Managing the Performance Tradeoffs from Partner Integration: Implications of Contract Choice in R&D Projects

Formal contracts represent an important governance instrument with which firms exercise control of and compensate partners in R&D projects. The specific type of contract used, however, can vary significantly across projects. In some, firms govern partnering relationships through fixed-price contracts, whereas in others, firms use more flexible time and materials or performance-based contracts. How do these choices affect the costs and benefits that arise from greater levels of partner integration? Furthermore, how are these relationships affected when the choice of contract is misaligned with the scope and objectives of the partnering relationship? Our study addresses these questions using data from 172 R&D projects that involve partners. We find that i) greater partner integration is associated with higher project costs for all contract types; ii) greater partner integration is associated with higher product quality only in projects that adopt more flexible time and materials or performance-based contracts; and iii) in projects where the choice of contract is misaligned with the scope and objectives of the partnering relationship, greater partner integration is associated with higher costs, but not with higher product quality. Our results shed light on the subtle interplay between formal and relational contracting. They have important implications for practice, with respect to designing optimal governance structures in partnered R&D projects.