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THE VIRTUAL CORPORATION: A STRATEGIC OPTION FOR SMALL AND MEDIUMSIZED ENTERPRISES (SME'S)
Conference Paper · January 2002
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THE VIRTUAL CORPORATION:
A STRATEGIC OPTION FOR SMALL AND MEDIUM-SIZED ENTERPRISES (SME'S)
Thomas Rautenstrauch
Professor of Business, Accounting and Controlling
University of Applied Sciences Bielefeld, Germany
ABSTRACT
The purpose of this paper is to
provide a theory-based outline of the
comparative advantages of the virtual
corporation as a modem organizational form
for small and medium-sized enterprises
(SMEs). Therefore, the virtual corporation is
examined from a transaction cost theory
point. Based on these results, it is argued
that a virtual corporation can provide a
higher level of transaction cost efficiency for
SMEs than alternative organizational forms.
Moreover, this article considers critical
success factors and challenges for SMEs
setting up virtual corporations. In
conclusion, the decision to build up a virtual
corporation is recommended as a strategic
option for SMEs in order to repair
comparative disadvantages caused by
limited resources.
INTRODUCTION
Network relationships as specific
cooperative arrangements among companies
are a present-day but not a completely new
phenomenon. In fact, networks and
networking are the result of external changes
and internal needs that both influence the
competitiveness of companies. In this
respect, a company's competitiveness does
not only depend on internal strength but also
on relationships with other companies and
organizations (Hakansson, 1987).
Whatever the stimuli alliances offer,
a global economy with increasing
importance of technologies and an
intensified degree of international
competition does not just affect large or
multinational firms but also small and
medium-sized enterprises (SMEs). As a
result, also SMEs, driven by growing
customer needs, are required to deliver
complete systems, products and services.
However, compared to SMEs, large firms
are normally better prepared to react to these
changes while SMEs are faced by the main
problem of limited resources such as skills,
knowledge, capital etc. In fact, empirical
data show a growing to support SMEs in
adjusting to the dynamic changes on the
national and international marketplace.
In this context, it seems to be a
strategic option for SMEs to cooperate with
partners that are concerned by the same
problems but have at the same time access to
complementary resources. This calls for
pooling when targeting a higher level of
competitiveness.
A modem organizational approach of
cooperative arrangements is the virtual
corporation that is commonly understood as
a temporary network of companies with
flexible boundaries and an intensive use of
electronic facilities which support the
network activities. Recently, the virtual
corporation has been seen an approach that
can offer comparative advantages for SMEs
compared to other forms of cooperative
arrangements.
The purpose of this paper is to
analyze and explain theoretically discuss the
virtual corporation as a cooperative
arrangement, that can be highly beneficial
for SMEs because they can bundle their
competencies and resources in a virtual
corporation in a more valuable way than
when kept separate.
THE VIRTUAL CORPORATION AS A
MODERN COOPERATIVE
ARRANGEMENT
Referring to computer science, the
concept of virtuality implies that all essential
parts of an object do exist though not in
actual shape. In the context of management
and organization studies, a virtual
organization refers to an inter-organizational
relationship among companies that results in
a network structure.
According to Byrne, a virtual
corporation can be defined as a temporary
network of companies that come together
quickly to exploit fast-changing
opportunities. In a virtual corporation,
companies can share costs, skills and access
to global markets with each partner
contributing what it's best at." (Byrne,
1993). In addition, Womack and Jones
emphasize the flexible boundaries by
describing a virtual corporation "[ ... ] in
which plug-compatible members of the
value stream come and go “[…]” (Womack
& Jones, 1994). Both definitions; reflect the
basic idea of how one firm can be flexibly
created by arranging organizational
resources from different companies. Thus,
the virtual corporation is considered as an
almost borderless organizational form with
continuously changing interfaces (Davidow
& Malone, 1992). Moreover, it shows a high
degree of flexibility while it is based on the
decentralized competencies that are brought
in by the participating
companies.
As shown in the following figure 1,
the partners of the virtual company provide
different value and non-value activities
within the value chain of the virtual
corporation that culminates in a real product
offered to the customer.
From an external view a network of
companies appears as a uniform corporation
as regards overall performance, which
requires at same time also sharing a vision,
management and overall strategy.
Furthermore, the required resources of the
participating partners are not centrally
located with the virtual corporation but are
made available through modem information
and communication technology. In other
words, it is a prerequisite that the
participating companies/units of a virtual
corporation be linked by electronic
information exchange and communication to
perform their functions (Child & Faulkner,
1998).
WHY CAN THE VIRTUAL
CORPORATION BE BENEFICIAL
FOR SME'S?
