Extendedness as a Relationship Governance Mechanism for Securing Cooperation in Marketing Relationships

Harald Biong

... Review of this manuscript was arranged by Department Editor JK Liker. TY Choi is with the Departments of Management and Supply Chain Management, College of Business, Arizona State University, Tempe, AZ 85287-4706 USA (e-mail: Thomas.choi@asu.edu). ...

No matter what type of relationship a buyer has with a particular supplier, the buyer faces the decision of whether to either stay with the supplier or to switch to another supplier. This paper introduces a model of the buyer's switching decision that integrates tenets of both transaction cost economics and relationship marketing. The model analyzes how the switching decision is affected by parameters such as transaction-specific assets, information quality and the time dimension. The resulting Nash equilibria reflect strategies in which each player makes its optimal decision, taking into account the optimal decision of the other players. A sensitivity analysis of the effects of the parameters on the performance measures of price and profit provide intuitively sound results, and demonstrates how a common ground can be found between two schools of thought on buyer-supplier relations.

Extendedness as a Relationship Governance Mechanism for Securing Cooperation in Marketing Relationships Harald Biong Ragnhild Silkoset ABSTRACT. Traditionally, buyers encourage fierce price competition among suppliers. Such price competition has been the dominating strategy for purchase of commodities in business markets. Undoubtedly, this practice has been effective in many cases. Unfortunately, transactional purchasing practices could have negative effects because they demotivate suppliers to engage in value creating activities and incur substantial transaction costs. In contrast to competition, buyer-seller cooperation can also bring prices and total costs down. One problem of cooperation is that the parties can realize individual gains by defection while the other continues to cooperate. This article examines how industrial buyers of a commodity can overcome this problem and realize cost savings and low prices by motivating the supplier to cooperate by offering an extended time frame for purchases. The authors test the research hypotheHarald Biong and Ragnhild Silkoset are Associate Professors, Norwegian School of Management, Department of Marketing, Elias Smiths vei 15, P. Box 580, N-1302 Sandvika, Norway (E-mail: harald.biong@bi.no and ragnhild.silkoset@bi.no). The authors acknowledge the assistance of Even Lanseng with data collection, and thank the Norwegian Electricity Industry Association for financing the study. The authors thank Robert Dahlstrom for his valuable support in the study and are also grateful to Kenneth H. Wathne, Arnt Buvik, Helge Thorbjørnsen, and two anonymous JBBM reviewers for their helpful comments on previous versions of this article. The authors are listed in alphabetical order. They both contributed equally to this article. Journal of Business-to-Business Marketing, Vol. 13(2) 2006 Available online at http://www.haworthpress.com/web/JBBM  2006 by The Haworth Press, Inc. All rights reserved. doi:10.1300/J033v13n02_03 29 30 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING ses in a sample of 347 industrial buyers of electricity. The empirical tests provide general support for their predictions. The implications of the findings for marketing theory and practice are discussed. [Article copies available for a fee from The Haworth Document Delivery Service: 1-800HAWORTH. E-mail address: <docdelivery@haworthpress.com> Website: <http:// www.HaworthPress.com> © 2006 by The Haworth Press, Inc. All rights reserved.] KEYWORDS. Governance mechanism, extendedness, cooperation, commodities, marketing relationships INTRODUCTION The philosophy behind deregulation of markets and dissolution of previous monopolies is to benefit the society by efficient resource utilization and lower prices for buyers. Examples of this trend have been the deregulation and privatization of the telecommunication and electric power industry both in the US and in Europe. Due to their commodity status those industries are regarded as well suited for competition to drive prices down. For example, a report by United States Federal Trade Commission (2000) notes that the results of restructuring the UK electric power industry into a privatized and gradually competitive industry is generally positive with lower prices for both large and small customers. Turning from a regulated market with monopolistic suppliers to a highly competitive one gives buyers the freedom to select whichever supplier that is able to offer the best price or price/cost combination for the commodity. In this scenario sellers might lose customers. In order to face that threat and stay competitive, commodity sellers have the option either to compete solely on price, or to differentiate their offerings with value adding services. For example, sellers can deploy their expertise to develop cost reducing activities in order to achieve total costs that are below the mere price effect of the commodity (Dyer, 1996; Fram, 1995). In the latter case the seller may offer the commodity and value adding service as a bundled product charging a price for the service less than its value, or free of charge (Anderson and Narus, 1991; Klein and Murphy, 1997). Efficiency is then achieved by buyer-seller cooperation rather than by a purely competitive approach. The underlying assumption for the bundling strategy to work is that buyers cooperate and buy the bundled offering (Anderson and Narus, 1991). However, some buy- Harald Biong and Ragnhild Silkoset 31 ers might take advantage of the free value added service by unbundling the offering and assigning the purchase of the commodity to whatever seller offering the lowest price (Williamson, 1983). This outcome is well described by Jackson (1985). In the short run the buyer will benefit from both free service and low price. In the long run sellers facing the possibility of losing out to lower cost competitors might stop investing in value adding services. Therefore, also buyers wanting such services will be harmed unless some governance mechanisms that could