Competition and Trust: Evidence from German Car Manufacturers

Trust is an essential ingredient of social life. But trust is not considered an essential ingredient in the models of selfish behavior on which modern economic theory is built. In the present study, we investigate theoretically and empirically the effects of trust on economic interaction. Our empirical object of analysis is the interaction between key upstream suppliers into the German automotive industry, and their German buyers. We start from a simple model of procurement in such an industry. The situation is characterized by strong buyer power. Our notion of trust is related to that situation. It is associated with the upstream supplier’s belief in being compensated for his buyer-specific investment into a product supplied to a specific automotive manufacturer. Within that model, we show that the upstream supplier’s relationship-specific investment increases in that belief. In contrast to the existing literature emphasizing exclusivity in trust relationships, we furthermore show that increasing trust specified this way allows the procuring automotive manufacturer to induce more competition between the upstream suppliers, because this way he can extract a higher rent from the interaction. Our empirical analysis rests on an extensive survey research study on the interaction between first tear upstream suppliers and the automotive manufacturers in the German automotive industry, that we conducted for the German Association of Automotive Manufacturers (VDA). While the idea that increasing trust should increase the supplier’s buyer-specific investment has been around in the theoretical literature for a while, we show for the first time empirically that trust in a specific institution – in this case of the upstream supplier into the behavior of the procuring automotive manufacturer, induces increased buyer-specific investment by that supplier, that results in lesser failure rates of the part produced. Most importantly, and in contrast to the existing literature, we demonstrate also empirically that increasing trust is unequivocally associated with increasing competition in procurement, as induced by the procuring automotive manufacturer.

Felli, Leonardo, Johannes Koenen and Konrad Stahl (2011), Competition and Trust: Evidence from German Car Manufacturers, ZEW Discussion Paper No. 11-072, Mannheim.