consume them. These costs can certainly consume land, labor, and capital, but these activities are not productive, rather represent the costs of allocating or delivering products to their final user via distribution or exchange. Indeed, Coase might argue that there are two types of costs, production costs and transaction costs. Transactions costs include, but are not limited to:

Buyer/seller identification
Product information exchange
Negotiation
Transfer of ownership
Contract enforcement.

If we define healthy relationships as those that are mutually beneficial and mutually pleasant, or perhaps those that minimize the costs of transactions, distribution, or resource allocation, it may seem axiomatic to claim that healthy relationships are less expensive and more beneficial than unhealthy relationships. However, this definition does not guarantee that individuals and organizations can readily identify or recognize their least cost/highest benefit relationships, nor does it inform the level of investment in relationships that may optimize the reduction in the marginal transactions costs identified above.

From a transaction cost perspective, there is a tradeoff between relationship maintenance costs and potentially higher costs of independent transactions. One potential cost is associated with risk of exposure to market power. By catering to a specific buyer, a supplier may grant their buyer monopsony power or create hold-up problems. Additionally, as with any productive asset, malinvestment wastes resources if the wrong relationships are cultivated. So how do we know who to trust with relationship-specific investment? How do we choose who to cultivate relationships with?

Related literature includes several different economic fields. The first articles that come to mind are Joskow’s classic “Contract Duration and Relationship-Specific Investments (1987),” or a little more current paper from Krause, Handfield, and Tyler (KHT), “The Relationship Between Supplier Development, Commitment, Social Capital Accumulation and Performance Improvement.” As Joskow finds that relationship-specific investments encourage longer contracting periods, the more recent paper identifies the existence of benefits in the form of lower costs from healthy relationships associated with coordination, opinions and goals in common between suppliers and buyers. KHT find that there can be payoffs to buyers of fostering supplier development through investment in relationship capital. That is, by engaging in activities that improve the costs and benefits of their suppliers, buyers can increase their own profits.

Here are a few specific points from their discussion:

Commitment between firms helps establish performance goals that enhance social capital accumulation between buyers and sellers.
Shared values, reflected by mutual dependence, reduce cost for buyers and suppliers
Direct supplier development activities from buyers improve the achievement of quality, delivery, and flexibility objectives.

These findings seem to indicate that various types of investment in relationship capital can be mutually beneficial but don’t reflect the rates of return on investment.

Lee, Lee, and Penning’s findings in “Internal capabilities, external networks, and performance (2001)” that only specific types of relationship capital seem to predict success of startup tech companies in Korea lead me to think that a strategic approach to the development of relationship capital can improve corporate performance. Thus, I’m curious, how well do individuals and corporations manage relationship capital portfolios? Do we over- or under-invest in this capital market? Thus, the two research questions, rephrased and broadened – (1) how much does considering others (investing in relationship capital) affect my utility? (2) Do people invest efficiently?

These ideas also lead me to consider a wide variety of research questions at various levels of organizational and individual decision-making. Finding answers to the questions presented below may require more time and skills than I currently have, but I believe the central unifying theme of learning about relationship capital could improve resource allocation decisions for individuals and organizations and provide valuable returns to society. To demonstrate my scope of interest and direction of current thoughts, I provide here a sampling of research questions that I’m interested in addressing over time:

How much are operating (production and distribution) costs affected by healthy/unhealthy relationships?
1. How do we quantify this?
How much do we (organizations and individuals) invest in relationships?
1. How do we invest in relationships? Are there specific methods for relationship investment that are more cost effective than others?
2. Do more productive or more successful people or organizations invest differently in relationship capital than less productive/successful people?
How does the return on investment in relationship capital compare to return on investment in other types of capital?
What elements of an operating environment increase the productivity of relationships (decrease cost, increase benefit)?
1. How do types of organizational management or control (government) affect internal and external relationship capital?
Do relationship portfolio management strategies manifest the same types of risk vs return properties as other asset markets?
1. Is there a difference between investing in healthy relationships and protecting against unhealthy relationships?
To what level are relationship capital assets transferable? What mechanisms in current market practices attribute value to relationship capital?
How does depreciation of relationship capital compare to other types of depreciation?
Do relationship capital balances follow the same patterns of investment and divestiture as other types of capital? How does consumption of relationship capital affect relationship portfolio balances?
How is technology affecting the supply, demand, and productivity of relationship capital?
1. Are various types of relationship capital more or less valuable in current markets than historically?
2. How does the origin of a relationship (common friend, independent acquaintance, virtual relationship vs in-person association) impact real returns or perceived returns of a relationship?

While I have laid out lots of questions above, I perceive three “levels” of inquiry: (1) strategic resource allocation decisions associated with investment in relationship capital vs other types of capital, (2) operational structures that foster the development and utilization of relationship capital, and (3) tactical decisions for how individuals interact to maximize their return on investment in relationship capital. I’m happy to engage at any of these levels and hope that collaboration can lead to quality research!