motivate sellers continuing to offer value-adding services are put in place. Broadly the scenario described could be explained by the parties viewing their relationship, in game theory terms, as a Prisoner’s Dilemma situation (Gulati, Khanna, and Nohria, 1994). A crucial trait with a Prisoner’s Dilemma situation is that the parties gain more from joint cooperation than from joint defection, but they will gain even more individually if they can defect while their partner cooperates (Heide and Miner, 1992). The challenge is therefore to make the business relationship work and realize cooperative gains. One stream of literature has emphasized the significance of interdependence; parties cooperate when they depend on each other (Buchanan, 1992; Dwyer, Schurr, and Oh, 1987; Pfeffer and Salancik, 1978). In this case it is the structure of the relationship that motivates cooperation. Other theorists have identified traits of the parties, such as trust and commitment, as significant sources of cooperation (Morgan and Hunt, 1994). The organizations, or the persons within them, come to care about each other and cooperate out of altruism rather than because of exogenous requirements (Heide and Miner, 1992). As an alternative, our study explores the effect of the possibility of future interactions as a means to achieve cooperation, building on the theoretical implications of repeated games (Axelrod, 1984; Heide and Miner, 1992). For example, Heide and Miner (1992) suggest that increasing the extent of anticipated future interaction rather than changing fixed traits or investing the time required to develop commitment could sometimes increase cooperation more readily. In essence, our study rests on the assumption that suppliers of a commodity possess to a varying degree expertise that can be applied for value adding purposes, such as cost reductions, for the buyer. The buyers then have the option to buy either the core product without further involvement with the supplier or a bundled product consisting of both the core commodity and the expertise (Anderson and Narus, 1991). The prediction of our article is that buyers of this commodity in a business market can motivate suppliers to deploy their expertise and cooperate to bring 32 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING costs down below the effect of a low purchasing price by communicating extendedness through repurchase intentions. As such, one contribution of our study is an assessment of logic from Prisoner’s Dilemma research in an applied setting. By choosing the purchase of commodities as the research context, (1) initial structural properties of the relationship should not interfere with our basic proposition (Heide and Miner, 1992), and (2) we challenge the assumption that price is the main concern for efficient procurement of commodities. Second, our study is a response to the call for relationship governance studies examining value creation in the sense of total cost minimization, rather than controlling opportunism and transaction costs (Ghosh and John, 1999; Zajac and Olsen, 1993). The article is organized as follows. In the next section the conceptual framework including hypotheses is presented. Then the research design and the empirical tests are described. Finally, the implications of the findings, the study’s limitations, and possible topics for further research are discussed. THEORY AND HYPOTHESES Model The main focus of this study is cooperation and ways in which buyer-supplier cooperation can increase buyer efficiency. Specifically, we examine how a specific governance mechanism applied by the buyer (repurchase intentions) can motivate the supplier to perform certain actions that contribute to reductions of the buyer’s production costs. We also examine whether this governance mechanism indirectly could affect the structure of the relationship with potential negative or positive cooperative effects. Our focus is consistent with the vast stream of the literature on cooperative marketing relationships (e.g., Heide and John, 1990; Morgan and Hunt, 1994; Webster, 1992). In contrast with most of the literature on relationship marketing that has focused on what a seller can do to motivate buyer cooperation (Anderson and Weitz, 1989; Doney and Cannon, 1997; Morgan and Hunt, 1994), we emphasize the buyer’s initiative. In general, cooperation refers to situations in which parties work together to achieve mutual goals (Anderson and Narus, 1999). In our terms, cooperation means active deployment of activities and resources. In order to realize gains by cooperation (1) actions and decisions need to Harald Biong and Ragnhild Silkoset 33 be coordinated, and (2) the parties must be motivated to commit resources and carry out their parts of the cooperative activities (Milgrom and Roberts, 1992). In particular, we look at one of the dimensions of cooperation identified by Heide and Miner (1992)–information exchange and its effect on buyer efficiency.1 While Heide and Miner (1992) treated information exchange as one of four domains of potential cooperation, we are focusing on information exchange in the sense of vertical coordination (Buvik and John, 2000) since this construct reflects revelation and utilization of expertise as discussed below. Our theoretical model is outlined in Figure 1. Buyer’s Repurchase Intentions Conceptually, repurchase intentions refer to the buyer’s intentions to continue to purchase at least the same volume from a specific supplier for an extended period of time. Broadly, this conceptualization is consistent with Heide and Miner’s (1992) extendedness concept. More particularly, intentions to repurchase from the supplier (1) communicates a long-term rather than a transactional orientation, (2) gives the supplier a value of future interactions through repeated sales, and (3) presents a FIGURE 1. Theoretical Model H1: + SUPPLIER’S INFORMATION EXCHANGE H5: + H4: + BUYER’S REPURCHASE INTENTIONS H2: + PERCEIVED LOW PRICE H6: – H3: + PERCEIVED DEPENDENCE ON SUPPLIER H8: + PERCEIVED COST REDUCTIONS H7: – 34 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING large possibility that the parties will interact in the future, thus satisfying the requirements for enlarging the “shadow of the future” (Axelrod, 1984). Theoretically, it