Understanding trust in international alliances

Understanding Trust in International Alliances ARVIND PARKHE

Many firms are discovering that formal contracts, while necessary, are not a substitute for informal understandings. Trust plays an important (often dominant) role in successful alliances, and managers often cite lack of trust as a key reason for failed alliances. This paper attempts to deepen our understanding of trust, by systematically examining the psychological, sociological, and economic components of trust, intercultural differences in the notion of trust, and the various mechanisms through which trust may be generated. A follow-up paper, "Building Trust in International Alliances," shows how partners can proactively manage an alliance relationship in order to develop trust.

Man is the only animal that makes promises.--Friedrich Nietzsche, German philosopher The key ingredient in a successful alliance is trust.--James R. Houghton, Chairman, Coming Glass Works

I

nternational alliances have swept powerfully onto the global business landscape. In their wake, the familiar model of a single company doing all (or even most) things i n - h o u s e is becoming increasingly obsolete. Moreover, the technological, political, financial, and competitive forces that have spawned the rapid growth of international alliances are likely to further strengthen, not abate ,) in the foreseeable future. And so the recent dramatic shift Arvind Parkhe, Department of Management, Kelley School of Business, Indiana University, Bloomington, IN 47405 .

in global business, away from corporate loners and t o w a r d more alliances, seems destined to continue, and perhaps even accelerate, in coming years. In successful alliances, trust is often touted as a prerequisite, a necessity, an absolute must (Byrne, 1993). The reverse is also true: a major contributor to failed alliances is lack of trust (Peng & Shenkar, 1997). As the above quotes suggest, interfirm cooperative relationships involve promises--both explicit and implicit--about future behaviors, and trust transforms such promises into credible propositions. Plainly, a systematic study focusing on trust in the context of international alliances seems timely. As such, the main purposes of this article are to address the following intriguing questions:

UnderstandingTrust in International Alliances 219

•

At the core, what is the role of trust in international alliances? • What are the psychological, sociological, and economic components of trust, and how do they relate to each other? • Are there basic differences internationally in interpreting the concept of "trust"? • Can trust actually be "produced"? Together, these questions are aimed at developing a deeper understanding of trust in international alliances, primarily before the start of a collaborative relationship. A follow-up article will focus on issues related to "Building Trust in International Alliances," primarily after a collaborative relationship has commenced. We begin with the first question.

TRUST AS A CENTRAL ORGANIZING PRINCIPLE IN ALLIANCE MANAGEMENT

It is useful to remember that despite their growing occurrence, alliances are generally the last resort, not the first choice, for most North American companies. Intensifying global competition, faster technological change, and rising costs and risks of developing new products have left companies unable to do everything for themselves. Alliances offer a partial, imperfect solution, by providing a way to pool costs and risks, trim product development times, penetrate new markets, and gain access to new technologies and economies of scale. In short, alliances involve interfirm cooperation, undertaken in the pursuit of global competitive advantage 220 Journalof World Business / 33(3) / 1998

of each partner firm. Philip E. Benton Jr., president of Ford's automotive group, made this point nicely when he said that Ford linked up with Volkswagen in South America, creating Autolatina, purely to survive: " I ' m looking for a competitive advantage. I'm not out there to make Volkswagen stronger" (Kraar, 1989, p. 68). During the simultaneously competitive and cooperative life of such relationships, the internal and external circumstances of an alliance may change, often in unexpected ways. How partners adapt to these changing circumstances can determine whether an alliance prospers or flounders. However, it is impossible to predict and plan for all possible future contingencies beforehand. Successful adaptation therefore calls for a delicate balance between the twin virtues of reliability and flexibility. Flexibility is necessary for partners to have a viable relationship in the face of changing circumstances, yet unlimited flexibility affords companies the opportunity and incentive to cheat, 1 reducing the reliance partners can place on each other. There are thus two types of uncertainty in alliances: Uncertainty regarding u n k n o w n f u t u r e e v e n t s , and uncertainty regarding partner's responses to those future events. It is in this environment of double uncertainty that trust emerges as a central organizing principle in alliances. Trust reduces complex and uncertain realities far more quickly and economically than prediction, authority, or bargaining (Powell, 1990), and thus improves performance (Baughn, Denekamp, Stevens, & Osborn, 1997).

Evidence of such trust-based performance improvement is found by comparing supplier relationships in the auto industry in Japan and in the U.S. (Barney & Hansen, 1994; Dyer, 1996). Toyota's relationships are deeply embedded in long-standing networks of social and economic relations that are characterized by higher levels of trust and lower fear of opportunism. Toyota and its suppliers feel freer therefore to engage in very specialized, vulnerable exchanges, which boost efficiency while substantially lowering reliance on formal contracts than at General Motors. Without this ability to rely on social embeddedness to constrain possible opportunistic behavior by its suppliers, GM has had to deal with the threat of opportunism by reducing the level of transactionspecific investment in its suppliers (i.e., by having multiple competing partners), by insisting on elaborate contractual protections, or by vertically integrating the supply relationship. As a result, report Cusumano and Takeishi (1991), buyer-seller relationships in the auto industry in Japan tend to be longer term, more stable, and with earlier supplier involvement in product development than in the U.S., where heavier reliance is placed on direct market forces among suppliers (competitive bidding). The performance differences were striking. The Japanese enjoyed a significant advantage in several efficiency measures, such as total engineering hours required to develop a new car (1.2 million in Japan, versus 3.5 million in the U.S. and Europe) and in the number of months required to complete and deliver a new product (43 months in Japan, versus 58 months in Europe and

62 m o n t h s in the U . S . ) . F u r t h e r , because suppliers were trusted to maintain their level of defects at close to zero, Japanese firms generally did not inspect incoming parts and thus saved on inspection labor as well as losses from the costs of defects. Clearly, higher trust levels can enhance cooperative performance. Defining Trust 2

Numerous definitions of trust have been proposed in the literature, each focusing on particular aspects of a relationship. Consider the following: "Trust is the mutual confidence that no party to an exchange will exploit another's vulnerabilities" (Sabel, 1993, p. 1133). "(Trust) is the willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will perform a particular action important to the trustor, irrespective of the ability to monitor or control that other party" (Mayer, Davis, & Schoorman, 1995, p. 712). Common thoughts stand out from these definitions. 1.

