Building Trust and Making Contracts in Product ...

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Building Trust and Making Contracts in Product Development Collaboration Abstract

There are three main positions concerning the relationship between trust and contracts in inter-firm collaboration. Transaction cost economics states that trust has no role in the management of relationships between rational economic actors. New economic sociology holds that trust is an alternative to formal contractual arrangements. Finally, a mediating position finds trust and contracts as complementary mechanisms of governing inter-firm relationships. To avoid a simplistic framework based on the juxtaposition between trust and contracts, we analyse the formation of trust during a joint product development project by two biotechnology firms. In this context, contracts are analysed as instruments of cooperation and trust construction in relation to several other means, such as product seminars in marketing collaboration and parallel experimenting in product development. The marketing collaboration proved vital for the formation of the initial trust and ultimately led into the joint product development project between the partners. Formal contracts, on the other hand, were a necessary but not sufficient means of building trust. They contributed to the intentional trust between the partners, but did not play a role in the formation of competence trust. The major mechanisms in the building of the competence trust included doing parallel experiments as well as adhering to agreed rules and work schedules.

Keywords: trust, contacts, inter-firm collaboration, product development

2 Introduction

One of the central arguments in organizational sociology and innovation studies has been that the exchange of new technological knowledge is best realized in a network type of organization. In this context, networks are seen as an alternative to markets and hierarchies. While markets rely on the price mechanism by means of which relationships between buyers and sellers are mediated, hierarchies use authority to coordinate cooperation and the division of labour between different organizational units. Because development of innovative products requires a substantial amount of joint work, interaction, learning as well as coping with uncertainty, neither price nor authority is an appropriate coordination mechanism. In their place, companies use networks that are managed either through trust or contracts, or a mixture of both (Poppo and Zenger 2002; Woolthuis et al. 2005).

In transaction costs economics (Williamson 1996), networks are regarded as hybrid entities sustained by long-term contracts between companies, combined with other administrative arrangements such as information disclosure and conflict-resolution mechanisms. Because parties that enter into such relationships are rational and calculating agents seeking to maximize their separate benefits, the role of trust in the management of the relationship remains virtually non-existent. Instead of trust, economic rationality and foresight on the part of the collaborating partners allow the problem of uncertainty to be reduced to one of calculable risk: “I argue that it is redundant at best and can be misleading to use the term ‘trust’to describe commercial exchange for which cost-effective safeguards have been devised in support of more efficient exchange” (Williamson 1996: 256). In transaction costs economics, trust should thus be reserved for personal relations between family, friends and lovers only (Williamson 1996: 273-275).

In contrast to transaction costs economics, new economic sociology (Granovetter 1985; Uzzi 1996) as well as some organization (Adler 2001) and legal researchers (Macaulay 1963) have argued that the norms of trust and reciprocity are, in fact, alternatives to formal contracts. Networks, according to this view, are distinct forms of organizations based on mutual trust between partners. Trust reduces both transaction costs by “replacing contracts with handshakes” and agency risks by

3 increasing “mutual confidence” (Adler 2001: 219). The social embeddedness (Granovetter 1985) of transactions in trustful personal relationships makes it possible for economic actors to push formal contracts into the background in collaboration management (Larson 1992). An extreme version of this substitution thesis claims that the use of contracts hinders the development of a trusting relationship because the introduction of formal safeguards into cooperative networks will be interpreted as a sign of distrust (Macaulay 1963).

There is also an intermediary position between these two competing alternatives, according to which contracts and relational governance are viewed as complementary mechanisms of governing inter-firm relations (Das and Bing-Sheng 1998; Poppo and Zenger 2002; Bennett and Robson 2004). Poppo and Zenger (2002) argue, for instance, that customized contracts facilitate the evolution of cooperative exchange relationships. This is so because they require parties to “mutually determine and commit to processes for dealing with unexpected changes, penalties for noncompliance, and other joint expectations of trade”(Poppo and Zenger 2002: 713, italics in original). Because there are always some aspects of exchange that are impossible to specify in contracts, trust-based relationships complement formal contracts by generating contractual refinements that foster collaboration and bilateralism in situations of change and conflict. And vice versa: well-specified contracts may act as devices that promote more cooperative and trusting relationships by way of narrowing down the domain of uncertainty (Poppo and Zenger 2002: 708).

Although this complementarity thesis seems constructive and credible at first sight, it tends to remain too simple. The empirical research has given mixed results and has found the relationship between trust and contracts an extremely complicated issue (e.g., Chaserant 2003; Gulati 1995; Larson 1992; Lorenz 1999; Malhotra and Murnighan 2002; Sitkin and Roth 1993; Woolthuis et al. 2005). To avoid a simplistic framework based on the juxtaposition of trust and contracts, we suggest four methodological starting points for the study of their relationship. These are based on the view of product design collaboration as object-oriented mediated activity that has been developed by activity theory in dialogue with science and technology studies, particularly actor network theory (references deleted owing to the review process).