means that extendedness of the relationship is high when the intended repurchasing period of the commodity is long and termination is unknown (Heide and Miner, 1992; Parkhe, 1993). As Heide and Miner (1992) note, a relationship’s level of extendedness thus reflects the strength of expectation that it will continue for an indefinite time period. It should be noted that for repurchase intentions to work as a proxy for extendedness, these intentions have to be communicated from the buyer to the seller. What puzzles both theorists and practitioners is the observation that cooperation may not come naturally even if it has obvious benefits, as discussed briefly in our introduction. Game theorists explain the noncooperative outcome (stable but Pareto deficient) in situations where cooperation would be more beneficial, such as in a Prisoner’s Dilemma game, by the time horizon and incentive structure of the game (Zagare, 1984). For example, if both parties in a business relationship commit activities and resources they will both benefit. A problem is, however, that while one party’s commitment of input to a cooperative arrangement will benefit both, the contributor carries all the costs of the contribution and thus may be worse off if the other party does not reciprocate. Therefore, it is an underlying threat with this situation that each party has an incentive to reap the benefits from the other party’s contribution while holding back on its own input. If this game is played for only one period the likely outcome is that mutual defection rather than mutual cooperation will occur.2 In such a situation what can a buyer do to motivate the supplier to cooperate? Both experimental (Axelrod, 1984; Macy and Skvoretz, 1998) and empirical (Heide and Miner, 1992) research show that cooperation is the likely outcome if the extendedness of the game is changed. However, the cooperative results in the repeated Prisoner’s game depend on a specific set of assumptions (Zagare, 1984). First, the probability that the parties will interact again must be high and the value derived from their future transactions should be greater than the value of present defections (Telser, 1980). Thus the parties will cooperate as long as there is an economic incentive to cooperate. Second, the parties should play a “tit-for-tat” strategy, that is open with cooperation and then respond in the same way whatever the other party does in the previous round. Third, the parties should not know when the game is ended. In a finite game with a fixed end, the theoretical solution is that the parties will anticipate this and defect at the end of the game. Then it would pay to de- Harald Biong and Ragnhild Silkoset 35 fect in the next-to-last transaction and so on and the game would unravel.3 Therefore, supported by the insight provided from theory of repeated games, offering the commodity supplier long-term sales in the form of repurchase intentions would be a promising option (Heide and John, 1990; Heide and Miner, 1992; Parkhe, 1993). By doing so, the buyer communicates its cooperativeness, providing a safeguard for the supplier to make cooperative investments (Farrell and Gibbons, 1995) with the ultimate goal of cost reductions. For example, development of specific cost reducing solutions may require the supplier to exchange detailed engineering skills with threat of losing intellectual property (Buvik and John, 2000). As a result, ownership rights to specific cost saving solutions might be difficult to protect contractually, because they might be the result of joint action by the parties (Heide and John, 1990). In this case, stronger expectations of continuity might help each party to be more confident that the other will perform its activities faithfully because the “shadow of the future” has been enlarged (Heide and John, 1990). These arguments are supported by the findings of Heide and Miner (1992) showing a strong positive association between extendedness and information exchange, while Deutsch (1960) also shows that cooperation is the most likely outcome, even in end games situations, when the parties signal cooperativeness. Thus, repurchase intentions are antecedent to cooperation (Heide and Miner, 1992) and cooperation then yields desired outcomes (e.g., cost reductions). Taken together, repurchase intentions and cost reductions provide insurance and incentives for cooperation. This is consistent with the theoretical recommendation of Axelrod (1984) to open with a cooperative move and present a sufficient value on the future. Summing up these arguments we offer the following prediction: H1: The buyer’s repurchase intentions will have a positive effect on the extent of the supplier’s information exchange. Next, we revert to a non-cooperative competitive bidding situation. In economic terms the buyer has all the bargaining power, because it is in a position to refuse or accept the supplier’s offer. Given that the bidding suppliers may not know the buyer’s reservation price (that is the highest price the buyer is willing to pay) and the competing suppliers’ price offerings, each supplier is likely to offer its lowest possible price in order to be attractive. In this case it is the attractiveness of the customer’s business and the fear of losing to competitors that drive prices 36 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING down (Anderson and Narus, 1999). By contrast, a cooperative approach gives an opposite scenario. By extending the relationship and offering repeat business, the buyer may demand a low price in return (Dyer, 1996; Fram, 1995; Lyons, Krachenberg, and Henke, 1990). What should be emphasized from these studies is the buyers’ initiative to offer long-term contracts, usually combined with a reduction in the supplier base in favour of cooperative actions from the suppliers such as lower prices and other value adding contributions. For the supplier this offering might be beneficial for at least three reasons. First, it permits an extended sales period to recover initially reduced margins. Second, an extended and predictable sales period will allow for better production planning with potential positive cost effects (Kalwani and Narayandas, 1995), and third, the supplier does not incur the costs of competitive