2.

3.

Trust inherently involves uncertainty about the future, as argued above. Trust implies vulnerability, that is, the risk of losing something of value. The magnitude of this potential loss from untrustworthy behavior is typically much greater than the anticipated gains from trustworthy behavior, as we discuss shortly. Trust is placed in another whose behavior is not under one's control, so that each partner exercises only

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partial influence over alliance outcomes. Trust and distrust do not share a direct, simple relationship. Violation of expected behaviors produces a sense of disruption of trust, of profound confusion, but not of distrust (Zucker, 1986). Distrust only arises when there is suspicion that expectations were violated intentionally, and that such violations are likely to occur repeatedly.

Role and Degree of Trust In a Relationship The role that trust plays, and the degree of trust required, varies by relationship. To better appreciate this, consider the three common elements of trust definitions extracted above. The first element involves uncertainty. The greater the uncertainty surrounding future events and a partner's responses to those future events, the greater the trust required. Trust plays the role of reassuring partners of mutually adaptive behaviors in response to u n k n o w n future circumstances. The second element involves vulnerability. The greater the potential loss through an alliance, the greater the trust required. Trust lowers the perceived likelihood that opportunities representing significant vulnerability will be exploited by a partner, permitting better sharing and greater specialization of resources. The third element involves control. The lower the control exercised by one alliance partner over the other(s), the greater the trust required from that partner. There exists a "control gap" in 222 Journal of World Business / 33(3) / 1998

managing alliances, as compared to managing hierarchical organizations. Full control is possible in the latter, but only partial control is possible in the former. Trust helps fill the control gap. Conversely, trust plays a less significant role, and less trust is required, in alliance situations in which a company possesses relatively complete, accurate, and timely i n f o r m a t i o n (since such information reduces uncertainty and can be used in planning, structuring, and running partnerships); in which vulnerability is low (so the prospects of damaging one's interests are minimal); and in which a relatively high degree of control can be exercised (so that powerlessness over alliance outcomes is minim i z e d ) . 3 As a p r a c t i c a l m a t t e r , however, in real-life alliances there will always be some uncertainty, since even with the most thorough reporting and auditing systems and the most expensive scanning and surveillance mechanisms, there are gaps in information. There will always be some vulnerability, since the risk of loss of items of value (technology, knowhow, markets, personnel) through alliancing is everpresent. And there will always be less than full control, since each partner's influence over the other's behavior is marked by partial impotence. Real-life alliances, therefore, benefit tremend o u s l y from the p r e s e n c e of trust between partners. We have thus far painted a broad-brush, generic picture of trust. Precisely what are the components of trust, and how do they relate to each other? The next section examines these questions.

THE COMPONENTS OF TRUST IN PRACTICE

Trust as Psychological, Sociological, and Economic Phenomena Since the above definitions suggest that trust reflects "mutual confidence" and a "willingness to be vulnerable," trust must occur within individuals, and it can properly be viewed as a psychological event. Yet the primary function of trust is sociological rather than psychological, because individuals would have no occasion or need to trust apart from social relationships (Lewis & Weigert, 1985). Finally, trust is unnecessary without vulnerability, and trust is required only in situations where the possible economic damage exceeds expected economic gains. In the context of alliances, trust is thus seen to have important psychological, sociological, and e c o n o m i c p r o p e r t i e s s i m u l t a neously. The particular mix of each of these components depends upon the specific set of alliance partners, and even the individual alliance situation. For example, Barney and Hansen (1994) identified three types of trust: weak form, semi-strong form, and strong form. Although each trust type reflects the confidence that one's vulnerabilities will not be exploited in an exchange, the reasons underlying this confidence vary.

Weak form trust arises when there are limited opportunities for opportunism (Barney & Hansen, 1994, p. 177). Here, partners can have the mutual confidence that others will not exploit their vulnerabilities because they have no significant vulnerabilities (e.g., the mar-

kets for crude oil or soy beans). This type of trust is called weak form trust because its existence does not depend on the creation of elaborate governance mechanisms, nor on commitments by partners to highly trustworthy standards of behavior. Obviously, weak form trust emerges in only very specific kinds of exchanges, where the quality of goods or services being exchanged can be e v a l u a t e d at low cost, and w h e r e exchange partners don't need to make considerable transaction-specific investments. Semi-strong form trust can be called "trust through governance" (Barney & H a n s e n , 1994, p. 177). T r u s t can emerge even when significant vulnerabilities exist, if parties to an alliance are protected through various governance devices. These governance devices impose costs (social and economic) on parties that behave opportunistically. Thus, if the appropriate governance devices are in place, then the cost of opportunistic behavior will be greater than its benefit, and it will be in the rational self-interest of alliance partners to behave in a trustworthy way. Put another way, partners have the mutual confidence that their vulnerabilities will not be exploited because it would be irrational for the other side to do so. Such governance devices can be market-based (e.g., market for reputations) or contractual (e.g., contingent claims contracts, sequential contracts, or reciprocal agreements). For instance, Motorola included incentives in a prenuptial agreement to ensure cooperation from Toshiba. T o s h i b a craved access to Motorola' s microprocessor technology, and Motorola wanted help in gaining UnderstandingTrust in InternationalAlliances 223

greater access to the Japanese market. Motorola handed over its technology in stages, in direct proportion to Toshiba's delivery on its pledges. Strong form trust is "hard-core trustworthiness" (Bamey& Hansen, 1994, p. 179). As the name implies, trust emerges in the face of significant vulnerabilities, independent of whether or not elaborate social and economic governance devices exist, because opportunistic behavior would violate values, principles, and standards of behavior that have been internalized by alliance partners. A company may be strong form trustworthy for at least two reasons. It may possess a culture and associated control systems that reward strong form trustworthy behavior, or the specific individuals representing the company in an alliance may be strong form trustworthy. Also called "principled trust," this type of trust is evident in the alliance philosophy of Coming Glass Works (Houghton, 1987). Alliances are so central to Coming's strategy that the corporation now defines itself as a "network of organizations." This network includes Dow Coming, Corning's Fortune-500 joint venture with Dow Chemical, plus major linkups with Siemens, Germany's electronics conglomerate, and Vitro, Mexico's biggest glassmaker. Coming's success at alliances derives from working with a very long-term perspective, in which strong form trust is key. Explains Coming vice chairman Van Campbell: "We're looking only for lifetime associations, because you have to invest an enormous amount of energy to make a partnership work. You not only have to deal with the business; you also con224 Journal of World Business / 33(3) / 1998