4 First, contracts must be addressed in relation to the history of the collaboration in question. This is needed in order to better understand the specific foundations of trust before a given contract becomes drafted and signed. Referring to this, Blomqvist and others (2005: 499) speak about an initial or “threshold amount of trust”that proceeds contracting. They point out that trust and contracts are related to each other in different ways and in different phases of the relationship. We think that this is true even during an individual innovation process, i.e., during the course of the collaborative development of a single product.

Secondly, contracts should be understood as instruments of cooperation. Seen from this perspective, contractual behaviour is not an independent activity per se but must be understood as part of a more extensive collaborative relationship: “The first thing to note about contract is the fact that it concerns [… ] co-operative social behaviour, behaviour characterized by a willingness and ability to work with others [… ]” (Macneil 1968: 14). The purpose of this working together is not to establish a social relationship as such but to construct an object –a product or a use-value –considered valuable by the partners. Accordingly, we will examine the product development process as joint object construction during which trust and reciprocity are created through the use of various means, including rules that consist of both written consents and unarticulated norms of shared activity (references deleted owing to the review process).

Thirdly, as a corollary to the previous point, the contribution of different kinds of instruments and means needs to be analysed (Leont’ev 1978; Engeström et al. 1999). Since different kinds of contracts are used in different phases of collaboration, it is their role in trust construction that will be analysed here. On the other hand, their role and significance needs to be evaluated in relation to other means and tools of collaboration.

Fourth, we find the distinction between competence trust and intentional trust (Woolthuis et al. 2005; Blomqvist 1997) important. Competence trust refers to the belief that a partner can technically and managerially accomplish what has been agreed in a collaborative project. Intentional trust refers, on the other hand, to the absence of deliberate opportunism by a partner in economic activity. This conceptual

5 division is based on the dual nature of commodities as use-values and exchangevalues (Marx 1990). Competence trust is thus related to the use-value, i.e., to the capabilities and skills of the partners and to the actual use of objects in the product development work. Intentional trust, on the other hand, is related to the exchange value, namely to the control of the economic gains from a product, to the IPRs related to it, and to the distribution of income in a way that is in a fair relation to the contributions of the partners. In this paper we will examine whether or not these two types of trust have been achieved by differing means, by different people and in different phases of cooperation.

Research site and data

In the present study, we will examine the developmental trajectory of a joint product development project involving the Finnish and American life-sciences companies Finnzymes and MJ Bioworks accomplished during the years 2000-03. Finnzymes was established in 1986 and specialized in enzyme products used in molecular biology. MJ Bioworks, on the other hand, was established in the late 1990s and was a sister company to MJ Research, a U.S.-based market leader and manufacturer of automated DNA sequencers and genotypers used in biological research. Both companies were private entities that produced and sold reagents, enzymes and instruments for genetic engineering and research purposes. Their customers typically were researchers working in academic, clinical or industrial research laboratories. While there were hundreds of small biotechnology companies operating in this area, only a couple of dozen companies, including Finnzymes and MJ Bioworks, operated on a global level.

The main products of Finnzymes were DNA-polymerase enzymes used in PCR technology. PCR –Polymerase Chain Reaction – was invented in 1983 and is one of the basic methods used in molecular biology and biomedical research. In this process millions of copies are produced from a single DNA fragment. The multiplication effect is achieved by heating and cooling the PCR mixture. During the process, the polymerase enzymes catalyze the DNA multiplication process. PCR is extensively used in many diagnostic methods, such as forensic DNA testing and the detection of viral diseases as well as genetic engineering. In this paper, we will look at the development of a polymerase enzyme called Phusion. The enzyme was developed by

6 fusing polymerase with a DNA binding protein (called Sso7d) that made the resulting enzyme more rapid and reliable than any other polymerase on the market at the time.

Our empirical data comprises interviews with the chief executive officer (CEO), R&D director, director of international sales and production manager of Finnzymes as well as former vice president of the sales and marketing department of MJ Research. In addition, we discussed the significance and use of contracts with a researcher specialized in intellectual property rights (IPRs) and contracts. Since agreements related to the Phusion project were strictly proprietary, we asked the CEO to go through the contents of the contracts used and explain the significance of each article in them. Our informants described how these contracts were drafted and agreed upon, and also reflected on their importance from the point of view of the joint product development work and of the construction of trust between the partners. Having studied Finnzymes since 1997 (reference deleted owing to the review process) we also had data on the company’s prior collaborative relationships, which allowed us to put the project in a historical perspective. By so doing, we were able to analyse the foundations of Finnzymes’reputation that played a significant role in the initiation of the joint work with the American company.