bidding which in worst case are lost when contracts are not won (Newman, 1988; Sheth and Parvatiyar, 1995). Taken together, improved predictability allows for cost savings that might be shared with the buyer in terms of lower prices (Dyer, 1996; Fram, 1995). Therefore, we propose the following hypothesis: H2: The buyer’s repurchase intentions will have a positive effect on the perception of having obtained the lowest price from the supplier.4 However, the buyer’s commitment to a specific supplier through promises of repeat purchases may have indirect structural impacts on the relationship besides its cooperative effects. One reason for having many suppliers competing against each other is to avoid dependence on a specific supplier and use this power advantage to drive prices down (Baker, 1990; Dyer, 1996; Porter, 1980). For example, do previous studies suggest that the fear of dependence discourages customers from establishing close relationships (Biong, Wathne, and Parvatiyar, 1997; Han, Wilson, and Dant, 1993; Lyons, Krachenberg, and Henke, 1990)? Conversely, by committing to a specific supplier for an extended period, the buyer deliberately restricts the available number of suppliers. By doing so, some bargaining power is shifted to the supplier, making the buyer more dependent (Baker, 1990; Dyer, 1996). Hence, we offer the following hypothesis: H3: The buyer’s repurchase intentions will have a positive effect on the buyer’s (perceived) dependence on the supplier. Harald Biong and Ragnhild Silkoset 37 Supplier’s Information Exchange By information exchange, what is meant is the extent to which the supplier exchanges information with the buyer about prices, current and future demand for the commodity, and ways of economizing on utilization of the commodity. Information exchange may be handled by various functions such as application engineers, logistic specialists or IT people. However, in this study we focus on the supplier’s information exchange with the buyer channeled through the salesperson. As noted by Farrel and Gibbons (1995), information exchange is necessary for the supplier to learn about the customer and adapt value creating activities and solutions to specific customer needs. Information exchange parallels the vertical coordination construct developed by Buvik and John (2000). While our study conceives information exchange as a coordinating mechanism in order to achieve efficiency, the study of Frazier and Summers (1984) shows the effectiveness of information exchange as an influence strategy in a cooperative marketing channel environment. The study of Buvik and John (2000) shows how suppliers with minimal buyer specific investments benefit from engaging in greater vertical coordination by information exchange to cope with changing circumstances (in the context of this study, fluctuations in supply and demand, prices of the commodity, and new cost economizing technology). In competitive markets, buyers have to engage in ongoing search activities to be sufficiently informed about the actual price picture in order to negotiate advantageous prices. When price dispersion is great, the search costs can be substantial for price sensitive buyers (Wilde, 1980). A factor complicating the price search is that in several commodity markets, the price paid is not simply a general list price for the commodity. Rather, the price fluctuates with general supply and demand in the market and is also affected by the buyer’s future demand and risk preferences. Since future prices are difficult to predict accurately, a contract may contain a spot market component to benefit from sudden drops in the market price. A negative consequence is unwanted risk and exposure to unforeseen price increases. Therefore, the buyer may also want a hedging component securing a fixed price for some of its consumption of the commodity. In an uncertain market situation, a salesperson could benefit by being proactive. Information exchange helps the salesperson in identifying the buyer’s consumption pattern and risk preferences in order to design the best contract, reducing the customer’s search costs. Moreover, it should be in the interest of the salesperson to reduce the 38 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING buyer’s uncertainty about the supplier’s prices (Stigler, 1961). In particular, this might be the case as the received price might be a joint consideration of factors mentioned above. However, the salesperson may not know the extent of the buyer’s search activities and should therefore quote a sufficiently low price in order to obtain the buyer’s patronage (Stigler, 1961). What a sufficiently low price is will better be understood by extended information exchange on current and future needs for the commodity as well as on prevailing prices from competing suppliers. In that case, information exchange may help the seller by revealing the buyer’s reservation price (Tenbrunsel et al., 1999), thus enabling the seller to charge its price accordingly. So far, the seller’s motivation for exchanging information and offering a low price has been emphasized. Still, the buyer may not know for certain whether this information exchange has resulted in a low price without consulting other sources (Baker, 1990). However, frequent and repeated interactions may breed familiarity and trust (Gulati, 1995) and an impression of cooperation (Axelrod, 1984). In this vein, previous studies (Halpern, 1994; Sally, 2002) show that “friend” sellers tend to charge less than “stranger”-sellers, whereas friend-sellers and friendbuyers tend to agree on price more willingly than strangers. Summing up the preceding argument, the following hypothesis is offered: H4: The greater the extent of the supplier’s information exchange, the stronger the buyer’s perception of having obtained the lowest price. Recall that the ultimate goal for the buyer to motivate the supplier to cooperate is the outlook for cost reductions in application of the supplier’s product. The supplier may have general expertise in such achievement but this expertise has to be tailored to the specific buyer. With reference to the extant literature (Buvik and John, 2000; Farrell and Gibbons, 1995; Heide and John, 1992), information exchange is crucial for adaptations