stantly have to deal with the relationship you have with the partner--nurturing it and maintaining high-level contacts, so that when you deal with items of substance you will be dealing with friends, people you understand and respect. A partnership that is going to last only five to seven years simply doesn't warrant that kind of investment" (Sherman, 1992). In practice, weak form trust, semistrong form trust, and strong form trust all have psychological, sociological, and economic components in them, but the mix varies. Strong form trust involves a higher willingness to be vulnerable, given the mutual confidence that one's alliance partner will not exploit such vulnerability. Thus, "soft," socio-psychological assessments rather than "hard," rational, economic criterai, dominate management of such relationships. One should be careful, however, to separate motivations for alliance formation from mechanisms for alliance governance. Even alliances involving strong form trust are motivated by expectation of economic gain, sooner or later, directly or indirectly. As Ohmae (1989, p. 149) urged, "Remember that both partners must get something out of it (money, eventually). Mutual benefit is vital." But economic factors play a secondary role in alliance governance in strong form trust relationships. This situation is reversed in semi-strong form trust relationships, where adherence to the letter and spirit of a collaborative agreement is sought through suitable governance devices. Such devices serve to realign partners' incentives along desirable paths, promoting cooperative behavior as each side's

uncertainty regarding the other's likely behavior is reduced. And in weak form trust situations, where little vulnerability exists, socio-psychological factors play the least important role throughout the life of a relationship. We may correctly infer, then, that in potential alliance situations where vulnerability is high but strong form trust does not exist (say, because a partner's reputation is not known or because a sufficient history of cooperation does not exist between the firms), would-be partners may be moved to greater reliance on governance devices, that is, to shift from strong form trust to semistrong form trust. But g o v e r n a n c e devices are not costless. So alliances with semi-strong form trustworthy partners will not be pursued whenever the cost of governance is greater than the expected gains from collaboration (Barney & Hansen, 1994).

A Framework for Managerial Decisionmaking A company that quantifies its potential vulnerability in an alliance, and its potential gains from the alliance, would conclude that no trust is required if the gains exceed its vulnerability, for then the alliance is devoid of risk. Trust is r e q u i r e d o n l y when v u l n e r a b i l i t y exceeds gains. The greater this difference, the higher the trust level required to sustain an alliance. But this discussion includes only raw economic data. As noted, also crucial is a manager's socio-psychological filter through which hard numbers must pass; this filter may magnify or shrink the raw numbers, adjusting them to generate expected values of vulnerability and

gains. For example, suppose a manager assigns a probability, x, that a particular alliance partner will behave in a trustworthy manner, and will not exploit vulnerabilities. The higher this probability, the greater the trust level in an alliance; the lower the probability, the less the certainty that a partner will behave in a cooperative, trustworthy way. This p r o b a b i l i t y can be mapped against potential v u l n e r a b i l i t y and anticipated gains in an alliance, as shown in Table 1. Thus, two alliance opportunities involving similar vulnerabilities and gains, but with partners possessing different levels of trustworthiness, may lead to different conclusions about whether to initiate an alliance relationship. Clearly, the best G-V-T combination (gains-vulnerability-trustworthiness) is high-low-high, and the least desirable combination is low-high-low. But most alliance situations fall in the gray area in between, and Table 1 p r o v i d e s guidance on appropriate decisions in such cases. For example, House (1995) recently noted that despite China's large market size, its allure is fading. Lehman Brothers, McDonald's and scores of other Western companies have faced covert and overt acts of opportunism in China, including blatant copyright infringement, with no reliable legal recourse to ensure intellectual property protection. In such alliances, the attractiveness of high anticipated gains is seriously eroded by low trustworthiness. Conversely, high trustworthiness in a partn e r m a y e s s e n t i a l l y o f f s e t the vulnerability of some high-risk ventures. Understanding Trust in International Alliances

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Table 1 Deciding Whether To Pursue an Alliance (Potential Vulnerability) Low

High

Anticipated Gains

Anticipated Gains

High Probability

High

of

Partner

High

Low Pursue if

pursue

Trustworthy Behavior of

Note:

Low

Definitely ?

?

Start slowly,

Start slowly,

governance costs are modest

Low

?

Build trust,

build trust,

then review

then review

Don't pursue

? = More analysisis needed. Probedeeper, gather more informationon partner and partnershipbefore deciding.

Contractor (1985) and Contractor and Lorange (1988) extended this discussion in important ways. In addition to its own expected gains and vulnerabilities, each alliance partner also weighs the relative share of gains between partners. Thus, not only is the size of the pie generated by an alliance important, but so is the slice of the pie allocated to each partner. A company may feel aggrieved even when it does not suffer a loss from an alliance, if it has not received a share of the gains commensurate with its contributions. This issue, of the appropriate division of incremental value created in an alliance by the partners, is critical in establishing perceptions of fairness and equity, which are important toward building a trustful relationship. Trust breaks down and alliances prematurely terminate (even profitable ones), if this issue is not adequately addressed upfront and reviewed periodically through the life of an alliance. A good current example of such challenges is Procter & Gamble Vietnam Ltd., a joint venture between Procter & 226 Journal of World Business / 33(3) / 1998

Gamble Company and its state-owned Vietnamese partner, Phuong Dong Soap & Detergent. P&G considers Vietnam, with its 76 million consumers, a "sizeable market" with "significant longterm potential" for its Tide detergent, Head & Shoulders shampoo, and Crest toothpaste (Marshall, 1998). P&G controls 70% of the alliance, and when the venture started up, P&G put up money for its cash-poor Vietnamese partner's 30% share. However, now P&G wants to invest an additional $60 million, and it would like Phuong Dong to match that with a proportional $18 million of its own. Failing that, P&G would like to effectively dissolve the alliance, by taking 100% ownership. The Vietnamese partner has openly refused to make a matching contribution, or to terminate the venture. Although such economic calculations are fundamental to alliances, it was stressed earlier that trust unavoidably involves additional psychological and sociological components as well. The components need to be viewed together in their totality, an issue to which we turn next.