Formation of initial trust in marketing collaboration

The Phusion project was based on prior marketing collaboration between Finnzymes and MJ Bioworks, a sister company to MJ Research. Since 1990 Finnzymes had sold in Europe PCR equipment developed and manufactured by MJ Research. MJ Research, on the other hand, had acted as an agent for the products of Finnzymes in North America and Japan since 1996. The companies were satisfied with the results of this cooperation and, according to Finnzymes’director of international sales, “we would hardly have ever started the joint product development work unless this collaboration had been underway”. In other words, the marketing collaboration provided an effective means for the companies to assess the level of each other’s expertise and to build initial trust based on that. Speaking in a more general level the vice president of the sales and marketing department of MJ Research recalled:

7 The relationship between Finnzymes’ reagent business and MJ Bioworks / MJ Research was strong since 1997-98. [… ] [Our thinking] was very much in line with Finnzymes’sort of corporate philosophy. That’s why the two companies collaborated. There was a similar perspective of how to run a company and how to recruit employees and what is really important to a company.

The marketing collaboration also made it possible for the companies to learn about one another’s products, competences and financial standing. The mechanisms of such learning included marketing sessions, trade shows, product seminars, customer visits and training courses. In the trade shows and product seminars, agents selling the partner’s products met with customers and heard, as noted by Finnzymes’ sales director, “uncensored feedback concerning the products, good or bad”. The same held true for the joint product seminars that Finnzymes and MJ Research arranged on university campuses in the United States. Even more direct feedback was received through customer visits that were regularly organized by both companies. Still another mechanism through which the quality of the products could be monitored was customer reclamations. Finally, training courses of various kinds were arranged for distributors either at the companies’headquarters or in major trade fairs. In the words of the sales director, these courses served multiple purposes:

There is product training [and] marketing training but, in addition to these, a social aspect as well. That is, people meet with each other: we see our distributors and distributors meet with one another [and] can exchange experiences. Usually we also invite some agents to tell us about their country and marketing efforts as well as the results [so achieved]. [… ] And if there is someone who has not yet visited our facilities and is not familiar with Finnzymes, it is nice to invite him or her here and show [our premises]. It gives credence.

In addition to the product information, the partners’ credibility grew through delivering to one another sales reports and other facts about each other’s finances. Finnzymes and MJ Bioworks knew, for instance, each another’s sales progress, turnover and overall financial status. The fact that both companies were relatively small and owned by their operative management also fostered trust formation: any issues that came up could be directly addressed with the person who had ultimate say

8 in the company, the owner-manager. The sales director of Finnzymes articulated this viewpoint as follows:

[It] brings continuity in business because we do not have to follow the rules of stock markets and their quarterly reporting. If we agree on something, the owners who also work in management are involved. We have known them for years, which produce stability and trust in collaboration.

In summary, the marketing collaboration between Finnzymes and MJ Bioworks increased MJ Bioworks’awareness of Finnzymes’product development capabilities and its financial standing thereby making it a potential partner in future product development projects. In addition, two other reasons contributed to the formation of the joint project. First, Finnzymes had resources and expertise that MJ Bioworks needed in order to realize the Phusion enzyme idea. Having a background in PCR instruments, the MJ group of companies did not have the know-how of designing and producing enzymes. Finnzymes, on the other hand, had a good, long-standing experience in exactly this. It had been active in the DNA sequencing and PCR markets since their emergence developing, producing and marketing many highquality products. Secondly, MJ Bioworks did not have the immaterial property rights required for manufacturing and selling polymerase enzymes for PCR. A license for the PCR technology was needed from the global health-care giant, Hoffman-La Roche Ltd. Finnzymes had that license. Given these reasons, the Phusion project was a natural step forward in the relationship between the partners. According to the vice president of sales and marketing of MJ Research:

Finnzymes was a distributor of MJ’s products since the early 1990s. So, there was already a relationship there. Finnzymes had the licence from Roche to sell Tag polymerases required for PCR. So, they had a licence that MJ Research could not get. So… Two important pieces: you know the person, you trust the organization, and they had the required licenses for freedom to operate.

9 The launch of the Phusion project and the relevance of the secrecy agreement

The Phusion project began in August of 2000 when the research director of MJ Bioworks along with a company researcher visited Finnzymes’ headquarters in Espoo, Finland. The research director and researcher told the CEO of Finnzymes that the fusion of a specific binding protein known as SSo7d with polymerase enzymes seemed to make PCR more effective than was currently the case. They asked whether Finnzymes would be interested in starting a collaborative project to further develop this invention into finished enzyme products.