and learning about the buyer’s organization, tastes, and preferences. Through information exchange the customer helps the salesperson in building up customer specific knowledge, which is essential for the development of cost reducing solutions. In support for this argument Glazer (1991) writes that information in a buyer-seller relationship provides value by cost reductions of factor inputs that go into the firm’s products and services. When more information is exchanged between the buyer and seller, the information intensity in the relationship increases. Over time the seller builds a stock of information about the Harald Biong and Ragnhild Silkoset 39 buyer, its organization, routines and future requirements. This stock will then serve as a basis for future value-adding possibilities, either in greater revenues or lower costs of future transactions (Glazer, 1991). Still it might not be clear how increased information intensity could generate value when homogenous commodities are transacted. One example might be illustrative. Recent purchasing strategy has shifted from emphasizing lowest price per purchased unit to total cost of use of input factors (Fram, 1995; Kanter, 1989). The stock of information accumulated through buyer-seller interactions may help the buyer in developing more cost efficient use of the commodity through improved equipment and working processes. The arguments are summed up formally as follows: H5: The extent of the supplier’s information exchange will have a positive effect on the buyer’s perceived cost reductions. Dependence on Supplier Consistent with resource-dependence theory, dependence refers to there being few alternative suppliers available for the commodity (Pfeffer and Salancik, 1978). It should be recalled that our point of departure is a competitive market for a commodity with several potential suppliers and no commitments to any specific ones (Porter, 1980). However, when the commodity supplier offers a bundle consisting of the commodity and supplementary services related to utilization of the commodity, the intent is to increase its attractiveness so the number of alternatives is reduced. As suggested by the literature (e.g., Rubin, 1990), the supplier can take advantage of this position. For example, it can offer an especially low price in favor of the extended purchase period but with the intention of raising the price once the buyer has been locked-in (Lyons, Krachenberg, and Henke, 1990; Williamson, 1996; Zagare, 1984). It can do so in the knowledge that it will not face competition for an extended period (Baker, 1990). This is the “sucker’s pay-off” in the Prisoner’s Dilemma game, one player (the buyer) cooperates, while the other (the supplier) does not. However, another and more cooperative explanation for the expected effect of increased dependence on price is also plausible. A buyer derives value both from purchasing the supplier’s commodity and from the supplier’s expertise in cost reduction activities (Anderson and Narus, 1991, 1998). In this case access to this expertise might be one reason for extending the purchase period in the first place; otherwise an arm’s length transactional relationship might be sufficient. As Bu- 40 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING chanan (1992) notes, the buyer must pay a price to benefit from this resource. Therefore, the price might reflect the effect of two components, one component consisting of the price for the core commodity for which there is a competitive supplier market, and the other component consisting of the price for the supplier’s expertise for which there is a competitive buyer market. These arguments are summed up in the following hypothesis: H6: Dependence on the supplier will have a negative effect on the buyer’s perception of having obtained the lowest price. In its absolute sense, dependence or its reverse concept, power (Emerson, 1962), means control (Heide, 1994). The most powerful party has the ability to control the other party and make it undertake actions it otherwise would not do (Gaski, 1984). Basically, we assume that it should be in the long-term interest of the buyer to use its input resources more cost efficiently. As economizing on the commodity would contradict the interests of the supplier to sell as much as possible or to maximize its prices,5 it would be reasonable to suppose that a powerful supplier would not contribute to cost saving activities. Moreover, as Buchanan (1992) notes, committing its resources to the buyer means increased costs for the supplier, thereby decreasing the value of the trade. Thus, by having gained some power, the supplier may decline to deploy its expertise to bolster the supplier’s cost economizing activities. In sum, we propose the following hypothesis: H7: Increased buyer dependence on the supplier will have a negative effect on the supplier’s contribution to the buyer’s perceived cost reductions. Price Conceptually, price is the amount of money a buyer pays for a unit of a good purchased from a seller. It should be noted that price can be quoted in any unit (Milgrom and Roberts, 1992), but in this study price is conceived in monetary terms. It should also be noted that when the term price is used in this study, it is the buyer’s perceived price that is referred to, not the absolute nominal price. Moreover, the price concept encompasses both the current price of the commodity and expectations of future price development. Economists contend that in the long run firms should maximize their efficiency (Williamson, 1991). Since prices of purchased goods repre- Harald Biong and Ragnhild Silkoset 41 sent buyer costs it should also be in the buyer’s interest to pay as low a price as possible because this effect goes straight down to the buyer’s bottom line (Buvik and John, 2000). Thus, low prices for input factors contribute to low total costs than other factors held constant. Purchasers’ efforts to press prices down underscore this argument (Anderson and Narus 1999; Dyer, 1996; Helper, 1991). Especially this is the case when the buyer can expect the same quality regardless of supplier or when quality can easily be assessed before purchase, as for search products (Rao and Monroe, 1996). Recall the context of our study, a commodity with