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A
Welcome to the LSE Events podcast by the London School of Economics and Political Science. Get ready to hear from some of the most influential international figures in the social sciences.
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B
Good evening, everybody. It's a great pleasure to say to welcome you to the London School of Economics. It's really wonderful to see so many of you here. I know there is a high opportunity cost. There is a party going on outside and you're here. So I don't know what that tells you about yourselves and about the party. No, no, the inference I should make. But anyway, we have a fantastic occasion. It's the inaugural lecture of Professor Rocco Machiavelli. I am. I'm a professor at the Economics department and I'm totally thrilled to chair this session. Inaugural lectures are a truly special occasion. It's not just the celebration of the individual and of his work, but it's the coming together of the academic community to learn what our colleagues are doing all the time when they're running around. Now, I have a few words to say about Rocco, but before I do that, let me do the boring things now. Housekeeping. Housekeeping rules. So at the end of the talk, you'll have a chance to ask questions to Rocco. We'll take questions both for the audience in person and for those online. For those of you here in the theater, please raise your hand, state your name, and remember that less is more. Be brief. Those of you joining online, you can use the Q and A feature. And please let us know your name. And again, less is more. Finally, those of you social media young people out there, the hashtag for today is lsevents. This will be recorded and it will be podcasted, whatever that means. Now, me, me, me, me, me. I'm really delighted to be here and I have a whopping five minutes to tell you everything I know about Rocco. So I'm very pleased to introduce Rocco to his inaugural lecture. Now, it goes without saying that Rocco's research asks very important questions and answers them rigorously, creatively, and to the best that you possibly can do with the state of the art methods. But that goes without saying, right? He's a professor at the lse. It's like, you know, you apply to play for the water polo team in the Olympics. You need to know how to swim. So that's really not so distinguished. It's kind of the minimum. So. But that, as I said, is just the beginning. The first thing that distinguishes Rocco's research, he's really an entrepreneur. He's not a normal researcher that sits in his ivory tower. I haven't seen his ivory tower. So, though the room that they put us upstairs today was pretty close for an ivory tower. But it's not like that he actually goes out in the field. He doesn't just go out in the field and work with the regular ngo. He forms collaborations with firms, with firms that produce coffee, firms that shade flowers, farms that do wine. Everything you can think of, from Uganda to Rwanda to Bangladesh. And when you hear those words, people who are not economists start thinking. These are the usual economists. They sit in an office, they download the data, they don't care where they come from. They don't know anything about the context. But not Rocco. If you read Rocco's paper, you see that he has a very intimate knowledge of the context that he's studying. And that even is not the most surprising thing. I think the amazing thing about Rocco's papers is that they're all empirical. That's amazing enough. But they study relationship between variables that by definition are invisible. He studies relational contracts. What are relational contracts are what regulates the transaction between two parties when they cannot write a contract. So by definition, these things cannot be seen. So how does he do it? It's quite amazing. The only thing that came to mind that I could explain what he does is this Picasso painting. A clever use of theory. I don't know if you've ever thought about Cubism. Not particularly my thing, but my daughter explained. And then that's where it came to mind that you see that hand on the top of the person's head that cannot be there. It's anatomically impossible. So what do you do? You use your theory, you use your knowledge of physics and anatomy to understand that that hand is not there at the same time as the person is facing this way. The hand represents movement. Okay, so what Picasso does with this technique is to add a third dimension to something that has only two dimensions. And then you use theory, that is your knowledge of anatomy and physics, to figure out what's going on. That's exactly what Rocco does in his papers. He uses theoretical models not to be smart and to look like he can do math, not to estimate them necessarily and come out with all sorts of counterfactuals, but actually use theoretical model in a very clever way to derive predictions that then he puts all together and checks with the data. And that's how it makes us see the invisible, the same way as Picasso makes us see movement here. So now join me to welcome Pablo. Pablo Rocco.
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A
All right, well, thank you so much, Ariana, for this really wonderful and kind introduction and thanks everybody for being here and indeed joining us this evening, despite flu, despite parties, despite many other nice things going on. So it's a really huge honor and pleasure to give this lecture here at the lse. Just on a personal note, I came to the LSE 24 years ago as a visiting PhD student. So I just finished my Master in Paris and I literally had won the prize to come to the lse because even from the glittering lights of la Ville Lumiere, you know, LSE was a privilege, a prize to be won. And I've been incredibly lucky to stay here for my PhD in the econ department, which is a hotbed of economic ideas. And that was true in many fields. It was particularly true in development economics and organizational economics, which are the two fields I've been kind of trying to marry during my research. And of course, there is no better testament than sharing the floor with Orianna to. So it's really a huge, huge pleasure and a huge honor. So let's then get down to business. What I hope to share with you tonight is some thoughts on supply chains and in particular on sustainable supply chains. Now, if you have looked at the news over the past few years, this has been a topic supply chains in general, sustainability, resilience of supply chains, which is of course connected, although I won't talk about about it much. This has been a topic that has been on the news very much so, and it's a huge topic and the world is still so interconnected that essentially the topic of supply chain is almost boundless and is also theoretically complex and with myriads of policy implications. Okay, so the task of lecturing about supply chains feels a little bit daunting. And therefore what I'm going to do instead is that I'm going to try to tell you a few stories. Now, I don't want to undersell the word stories here. When I mean stories, I mean stories that come from particular places and contexts. But of course, always stories that we tell with data, or rather we collect a lot of data and then we hope that this data tells some stories. And I want to stress the data part because of course, collecting this data is something that requires a collective effort. And so although I am the person that tonight that is going to share these stories with you, I have been very fortunate to be joined during, you know, this journey by many, many people, many of which are not on this picture. So the picture is the random sample of people I work with, from mentors to former students, arrays, co author, PhDs and so forth. Okay, so I just want to thank all these people and then sort of move on. All right, so I'll tell you a few stories. Now. These stories, as I said, are going to come from very specific context, but I think that I hope that they will raise some questions. And these are questions that I think we should think about anytime we think about any specific supply chain, be it as academics or students, or perhaps more importantly, be it as practitioner, perhaps if you are the, say, the vice president for sourcing of a large multinational or if you are in charge of export promotion for your country. So let me start with one story then. So on one morning in April 2013, there was a power outage, one of the usual power outages in Bangladesh, Dhaka. And so the factories inside the Rana Plaza building started their generators, which is what they do when there are power outages. But of course, the building unfortunately suffered from structural inadequacies. In fact, the building did not have all the approval. And shortly after the generators were started one more time, the building collapsed. And in the process, it killed over 1,000 people and injured 3,000 more. So this is the largest industrial disaster that has occurred in the global apparel sector. It was by no means, it was the largest, but it was by no means an isolated one. In fact, there had been several other similar accidents in Bangladesh, including fires that killed all of people a few months before at a different factory. And this Rana Plaza disaster kind of strike in a certain way with the incredible success of the Bangladeshi garment sector. So Bangladesh gained independence in the. In the 70s was a young country, incredibly poor. And in the early 80s there was essentially no garment export. And within the space of four decades, the garment sector has become, in bandages, become the second largest garment sector in the world. It accounts for 80% of the country's export. And in fact, Bangladesh is now on the verge of becoming a lower middle income country to a large extent thanks to the sector. The sector has been a huge engine for the economic transformation of the country, but it has done much beyond that because the sector employs about 4 to 5 million people, most of which are women. So the sector has also been a massive engine for societal transformation of that country. Pretty much around the same time when the Rana Plaza collapse took place, South Sudan also became the youngest country in the world. And it emerged after decades of civic war which had left a completely ravaged economy. So huge illiteracy rate, huge very high child mortality rate, and really very little productive activity going on. And yet, shortly after independence, Nespresso partnered up with techno serve a very Progressive ngo. And what they did, essentially they worked together, a large multinational NGO to revitalize the South Sudan coffee sector. They trained thousands of farmers essentially to allow them to give them the skills and the infrastructure to produce export quality grade of coffee. And indeed nespresso was able to market, you know, these single origins outside it saud Sudan coffee. And so for the first few years of Sudan independence, the facto Nespresso was the only buyer, you can say, the monopsonist of coffee from South Sudan. So what are these two stories telling us? I think they are telling us a couple of things. The first one is that there are enormous gains from participating in supply chains in global supply chains. And I've picked two examples deliberately that speak a lot about the connection between participation in global supply chains and poverty reductions. And I've done so deliberately because we are going to talk, I hope, a little bit about sustainability. And I think it's going to be hard to do a lot about sustainability if at the same time we also don't try to do something sensible about poverty. So the first thing that we learn from these stories, I think is that the enormous gains. But the second thing also is that I think that the participation in global supply chains poses very important, very severe governance challenges. And so we need to think about the governance challenges associated with these supply chains. And so this is what I'm going to talk about in the lecture. So we start by thinking a little bit about what makes these supply chains complex. Then we will try to look a little bit about how are these supply chains organized? And then does this matter for sustainability goals? And then finally, at the very end, I hope to share some work that my team and I are doing with partners on how we can try to build more sustainable supply chains. Okay, now I know it's the last week of the term, it's late, so I'm gonna tell you one more story which I hope is going to capture in the simplest possible term, I think what is going to be the main message of my lecture. So this is Joseph. I mean, the name is hypothetical. In this particular case, you have to think about Joseph. He's a dairy farmer in Imuru in central Kenya, not too far from Nairobi. And Joseph has a couple of cows. And his day pretty much unfolds as follows. He wakes up very early in the morning, he milks the cow, and then he takes the milk to the cooperative buying center. Then he goes back to his farm. He tend the cow, he tend his other garden. And then in the afternoon again, he needs to milk the cow, maybe he keeps a little bit of the milk for himself and his wife. And then this time, instead of taking it to the cooperative, he takes it to traders that are sitting with motorbikes next to the local parish. And he does that every single day of the month, in fact, in a very regular way. What is interesting about Joseph is that when he sells to the cooperative, he gets about 40 Kenyan shillings lit, perhaps liter, okay, for his meal. The cooperative keeps track of all Joseph deliveries. And then at the end of the month, the cooperative pay Joseph on an account that the cooperative keeps. When Joseph, in the afternoon, sells the milk to the trader instead, he gets paid 40 Kenyan shillings per liter. And he gets paid cash immediately. So it's kind of interesting that Joseph, you see, every morning is selling most of his milk for a much lower price. And then for something that will be paid later. And then they sell the lesser of his milk for a much higher price and being paid cash. In fact, when we started working on this, the cooperative, which was our partner, wanted to know how can we increase loyalty from our members? And became apparent to us. The real question was, why do they sell to you at all? In fact, you pay them less. And later. Now it turns out that Joseph valued these bulky, infrequent payment from the cooperatives because they help him to save. So Joseph needs to pay the school fees, he needs to buy feeds from the cow. And also, perhaps if you had all this cash at hand, maybe it would be harder to resist the neighbors that come and ask for help. Or maybe having the odd beers with friends. And, you know, everything that helps saving is useful. So that's an important part of the story. Joseph values with infrequent and delayed paper. But that cannot be the old story, because if that was the case, why don't the trader also offer Joseph the possibility of saying, look, I will pay you at the end of the month. If they could do that, the traders will save a lot of money. They will be able to pay much less. And the answer there is that Joseph would not trust the trader with the money. Joseph would not trust giving the meat for a month to the trader, that the trader will come back with the money. So really, what we see here is one reason why I like this example is that trust is going to be key for the functioning of supply chains. And in particular, in this example, we see both what are the costs of not having trust? What happens when there is no trust? There are huge gains from trade that are left unrealized. And conversely, we see that the cooperative who has this capacity to be trust by Joseph Driving a lot of rents. It's a huge source of competitive advantage for the cooperative to possess that monopoly over trust in this market. So the rest of the talk, really. I'm gonna try to give you a few more stories for why trust matters, how does it function, and whether we can build it to promote more sustainable supply chains. All right, so what makes supply chains complex? Let's start with a very well known graph that everybody will for sure already know or you know, some, something similar, you know. This is the amount of export, global exports, the evolution of global export over the last 40 years and it has exploded, it has increased tenfold in real time. So there's been a huge increase in international trade, we all know that. But what is interesting is not just that there's been an explosion in international trade, there's also been a change in the type of international trade. So if you think about the T shirt, the typical T shirt, and you think about $10 worth of t shirts, say exported from Bangladesh to the United States, the export flow is worth $10, but actually only 2.5 dollars are added value in Bangladesh. Of these $10, only 2.5 are actually produced in Bangladesh. The rest has been produced elsewhere. You know, perhaps the fabric comes from Malaysia, perhaps the button comes from China or from India. And so, okay, so what we say is that alongside the explosion in volume of trade, there's also been a qualitative change in the type of trade. There has been trade fragmentation. So the share of domestic value addition in the sales value of export has declined over time. It was 85% in the 70s, now it's closer to 65, 70%. And this is really what is telling us that it's not just a traders increase, but the nature of trade has changed. Supply chains have become more fragmented. Okay. And this has been largely due to the entry of lower income countries, emerging economies into global supply chains. So if we go back now, we try to derive what does it mean from the point of view of sustainability. Why does this matter? Well, let's stick with the shirt. Now you might think that I'm Italian and observed by fashion and shirts is not the case now. The shirts are. Garments are important first of all. So it's really sort of the flying ease model of development. It turns out that every country that has industrialized, that has eradicated poverty or reduced poverty, has industrialized. And typical industrialization has started in a sector like Apart, which is very labor intensive. It's probably a sector where countries learn how to do manufacturing before they move on and do more complex things. But from the point of view of what I want to discuss, shirts has another advantage, is a relatively straightforward product so that we can learn something. But at the same time, I think it's sufficiently complex that what we learn maybe speaks to issues that are relevant also in other sectors. So think about these, you know, large and well known brands. Sourcing shirts from Bangladesh. Yep. And indeed the shirt is manufactured in Bangladesh, so it's cut, it's stitching, finishing takes place there. But as I mentioned, the fabric