Discussing the commercial potential of the invention required the exchange of confidential information. To allow for this, the partners signed a secrecy agreement. According to the CEO of Finnzymes, this was a routine thing to do:

This is quite usual these days. In the fusion case, for instance, other people call you up and say: “Hey, we have probably invented a means to make an enzyme which is more processive, or speedy, are you interested in it?”You accept [the offer] and say that you are interested. “Well, is it ok for us to come by and demonstrate it?”Once they arrive, the first thing to do is to sign a secrecy agreement.

The function of the secrecy agreement was to ensure that information shared in the joint discussion was not disclosed to outsiders. According to it, the company revealing confidential information was to inform the other in writing that such was the case. This announcement had to be made within two weeks of disclosing the material to be kept confidential. In addition, the secrecy agreement stipulated that any information made public by a third party was not to be regarded as confidential. Keeping product development information confidential was customary for Finnzymes’business culture. The production manager stated that the employees of the company were “often reminded that every development project was always secret”. Therefore, the CEO’s signing of the agreement did not impose any extra restrictions on the firm’s personnel.

10 Immediately after this meeting, in September 2000, Finnzymes began to test the experimental results that MJ Bioworks had reported. As the production manager of Finnzymes recalled:

We began testing the enzymes they [MJ Bioworks] had produced on a small scale [… ] so as to reveal their potential advantage. That is, [we wanted to see] whether or not we were able to bring about similar advantages by using an experimental set up identical to what they had shown us in that presentation.

The results of these preliminary experiments gave reason to assume that a speedy and reliable enzyme product could be achieved. Consequently, Finnzymes decided to engage in the project and invest a significant sum of money in it. Compared with other project proposals Finnzymes had received, the decision of starting to cooperate with MJ Bioworks was “among the most easiest”, as was noted by the company’s R&D director. The invention looked promising both technically and commercially. In addition, it was directly connected with Finnzymes’ main business area, i.e., producing and selling DNA polymerases. Through the project, Finnzymes sought to increase its expertise in this business area and also expand its product portfolio to polymerases used in a new, rapidly developing subfield of PCR technology, quantitative PCR.

The cooperative agreement and the beginning of the product development work

Once the product development work began in late 2000 the companies agreed upon an eight-page cooperative agreement summarized in Table. The Phusion project can be characterized as a project-based non-equity partnership. According to Hagedoorn and Hesen (2007: 353) contracts regulating these kinds of partnerships oblige partners to act collaboratively and to make efforts to fulfil their respective obligations. The content of the contract can be divided into six main categories addressing 1) division of labour, 2) confidentiality, 3) hardship and damage measures, 4) termination rights as well as 5) dispute resolution.

The only clause in the agreement that referred to the contents of the product development work was article entitled “Duties”. The function of this clause –

11 regarded as the most important element of the contract by the CEO of Finnzymes – was to provide the project with an initial plan according to which major tasks and expenses would be distributed between the partners. The division of labour was based on the partner’s expertise. Finnzymes was responsible for the fidelity testing of the developed fusion enzymes, i.e., examining the degree of similarity between the original string of DNA and the resulting copy of it. MJ Bioworks, on the other hand, focused on studying the processivity of these enzymes, which means their ability to repetitively continue their function during the DNA replication process.

Although the division of labour as well as the distribution of expenses between the partners were written in the cooperative contract, the division of labour began to alter as soon as the product development work commenced. During the course of the project the tasks performed by the companies were redefined on an ongoing basis:

The situation changed all the time. The course of action was determined by new research results. Both [companies] worked in a comprehensive manner, which means that it [the division of labour] was no longer strictly defined. [… ]. Sure, there were experiments where one or the other had more know-how and these were definitely done by that one. [… ] We did not want to stick to a certain [division of labour] but act more like one large project group where neither side had any limitations concerning what to do. (Production manager, Finnzymes)

A similar kind of flexibility pertained to the distribution of expenses. As explained by the CEO of Finnzymes, it was “impossible to know in advance how much time, money or [other] resources would go into working out certain things”. Therefore, the allocation of expenses was agreed on during the course of the project.

In addition to the duties of the partners, the cooperative contract sought to protect the partners’IPRs and other vital product development information from violation or exploitation by uninvited third parties. The contract thus described the ways in which confidential information was determined during the course of the project as well as how partners were to assist one another against possible infringements of their respective IPRs. The IPRs of the Phusion technology were not defined in the cooperative contract because the invention was patented by MJ Bioworks prior to the

12 establishment of the relationship. When it came down to the confidential information, the contract defined the kinds of studies that were under the purview of the agreement.