the same quality across suppliers regulated by industry norms (Rao and Monroe, 1996). Therefore, a low price of the commodity contributes to reducing the buyer’s total costs. Hence we propose the following hypothesis: H8: The lower the perceived price received from the supplier the more the supplier contributes to the buyer’s perceived cost reductions. METHOD Research Context A problem when examining price and price effects could be the potential quality differences between products and suppliers that might be associated with different price levels (Kirmani and Rao, 2000; Stiglitz, 1987). For that reason organizational buyers of electricity in a deregulated market for electric power (i.e., the Norwegian electricity market) were chosen as the research context. As a pioneer country, Norway liberalized its electricity market in 1991. Before the liberalization, the electricity market had been regulated and dominated by public administration for about 90 years. The economic motivation behind the market liberalization was to “increase the efficiency and flexibility of energy utilization. The law amendment must ensure that the organization of the energy supply market enhances a socio-economic adaptation in production and consumption” (Ot.prp. nr. 43 (1989-1990)). Several European countries have later followed the Norwegian example. In order to understand the complexity of this market it is important to have some knowledge of its underlying structure. Historically, the Norwegian domestic production of electricity is based on waterfalls mean- 42 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING ing that the supply side is heavily influenced by the acts of nature. In order to reduce supply uncertainty the market supply is balanced with purchases from other Nordic countries through the Nordic trading company “Nord Pool”, an institution organizing transactions of electricity between Norway, Sweden, Finland and Denmark. It should be noted that production of electricity in those other countries is mainly based on coal, oil, or nuclear power, meaning a more stable production. In the domestic industrial market the transactions either take place directly between manufacturers and users or through trading companies acting as wholesalers buying large quantities from the manufacturers for resale to the users. In this respect both manufacturers and wholesalers are considered as suppliers from the end user point of view. Basically, electric power is a very homogenous commodity with the same quality across producers. When transferred through the electricity network, it is impossible for the buyer even to recognize either the source of energy applied to produce the electricity or which producer delivers the actual amount of electricity consumed. Therefore, when competition is free, buyers can freely switch among producers without facing quality differences and compatibility problems often associated with other types of products and services (Darby and Karni, 1973). However, producers of electric power may face different production costs due to variation in production inputs for the reasons mentioned above. Moreover, they may interpret supply and demand differently and therefore quote different prices even at the same point of time, while also prices vary across contract types. As a result there is wide price dispersion both across contract types and suppliers. Figure 2 shows the dispersion of prices of electric power for different types of contracts in the period of 1994 until 2002 for the Norwegian wholesale market. To illustrate the effect of weather conditions, the summer, 1996 was very dry in Norway. This is reflected in the very high spot price and a lagging effect in the contracts. The figure also shows that actors buying electricity on long-term contracts with fixed prices for more than five years obtained a lower price than those who had shorter-term contracts or bought electricity through the spot market. For example, the spot market price in mid 2002 was almost the double of a five-year contract price. When examining recent price variation among suppliers we find a difference of 42% between highest and lowest price for new fixed-price contracts, 611% for older fixed-price contracts, and 117% for contracts connected to the el-spot price. Those examples should be illustrative for the difficulty of both choosing among contract types and suppliers in order to obtain the lowest price. Harald Biong and Ragnhild Silkoset 43 FIGURE 2. Price of Electric Power in the Wholesale Market, NOK øre per kwh 30 25 20 15 10 Contracts > 1 year Contracts 1-5 years 5 Contracts < 5 years Nord Pool spot market 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 Source: Statistic Norway. While the core product, in this case electricity, is a homogenous commodity, suppliers may attempt to differentiate themselves on additional services, such as energy economizing advice (Anderson and Narus, 1991). Results from a qualitative pre-study confirmed such practice in this industry. Consequently, the quality of the core product is the same across producers, while the price and quality of additional services may differ. However, some companies also reported of losing out to lower price competitors after having provided advice on energy economizing activities. As emphasized by Heide and Miner (1992) experience from this industry conforms to the ordering of payoffs for cooperation and defection that define a Prisoner’s dilemma game. A firm’s immediate payoff is (1) highest if the firm defects and the other cooperates (e.g., 44 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING buyer assigns cost reduction solutions to another supplier, seller carries development costs), (2) next highest when both cooperate (e.g., buyer receives low price and cost reduction solutions, seller receives repeat business), (3) third highest when both defect (e.g., buyer pays market prices, seller keeps trade secrets and avoids development costs), and (4) lowest if one firm cooperates and the other defects (e.g., buyer contributes to cost reduction solutions and offers repeat business, seller raises the price or sells the solution to other buyers). In sum, the electricity market should provide a suitable context for studying the effects of extendedness