Pulling the Components Together: Trust as Gestalt Dissecting trust into its individual components is useful, because such analysis permits a deeper understanding of its distinct, interrelated elements. Ultimately, however, trust is a gestalt. It is a complex integration of the psychological, sociological, and economic dimensions into an irreducible whole experience. To i l l u s t r a t e , c o n s i d e r how we choose a job or a house on one hand, and a friend on the other hand (Kaplan, 1964). We may choose a job by first separately weighing a number of components (salary, benefits, prospects, etc.), and then by somehow summing the results. We may perform a similar analysis with a house (size, cost, location, etc.). But we do not choose our friends by summing our appraisals of component traits and habits; we react, rather, to the personality as a whole. Likewise, trust in an alliance partner is the overall outcome not of the summation of component parts, but of a holistic assessment of the past, present, and future of the relationship with that partner.

Getting a Realistic Assessment: An Internal Trust Audit Armed with knowledge of trust definitions, trust components, and trust gestalt, we can now pose a set of questions that companies must attempt to answer for each partner and for each alliance. This analysis provides a starting point for an internal audit of trust for a company's portfolio of alliances.

1. GENERAL FACTORS

•

•

•

What is the nature of the industry and the nature of transactions within the industry? If the industry is atomistic (with numerous small companies competing more or less anonymously), and if reputation effects are weak or absent, then trust will be less important. What is the type of alliance? Contractor & Lorange (1988) catalog an inventory of cooperative arrangements, ranging from technical training/start-up assistance agreements (which have negligible interorganizational dependence) to equity joint ventures (high interorganizational dependence). Bechtel's numerous turnkey agreements worldwide are a good example of the former, and the long-lasting Fuji Xerox alliance is a good example of the latter. The lower the degree of interlocking interests, the lower the vulnerabilities, and the less important trust will be. What are the sources of uncertainty? Undoubtedly, uncertainty is an inherent feature of alliances, and external uncertainty cannot generally be controlled. Still, uncertainty internal to an alliance can be minimized. The best antidote for uncertainty regarding a partner is highquality information. Potential for misperception can be reduced by installing mechanisms for recognition, verification, and signaling, which together improve behavior transparency. Low transparency leads to greater uncertainty and lower trust levels, other things being Understanding Trust in International Alliances

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equal. An important extension of this thought is that managers can seek to reduce uncertainty in both directions (their uncertainty about partner, and partner's uncertainty about them). Thus, strong form trustworthy firms will not only demand high transparency from their partner, but also encourage their partner to demand it from them. What mechanisms are in place to gauge the likelihood that an alliance partner will behave in a trustworthy manner (see Table 1)? What individual or committee is charged with this critical, subjective task, and is this decision maker a risk taker or risk averse? How is this assessment made, given the covertness of opportunism and the customary lack of such information in the public domain? It is important to make sure that one's internal assessments are as accurate as possible. Finally, there is a direct, strong link among anticipated gains from alliances, motivation for alliance formation, and trustful behavior. Yet, anticipating gains is a highly subjective process. It may be done conservatively or generously. It may be done by rule-of-thumb procedures or by complex calculations of discounted present value of expected future income streams. Thus, systematic biases (under- or over-estimation) of gains may lead to flawed conclusions about the economic contributions of alliances, and about the realistic need for trust. It is not unusual for managers to make piein-the-sky forecasts of alliance prof228

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itability, as occurred in the linkup between Northwest and KLM Royal Dutch Airlines, which deteriorated into an "Alliance from hell" (Tully, 1996). And there may be fundamental differences between partners not only in the expected level of profits, but also in the timing with which future profit streams are expected to roll in. Some companies are patient, others highly anxious. For example, in their U.S. auto-parts joint ventures, the Japanese are in it for the long haul, and they are not known for quitting when things get bad, even if it means sustaining losses for years. A Japanese executive was not perturbed by the loss of a major bid for GM's auto parts business. He said matter-of-factly, "We will have to readjust our forecasts. But it does not affect our intentions to win market share" (Phillips, 1989). 2.

SPECIFIC FACTORS

Know Thy Partner. Although this may seem self-evident, many managers short-circuit the necessary hard thinking and rely instead on gut feeling or industry image alone. For each potential partner, it is important to ask: What are the sources for our social and psychological cues? Are our mental triggers based upon a long and successful cooperative history? Good personal chemistry? Or vicariously, through the partner's good reputation in alliances with other firms? Based on these cues, do we believe their word to be as good as their bond? When Honda picked

Donnelley Corporation to make all the mirrors (interior and exterior) for its U.S.-manufactured cars, Honda knew that the Holland, Michiganbased company had never made exterior mirrors and had no factory for making them. But Honda managers had known Donnelley for many years as an interior-mirror supplier, and they liked Donnelley's values and culture. That was sufficient. Tactical Vulnerability.4 Specific to each alliance, it is important to candidly estimate the tangible interests at risk through that alliance. (In a full analysis, this exercise should be repeated from the partner's perspective as well.) Tangible interests include all alliance-specific investments, which become sunk costs. Such investments are highly specialized, not easily redeployable, and have little salvage value in alternative uses. Paradoxically, the greater our tactical vulnerability, the more our alliance partner will be inclined to trust us. A case in point is a U.S.Russian joint venture called Dialogue. The U.S. partner is Joe Ritchie, a Chicagoan, and the Russian partners are Tatyana and Pytor Zrelov, a married couple who run the venture. Tatyana Zrelov recalls her surprise when she and her husband met with Joe Ritchie so that he could read, discuss, and sign all of the documents they had prepared for the launching of the joint venture. Ritchie asked the Zrelovs if they had written the documents themselves. The Zrelovs said yes. Ritchie signed the documents without reading them, making a unilateral display of

trust that set the tone for their relationship (Fey, 1995). Strategic Vulnerability. Specific to each partner, what are our intangible interests at risk through the entire relationship with that partner? Although intangible interests are subtler to measure and quantify, over time, they can be crucial in building or destroying a company's competitiveness. On the plus side, such interests include anticipated synergies and spillover benefits that may be gained through a relationship, and on the minus side they include core competencies that may be leaked through that relationship. Sample questions that tap into strategic vulnerability include: (a) What is the scope of the relationship? (b) What is the scale of the relationship? ( c ) How close is the relationship to our core technologies, products, and markets, and are we comfortable with the trend in this regard? Trust will be less important the narrower the scope, and smaller the scale, the more peripheral the technologies, the less core the products, and the more secondary the geographic markets covered by a relationship.5 It is advisable to remember that symmetry of strategic vulnerability need not exist in collaborative relationships. For example, in partnerships involving large and small companies, small companies typically have greater strategic vulnerability, given their more limited repertoire of competencies. Commenting on the explosion of large-small alliances in the biotechnology industry in the early Understanding Trust in International Alliances