The rest of the contract was mostly set to provide the companies with a set of precautionary measures designed against potential problems and difficulty that might prevent either one from fulfilling its obligations. According to Hagedoorn and Hesen (2007: 349), the substantial number of contractual safeguards in non-equity partnerships is due to the lack of a common ownership structure, such as a joint venture, as well as the complex business environment. One such clause in the contract was “Warranties”. It discharged partners from liability to each other if events beyond their reasonable control prevented them from performing their obligations. In such a case, the contract would be either terminated or suspended. The ways in which termination or expiration might take place were also described. The precautionary measures defined in the contract included the ways in which disputes were to be resolved and which country’s jurisdiction was to be applied in the dispute resolution. In addition, the partners were given an exemption from the penalties and liabilities incurred as a result of the possible termination of the contract.

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Evidently the major function of the cooperative agreement was to serve as a legal frame of reference and a precautionary means to be used in situations considered detrimental to the objectives of the joint project. This state of affairs was expressed by the CEO of Finnzymes as follows: “a major part of any contract is to deal with the potential conflict situations, that is, the bulk of the contract is never needed”. This was confirmed by what happened in the project. The cooperative contract between Finnzymes and MJ Bioworks was neither discussed nor referred to in the product development meetings between the partners. The production manager of Finnzymes in charge of the Phusion project never saw either the secrecy or co-operative agreement.

13 Parallel experiments as a means of creating competence trust between the partners

The two main tasks of the joint project were to find a way of fusing the binding protein with various polymerase enzymes and examining how these enzymes behaved in PCR. It turned out that the new enzymes made the PCR reaction not only robust (i.e., usable in various experimental environments) and quick but also more reliable than any other polymerase on the market at the time. These features constituted the foundation of the competitive edge of the products that were ultimately created. This experimental work was also instrumental in creating trust between the partners concerning their technical and managerial capabilities in accomplishing the goals of the project.

An important way of creating trust between the partners was parallel testing, i.e., testing the same things in the laboratories of both partners. Four kinds of tests were done: 1) pre-tests of the initial information supplied by the inventor, 2) parallel tests during the early phases of the project, 3) alfatests at the end of the project and 4) betatests before the products’market launch. Each type of experimentation played a different role in the product development process as well as in the building of trust between the partners.

First, the pre-tests were done before the product development collaboration began. The production manager of Finnzymes charaterized the significance of these tests as follows: “They [MJ Bioworks] presented us with an idea that seemed good in black and white. But before we started the collaboration we had to make sure that it really worked the way they had said.”According to the production manager, pre-tests of this sort were always done in the preparatory phases of new product development projects, along with untangling the IPRs.

Second, many of the tests during the early phases of the product development work were done in parallel at the laboratories of both partners. There were several reasons for this. The experiments were needed to determine the way in which the new binding protein influenced the quality of the enzymes and in what applications it could best be used. Due to the fact that new functions and uses of the fusion enzymes were at stake,

14 both of the companies wanted to conduct the decisive experiments themselves. The results thus became cross-checked, and a shared foundation for future discussions concerning the direction of the project was created. The parallel tests also served two other purposes. First, they were useful from the point of view of the standardization of the experimental procedures between the two laboratories and, second, they facilitated the creation of trust between the partners as regards their technical competence. Along with these tests, a rough division of labour between the partners outlined in the cooperative contract became established. MJ Bioworks tested the fidelity of the enzymes while Finnzymes assumed responsibility for processivity. This division of labour was based on the specificity of the technical resources of the partners.

Third, in the alfatests the functionality and repeatability of the effects produced by the fusion enzyme were investigated by using various sorts of devices manufactured by different companies. Because Finnzymes had experience in bringing new enzymes to the market, it assumed most of the responsibility for carrying out these tests. The purpose of using a variety of experimental set-ups was to make sure that the reaction could be reproduced using different kinds of instruments by different people in different locales. As explained by the production manager:

Once we started to approach the market launch, [… ] we had to ensure that these products work also in instruments produced by manufacturers [other than MJ Research]. They [MJ Bioworks] did not have that opportunity at their disposal. They only had machines of their own, while we had, instruments from other manufacturers as well.

Finally, in betatesting, different prototypes of the products were sent to laboratories all over the world to collect experiences and reactions from the expected users. In these tests, experimental conditions in which the enzymes were used were further scrutinized. In one case, for example, Finnzymes and MJ Bioworks were not able to make up their minds on how to decide which pH value and what combination of chemicals was the most optimal alternative to be used in the final product. So, two different formulations were sent randomly to different customers and feedback concerning their functionality was collected. This response increased the companies’

15 understanding so that a sound decision concerning the most appropriate experimental conditions could be made.

During the betatests, the efficacy and applicability of the forthcoming products were investigated, once again with the help of Finnzymes’customers. These tests were crucial from the perspective of further establishing the initial trust that the partners had in the products’competitive advantage. It was found in these tests that one of the new enzymes, Phusion, was significantly better for the cloning of DNA in certain circumstances than any other polymerase on the market at the time. In addition, the companies had also developed a new group of enzymes called DyNAmo for quantitative PCR. These too were found to be of high quality, thus warranting the market launch.