on cooperation and structure. Development of Measures In the process of developing the model and measures for the study, the existing literature on buyer-seller relationships and specific studies related to the electricity market were initially consulted. Throughout the study a steering committee with representatives from the electricity supplier industry was consulted. After the literature review and initial meetings with the steering group members, eight qualitative interviews with professional buyers of electric power were conducted. These interviews lasted between 45 minutes and one hour. The interviews were analyzed, compared with the literature, and discussed with the steering committee. Thereafter, the survey questionnaire was developed. The questionnaire was discussed with the members of the steering group and two test interviews with buyers were conducted. Based on the results of the discussions and test interviews some minor changes were made. The measures used in the study are reported in Appendix A. Buyer’s repurchase intentions. Conceptually buyer’s repurchase intentions mean the buyer’s intentions of continuing the business relationship with the supplier by buying the same or a greater share of its consumption of the commodity from its incumbent supplier and having a long-term perspective of the relationship with the buyer. The definition is consistent with related measures such as perceived continuity (Anderson and Weitz, 1989), expectations of continuity (Heide and John, 1990; Heide and Stump, 1995), and extendedness (Heide and Miner, 1992). Supplier’s information exchange. The information exchange scale describes the salesperson’s attempts to provide and exchange information that might be useful for creating value both in terms of obtaining the most favorable contracts and economizing on total costs of electric energy utilization. The scale is inspired by a scale used by Biong and Harald Biong and Ragnhild Silkoset 45 Selnes (1996). Furthermore, the scale is related to Buvik and John’s (2000) vertical coordination scale. As noted by Buvik and John (2000), information exchange helps the receiver, in this case the buyer, change its activities to accommodate to changes on the sender’s (buyer) side for enhancement of value creation. Perceived price. The items comprising the perceived price scale described the buyer’s perceptions that (1) the supplier offered the lowest market price at the time of contract establishment, and (2) the contract offered was the most favorable, taking into account future market development. The scale is developed based on the qualitative prestudy. Perceived dependence on supplier. This scale builds conceptually on the scale developed by Ganesan (1994). Dependence occurs when alternative sources of supply are restricted (Pfeffer and Salancik, 1978), as when the bundled product of electric power and additional services is unique. Conversely, buyer dependence on the supplier gives the supplier a certain amount of power over the buyer (Emerson, 1962). The scale reflects these dimensions of buyer dependence on a specific supplier. Perceived cost reductions. This scale captures the extent to which the supplier contributes to cost reductions by efficient application of electric power within the buyer’s corporation. The scale comprises two items: (1) the supplier contributes to efficient and competitive utilization of the buyer’s electric equipment and installations, and (2) the supplier contributes in making the buyer more cost efficient and competitive with respect to use and utilization of energy. This scale is self-developed and builds on the qualitative prestudy. Sampling and Data Collection The sampling frame for the study was defined as organizations purchasing at least 0.5 gigawatthours (GWh) of electric energy per year. This limit was chosen upon advice from the steering committee, as it defines the lowest volume to be interesting for active sales efforts from the supplier side. The sample constituted organizations from manufacturing (31%), trade (20%), private and public services (41%), and other industries (8%) in proportion to their representation in the total sample frame. In this sample, the types of contracts varied as the follow: 62% of the companies reported that they had a fixed-price agreement with their main supplier, 8% reported that they bought electricity through the spot market, and 30% reported that they bought electricity by combining 46 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING fixed-price contracts and spot price market-contracts. Hence, the composition of the sample reflects the behavior examined in the study. For data collection a key informant approach was applied (Campbell, 1955). The key informant selected was the person in charge of purchasing electricity for the organization. This method was chosen based on the initial qualitative interviews. A professional marketing research company administered the data collection by telephone by CATI (computer assisted telephone interview). Each interview was reported to last about 30 minutes, and the interviewers reported great interest from the informants and no difficulties in conducting the interviews. A total of 349 interviews composed according to the sampling instructions were obtained. Two questionnaires were eliminated from further analysis because they had excessive amount of minimal interaction, extensive missing observations and/or outliers beyond 3 standard deviations. The remaining sample of 347 questionnaires was subject to additional data checks. A test of missing values discovered that the data contained randomly missing data. To reduce the risk of creating non-existing correlation in the factor structure, the method of regression weight(s) reported by the sample of items was estimated for each of the constructs (Roth, 1994). Regression imputation predicts the missing value based on other variables which are not missing. The estimates were then imputed into the raw data matrix (Roth, 1994). Such an approach does slightly artificially underestimate variance and covariance statistics and thus, strengthen the test of power (Bollen, 1989). Measurement Model Convergent Validity For the statistical analysis we employed EQS/Windows 5.7b (Bentler and Wu, 1993). We used