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1990s, venture capitalist Barry Weinberg noted this asymmetry: The large European and Japanese pharmaceutical companies liked the idea that they can pay as they go, without making a large initial payment. "The deals are designed in such a way to make it easy for large companies to throw some money at potentially exciting projects and see what happens to them," but the small U.S. biotechnology firms "have lost access to capital because the [initial public offering] market has shut down" (Gupta, 1993). Facing a worsening capital crunch, such firms had little choice but to reach into the deep pockets of the big corporations.

INTERNATIONAL D I F F E R E N C E S IN A P P R O A C H E S TOWARD TRUST

Although we have focused thus far on important aspects of trust in alliances generally, we have not explicitly considered international differences in the propensity for trust, attitudes toward trust, and trust levels. These differences can be crucial. International alliances often bring together managers who may have different patterns of behaving and believing, fundamentally different cognitive blueprints for interpreting the world, and, differences in the very structure of perceiving, thinking, and r e a s o n i n g ( M a r u y a m a , 1984). For example, Adler (1997) ponders the question: What is the nature of the individual, good or evil? The answer varies across countries, with implications for trust levels. Americans see people as a mixture of good and evil, capable of 230

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choosing one over the other. Some other cultures see people as basically evil (as reflected in Puritanical thinking) or as basically good (as reflected in utopian societies). Societies that consider people good tend to trust them a great deal, whereas societies that consider people evil tend to suspect and to mistrust them. 6 F u k u y a m a (1995) picks up this theme and carries it further, arguing that we must go beyond economists' models of rational, selfish human behavior, and consider such "arational" factors as religion, tradition, and the concepts of h o n o r and l o y a l t y . How a s o c i e t y approaches these parts of communal life dictates how much trust exists among its members. Higher trust societies include Japan, Germany, and perhaps to a lesser extent, the U.S. These countries enjoy relatively high levels of "social capital," "spontaneous sociability," and trust. People tend to form and join a range of voluntary organizations, from sports s o c i e t i e s to r e l i g i o u s groups. These in turn prepare citizens to work cooperatively in large, private companies (e.g., IBM, AT&T, Toyota, GM, Mitsubishi, Siemens, DaimlerBenz) that are able to amass capital and develop technologies efficiently, leading to high economic performance and the creation of prosperity. In contrast, citizens of lower trust societies such as Italy, China, and France tend to avoid people who are not part of their immediate families, thus crippling attempts to build large, private business organizations. Whereas hightrust societies benefit from their lower costs in forming large enterprises, lowtrust societies confront higher costs that

impede the formation of such enterprises. These differences can be crucially important for international alliances managers. Persons from low- versus high-trust countries are likely to focus on subtle but important differences in criteria in evaluating partners and partnerships. For example, persons from low-trust societies tend to assess alliances more on person-specific trust, where socio-psychological factors play a larger role. Thorelli (1986) observed that especially in Oriental cultures, trust is a vital supplement to contractual arrangements, and it may even take their place. And the establishment of such trust with Oriental managers often takes more time and patience than many W e s t e r n e x e c u t i v e s would like to invest. It was noted earlier that higher trust levels within a country can enhance cooperative performance (Cusumano & Takeishi, 1991). A tougher challenge is to answer if companies from high-trust countries will be able to leverage their domestic collaborative experience to achieve high performance in their intern a t i o n a l a l l i a n c e s as well. Kanter (1994) responds affirmatively, Asian companies are the most comfortable with relationships, and therefore they are the most adept at using and exploiting alliances. Hamel (1991) and Reich and Mankin (1986) strongly corroborate this point. Kanter worries that American companies' "Anglo-Saxon style of management" is not conducive to trusting relationships with other companies, because of its "narrow, opportunistic view of relationships, evaluating them strictly in financial terms or seeing

them as barely tolerable alternatives to outright acquisition." European companies fall in the middle. Kenichi Ohmae, head of McKinsey's Tokyo office, used numbers to explain these international differences. Arguing that having control doesn't necessarily mean a better managed company, he wrote: "This need for control is deeply rooted. The tradition of Western capitalism lies behind it, a tradition that has long taught managers the dangerously incorrect arithmetic that equates 51% with 100% and 49% with 0%. Yes, of course, 51% buys you full legal control. But it is control of activities in a foreign market, about which you may know little as you sit far removed from the needs of customers in your red-carpeted office in Manhattan, Tokyo, or Frankfurt. When Americans and Europeans come to Japan, they all want 51%. That's the magic number because it ensures majority position and control over personnel, brand decisions, and investment choices. But good partnerships, like good marriages, don't work on the basis of ownership or control. It takes effort and commitment and enthusiasm from both sides if either is to realize the hoped-for benefits. You cannot own a successful partner any more than you can own a husband or a wife" (1989, p. 148).

Western managers also need to recognize that there may be culturallyshaped ways in which their international counterparts make judgments about trustworthiness. These include possible Confucian influences in Oriental managers' thinking. An empirical study of U.S.-Japanese alliances found that American managers rated consistency between future and past behaviors to be an important part of trust, whereas Understanding Trust in International Alliances 231

Japanese managers did not (Sullivan, Peterson, Kameda, & Shimada, 1981). Thus, the Japanese seem more willing to develop trust even in the face of unexpected, inconsistent behavior of the alliance partner. Sullivan et al. link this finding to differences in cultural values regarding an individual's relationship to his/her experiences. The Japanese believe that individuals must accommodate themselves to a continuously unfolding set of events, and must learn to accept ambivalent behaviors of others. Americans, however, have a lower tolerance for ambiguity. This, coupled with their need to seek mastery of a situation, made American managers unable to go as far as the Japanese managers in their willingness to build trust in the face of unpredictable, inconsistent, and ambivalent behavior. MORAL: Cookie-cutter alliance management is a recipe for failure. Particularly in addressing issues as central as trust, it is important to know and to understand cultural differences.