Descriptive studies related to the
formation and functioning of networks in
different industries show that networks have
prospered (Powell, 1990). When referring to
the benefit of the virtual corporation as an
cooperative organizational form, we should
analyze in which situations setting up of a
virtual organization can be efficient. One
theoretical approach that contributes further
insights into the governance forms that
cooperative arrangements may take is the
transaction cost theory. Thus, the theoretical
framework offered by transaction cost
theory is used to explain the relative
efficiency of the virtual corporation from an
SME perspective.
According to Ronald H. Coase's
paradigm of markets and hierarchies that
was later on expanded by O.E. Williamson,
transactions can be coordinated between two
extremes' of the governance structure:
contracting transactions externally on a
market versus integrating transactions
vertically within a firm understood as
'hierarchy' (Williamson, 1975). In between
these two extremes a number of hybrid
forms of cooperative arrangements exist.
Decisions on what is an appropriate
governance structure, i.e. the most efficient
coordination of transactions in market,
hierarchy or any hybrid form, depend on
transaction costs. Transaction costs
associated with each organizational form
occur when market transactions are
arranged, managed and monitored and are
considered as costs of information and
communication needed for finding,
negotiating, agreeing upon and monitoring
contracts (Gerybadze, 1995). To explain the
comparative efficiency of an organizational
form behavioral and situational
characteristics have to be considered
(Williamson, 1985). Transaction costs are
influenced by two behavioral assumptions:
bounded rationality and opportunism.
Bounded rationality describes that an agent
acts purposefully and rationally while
informational and other limits to the exercise
of rationality exist. Opportunism is
considered as behavior that is self-interest
and deceptive. According to Williamson,
both behavioral assumptions are a major
source of risk (Williamson, 1975). Both
behavioral assumptions induce a relatively
high level of uncertainty concerning
contracting agreements because contracts
will be more complex and costly.
Additionally, three situational
assumptions are to be considered as features
of a transaction: asset specificity,
uncertainty and frequency. Asset specificity
describes the complementarity by which the
use and transfer of investments is restrained.
A high degree of asset specificity implies
low salvage values and high exit costs for
those non-deployable investments (Carney,
1998).
An increasing level of asset
specificity and uncertainty provides a rise of
external transaction costs, if the frequency
of recurring transaction is low. Therefore the
transaction will be more efficiently
coordinated in a virtual corporation as long
as the internal cost (IC) of doing it is lower
than the external cost (EC) incurred when
contracting it in the market. The external
cost of the market solution includes the
external price (EP) that is charged plus the
transaction cost (TC). The integrated
organizational form will thus be preferred if
external cost are higher than internal cost:
EC = EP + TC > IC. According to Jarillo,
the virtual corporation can be considered as
relatively beneficial, if the external price is
lower than the internal cost for an activity,
and if transaction costs can be lowered
(Jarillo, 1993). In comparison to the market
mode or integrated mode of governance and
organization the virtual corporation as a
network will efficient if transaction costs are
high, but lowered by a specific company:
are able to contribute highly specific
knowledge domains when performing
complex tasks. This is because
transaction costs (TC) can be
lowered by contracting with a small
group of market participants who are
dealing in a trustful relationship
production costs (EP) can be lowered
by specialization undertaken by
independent companies
a certain level of transparency and
monitoring of changes within the
transaction cost structure is provided
by a network (Gerybadze, 1995).
Out of these three reasons, a virtual
corporation can offer sustainable
comparative advantages to SMEs.
CRITICAL SUCCESS FACTORS OF A
VIRTUAL CORPORATION FROM AN
SME PERSPECTIVE
EC < IC, while TC are selectively low.
A virtual corporation, in which
agents collaborate, will provide a higher
level of efficiency compared to other
organizational forms, if independent agents
While according to Porter, the
predominant motives of companies to join
strategic alliances are the development of
new products, the filling of expertise gaps,
the acquisition of new competencies, the
improvement of efficiency, the increase in
economies of scale in manufacturing and
market access, things are different for the
virtual corporation (Porter, 1990).
The main objective of a virtual
corporation can be described as the different
functions contributed by the network
members being provided in a way that a
competitive product will be delivered to the
customer. In this context, the most critical
success factors for a virtual corporation can
be seen in trust, knowledge and information
technology.
Trust within a virtual company
means that the partners within the network
rely on each other to share unforeseen
benefits and costs related to the exchange.
Therefore, trust leads to a reduction of
uncertainty and complexity by excluding
possible trust-breaking behavior of the other
partners (Borch & Arthur, 1995). The
function of trust in a virtual corporation is
not just to protect the participating
companies of the network from damages
caused by their partners but also to motivate
all companies to share their expertise,
knowledge and competences by generating
an exchange-friendly atmosphere and teamspirit.
