Spilling secrets and shrinking chains: How weak laws narrow supply networks

Modern manufacturing often requires firms to share confidential information with outside suppliers, some of whom also supply their competitors. Using more than 160,000 contracts from the global automotive industry, this column examines how manufacturers respond to this risk and the costs of doing so. The findings suggest that when legal protection is weak, firms may instead turn to contractual exclusivity by limiting the number of manufacturers their suppliers can serve, reducing the suppliers’ customer base and bargaining power and potentially weakening their incentives to invest. Stronger legal protection reduces the need for this contractual response and can therefore support broader supplier networks.

Suppose a carmaker develops a new braking system. Producing it may require sharing detailed information about its design, tolerances, and materials with a specialised supplier. That supplier may also produce braking components for a competing carmaker.

This problem is common in modern manufacturing. Very few manufacturers produce everything themselves. A single car is assembled from thousands of parts sourced from hundreds of specialised firms, and the same supplier will often work for several carmakers. By serving several manufacturers, suppliers can spread their costs across a larger customer base. Manufacturers, in turn, gain access to specialised expertise without developing it internally. These relationships also create a risk that confidential information will reach competitors.

Two ways to guard an idea

Patents are only one of the ways in which firms protect their knowledge. Surveys consistently find that firms consider secrecy more important than patenting (Guriev and Bhattacharya 2007, Mezzanotti and Simcoe 2023). A patent grants an inventor exclusive rights for a limited period in exchange for disclosing the invention. Secrecy provides no comparable exclusive right, but it avoids disclosure and can prevent imitation for as long as the underlying knowledge remains confidential.

Trade secret protection depends on the ability to prevent or sanction unauthorised disclosure. Once firms share information with outside partners, the effectiveness of contractual safeguards depends partly on the local legal system. Courts in some countries enforce contracts designed to prevent the misuse of trade secrets. In others, enforcement is weak or legal proceedings are too slow and costly to be effective.

When the law can’t help

So what does a firm do if it cannot trust the courts to protect the information it hands to a supplier? The answer, from the automotive data, is that it changes the shape of the relationship itself. If a supplier serves only one customer, there is nobody for that customer’s secrets to leak to. Restricting a supplier to a single buyer, making the relationship exclusive, becomes the firm’s own way of protecting itself when the courts won’t.

We used MarkLines’ Who Supplies Whom database, which covers supply relationships between 226 carmakers and 4,124 parts suppliers worldwide between 2006 and 2016, and compared this with how strongly each country’s laws protect trade secrets. The raw data show a clear negative association: countries with weaker trade secret protection have a higher share of exclusive supplier contracts.

Figure 1 Weaker legal protection, more exclusive contracts

Notes: Each dot is a country. The weaker its legal protection for trade secrets, the higher the share of car-parts contracts in that country that are exclusive.
Source: Angenendt et al. (2026), Figure 1.

This correlation alone does not establish the proposed mechanism. We therefore examine the types of components for which trade secret protection should matter most.

The cost of exclusivity

Exclusivity is not a free lunch. Suppliers often have to make investments tailored to one particular customer, retooling a production line or training staff on a specific process, that are hard to spell out fully in a contract in advance. Once that investment is made, the supplier becomes vulnerable: if it can sell what it built to only one buyer, that buyer gains the upper hand in any future price negotiation. Economists call this being held up, a problem the economist Oliver Williamson wrote about in explaining why firms organise their business relationships the way they do (Williamson 1979). It is also why firms in general tend to stick with the suppliers they already have rather than switch: building a relationship from scratch is itself costly (Faber et al. 2025).

Access to other customers protects a supplier from being held up. Exclusivity may reduce the risk of disclosure, but it also weakens the supplier’s bargaining position and may reduce its incentive to invest in the relationship. The same logic appears in international trade more broadly: countries with strong courts tend to produce more goods that require close, customised relationships between buyers and suppliers because their legal systems can prevent a supplier from being exploited after it has invested (Nunn 2007). Where legal protection is weak, firms rely more heavily on contractual restrictions such as exclusivity.

Where the mechanism should be strongest

This trade-off is not the same for every product. Picture an entirely standard part, a generic bolt, say. There is nothing secret embedded in it, so weak trade secret law poses little threat, and restricting the supplier to one buyer would be needlessly costly, since that supplier could easily sell it elsewhere. Now picture the opposite: a component so custom-made that it is essentially useless to anyone else. Genuine know-how might be involved, but restricting other customers barely helps, because there was no alternative buyer anyway.

The tension is sharpest in the middle: components custom-made enough that making them requires access to genuinely sensitive information, but standard enough that the supplier could plausibly sell something similar elsewhere. It is precisely for products like these that trade secret protection should matter most for how firms deal with their suppliers.

Empirical results

The estimates are consistent with this prediction. For components with intermediate levels of customisation, stronger trade secret protection is associated with suppliers serving more manufacturers. A substantial increase in trade secret protection is associated with suppliers serving approximately 25% more manufacturers on average. Comparing the countries with the weakest and strongest trade secret laws in our data, a supplier in the best protected country serves about one more manufacturer, on average, than an otherwise similar supplier in the worst protected country. Suppliers in this group serve 2.4 manufacturers on average, so the estimated difference is economically substantial. For fully standard and fully customised components, the association between trade secret protection and the number of customers largely disappears.

Figure 2 The effect is concentrated in the middle

Notes: Stronger trade secret protection is associated with more customers per supplier, mainly for components that are neither fully standard nor fully customised. The estimated association is close to zero for standard and highly customised components.
Source: Angenendt et al. (2026), Figure 4.

Additional tests support this interpretation. The association becomes much weaker when suppliers are large relative to their buyers or operate in component industries with a history of cartelisation, two circumstances in which manufacturers have less power to impose exclusivity. It is almost absent when the manufacturer owns the supplier. 

A separate analysis across US states also finds wider supplier networks where courts provide stronger protection against employees transferring trade secrets to a new employer. As in the main analysis, this relationship is concentrated among components with intermediate levels of customisation.

Implications for intellectual property and competition policy

Debates about intellectual property often focus on the balance between rewarding invention and limiting the diffusion of ideas. Our results identify an additional channel: legal protection also influences how firms organise relationships with the suppliers on which production depends.

When legal protection is weak, firms may substitute contractual exclusivity for public enforcement by limiting the number of manufacturers their suppliers can serve. This restriction reduces suppliers’ customer base and bargaining power and may weaken their incentives to invest. Stronger legal protection reduces the need for this contractual response and can therefore support broader supplier networks.

This interpretation is also relevant to the regulation of exclusive contracts. When a buyer requires a supplier to serve only one customer, regulators often ask whether the arrangement is intended to exclude a rival. Our findings suggest that exclusivity may instead protect confidential knowledge where legal enforcement is weak. Exclusivity may still harm competition. Regulators should nevertheless consider whether a restriction protects information that would otherwise be vulnerable to disclosure.

As production spreads across more countries with very different courts, and as more of what makes a car, a phone, or a battery valuable is something you cannot touch – like software or manufacturing know-how – rather than steel, that question is only going to come up more often. Trade secret enforcement can therefore influence the structure of supply networks, including how widely suppliers can serve competing manufacturers.

Source : VOXeu