Once the market launch was approaching, the experimental results achieved in the alfa- and betatests were compiled in four-page long instructions for use enclosed in the sales packages of the products. In these instructions, components and conditions for the PCR were defined in detail, in addition to providing knowledge concerning the characteristics of the enzyme, instructions for troubleshooting, references to scientific papers and warranty clauses. The use of the new enzymes thus became stabilized and standardized across a whole range of experimental conditions.

The overlapping testing, pre-tests and the parallel experiments in the early stages of the project, contributed to the formation of trust between the partners. In the early stages of the project, the members of the two research teams did not fully trust each other and each other’s competence. With the help of the parallel testing, and the comparison of the results and discussions related to them, they learned to rely on the knowledge and expertise of their counterparts:

In the start-up phase, neither one fully trusted the other’s experiments and results. Because of this, overlapping work was done. The companies wanted to check, to make sure how the experiments were done. But as the project advanced, mutual trust developed for sure and we learned the level of each other’s competence. (Production manager, Finnzymes)

16 During the project the partners not only learned to trust each other’s competence but also the shared object of the work, the forthcoming enzyme products. The pre-tests performed by Finnzymes confirmed the viability of the initial invention by MJ Bioworks, as did further experimentation. It was also confirmed by potential customers in beta tests. Taken together, the competence trust and the trust concerning the joint object of the cooperation exemplify some crucial working aspects that must be in place in order to make a collaboration relationship endure.

Following rules and keeping schedules as means of building trust

Because the laboratories of the companies were located in different parts of the world, the task of organizing the joint work became an issue in its own right. A major way of managing this interaction was to hold telephone conferences every second week to discuss the results achieved in the project and to make decisions concerning the future steps to be taken. In these meetings two specific rules that contributed to the building of trust were instituted: first, the companies agreed to deliver to one another the results of the previous weeks’experiments early enough to ensure each other’s ability to examine them before the meeting; second, each and every task to be accomplished in the project was to be written down on a so-called action list so as to make sure that it would be addressed properly and on time. These two mundane and practical things, keeping schedules and using the action lists, contributed to the formation of trust between the companies.

The telephone conferences were usually held on Tuesday evening Finnish time. The meetings were organized basically the same way for the duration of the project. Before each meeting, the firms held preparatory laboratory meetings where the experimental results of the preceding two-week period were discussed. After that, the results were summarized in Power Point slides and sent over to the other company the day before the conference. By so doing, sufficient time was provided for both parties to get acquainted with the new results and consider possible queries concerning them. This practice was important for the establishment of trust between the partners. According to the CEO of Finnzymes:

17 In my opinion, trust grows up out of small things. If we say that the Power Point presentation describing the previous week’s results will be sent on Monday night, it really has to be sent. This is because the other [company] must have time to take a close look at it before Tuesday evening so as to consider whether or not we are of the same mind on the issues. If the results are delivered in the meeting only, no one can commit oneself to anything. This is how trust comes about.

In each meeting the experimental results achieved were first summarized and the problems related to them discussed. After that, the experiments concerning the forthcoming working period were defined. Once the project was nearing conclusion issues related to the market launch of the new products were added to the meetings’ agendas. Topics included concerned, for instance, the question of identifying potential customers and what sort of promotion would be needed in selling the products.

The original innovator of the fusion technology, who also acted as the meeting’s chair and secretary, was responsible for drafting the action list. In it, subsequent experimental work was outlined and specific tasks to be carried out before the next meeting were assigned to the partners. Secondly, long-term undertakings, such as acquiring the necessary licenses from other companies, were written down to ensure their timely fulfilment. From the point of view of building trust, it was important that the tasks agreed upon in the action list were binding to both parties. This meant that they remained in force until they were accomplished. Each and every task mentioned on the list was thus always addressed in the telephone conference. For the companies this generated the need to give accounts to each other as regards the progress of the joint work. If a certain task remained unfinished, the causes were noted and the job was transferred onto the next action list:

All of the items mentioned on the list were addressed in the meeting. If no results had been sent, the issue was talked through. One had to tell the other the reason why there were no results yet, that experiments were still pending, or that you had some preliminary results only. (Production manager, Finnzymes)

The rules of the joint work were quite strict and the partners adhered to them. This contributed to the increase in transparency within the project and made it clear that

18 everybody was living up their promises. As summarized by the CEO of Finnzymes: “What is trust? It can be interpersonal as well, that is, keeping one’s word.”