SOURCES OF TRUST IN INTERNATIONAL ALLIANCES

described below. Before exploring them, however, a caveat: Much disagreement exists in the literature as to whether trust leads to c o o p e r a t i v e behavior or vice versa. No attempt is made here to advance this chicken-oregg debate of causality. Instead, we take the more modest position that cooperative behavior and trust can both build or deteriorate concurrently. Further, we should note that although the factors described below apply to international alliances generally, the specific context of each individual alliance merits careful attention as well. The particular industry sector, strategic goals of alliance partners, degree of integration between partner firms, and the structure of a cooperative agreement can all make a difference in the role that trust plays in an alliance (see Osborn & Hagedoorn, 1997). For example, in sectors with low or medium technology intensity, a larger share of equity joint ventures are found; in contrast, sectors with high technology intensity (that is, high R&D intensity) show a preference for contractual agreements and a higher degree of organizational flexibility (Hagedoorn, 1998). As we show below, the incentive structures and trust features of e q u i t y versus c o n t r a c t u a l arrangements can be quite different.

Before an Extensive History of an Alliance Relationship

Process-Based Trust Production

Can trust deliberately be "produced"? This is of course a provocative question, and the short answer is, Yes. Systematic management attention to certain "trust-generating factors" (Zucker, 1986) can create trust in new relationships and enhance trust in existing relat i o n s h i p s . T h r e e such f a c t o r s are

Zucker (1986) observes that the " G o o d H o u s e k e e p i n g S e a l of Approval," formal warranties that come with major appliances, Christmas giftgiving, brand names, and reputation all have one thing in common: these are all sources and signals of trust. In processbased trust production, trust develops

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from the exchange process itself, based on past or (expected) future interactions. Similarly, in alliances, trust can arise based on the past or the future. Consider the following specific sources of trust.

Looking Back at Past Dealings: Partners' Cooperative History. It is almost a truism that experience breeds trust. With an evolving history, each alliance partner has the opportunity to assess the willingness and ability of the other to abide by the letter, as well as the spirit, of the cooperative agreement (Ring & Van de Ven, 1992). The better the match between expectations and past outcomes, the more confident a firm can be in believing that its partner will follow through on its current promises. Moreover, the older a relationship, the greater the likelihood that it has passed through a critical "shakeout" period of conflict and influence attempts by both sides. If an allia n c e s u r v i v e s this p e r i o d , the foundation is laid for personal trust, mutual liking, and a good working relationship (Anderson & Weitz, 1989). Finally, even without passing through crises, partners come to learn each o t h e r ' s i d i o s y n c r a c i e s and deepen mutual understanding over time, which improves the affective (emotional) quality of the relationship. Recall that economic logic is important (including anticipated profits and vulnerability), yet alliances don't operate in a vacuum of economic rationality. With a growing cooperative history, concrete personal relations help to strengthen the socio-psychological bonds that generate trust.

Looking Back at Past Dealings: Reputation Effects Often, a company has little direct prior experience with a partner. Trust may still develop in such relationships, based not on a shared cooperative history, but on the vicarious, second-best alternative of the partner's reputation for trustworthiness. Thus, an alliance partner's likely future behavior is ascertained by relying on its record of cumulative past behaviors. As in brand names for repeat business, reputation creates trust by imposing self-restraint on actions, as a company strives to preserve and protect what it has painstakingly built. The stronger the reputation, the greater the tacit assurance of continuing trustworthy behavior in the future, and the greater the trust generated. Looking Forward to (Expected) Future Dealings Give a m a n the s e c u r e p o s s e s s i o n o f a bleak rock, and he will convert it into a garden; give him a nine year lease o f a garden, and he will convert it into a d e s e r t - - source unknown

This quote tellingly illustrates the importance of time horizons in relationships. Different types of behaviors tend to be observed in relationships involving long time horizons (e.g., home ownership) than those involving short time horizons (e.g., apartment leasing). Similarly, to the extent that alliance partners anticipate mutually advantageous interdependence extending well into the foreseeable future, time horizons are long, and the expected future gains from the alliance promote cooperative, trustworthy behavior. Through such UnderstandingTrust in International Alliances 2 3 3

expectations of cooperation (and the resulting gains from the alliance), the future casts a shadow back upon the present, affecting current behavior patterns. This bond between a company's anticipated benefits in the future and its present actions is sometimes called the "shadow of the future" (Axelrod, 1984). Process-based trust is greater the longer the shadow of the future, that is, the tighter the connection between current actions and future consequences. Conversely, in alliances with sunset clauses (e.g., fadeout agreements), the shadow of the future is short. And in spot market transactions, the shadow is altogether nonexistent. In such cases, and in troubled alliances facing dissolution, the high visibility of a relationship's terminal date distorts behaviors toward "endgame plays." Serapio and Cascio (1996) have richly documented how cooperation and trust tend to suffer in such international alliances. Take the G M - D a e w o o 50-50 j o i n t venture, started in 1984. The goal was to build the Pontiac LeMans in Inchon, South Korea, using the design of GM's Opel unit in Germany. As the Inchon facility reached its p r o d u c t i o n capacity of 270,000 cars per year, Daewoo planned to export half of its output to the U.S., and to sell the other half in South Korea. But the LeMans experienced disappointing sales in the U.S. market, peaking at fewer than 50,000 cars in 1988. With the venture now on the rocks, the partners' time horizons shortened considerably, and the bickering and finger-pointing began. Each side blamed the other for the lackluster sales of the LeMans in the U.S. Daewoo accused GM of failing to market the 234

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LeMans aggressively in the U.S., and GM shot back that the initial poor quality of the LeMans and the on-again, offagain availability of supplies soured dealers on the car. After much haggling about the details of the divorce, the alliance ended in 1992. Characteristic-Based Trust Production

Research has shown that as companies internationalize, their initial forays typically are into countries that share substantial cultural and institutional similarities with the home country. The logic is straightforward: Similarity promotes greater knowledge of and familiarity with a host country environment, which in turn increases comfort level and reduces learning cost and time. A parallel logic may apply in international alliances, in which similarity can generate h o m o g e n e o u s expectations and common assumptions regarding a partner and partnership, inducing characteri s t i c - b a s e d trust, and f a c i l i t a t i n g cooperative success. This begs the question, similarity of what? What are the characteristics along which international alliance partners can be similar (or different)? The answers include societal culture and corporate culture of partner firms (Parkhe, 1991). IBM's experience is instructive. Lei, Slocum, and Pitts (1997) note that IBM's growing relationship with Motorola in advanced semiconductors has largely been harmonious. Both companies have tacit technological and organizational capabilities that can be shared only through closely managed joint ventures, and the fact that both companies are U.S.-based

makes it easier to understand and manage the flow of such knowledge, since there are no cultural differences that could "distort or filter out the transfer of such skills" (1997, p. 217). But IBM's relationships with several Japanese firms (e.g., Toshiba, Canon, Hitachi) have been described as "tempestuous," the difficulties stemming from differences in both societal and corporate cultures. It is hard for I B M to learn complex manufacturing techniques in a Japanese setting not only because Japanese manufacturing routines are embedded in organizational practices unique to Japan, but also because of the language problems that non-Japanese personnel face in these alliances. It would be incorrect, however, to assume that societal and corporate cultures always go hand in hand, or that domestic alliances always enjoy higher levels of characteristic-based trust than international alliances. Deep differences in corporate cultures, value systems, and strategic thrusts often mark companies from the same country (e.g., Apple and IBM in the U.S. or Hitachi, Toshiba, and Mitsubishi in Japan). In addition, the logic of the "similarity hypothesis" notwithstanding, there is little evidence to support that domestic alliances are harmonious; tempestuous alliances abound, such as the noisy divorce of IBM and Microsoft in 1991. Nor are international alliances necessarily tempestuous; congenial international alliances can easily be cited, including F o r d - M a z d a , F u j i - X e r o x , and GEFanuc, and Siemens-Corning's Siecor Corporation. (Importantly, a lesson from these successful international alliances is that differences in societal cul-

tures and corporate cultures can be effectively managed by international alliance partners, enhancing the probability of successful collaboration. This point is discussed in greater detail in the follow-up paper, "Building Trust in International Alliances.") Institutional-Based Trust Production

As the name suggests, production of trust in this mode relies on formal mechanisms, rather than on past or future cooperation or on characteristics of a partner. Process-based and characteristic-based trust both require much detailed, specific, non-transferable information regarding a partner. As such, these two types of trust may arise too slowly to be of immediate use to alliance partners. And even if they do arise, they may easily be disrupted in today's fast-changing, fluid global business environment. Under such circumstances, parties may rely upon two types of trust-production mechanisms (Zucker, 1986), both of which are tied to formal social structures. Each will be described in turn.

Providing Implicit "Guarantees'" Companies routinely signal a baseline level of trustworthiness by belonging to professional associations such as the New York Stock Exchange or the Federal Deposit Insurance Corporation (FDIC). Likewise, individuals signal competence and trustworthiness via professional certification and credentialing (e.g., CPA, licensed real estate broker, medical doctor). In each of these cases, the goal is to reveal company or individual attributes that are Understanding Trust in International Alliances 235

general (beyond particular transactions) and objective (anyone would reach the same conclusions). Such objectivity rests on membership in a professional subculture within which carefully developed behavior patterns are expected to be followed, signaling trustworthiness. Note that this type of trust, which Zucker (1986) calls person/ firm-specific trust, can be purchased (e.g., through association membership or licensing as a real estate broker). Zucker argues: " I f trust-producing mechanisms become institutionalized, and thus m o r e f o r m a l , then trust becomes a saleable product, and the size of the market for trust determines the amount of trust produced" (1986, p. 54). Interestingly, with the rapid proliferation of international alliances, there would appear to be a substantial market for this type of trust, yet at this point in time there exist few mechanisms to deliver implicit guarantees of trustworthiness of potential alliance partners.

Intermediary Mechanisms Here, trust is produced by counteracting concerns that a particular transaction may not be completed as planned, either through no fault of either party or because of opportunism. Toward this end, partners can (a) reduce the attractiveness of cheating, (b) increase the costs of cheating, or (c) increase the gains from cooperation. Measures are available to pursue these goals in advance of possible wrongdoing, in order to discourage cheating before it occurs, or subsequent to actual wrongdoing, in order to punish cheating after it has occurred and been detected. 236

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The first class of measures, aimed at

discouraging cheating before the start of an alliance, seek to create trust through a show of good faith, by voluntarily taking actions that "lock" oneself into delivering expected performance. Thus, alliance partners create for themselves obstacles (exit barriers) to lightly abandoning a relationship, which lessens fears of opportunism and induces trust. These self-imposed obstacles may be in the form of reciprocal agreements (such as guaranteed purchase of each other's products/services at guaranteed prices), or commitment of other types of nonrecoverable investments in the alliance. The notion of nonrecoverable investments includes physical asset specificity (e.g., plant and equipment), but goes further to also include site specificity, human asset specificity, and dedicated assets (Williamson, 1985). A good example is the Honda-Donnelley partnership referred to earlier. With only a handshake to mark the birth of the new alliance, Donnelley built an entirely new plant to make Honda's exterior mirrors (Magnet, 1994). The second class of measures seek to

promote cooperative behavior by reducing potential gains from cheating through prospective punishments after the fact. These measures consist of contractual safeguards, or legal stipulations in the partnership agreement, that inflict penalties for omission of cooperative behaviors or commission of violative behaviors. By anticipating possible contingencies, and by stipulating appropriate adaptations (and punishments) for each, such measures attempt to increase the level of confidence in a partner's probable behavior. T R W Inc., for

example, has three joint ventures with big Japanese auto suppliers to produce seat belts, engine valves, and steering gears for sale to Japanese transplants in the U.S. TRW has inserted clauses in its contracts barring the Japanese from poaching on its domestic auto business. Yet we should note that such measures are primarily preventive, not punitive. Parties typically hope that these safeguards never have to be used; the purpose is deterrence beforehand, not revenge afterward. Both classes of measures thus share the common goal of developing an alliance structure that provides built-in incentives toward cooperative, trustworthy behavior. Note finally that the above modes of trust production, though conceptually distinct, are interrelated and may reinforce or substitute for each other. For instance, an escrow account may act as an effective substitute for reputation, and vice versa (Zucker, 1986). Similarly, with a growing cooperative history, the significance of nonrecoverable investments and contractual safeguards (intermediary mechanisms) may decrease, as alliance managers increasingly come to know and trust each other (process-based trust).