might be coming from Malaysia, where the yarn was washed, bleached and so forth. And maybe even before that, the cotton might have been cultivated in China. And then of course, to do the shirts, you also need some accessories like button and bows might also come from abroad. Okay, so now imagine you are the vice president for sourcing for one of these big brands. And what are the kind of things you are thinking about? Well, the first thing, of course, you want to make sure that you get the shirts of the right quality, of the right volume, at the right time, in the right place. So you know, in other words, that your supplier is a reliable supplier. That will be the first thing that you presumably care about. So you will care about quality and timely delivery. But maybe you'll also care about how your supplier is financing the working capital to produce the shirts. Maybe you start also caring about the working conditions. You don't want to be engulfed in a scandal like the Rana Plaza one. When the building collapsed, one problem was that many of the doors were actually locked. And the doors were locked to prevent people from sort of leaving the production floor. Now, when the building collapsed, that wasn't something that helped people save themselves. You might be concerned, of course, about whether there are materials or chemical or something, substances that go into the production of the fabric that are not compliant with the regulation in your importing market. And even further up the chain, you might be concerned about the environmental footprint of the cotton that goes into your shirt or maybe about the use of forced labor or child labor in cotton picking. So if you have concern about all these things, then you're going to have to sit down and talk to your supplier about this. And these are going to be difficult comparison conversation because a lot of these things are, you know, of course we might agree what is it that we want to achieve. But then actually, how we achieve what we want to achieve in practice will depend on how we adapt to many circumstances. And at the time in which we are kind of negotiating the deal with the suppliers we cannot foresee. Okay. So in other words, we're going to have what, as economists, we like to call very highly incomplete contracts along the supply chain. So a lot of the things you care about is not something that you can write down on a contract, and then once it's written down in a contract, you know you will get it. No, that's actually not how it works. You'll have to do a lot more in order to guarantee that you get what you want. Okay. So I think that what we learn from these very simple supply chains is a couple of things. The first one, of course, is that, as I mentioned before, supply chains have become more complex.
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Okay.
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And the second one is that many of the sustainability challenges that we are concerned about happens further away from where the chain is actually organized. So now we need to understand our. These brands and similar firms sort of solve this type of problems to the extent that they try to solve them. And so, in other words, we need to ask the question our supply chains organized. So we can ask this question to, you know, Ronald Cowles, Oliver Williamson, and Oliver at 1, that Nobel Prize in economics at a different point in time for having asked essentially the question of what drives how transactions are organized. And I wanted to particularly stress Ronald Cozier because he actually started this agenda in his undergrad dissertation here at the LSE on the nature of the firms in 1937. So it's nice to give it inaugural and have Ronald Cohen's pictures on the slide. So to cut a long story short, the main insights of these gentlemen, starting from calls and then the enormous fee that they have spurred, is that transactions differ in how complex they are in what we might call their transaction cost. And essentially, markets tend to work well when transactions are relatively simple, while firms tend to work better when transactions are complex. That's a basic field, so I always teach it using two examples. One example is to the left is the Dutch flower markets. So selling flowers is a relatively simple transaction. You just need to show up, you inspect the flowers. The only thing that you need to make sure is that you sell the flower fast. That's why the Dutch came up with this very beautiful auction format, the Dutch auction, the descending price, which guarantees a very fast location of the flowers. And this is really a mechanism which gets as close as possible to the idealized spot markets that we teach in our economics underground. And there you see that it's really the price is what allocates the scarce resource, the flower. Now, to the other extreme, you might think about another problem of Allocating scarce resources to a particular yield. You can think about allocating horses and soldier on the battlefield. Now that is a transaction that we would classify as being very costly. In particular, what makes it very complex perhaps is the fact that you need to adapt very fast. And you know, by design your enemy is kind of trying to create conditions so that you need to adapt. So if you need to adapt, you don't have the time to set up the price system. You probably don't even have a lot of time to have, you know, lengthy committees and so forth. So the only way we, you know, the way we did it as an organization is that we agree beforehand who is in charge. So the other extreme, you have hierarchies, you have bosses, employees, there's a chain of command. Okay? Now as it happens, most transactions, however, do not happen in this extreme form. The idealized spot market or hierarchies that resemble military organization. Mass majority of transactions happen in an ingredient organizational form, which are sort of business to business long term relationships. And these are ingrid organizational forms because they are not like the market, because of course there is a price which is negotiated, but the price is not the only thing and probably not even the most important thing that is negotiated. But they are also not the hierarchies because there are multi different organization, sort of polycentric governance form, if you like, where there are multiple entities that are independent and negotiate with each other. Okay, now these business to business relationships are based on trust. So how do they function? Well, they function like most, most relationships. So one implication, of course, from the point of view of a supply chain, is that I told you before that supply chains have become more complex. Indeed, if you look at the data, the vast majority of transactions in supply chains, if you look for instance at the universe of imports into the United States, do not take place in kind of sporadic transaction that would resemble spot market. They happen within this long term relationship or of course within multinational. Okay, so the theory in a way is well supported, if you like, by the data. So all these relationship functions, they function like any relationship. So you know, you can cooperate today and then if you cooperate today, then tomorrow you'll have a visa good relationship, or today you might be able to be more opportunistically, maybe the fact is too much. But then of course later on you'll have a worse relationship. Okay, so now you can shuffle the pictures around and what that gives you is the fundamental law, if you like, of relationship, which is that cooperation in a relationship can be sustained to the extent that the future Value of the relationship is larger than the temptation to deviate. Okay, now it turns out that when you think about the business to business transactions, these relationship value is not observed. It's not something that we see in the balance sheet of the company or on company statement. However, I've been fortunate in a series of paper with friends and co authors to study commodity markets where because we observe reference prices we can learn quite a bit about the temptations to deviate that firms face in these business to business transactions as well, therefore about the value of this relationship. So in the first paper we studied the exports of flour from Kenya and then we saw that these long term relationship between the large, say UK importers and the large exporters from Kenya, they very carefully structure their transaction, particularly around Valentine's Day, which is the time in which prices of course are higher and therefore temptations to deviate are right. And we also found that at the time of scarcity, firms very carefully chose which of their buyers to prioritize in order to protect the reputation that they have earned for being a reliable supplier in the coffee market. We were able instead to study forward contracts where the problem of if you like counterparty is the fact that promises don't get essentially bad is very, potentially very severe because the market is so volatile. And what we saw there is that these long term relationship really mitigate the risk of suppliers defaulting essentially on their contracts when market conditions improve. And by doing that, this relationship of course allow suppliers to access price insurance and also better credit. And then finally, one thing that is important to note is that a world in which relationships