the estimation method of maximum likelihood in the structural equation modeling. This method assumes normally distributed data (skewness and kurtosis), as indicated in Table 2. We followed Bollen’s (1989) recommendations of evaluating the adaptation of a measurement model prior to the parameter estimation. This is because the five constructs were reflective multi-item measures, following classical test theory where multiple indicators co-vary due to a common underlying cause (the latent variable) (Churchill, 1979; Bollen and Lennox, 1991). We implemented a confirmatory factor analysis (CFA) using maximum likelihood to control for unidimensionality. The original mea- Harald Biong and Ragnhild Silkoset 47 surement model showed relatively poor fit to the data (c2(74) = 148.684, p < .00, CFI = .88, RMR = .160, RMSEA = .07). Purification of multiple iterations of confirmatory analysis, reliability evaluation, and item-byitem substantive evaluation was performed to estimate items loading significant at each construct. However, one item in information exchange and one item in dependence reported factor loadings below .3. After carefully evaluating their importance due to the conceptual definition of the constructs, these two items were excluded from the further study. For the remaining items, all the t-values of the estimated factor loading of the information exchange and dependence constructs are within the accepted level. The composite reliability for buyer’s repurchase intentions, supplier’s information exchange, dependence on supplier, price, and cost reductions is at .61, .66, .75, .79, and .78 respectively. Nunnally (1978) recommends reliability to be at the .70 level, indicating that two of our constructs are slightly below this recommendation. Random measurement error leads to inconsistent estimates though it undermines attempts to estimate the effects of one variable on another with increasing bias due to size of random error (Bollen, 1989). One way of solving this problem would be to delete items with the lowest correlation, because the Cronbach Alpha coefficient is determined by the covariation of the constructs. On the other hand, deleting further items would increase reliability on the cost of construct validity. Based on this and the fact that the factor loadings are over .4, we decided not to delete any further items. Our argument is that such action would reduce the construct validity. The factor loadings, t-values, composite reliability and shared composite variance for the latent constructs are reported in Table 1. Summing up, the re-specified measurement model improved the fit of the model (c2(92) = 184.07, p < .00, CFI = .93, RMR = .12, RMSEA = .05, GFI = .94). Discriminant Validity Next, comparing models where all traits were allowed to correlate against a series of models where intertrait correlation was set to unity assessed discriminant validity. Each case reported significant chi-square difference between the different models. For example, the test of discrimination between supplier’s information exchange and buyer’s repurchase intentions is statistically significant (c2(1) = 155.08, p < . 05). Further, following Bagozzi, Yi and Phillips (1991) the procedure of one-factor versus a two-factor confirmatory model was adopted to as- 48 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING TABLE 1. Factor Analysis of the Reflective Measures Items Factor loadings t-values for factor loadings Composite reliability Shared variance .78 .63 .79 .66 .61 .37 .67 .30 .75 .44 PERCEIVED COST REDUCTIONS a X1 .77 X2 .82 -- b 10.13 PERCEIVED LOW PRICE X3 .67 X4 .93 -8.18 REPURCHASE INTENTIONS X5 .89 -- X6 .42 4.35 X7 .39 4.22 INFORMATION EXCHANGE X8 .76 -- X9 .49 6.25 X10 .47 6.09 X11 .54 6.66 X12 .42 5.11 PERCEIVED DEPENDENCE ON SUPPLIER X13 .46 -- X14 .75 7.65 X15 .84 7.65 X16 .52 6.50 a b = standardized loadings = fixed loading CHI-SQUARE (df) = 184.07 (92), p < 0.00, CFI = 0.93 RMR = .12 RMSEA = 0.05 GFI = 0.94 sess discriminant validity. A chi-square difference test was conducted. As an example, the one-factor solution between supplier’s information exchange and dependency produced a significantly worse fit (c2(27) = 280.31) than did a model treating information exchange and dependence as two separate factors (c2(26) = 71.08). The tests gives evidence for evaluating the constructs in this study as valid. Finally, as reported in Table 2, multivariate descriptive statistics reports acceptable levels for mean, standard deviation, skewness, and kurtosis. Correlation matrix for the constructs is reported in Table 3. Harald Biong and Ragnhild Silkoset 49 TABLE 2. Descriptive Statistics Construct Mean PERCEIVED LOW PRICE PERCEIVED COST REDUCTIONS INFO EXCHANGE PERCEIVED DEPENDENCE ON SUPPLIER REPURCHASE INTENTIONS Standard deviation Skewness Kurtosis 4.48 3.67 1.09 1.18 ⫺.83 ⫺.18 .44 ⫺.48 3.52 2.51 .91 1.11 ⫺.24 .70 .10 ⫺.05 4.32 .82 ⫺.40 .56 TABLE 3. Correlation Matrix for Measurement Scales RI REPURCHASE INTENTIONS (RI) INFO EXCHANGE (IE) PERCEIVED DEPENDENCE ON SUPPLIER (DS) PERCEIVED LOW PRICE (LP) PERCEIVED COST REDUCTIONS (CR) a b 1.00 -a .21 b (.00) .07 (.17) .23 (.00) .31 (.00) IE DS 1.00 -⫺.02 1.00 (.77) .20 (.00) .28 (.00) -⫺.18 (.00) .03 (.63) LP CR 1.00 -.37 (.00) 1.00 -- = correlation coefficient = significance level, two-tailed Based on the test of convergent and divergent validity, in addition to the descriptive statistics, we decided to implement the measures into the structural model. Results In accordance with Anderson and Gerbing (1988), the second phase in their framework is to employ the structural equation modeling to assess the proposed relationships. Analysis of the structural relationships was performed with EQS/Windows 5.7b (Bentler and Wu, 1993). The structural modeling corresponds to the proposed model by relative acceptable fit to the data (c2(94) = 202.61, p < .00, CFI = .91; RMR = .12, RMSEA = .06, GFI = .93). The findings are reported in Table 4. 50 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING TABLE 4. Estimates of Path Coefficient in Structural Model Dependent variables Independent variables REPURCHASE INTENTIONS INFORMATION EXCHANGE PERCEIVED LOW PRICE .38 ** (4.25) .27a ** (3.13)b INFORMATION EXCHANGE .20 ** (2.62) PERCEIVED DEPENDENCE ON SUPPLIER ