Can contracts substitute hierarchy? Evidence from high-quality coffee supply in Brazil

Purpose A trend toward higher quality has demanded more strategic investments in the transaction of coffee supply in Brazil. Instead of internalizing this transaction, one firm, illycaffe, has challenged the vertical integration assumption by adopting contracts to coordinate its supply. Aiming to investigate whether this firm is losing economic efficiency in terms of coordination, or whether it is being efficient due to a proper definition and allocation of property and decision rights, the purpose of this paper is to analyze the transaction attributes of illycaffe's suppliers according to the vertical integration dilemma. Design/methodology/approach The research design is based on a survey of 105 coffee growers analyzed through probit regression. Using a transaction costs approach, the study empirically tests whether well-designed contracts can act as a hierarchy by following the efficient alignment hypothesis. Findings The results emphasize asset specificity, uncertainty and incentives as determinants for being an illycaffe supplier. In other words, these findings demonstrate that a well-designed contract can substitute a hierarchy based on transaction costs economics. It contributes by illustrating other coordination alternatives overlapping vertical integration, even in environments of high uncertainty and asset specificity, which encourages other private strategies based on allocation of property and decision rights of hybrid arrangements. Originality/value The study adopts a unique survey about transaction costs in the transactions of high-quality coffee supply in Brazil. The main contribution is to shed light on the cases where, how and why contracts can substitute the need for in-house production, and to guide private and public strategies using this background.