Due to the fact that trust is essential
to the virtual corporation, it contributes to
achieving inherent stability within the
network. According to Dodgson, the extent
of trust in a virtual corporation does not just
depend on the number of participants in the
network but also on the intensity of
communication between the partners
(Dodgson, 1993). In comparison to SMEs,
large companies or multinationals would
reduce opportunistic behavior in order not to
damage their image or reputation. But SMEs
normally do not have an image or reputation
that is more than regionally focused and
therefore, SMEs fail in signaling their
willingness to cooperate reliably with other
partners. If a virtual corporation is mainly
and at the same time focused on the
reputation and image of the partners
involved, it is not suitable for SMEs.
Referring to SMEs, only relational contracts
with long-term oriented inter- and intraorganizational relationships are to be
considered as a prerequisite for building a
platform of confidence. Besides, due to the
fact that reputation and image are essential
to virtual corporations, SMEs are limited to
a certain geographical region with the virtual
corporation.
Sharing knowledge and competences
is considered as vital due to the fact that
virtual corporations are increasingly
established with regard to competencies
rather than to specific products (Davidow &
Malone, 1992). The readiness to share
knowledge and competencies with partners
depends on the level of trust between the
partners as well as on information exchange
behavior in the way that the less information
a company gets and the more information it
is asked to give, the less it will be interested
in staying with the network (Doney &
Cannon, 1997). At the same time the
spreading of knowledge and competencies
has a high impact on the speed and quality
of the product or process development.
Thus, it is the task of the virtual
corporation's management not only to
coordinate and control the stream of
knowledge and competencies between
exchange partners but also to reduce
conflict. Due to opportunistic behavior and
uncertainty implications, the higher the level
of trust in a virtual corporation rises the
lower the transaction costs will be.
Due to the functioning of the
network relations, information technology
(IT) is of high importance for the success of
a virtual corporation because it influences
the speed of the information exchange
process between the participants and the
corporation's ability to cream off synergies
independently from time and distance. Thus,
IT in the form of electronic mail, internet or
groupware enables the virtual corporation to
achieve its targets more flexibly, faster and
more cost-efficiently. In this context,
Davidow and Malone point at the
coordination and control of information as
critical success factors for a virtual
company. Their basic assumption is that
gathering and integrating the information
flow throughout the network is a
prerequisite for using it efficiently (Davidow
& Malone, 1992). Data exchange and interorganizational information systems are
considered to increase efficiency and to
stabilize cooperation within the virtual
corporation (Semich, 1994). In fact, due to
the limited financial resources of SMEs this
factor can induce difficulties or even a
hurdle for setting up a virtual corporation
caused by the necessary IT investments, i.e.
hardware and software of an appropriate
standard. This leads to increasing transaction
costs and so, the investment will only be
made if the expected benefits for each
company of the network exceed them.
The example of initial experiences
the German craft industry, particularly
construction businesses, had with virtual
corporations may illustrate this. Within
German craft industries, companies are
finding it increasingly attractive to build
networks in order to offer customers fullscale products and services. Customers are
interested in dealing with just one contract
partner rather than with various small and
medium-sized subcontractors. This is why
each of the virtual corporations in a craft
industry presents itself as one uniform
company to the customer. On an internal
level though, construction companies,
architects and engineers participate in the
network as partners. Each of the companies
is privately owned. They coordinate their
planning, engineering and construction
activities on different projects in order to
offer a one-stop shop including full
customer service to the customer. The
partners' communication is massively
supported by an intranet. Often, the positive
team spirit of the virtual corporation
motivates the different companies within the
network considerably, but at the same time it
may take some of the virtual corporations
more than a year to find suitable partners
with complementary competences.
CONCLUSION AND IMPLICATIONS
It has been shown that the virtual
company can be a cooperative arrangement
with comparative advantages for SMEs
under specific circumstances: if noncooperating behavior between the
participating companies of the network turns
out as dominant strategy, this tendency will
lead to instability of the network and finally
to its dispersal. Thus, SMEs should avoid
this inherent instability of the virtual
corporation by building long-term network
structures that are regionally focused and
provided with an efficient control and
sanction mechanism. This postulate has been
based on transaction cost advantages.
The virtual corporation as a network
of complementary skills and competencies
can provide an appropriate organizational
arrangement for small and entrepreneurial
companies that insist on a high level of
flexibility a low level of bureaucracy. But
those companies that plan to build up a
virtual corporation need to have information
and communication technologies like
internet, electronic mail or groupware by
which the network organization is enabled to
work and to reduce transaction costs at the
same time.
Apart from this, the participation of
SMEs in a virtual corporation requires the
ability and intention to build a trust culture.
Finally, the importance of virtual
corporations for SMEs should not be
underestimated because they serve a wide
range of purposes. But it should be
considered that virtual corporations among
SMEs can only supplement but not
substitute traditional economic activities.
Hakanson, H., 1987. Industrial Technologial
Development: A Network Approach.
London, Sydney and Dover (New
Hampshire) 1987.
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