The framework of Chinese business networks

However, to understand better the Chinese business network, ^[*] a theoretical framework is necessary. This can be accomplished by extending existing transaction cost theory and network theories .

When both markets and hierarchies fail, an intermediate mode of governance can be used to facilitate a transaction (Williamson 1979). Market failure can be caused by uncertainty and low volume conditions compounded by limited rationality and opportunism.

Uncertainty can be greatly reduced within a network. For example, the volume uncertainty, where there are few suppliers and many buyers and raw materials are in short supply, should not pose any serious problem for those buyers who have good guanxi with suppliers, because they have a greater chance of getting supplies than those who are not a member of the network. Furthermore, low volume conditions can also be dealt with effectively within a network. The network relationship is usually established through introduction and facilitation and is also witnessed by a third party. Contracting parties are less likely to behave opportunistically as the culprit will be penalized by the network codes/rules. Contrary to the conventional belief that the Chinese system of networked transactions is uncodified (Boisot and Child 1994), a network has its own rules and codes which are often 'invisible' but effective. An entrepreneur who behaves properly, in honouring verbal promises, repaying loans on time and caring for his family can be drawn into a Chinese business network (Wong 1995). It is fairly obvious that Chinese social networks such as clan associations, trade associations and dialect associations are established on the common values (codes) shared by members. For example, the foundation for a dialect association is the dialect which depicts shared values among members . Therefore, any opportunistic behaviour such as attempts to breach a contract or a 'gentleman's agreement' will be checked by potential penalties.

Another network mechanism is trust. Every single paper on network will mention trust as the key element of a network relationship. Without trust, there will be no network. Trust is regarded as confidence in the continuation of a mutually satisfying relationship (Thorelli 1986) or as 'glue' (Ouchi 1980). Trust is established on the positive feelings built by interacting with one another for a reasonable period of time. Therefore, trust can greatly reduce uncertainty which is usually faced by two contracting parties in a classic market. Network can also provide other effective means to deal with hazards in a market situation. Under a network relationship, opportunistic behaviour will be checked by the prospect of future business transactions, the need for reciprocity, reputation and the prospect of ostracism among peers (Williamson 1983; Maitland et al 1985; Macaulay 1963). These effects are in line with the key Chinese cultural values such as face, trust, reciprocity and so on. This is one of the main reasons why the business network has been ubiquitous in Chinese communities. As a result, therefore, with checked opportunistic behaviour and reduced uncertainty, the business network lowers transaction costs. As Williamson (1975) argues, it is not uncertainty or low volumes , individually or together, that results in market failure, it is the joining of these factors with limited rationality on the one hand and opportunism on the other that gives rise to exchange difficulties. Solinger (1989) discovered the advantages that business networks could provide in an economic environment where uncertainty persisted with regard to the honouring of trading agreements, the assurance of quality in goods exchanged, the provision of working capital, and so forth. Chong (1994) argues that whether it is personal reputation or the firm's, reputation can often play an important role in reaching agreements in East Asia.

Nevertheless, existing discussions on whether to internalise an activity within a firm or to farm it out to other firms in a network (Walker and Weber 1984) are rather limited in scope. The advantage of network is far beyond this 'make or buy' decision. By networking with potential partners in another industry or another consumer market, firms can support each other and share know-how and information. As a result, firms in a network relationship will become more competitive than their competitors outside the network. The firm is frequently faced with many limitations such as lack of finance, technology and the regulations of local government. Owing to the lack of information, there is sometimes no market to internalize in the first place. By networking with other enterprises , a firm can have better access to much needed information which is likely to flow between members within a network. Transactions require the production and exchange of information (Boisot and Child 1988). Consequently, a market can be created with the availability of information within a network. Therefore, network relationship cannot provide only economies of scale (or whatever source of efficiency) (Jarillo 1988) and synergy, but also help to create a new market which does not exist in the classic market. The benefit of a network is that it has the best of both worlds : markets and hierarchies. It provides the merits of a quasi internalization, such as reduced transaction costs and the creation of new markets, as well as the advantages of a classic market such as economies of scale, wider choice than total internalization and the flow of information. In conclusion, the network can provide three key advantages:

1. reduced transaction cost;

2. creation of a new market; and

3. synergy and economies of scale.

The network is not only efficient but also effective (Jarillo 1988). It was found that those firms that relied solely on core family members were less successful than those that relied also on friends (Omohundro 1983). This finding indicates that the limited sphere of family business is a liability rather than an asset to the success of a firm. It is the business network which can offer a wider sphere of interactions which resemble a classic market of more choice and an internalization which can protect firms from the hazards, such as uncertainty, and opportunities attached to the classic market.

However, like other forms of transaction governance, business networks can fail (Thorelli 1986). That is when the transaction costs of using a business network outweigh the benefits. For example, if the need for reciprocity disappears, either party may feel it is too costly to keep up the unnecessary relationship. As a result, the guanxi relation lapses (Alston 1988). However, members of a business network may change, but the business network itself often survives and develops with the joining of new members. According to Johanson and Mattsson (1985, 1987), networks are stable and changing with new relationships being established and old relationships dissolved. Therefore, the business network is a dynamic organization.

In real life, a firm may belong to dozens of business networks at the same time. Therefore, to many firms, network relationships are three dimensional. A firm may have horizontal inter-organizational relationships as well as vertical business relationships such as the relationship between the firm and local government offices. Sometimes these networks may overlap with each other. Therefore, to be a credited member, firms have to abide by the codes which are shared by other members. These 'invisible' codes and values are, more often than not, the substitution for an insufficient legal system.

^[*] Hereafter, the term Chinese business network refers to the business networks in all Chinese communities.