are important for exchange looks quite different from the standard world that we teach to our undergrads in economics. Why? Because take for example competition in general. And I believe so competition is definitely good. Yes, yes. So do I need to use this? Okay, that's good. I always hoped, Yeah, I was always dreaming to be a singer. So this is my, well I, I, I'll stick with the relationship and you know, don't, don't at least for now not bother you with the songs anyway. So, so, so think about competition. So competition. And I believe that competition is of course a good force. It tends to allocate resources more efficiently, creates environment where incentives are better. But imagine a world in which relationship are important for exchange. Then competition might depress a little bit the value of a relationship, the future value of relationship and it might also increase the temptation to deviate. So it could be that actually competition is bad for relationship and potentially for efficiency, which is something that we demonstrated in the context of the coffee Rwanda sector. All right, so this just to say that we have found ways of studying the value of this, you know, quantifying and understanding why these relationships are, are valuable. So now let's start thinking a little bit more precisely about how firms organize their supply chain and why that matters for sustainability. So in the early 80s there was a big concern in the United States that the United States were losing their manufacturing crown to Japan, which had industrialized very fast over the earlier 20s. And in no industry more than in car was this sort of shifting power, if you like, apparent. And therefore there was a huge interest in understanding why is it that there were on the one hand the struggling American car manufacturers and on the other end, this upcoming and agile Japanese manufacturer. Of course, there are many, many differences between the business model of these companies. But one particular dimension that gather attention was the fact that the Americans and the Japanese car manufacturer organized their supply chains very differently. In particular, the Americans essentially they procured parts through repeated auctions. So there was no sense of a long term commitment from the buyer towards the supplier. The order was always awarded to whichever of the supplier was putting in the lowest bid and which of course gave a very low prices, very good prices for the manufacturer. But then if there were problem with the parts, of course the manufacturer will have to bear the cost of the, of the suppliers poor performance. The Japanese did things very differently. Instead they work with very long term relationship. They worked only with few selected suppliers and they try to incentivize the suppliers to get better and better through training, through the promise of allocating orders in the future and occasionally also through higher prices. So we have been able to explore, to quantify a little bit or to come up with proxies for these different approaches to sourcing in the context of the garment sector. So again, the T shirts I'm obsessed about and we discovered a couple of interesting facts. The first fact is that across countries and products, so regardless of whether a company sourcing men's shirt from Bangladesh or women trousers from Vietnam, or you know, sports jacket from from India, regardless of that, companies tend to be either very relational in their approach to sourcing or they tend to be what we call spots. So they either always behave like Japanese or always behave like Americans, so to speak, in the example I mentioned before. So for example, H and M, the Swedish giants, is a very relational company in their approach to sourcing and they are relational pretty much regardless of where they source. The second thing that we discovered is that this matters for the Suppliers, margins. So the, the producer in Bangladesh in particular, when they produce the exact same piece of garments, they earn higher prices when they sell to a relational buyer than when they sell to a spot buyer. Yeah. Now the difference in price is not enormous, but in relative terms to the domestic value addition of the country is actually far from being negligible. So what this is telling us is that not only the way we organize the supply chains matter for how well the supply chain function for a, well, it responds to the shocks for how much of the gains from trade are realized. It also matter for all these gains from trade are shared between or along the supply chain. And so here we start seeing a little bit about why this might matter for sustainability.
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Yeah.
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So how does this matter for sustainability? So I'm gonna now leave the garment chain for a while and go to coffee. Now coffee is, if you have to do field work, study coffee, don't study garments. You'll find yourself in beautiful eels in the tropical landscape as opposed to, you know, sort of polluted industrial area. But you know, apart from this very important difference, actually from the point of view of what we are discussing, the two chains share many similarities. There are large buyers that organize the chain, there are intermediaries, exporters in between, and then there are in the case of garments workers, in the case of coffee, smallholder farm. So the sustainability concerns will be a little bit different, but the kind of structural problem that we are discussing are going to be fairly similar. So when we started being concerned about sustainability, the movement was really led by, to a large extent by NGOs that essentially promoted fair trade, sorry, the third party type of certification schemes. Think of fair trade now, I don't want to spend a lot of time. I think that this initiative had a lot of value in raising awareness. I think as a social scientist that relative to the impact that they had in terms of raising awareness, the evidence for their actual impact, say for example in the case of coffee on farmers income and other sustainability is not as large as we would have liked to see. And there are probably many reasons for that. But one reason is potentially the fact that these third party certification schemes lack, if you like, a buyer commitment or a demand commitment. So there is a tendency in this market to have a lot of production but get certified, but the relatively low share of this production that is then sold as certified because of the lack of demand. And so this already tells you that demand from the buyer can potentially improve on sustainability outcomes. And I'm going to illustrate this looking at the quality in the coffee Sector, I'm going to look at the physical quality of the bean because this makes the illustration of the logic particularly transparent. But of course, everything I'm going to say about the size of the bean, the quality of the coffee bean applies for the ori. If we think about other type of investment, not in the physical quality of the bean, but in the sustainability that comes embedded in the bean. So in coffee, to simplify, here is the commercial classification for coffee for Colombia. You can think that there are two large classes of coffee. There's a standard coffee that's called UGQ quality, and then there is the supremo beans, which is essentially larger coffee beans, which gives you higher quality. Okay, now to produce these higher quality beans, the farmer must undertake investment in their plantation. They need to plant trees, they need to replant trees to keep track of, you know, keep, take good care of the trees, pruning them, stamping the trees and so forth. Okay, so we, we gather data from one of the largest exporters of, from of coffee from Colombia. And for the different commercial grades. This figure illustrated the fact that there is quite significant price premium for these better coffee in the export market yet. And this is the orange line. When it comes to the price that the exporter pays for this quality to the farmers is absolutely no premium at all. Okay, so there's this discrepancy. And then again the question we can ask, why is that the case? Well, one reason is that in order to promise a price premium to the farmer, it is not enough and therefore induce the investment here in quality, but it will be the same in sustainability is not enough to pay. To promise the price premium just this year, you need to promise the price premium over the long term. And this might be difficult to make that promise credible in a market that is so volatile. At the same time, of course, it might be easier for the exporter to make that promise to the farmer for a stable long term price premium if the exporter had a good relationship with the buyer that was willing to pay a premium for a reliable supply of high quality. So you see that there is a little bit of a chicken and egg problem. The exporter doesn't have the relationship with the farmer because it doesn't have the relationship with the farmer. They don't have the relationship with the buyer and vice versa. It's hard to have the relationship with the buyer because I don't have the relationship with the farmer. So in other words, starting to address sustainability concern here is with upgrading. But the sustainability just makes the logic even In a way similar, but even harder to achieve, really requires building relationship along the entire chain. So solving a very complex coordination problem, which is to build relationship not just at one stage, but at multiple stage. And to cut a long story short, you know, this is the way essentially the Nespresso AAA program in Colombia led to massive upgrading in the, in the sector, precisely because Nespresso was able to leverage their relationship with the exporter to induce the exporter to create relationships with the farmers in which significant price premium were promised and consistently paid to the farmers. Now, Visa, you know, just in case this looks too much like an advertisement for, you know, some of the large corporation, I think that these, these buyer driven programs have a lot of promise, but of course they are, you know, they are not a panacea. There are all sorts of issues that we could discuss and indeed there are a number of regulatory interventions that, that are being discussed and being pushed forward in particular by the EU around these issues. Now I want to start wrapping up, yes, by getting to the final question, which is, okay, how can we build sustainable supply chains? Now here I'm just going to tell you a story which is kind of closer to what we are doing together with my team and in partnership with a fantastic company, which I'll tell you about in a second. Second. So in a way, what I told you so far is that the trust really lies at the art of building sustainable supply chains. So how do we build trust? Now? I think that this building trust is the real scarce resource and so generating more trust is really what needs to be done along the supply chain. This is particularly necessary and difficult when dealing with smallholder farmers in emerging economies. And the reason is that there are enormous, less mild challenges to reach these populations. And there's also low literacy, which could be an impediment to our trust. And there are many other different reasons. But the first question that we need to ask ourselves if we want to be trust is to understand what is trust. And I want to emphasize two dimensions of trust. The first one is credibility. Will we keep our promise? Relationship is an exchange of promises. And the first question is, will we keep this promise? And the second dimension, of course, is the clarity of these promises. Do we understand each other's promises? Okay, so what we did, we partner up with Rua Cough, which is the Rwandi subsidiary of Sucathina, who is one of the largest traders of coffee in the world and an extraordinarily good partner for us. But more importantly, extraordinarily forward thinking company when it comes to sustainability. And what we did, we devised together a program that we call Coffee Together Ikawa Hamwe. Okay. And the idea of the Ikawa Hamwe was simply, you know, already in their business as usual. Our partner Sukafina does a lot of provide a lot of services to the farmers and, you know, sustainability related initiatives. These were all things that were already going on. We had not brought anything new to the table. What we did together with them was to sit down and explain to the farmers essentially, essentially the quid pro quo that the company would like to have with them and kind of tell them, hey, dear farmer, you know, you can keep the business as usual, or, you know, if you do certain things, you might expect more services, you might expect to become eligible for other things. Okay? So it was really an intervention that was aimed at building clarity with the farmers about which kind of relationship did the company would like to have with them and what we found, so we randomized, it turns out, invitation to the training. So it was a very cheap intervention. And reassuringly, you know, we see that the training increased the clarity and credibility that the farmers perceive to have in their relationship with the company. So, so far, so good. They, you know, this in a way, was a kind of a low bar if we stop there. The second thing that happened, however, this starts being more important, is that the training increased the traceability, which is something that is conceptually very straightforward, but of course is a prerequisite for sustainability and in this type of context is extraordinarily difficult to achieve. Okay, so it's something that is conceptually not very difficult, but of course super important. But the real kicking, if you like, for the bucks that we got was about a year and a half after we did this training program, we were collaborating to roll out another sustainability intervention, A tree stamping intervention, it turns out that is very important, important also from a point of view of climate change adaptation to stamp the trees. This is something that farmers know about a lot, but they are reluctant to do because when you stamp the tree, the tree doesn't generate harvest for a couple of years. Okay? So there's a loss in income for the farmers from doing these, non trivial loss in income from undertaking this sustainability intervention. So the innovation is that we offer these three stamping program under the business as usual, which is essentially a small subsidy at the time of tree stamping, or with an innovative contract, which we call a relational contract, in which the farmer gets the incentive if they are tree stamped, condition on tree stamping and condition on delivering coffee to the company. At harvest time. Now, this relational contract or relational scheme that we introduced is a scheme that has better property, it has better incentive property from the point of the view of inducing the behavior from the farmers. It is also potentially more cost effective because it replaces the loss of income to the farmers at the time the loss of income happened. It's not expensive to stump the trees expensive the fact that they don't generate income. However, crucially, you know, the farmer needs to believe that the company will in the future pay these incentives. So this was, if you remember exactly the problem that Joseph faced when deciding whether to sell to them traders or not. And what we find is that that attempt at building clarity substantially increased the take up of the sustainability intervention precisely when we offered it with this relational scheme. And so now we are working with the company to kind of build some of these ideas and you know, extend the collaboration to agroforestry of which we can talk about. Anyway, so let me wrap up here. So I told you, I told you quite a few different stories from many different environments. So what have I learned from these stories? The first one is that supply chains are complex and sustainability challenges often emerge far away from where the supply chain is organized. Okay. The second is that the key to sustainable supply chain is long term relationship based on mutual trust. And therefore sustainability is to a large extent about generating mistrust. Now trust, I showed you that is immensely valuable but is also hard to build and to maintain. Now for companies, I think that there is much scope to learn and experiment with sourcing practices to trying to foster trust in their supply chains and then this leading to sustainability, to the adoption of sustainability interventions for policymakers. We didn't have much time to discuss. I think there is scope for policy intervention, but it's very important that policy design must take into account actually all these long term business to business relationship functions in supply chain. So there's a lot of more things coming, you know, sort of on simmering in the pot if you like. You know, with my research we are doing many more projects. I hope that this example from garments and coffee. I hope and firmly believe that the kind of issues that they make us think about applies much more broadly to many other sectors and also potentially to other important issues not listed. Supply chain resilience. And from the point of view of teaching, we are launching here at the LSE an executive course on leadership in supply chains. And you can scan the QR code in case you are interested. Thank you.
- [44:56]
B
Hi, I'm interrupting this event to tell you about another awesome LSE podcast that we think you'd enjoy. Lseiq asks social scientists and other experts to answer one intelligent question like why do people believe in conspiracy theories? Or can we afford the super rich? Come check us out. Just search for lseiq wherever you get your podcasts. Now back to the event. I did tell you it was good. So now we can have questions. We're done. Wonderful lecture.
- [45:33]
A
Thanks again.
- [45:35]
B
So we can take questions. We start from the audience. Hands up, introduce yourself. And remember, less is more in the middle here. We take two, three questions at the same time. I saw you.
- [45:48]
A
Thank you professor for the presentation of the lecture. My name is Julian. I'm studying the management and strategy. I'll be in your class next term. You mentioned that the trust relationships between between buyers and producers was a kind of chicken neck problem and then mentioned all the buyer driven programs that you, you launched essentially. Is that kind of a definitive answer like is do buyer driven programs solve that chicken and egg problem or is it more up in the air on which has to come first.
- [46:25]
B
Thank you. There's one in the back. No, there was one further back with a gray jumper. So it's coming to you. I think he's coming to you. Hi. Thanks Rocco.