OVERVIEW

International alliances are playing a growingly important role in corporate strategy today. Yet the failure rates of such alliances are disturbingly high, with e n o r m o u s costs and strategic implications for participating firms. So it b e c o m e s c r i t i c a l l y i m p o r t a n t to understand the root causes for alliance failures, as well as the steps managers

can proactively take to heighten the odds of success (Gulati, 1998). In many cases, a good first step is to look beyond formal contracts and consider the allpervasive influence of "soft" factors that drive international alliances. As B a u g h n , D e n e k a m p , S t e v e n s , and Osborn (1997) noted recently: Firms must realize that the formal alliance structure and governance provisions cover only a fraction of the skills that could potentially flow from one firm to another, and the means by which such transfer could take place (1997, p. 115). If formal alliance structure and governance provisions are the tip of the relationship iceberg, then to more fully understand the rest, managers must focus on understanding, and then building, trust. This means, first, appreciating the crucial role that trust plays in alliance management. Trust will be important whenever there exist uncertainty, vulnerability, and an absence of total control. As noted, these conditions exist almost universally in alliances. Next, managers must know and be able to evaluate the components of trust. Trust can rightly be viewed as psychological, sociological, and economic phenomena. It is all of them together, but none of them alone. Trust is p s y c h o l o g i c a l because it occurs within managers, sociological because it occurs between managers, and economic because each partner firm's tangible and intangible interests are at stake. The risk of potential damage to these interests creates, respectively, tactical vulnerability and strategic vulnerability. The particular mix of psychological, sociological, and economic components of trust depends Understanding Trust in International Alliances 237

upon the partners and the specific alliance situation. Alliances involving and r e q u i r i n g the h i g h e s t levels of trust, called strong form trust alliances, rely less on the e c o n o m i c c o m p o n e n t of trust and more on the psychological and sociological components. W e a k form trust alliances, on the other hand, rely m o s t l y on the e c o n o m i c c o m p o n e n t . M a n y a l l i a n c e s are c h a r a c t e r i z e d by semi-strong f o r m trust, w h i c h essentially g e n e r a t e s trust t h r o u g h governance devices. Particularly in international alliances, an important question concerns whether alliance m a n a g e r s v i e w "trust" similarly. It was s h o w n that f u n d a m e n t a l cultural differences may exist across countries and across companies in the n o t i o n of trust, p r o p e n s i t y for trust (high- versus low-trust societies), and triggers responsible for trust. For effective alliance management, it is critically important to know and understand these differences. Ignorance, cultural naivete, and ethnocentric arrogance can have costly consequences. F i n a l l y , p a r t n e r s s h o u l d a l s o be aware of the sources of trust, that is, the mechanisms through which trust is generated. Trust generation may occur through process-based, characteristicbased, and institutional-based mechanisms, and these mechanisms may comp l e m e n t or substitute for each other. Since m a n y of these m e c h a n i s m s are within m a n a g e m e n t ' s control, a basis exists to purposefully cultivate a trustful alliance relationship. This last point is elaborated in greater detail in a follow-up paper, "Building trust in international alliances." 238

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Acknowledgment:

I am grateful to two anonymous JWB referees for their detailed and thoughtful suggestions on an earlier version of this paper. I especially appreciate constructive input from Richard N. Osborn. This study was made possible by a research grant from the Kelley School of Business, Indiana University, Bloomington, IN 47405.

NOTES 1. Examples of cheating in alliances include witholding or distorting information, shirking or failing to fulfill promises, unauthorized takeover of partner's proprietary technology or key personnel, late payments, delivery of substandard products, and abrupt withdrawal from the alliance. 2. The American Heritage dictionary offers the following synonyms for trust: faith, confidence, reliance, dependence. Each of these nouns refer to a feeling that a person or thing will not fail in performance. But there are important shades of meaning. Trust implies depth and assurance of such feeling, which may not always be supported by proof. When acceptance of someone or something is unquestioning and emotionally charged, faith is the more appropriate term. Confidence suggests less intensity of feeling but, frequently, good evidence for being sure. Reliance implies a decision to commit oneself to another and to accept the consequences in case of failure. And with dependence, the commitment is not a free choice. 3. In fact, social order can be maintained via mechanisms other than trust, including exercising full control over another's actions (e.g., maximum security prison), auditing, monitoring, insurance against malfeasance, and finally, recourse to law (Zucker, 1986). But surpassing all of these in effectiveness is trust. These mechanisms may serve as functional complements to

4.

5.

6.

trust (Barber, 1983), but cannot act as substitutes for trust. Tactical vulnerability in the context of alliances is parallel to the transaction cost economics notion of asset specificity, and to game theoretic notion of sucker's payoff. In a world of pure competition, asset specificity is absent, vulnerability is zero, and parties to contracts have no continuing interest in each other's identity (Williamson, 1985). However, even when the scope is narrow, the scale is small, the technologies are peripheral, the products are non-core, and the geographic markets are secondary, trust will not be unimportant, for at least two reasons. One, such relationships will never grow into large, successful partnerships unless trustworthiness is demonstrated by both parties throughout, including (or perhaps especially) at their seemingly insignificant beginning. Two, as Barney and Hansen (1994) argued, a reputation for trustworthiness thus acquired can be a valuable source of competitive advantage. Adler (1997: 19) provides the following examples: In high-trust societies, people leave doors unlocked and do not fear being robbed or assaulted. In low-trust societies, people bolt their doors. After making a purchase, people in high-trust societies expect to receive the merchandise and correct change; they don't expect to be cheated. In low-trust societies, caveat emptor (let the buyer beware) rules the marketplace; one can trust only oneself.

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