Distributing the flow of income through the license agreement

The license agreement between the companies was signed in 2002, when the market launch of the new products was clearly in sight. In legal terms, a license agreement is a contract which gives official permission to the licensee to do something, for instance, to use, manufacture or distribute a product. As a formal arrangement, it is unilateral in nature when compared with a reciprocal co-operative agreement: that is, it entails a one-way flow of rights from the licensor to the licensee (Hagedoorn and Hesen 2007: 350). Basically, the rights so bestowed may be either exclusive or nonexclusive.

The license agreement signed by Finnzymes and MJ Bioworks, however, had explicit reciprocal elements stemming from the fact that the original invention was jointly developed into commercial products. The reciprocity of the agreement consisted of the following provisions: 1) MJ Bioworks owned the patent concerning the fusion enzymes and granted Finnzymes an exclusive right to make use of the innovation. Finnzymes thus became the sole manufacturer of the commercial products developed on the basis of the patent. 2) Because the products were marketed together, the agreement guaranteed that MJ Bioworks had the right to buy the manufactured products from Finnzymes for the lowest possible market price. 3) The contract also obliged the partners to inform one another about the progress they had made in the selling of the products covered by the agreement. 4) The partners split the global markets in two so that MJ Bioworks acted as an agent for the products in North America and Japan while Finnzymes had the rest of the world as its market area.

As was the case with the cooperative contract, the license agreement too included a wide variety of precautionary clauses designed to protect the contracting parties against various kinds of contingencies. The key function of the agreement was, however, the distribution of markets and revenues between the partners thus emphasizing the exchange value of the products developed jointly. This was done through the article entitled “Royalties and Reimbursement”, which defined precisely

19 how much Finnzymes was to pay to MJ Bioworks in terms of the license fee. As is often the case with licensing contracts, the license fee and the allocation of the revenues were determined through a complex mathematical formula (also Hegedoorn and Hesen 2007: 354-355).

The aim of the profit-sharing formula was to end up in a fifty-fifty split of the incoming money flow that was regarded as reasonable by both firms. Given the fact that the products were of various kinds, the task of reaching this outcome was a complex one, which can be separated into three distinct phases. First, the general terms of the agreement were negotiated in a meeting held in the United States. Second, the contract was outlined in writing, checked by the lawyers and discussed by the companies’representatives over the telephone. Third, the fees were settled by the firms in an intensive joint meeting in a product-specific manner; that is, enzymes to be sold as stand-alone products were assigned higher fees than those marketed as components of PCR kits. A PCR kit is a package of different kinds of tools, such as reagents, needed for the production of multiple copies of a sequence of DNA. Because enzymes formed just one part of the final product, the royalties paid by Finnzymes to MJ Bioworks were lower for kits than they were for stand-alone enzymes.

The fees were determined in the meeting so as to satisfy the economic interests of both companies while simultaneously seeking to maintain the product prices at the competitive level. The CEO of Finnzymes described how the intentional trust was achieved in practice:

There were four of us and they were perhaps from six to eight persons. We sat in a large room for two days and projected Excel sheets on the board to see what the results would be if we did this or if we did that. We formulated it mathematically: what kinds of shares we were likely to get from each market segment if the royalty percentage were this or that. Then we calculated the profits for each company, and changed the percentages if needed. We changed these until each one of us was satisfied.

20 During these negotiations different kinds of arguments were used by the companies. MJ Bioworks, for instance, considered the invention so important as to warrant a 50 per cent royalty from the final market price. Finnzymes acknowledged its high value but maintained that such a high royalty would undermine the products’ price competitiveness with regard to other products on the market:

To give reasons for this we calculated different possibilities: given this [royalty percentage], we do not have the prospect of competing against such and such products. That is, if we want this much profit from this product and if the royalty percentage is this, it leads to the situation where we have high quality stuff on the market but it is so expensive that it cannot be sold. They argued, on the other hand, that “yes, yes, but it is a brilliant innovation”. (CEO, Finnzymes)

Another issue relevant from the perspective of reaching a fair economic outcome was the splitting of the global markets between the firms. The firms agreed that MJ Bioworks would be allowed to sell the products in North America and Japan while Finnzymes was given the rest of the world to cover. From the perspective of the both companies, there was thus no need to risk the expected market shares by raising the royalties too high: having access to roughly a half of the world markets each firm would be able to realize a substantial profit.

Conclusions

The starting point of this paper was to transcend the framework of studying trust and contracts either as alternative or complementary mechanisms of coordinating interfirm product development processes (Hagedoorn and Hesen 2007). This was done by way of analysing the trust formation in the context of the history of object-oriented collaboration between two life-sciences companies, Finnzymes and MJ Bioworks. Contracts were analysed as instruments of cooperation and trust construction in relation to other relevant means and mechanisms, such as product seminars in marketing collaboration and parallel experiments in product development. The distinction between competence trust and intentional trust proved helpful specifically in analysing the trust formation in the product development work. As shown in the analysis, contracts were important in maintaining intentional trust between the

21 partners but hardly played a role in the formation of competence trust. Being, evidently, a customary means of inter-firm collaboration in biotechnology, not using them seems to be out of the question. Following Macneil (1969) we might thus conclude that when a legal means exists and its form and content is established, it tends to be routinely used.

The marketing collaboration between the two companies was an important precondition for the emergence of trust and the product development collaboration. We analysed the various mechanisms through which a firm was able to evaluate the quality of the products created by its partner, the partner’s competence as well as its reliability as a business associate. Product seminars, different kind of meetings, feedback from clients etc. belonged to these mechanisms. Through them, MJ Bioworks acquired the necessary knowledge and formed the preliminary trust that encouraged it to contact Finnzymes. However, it was also decisive that MJ Bioworks found Finnzymes’resources suitable for the development of the new technology and complementary to those of its own. Finnzymes’expertise in producing enzymes, its PCR license and its ability to acquire funding for the product development work were among those assets highly appreciated by MJ Bioworks.

The secrecy agreement, signed before the partners had engaged in any discussion concerning the idea of the new product, was designed to prevent information leaking to outsiders. Despite its protective function, it did not impose any extra obligations on the partners, as they considered all information pertaining to the product development work always confidential. Its role in the formation of both, intentional and competence trust was thus limited to a great extent. The cooperative agreement, in turn, was made as soon as the partners decided to become engaged in the joint project. Although it outlined the division of labour between the firms, its main function was to act as a precautionary measure against unforeseen contingencies that might have a detrimental effect on the project. It thus had some role in creating intentional trust but had no role whatsoever in building competence trust that was ultimately achieved by other means of collaboration. Finally, the license contract was signed once the market launch of the new products was in sight. Here, vital economic interests were at play. Complex calculations concerning different regional markets and products were needed to realize the agreed principle of a fifty-fifty distribution of income. The sense

22 of fairness that was felt through the establishment of the license contract contributed significantly to the maintenance of intentional trust.

As a result, the most important contribution of the contracts to the formation of trust was to reduce the risks associated with the product development collaboration or commercialization of the products resulting from it. In the studied collaboration, many of the contingencies that were managed through the contracts were, however, unlikely to ever occur. The precautionary clauses defined in the contracts might thus be best characterized as a necessary precautions reservoir having only a slight influence on the actual product development work in which the trust ultimately emerged. In it, competence trust, that is, trust in the partner’s ability to play a significant role in the product development process, was decisive. In addition to this, means other than contracts contributed to the emergence of the competence trust. The most important of these were 1) the conducting of parallel experiments by the companies and 2) adhering to the jointly agreed rules and schedules.

According to the product developers, one of the explicit goals of the parallel experiments was to confirm that the results reported by the partner could be trusted. This was a natural way of building trust since it also served other vital technical functions in the product’s development, such as ensuring the reliability of experimental results, the robustness of the product across different laboratory settings and the standardization of experimental procedures. Following the agreed rules concerning schedules and reliably doing what was agreed upon together constituted the operative foundation of trust in the product development work. The contracts did not play a role here. This is evident from the fact that the product development manager of Finnzymes was not involved in the drafting of the cooperative agreement nor was he acquainted with its contents.

In sum, contracts are a necessary but not in themselves sufficient means of building trust. In addition to them, several other means and mechanisms related to marketing collaboration and product development work are usually at play. Although contracts provide security and a legal framework for collaboration, trust in the innovative activity is first and foremost performance-based (Cohen and Fields 1999), constantly reconstructed and “earned” in actual, daily collaboration. The key means and

23 mechanisms of this reconstruction in different phases of collaboration need to be studied further in order to better understand the formation of trust in innovative activity.

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26

MAIN CATEGORIES OF ARTICLES DEFINED IN THE COOPERATIVE CONTRACT 1. Division of labour 2. Confidentiality 3. Hardship and damage measures

4. Termination rights 5. Dispute resolution

THE PURPOSE OF THE ARTICLES

The article defined the tasks and responsibilities of the parties. The article defined the confidential information and the way to manage such information. These articles discharged the parties from liabilities if events beyond their control (natural disasters, war and the like) prevented them from performing their obligations. They also obliged the companies to report to each other in cases of infringements against one another’s IPRs and protected the parties from financial claims in the case of a premature termination of the contract. The article defined the period of time of validity of the contract and the proper way to terminate it. These articles defined the place and method of resolving disputes as well as which country’s jurisdiction was to be applied in the dispute resolution. The statement concerning the purpose of the contract supplied a principle of interpretation to be used in the case of contractual disagreement.

Table. The articles included in the cooperative contract between Finnzymes and MJ Bioworks concerning the development of the fusion technology in 2000-03.