- [46:37]
A
Very interesting. My name is Jonas Galanes. I'm a visitor here. I'm at Queen Mary normally. I would like. Hi, I would like if you have time to tell us a bit about how you collect the data because it seemed to be something very interesting and Orianna said in the beginning and it will be nice to hear more about your field work experience. Hi, Amul Deshmukh, visitor here as well. I wanted to understand around how did the corporates who went about promising those premiums and building those long term relationships, how did they manage their own shareholders and their management teams expectations around returns from supply chains? Because long term thinking is not what a lot of the PNLs are driven by. So how did the corporates come up with a story for their shareholders to convince the importance of this?
- [47:30]
B
Thank you, sir. Do you want to take more or is.
- [47:34]
A
No. Okay, now we can start with these three. These are all excellent question and you know, we, you know, we'll both answer together. I guess the. Yeah, these are all three. Great question. Let me start with the first one which was about whether these buyer driven initiatives are the definitive answers. No, they are not. I don't think that they are. One thing I feel like sharing is that this is like a zoo with many different animals. And so one thing is to say that we have found some animals, by which I mean some buyers that have managed to solve these problems in a way in their supply chains and had a very meaningful impact. That doesn't mean that all buyers are trying to do it or that all buyers should try to do it. So that's the first thing I, I want to say that there is a lot of heterogeneity, very much like there is a lot of heterogeneity in the way these companies approach sourcing, even regardless of sustainability concern. There is a lot of heterogeneity in how much they, if you like, care or want to have an impact. The second thing is that there are good theoretical reason to imagine that these type of schemes, to the extent that they are, you know, useful and impactful, will be under provided in the market for a variety of reasons, which I at least on the slide. So maybe now let's not take too long during the answer. But. And so because of this, I believe that there is potentially some scope for, for regulation and indeed many, in fact, let's put the slides up since we still have it. So indeed many of the, of the. Yes, exactly. Many regulations that we are seeing pushed particularly by the EU. So think about the EUDR on deforestation, the CS3D, even the CBAM. To a large extent, these are all regulation that are very much aligned with what I told you in this lecture because these are regulations that are kind of trying to force buyers that bring products into the EU to take more ownership, more responsibility over their supply chain. Now, saying that there is a rationale for policy, of course doesn't mean necessarily that the specific way when the policy gets enacted is the correct one or is even beneficial. And so indeed, without going into detail, you might know that all of these regulations, particularly the UDR, for example, you know, was supposed to start, I think it has literally last week being its implementation has been kicked down, down the line for an extra year. Again, there are debate was about how exactly to implement a CS3DS and so forth. So saying that there is a rationale for regulation doesn't mean necessarily that, you know, it's straightforward to come up with sensible regulations. But yeah, so I don't think that the buyer driven, you know, sort of program are. They are the ultimate answer. They can work sometimes, but they have limitations, some of which are listed on the slide. The second. Then I'm gonna skip to the third question which was kind of related. How do these shareholders, how do these companies essentially manage when they promise this higher premium? How do they manage Their shareholders is a great question. I, when I was mentioning that in garments we see that there are these very different approaches to sourcing, I almost feel across companies that end up competing within narrowly defined segments of the market, both on the sourcing side and on the demand side. And in many ways we were not really able to explain which kind of characteristics of the buyer correlate with the adoption of his practices, I suspect. But here is a, is a paper I have not been able to write as of yet with the standard that I would like to apply to my research. I suspect that it boils down a lot to company culture. I really believe that organizations have culture. In fact, I think that is the DNA or the blood of an organization is its culture. It's just that some places have very dysfunctional culture and other places have a better functioning culture. I think culture is very difficult to build and to transform. But I do believe that there will be companies that are able to have those conversations with the shareholders and make a persuasive case for why addressing sustainability is not just to look good on a company report, but it's really a matter of sort of life and death in the long term for the organization. And then there was another intriguing, more introspective, if you like, question about how do I go about collecting data? Well, the first part to the answer to this question is thanks to the enormous amount of passion, drive, effort, work of his friends and colleagues I've worked with. The second will be the same and the third as well. And then down the line I think, I mean the papers I've mentioned, the data collection strategy was a bit different because sometimes we're trying to get data from public organizations like you know, from government agencies. Other times we're getting data from companies, other times where surveys and so forth. Building trust is fundamental for, for, for data collection. I think you need to, I always try in my research to have a relational approach to my research and sort of build, build relationships and then over time these relationship generate data, generate insights. It's also not just the data that we get from the partner organizations, but it's really the understanding of the context. And conversely to build research relationship you need to speak a little bit the language of the people you want to work with. So otherwise it's very hard to build that trust. So in fact I think that the vast majority of my research time is, is indeed spent sadly or not so sadly trying to build these relationships. I'm actually not the one often doing much of the data work or anything. Yeah. So trust Is important to get this.
- [53:36]
B
Data beautiful internally coherent.
- [53:38]
A
Yeah.
- [53:40]
B
Other questions? Plenty of questions. So here's second row, green jumper. Thank you. Professor, the wonderful lecture. My name is Rupa and I'm a visitor. Two important constructs that appear in your research are relation and trust. And what I find is you talk about trust and relationships being built at different levels. So what does this relationship building include and how does it look like as in what does it constitute of. And how do they, how do these buyers, the seller, sellers or build these relationships so that it translates into trust and everything that follows from there. Thank you. Many hands up there in the back with the. Okay, the glasses and the black jumper.
- [54:37]
A
Thank you.
- [54:38]
B
Hi, thank you so much. Professor Rocco, My name is Irene and I am a PhD student in accounting doing research on supply chain due diligence. I learned a lot of things from your lecture today.
- [54:50]
A
And I have a question regarding what you mentioned.
- [54:53]
B
One component of trust is clarity. Like do we understand each other's promises?
- [54:57]
A
Could you maybe give some concrete mechanisms.
- [55:00]
B
Or examples of how you improve the clarity? Especially given that sometimes supply chain is geographically spatially dispersed and also culturally dispersed with very different understanding. Thank you. You can give it that. Yeah, I can't see so I can't describe. Hi, my name is John from MPA program lse. Thank you Professor. So my question is at which link in the supply chain is trust most effective applied? So I'm assuming that the more, the farther down stream the harder it is to actually build trust because there's this relationship as you mentioned, trust tend to lower competition. But I wonder is the reversal relationship tend to also apply meaning the higher the competition the most the more important to actually build trust to win that competition. But this also then relates to how effective is the sustainability programs actually because be able to effectively implement it further downstream.
- [56:00]
A
So yeah, yeah, no, so again these are, these are great questions. And you know just the dynamic of an event like this one makes me feel I have to, I, I must have to, I must have something to say for all the questions. It's not the case. I'll pretend I do, but it's not necessarily the case. So the first question is how do I always trust? This is a great question, is a one million dollar question. I think it can be built in many ways now in the studies I've done, so I'll stay close to what I know. We definitely see that trust which we can measure in very specific ways gets built over time. So for instance, in the coffee sector a very good proxy for trust is Whether you sign fixed price contract or contracts that are differential. So you know, price indexed in a way. And you see very clearly that over time relationship. They start with price index contracts that don't require a lot of trust. And then only when they have dealt with each other for a long time, you know, they switch to fixed price. In the flower industry again, you know, it's really how much more flowers you trade at Valentine Day relative to what you trade usually. And again you see that that measure increases of. And you know, others have studied the trade credit and you see that the terms of payments which as relationship evolves. So relationships somehow build trust over time. Presumably because parties get to know each other better, they get to understand each other better and so forth. One aspect that sometimes doesn't get all the press that it deserves is that I also think that crisis, times of crisis are times in which trust can be built. So we saw that for example in the flower sector in Kenya because you know, there was a large episode of violence. The country sadly was nearly collapsing into civil war after the contested presidential election in 2008. Those relationship that survived that period where really the exporters did everything they could to protect the business, they thrived afterwards. More recently, when the COVID pandemic happened, this was an issue that was covered widely in the media. Of course, with all the lockdowns here, a lot of the garment buyers cancelled the orders that they had already placed to their exporters. And this put a lot of the exporters in very difficult positions because they had already financed the purchase of the fabric, they had already hired the workers. And now all of a sudden the order was gone. And so some buyers very deliberately invested at that time. So they canceled the order, but still paid for the fabric, they still paid for the workers. And we see not only of course that this temporary help really helped the suppliers and particularly the workers to survive the crisis, but those relationship became, if you like, more valuable afterwards. So often I think that just how is trust speed? I think trust is built progressively at times of crisis. Are also opportunities at times to build this trust. So the second question was from Irene. My daughter's name is Irene. So please Irene, come and talk to me. You are just a couple of floors downstairs in Marshall. I think you have the question of how do companies build clarity? Particularly when supply chains are very complex and span multi countries. I don't have a. I don't have a single answer. I mean there are companies, for example, you know, just staying closer to the, to the. To the example of, of the car Sector. You know, on the Toyota they are famous for having these suppliers clubs. Well, you know, every year they organize events with all their suppliers. It's almost like parties. And you know, this presumably create a lot of clarity around expectations. You know, this might be feasible in the context of the car industry. You know, in coffee I gave you an example where you know, essentially the company just tried to come up with a simple and sensible sort of training program. I guess in more complex, since you work in due diligence, which is something I'm very interested on, in more complex situation there might be third parties that need to be brought in to create alignment. And in that sense, and we enter also the conversation about to which extent buyers should collaborate and do collaborate to create sort of commonly agreed upon standard. And then the third question, I'm sorry, I tried to jot it down but I forgot about it. I think it was about competition and trust, but I forgot exactly what the question was. It was probably a very difficult question. I think that there is a two way interaction of course between if you like competition and relationship. So here I did mention that there is a sense in which competition might be harmful to relationship in the sense that it might make it harder for relationship to be sustainable. Of course, competition is a word that we use very loosely in economics. We will need to be precise. It's also true the reverse that if a lot of exchanges happen in exclusive relationship that tends to, if you like, make the market a little bit less competitive, which can also not be a great thing from, from an efficiency point of view. So this is just to say that the relationship between the two is quite complex. But I'm sure the question was somewhat different, but I don't remember it now.
- [61:25]
B
Yeah, well we can give the person a chance to re ask it. I think it's fair.
- [61:33]
A
Yes.
- [61:33]
B
So it's not that it's not memorable, it's just that we both have the flu. It is a test. It's basically at which link along the supply chain most effectively applied. Because I'm assuming the farther downstream the harder it is because it's more. Less value added. As you mentioned, the flying geese model, you know, so in that case, you know, when there's low technology, everything else the supposed to be higher, hence building that trust and relationship would be difficult. So that's one element of that. The other element will be the reversal relationship. And then how does that also relate to that? Apologies for all these things, the effectiveness of the sustainability program because the farther downstream, the less the trust, the less the trust the less the sustainability control.
- [62:23]
A
Yeah. Thank you. Now I remember the question and then I didn't want to answer it. It's not that I was. No, I don't know. So in that. In the sense that. So the question at which link? So yeah I've. If you've seen most of my work is really on and the examples I've used coming from apparel and coffee, those are two chains that are so called buyer driven in the sense that a lot of the value addition and the largest player tend to be downstream. And so those are the guys that organize in a way to chain. And so it's very. My impression is that the trust need to start there and then if there's enough, if you like profits or gain or concerns, then it can sort of percolate further up the chain where it becomes harder and harder to achieve. But there might be other. Not there might. There are other chains of course that are not buyer driven and in that sense it could be that the conjecture is more important to develop trust upstream but is a conjecture.
- [63:22]
B
Thank you. I do one more round of two questions from the audience and then we go on the online. The gentleman at the very bottom with a rugby top, I have to describe you so that.
- [63:39]
A
Thank you very much professor. Especially the interdisciplinarity of your topic. I'm Aditya, I graduate did from Econometrics and Mathematical Economics in 22. So at the moment I work in the field of energy trading and energy supply chains especially post 22 have been very much in the news. And just adding this for context, I would like to extrapolate and have your view of the insights of what role can the state play or can it skew the incentives either towards more complex or more simplification of building trust in such supply chains.
- [64:20]
B
Yes, here at the front.
- [64:26]
A
Thank you so much for an absolutely wonderful lecture, Rocco.
- [64:30]
B
I'm Sarah Ashwin from the Department of Management. So I'm wondering, you started with an image of the collapse of the Rana.
- [64:39]
A
Plaza building in Bangladesh.
- [64:41]
B
How do you think through which mechanism could trust in supply chains have prevented such an accident? That's one question.
- [64:50]
A
And just thinking about the main governance reaction to that disaster was actually a legally binding agreement between global unions and over 220 firms which perhaps you could.
- [65:03]
B
See, see the, the fact that they.
- [65:05]
A
Made it legally binding as a lack of trust. So I'm just interested in how you think the Rana Plaza building collapse relates.
- [65:12]
B
To your theme of. Of trust and relational supply chains.
- [65:15]
A
Thank you. Yeah, these are, these are two difficult questions that Push me way outside my comfort zone. So on the energy and so I don't know enough about energy. But I think your question was about the role of the state.
- [65:33]
B
My.
- [65:33]
A
So often we have a. We have a view that, you know, trust becomes important because we cannot enforce contracts. So, you know, for instance, the courts do not function well and that's why trust is important. And so as a result we tend to think, oh, you know, you go in countries where courts don't work well and therefore you have, you know, more relationship. I don't think that that's. I don't know if that's true or not. I personally, I don't. That would. Shouldn't be my working hypothesis because I think that what laws do or what the general culture does is that it creates an environment in which trust can be built. So it's easier. It's almost like a scaffolding, if you like. So one important role of the state, I think is potentially to create the parameters for which that makes it easier for relationship, if you like, to thrive, to organized. And it end up that in places where the state function better, then we can have relationship about more complex things. In places where the state function very badly, then we need to have a relationship even to conduct very, very trivial transaction. That's one. The other thing is that, but this is a completely different aspect is that of course in many markets I think that there is a problem of counterparty risk. And then of course, bilateral relationship can help mitigate counterparty risk under business as usual. But at times of crisis, of course, there's no way that bilateral relationship based on trust can somehow overcome the externalities that come from lack of counterparties. And I think if we think about some of the energy issues that have arise, particularly, you know, a few years ago, I think that the state has a lot as a huge role to play in restoring trust in the market. And this perhaps also allows me to establish a bridge with. To the question that, that Sarah asked. I don't have a good answer, Sarah. I really don't. Probably, you know, I could be wrong. You know, it's hard for me to imagine that collapse like Rana Plaza would have happened, you know, in the context of a supply chain of a buyer that is committed to worker safety and that had found the ways to prevent either those type of accident or, you know, doors being locked and so forth. So I'm not. So this just to say that obviously is a tautological point I'm making. But you know, that for a buyer that cares and I found a Way to, to solve the problem that would have not happened. And indeed the buyers involved I think or sourcing from those factories were quite different. Now of course there are, as I mentioned before, there are many buyers that you know that will not push the envelope so far as to prevent those type of accident. And then indeed some kind of regulation needs to come in. Then there is the question, we know that the regulation in Bangladesh was, were in place, they were not implemented. The buyers and the unions needed to get together. So there are kind of deeper questions of, you know, what sort of, what is the institutional environment under which we can achieve this type of sustainability. But I don't have a good, I don't have a good answer. I don't think that yeah, it's probably, you know, bilateral relationship based on trust would be sufficient to prevent all accident of that type of.
- [69:00]
B
Yeah, excellent. Should we go online?
- [69:05]
A
Thank you. I'll go for three questions. First one we have from Antonio Santos Burrito is a LSE visitor. He asks is there an impact of the tenure of the buyers in their role to build long term relationship with suppliers? Daniel Venard asks. In value chains with high year to year production volatility such as cocoa firms face significant supply and price risk when sourcing, sourcing from a single region. In these contexts are long term trust based sourcing relationships realistically achievable? And the third question from an anonymous user is you, you mentioned AI in supply chains for an area of future research. How, how do you see or can you give any insights into AI contributing sustainably to supply chains? Yes, thank you. These are, these are a great question on the, and these are really pushing the, the online world is pushing me outside of even more outside. So the, yeah, the, the volatility I think poses a big, a big challenge for, for trust because in a way trust is you know, sort of like, you know, should be sort of somewhat robust. Also in a way, you know, you trust someone because you think that, you know, most of the time or under more circle reasonable circumstances, you know, they will stick to their side of the deal. So volatility does pose a challenge. And, and one way in which companies try to protect themselves against volatility and shock of course is through diversification. However, diversification needs to be handled carefully. I think it kind of. Why because diversification potentially makes it harder to build the trust at any, you know, with any of the particular origins. You know, so if, if I set up a system in. What is diversification? Diversification means that I can very easily switch to an alternative source if I need to. But if I have this ability to very easily switch to an alternative source if I need to, then with the particular source I'm using now, if they know that, then they understand that I also have an ability to switch if I need to. Not because there is a shock there, but simply because it's better to shift. And so indeed I think to the extent that we were able to look at this in the data in the context of the garment sector, there seems to be a little bit of a negative relationship between the extent of diversification of origins that buyer pursue and the extent of our relational is their sourcing strategy. But again I, we never put this in any paper because we, we never felt as confident about, about this result. But yes, volatility creates a problem. Diversification needs typically solution. But diversification then needs to be taken into account when thinking about designing this long term trust. Now on AI, I, I really don't, you know, I, I, I have some thoughts but they are very, you know, preliminary is really an area where I open that I, I will change my thoughts many times, many, many times over the course of the next few years. Maybe a couple of things. So one of course AI has enormous, you know, potential to, if you like, simplify, you know, the day to day operations, if you like, of supply chains which, you know, requires contract negotiation, contract executions and so forth. So that of course is going to probably be some operational gains there. Thinking a little bit more from a strategic point of view, one thought I have is that these business to business relationship that we described, we talked about, these are what we refer to as relational contracts, so visa agreement that are very rooted in the specific circumstances of the relationship and that make them not enforceable by further parties. So in a way a relational contract both between firms as well as within firms, in that sense there's no difference. It's also within organizations really is a form of tacit knowledge that is very specific to a set of individuals that are working together. Now we could imagine and some organizations are deliberately trying to do that, to use AI to codify this tacit knowledge. So does that mean that this relationship will become less valuable? Because now the machines will essentially have codified all the tacit knowledge this is embedded in the collaboration. I personally doubt it. Again, it can help. But then that means that the source of rents which always come from scarcity, will just shift somewhere else. I don't think that the machine will sort of substitute for, for the importance of sort of these relationships.
- [73:52]
B
Thank you. I know that the opportunity cost of our time is a wonderful reception of waits outside. So if you want to take one more question because we are due to finish at 5:2.
- [74:06]
A
Okay.
- [74:08]
B
There's time for one quick question.
- [74:12]
A
Yeah. We have a few ladies. Thank you for this lecture. So I'm Hardik and you are my program director. So my only question is that tariffs and countries turning protectionists, they are like revamping supply chain entirely. Like the world has to go back to the drawing board to think again like how the supply chain change. So what are your thoughts on that? Like how will over the next 10 years or how will, or is this the five year period Donald Trump is there in presidency and then all goes back to the normal. How are you doing that? So I think the question was about the, the change that are going at the moment in the, in the, the global trade environment. So with the, with the trade dispute and the, and the trade war. And so I, I think it's very hard to, to at least for me to sort of to predict exactly what's, what is going to happen partly because I think that so there's, there's a trade aspect and then there is I think the international macro slash international finance aspects and then there is the broader sort of geopolitics aspect. But so I think that there will be major restructuring of, of certainly some supply chains. Maybe the price mechanism will in some supply chain become less central in thinking about how certain scarce resources are going to be allocated. There will be routing, there will be quotas, there will be prioritization of certain use. I mean I, you know, I hope we don't go into really worse, worse worst case scenarios in which you know, historically we, but, but I don't think that this will sort of suppress if you like, the economics of, of what we have discussed. I mean the world is going to remain to a large extent that integrated maybe, but supply chains are going to shift, are going to be organized within blocks. But yeah, I don't think that there's going to, yeah, for, for the purpose of what we have discussed tonight, I, I don't think that there will be major changes in terms of the economics, the underlying economics logic if you like, of how the supply chains will function. So thanks everyone. And.
- [76:24]
B
If you want to know more, you can scan the QR code to know more about the program, the new program that Rocco started. And thank you Rocco. Now you know what I meant when I said this was an exceptional lecture and an exceptional lecturer. So everybody's invited to toast to Rocco. Outside there's a reception waiting. And thank you so much for the organizers who have done a marvelous job.
- [76:50]
A
Thank you everyone.
- [76:58]
B
Thank you for listening. You can subscribe to the LSE Events.
- [77:01]
A
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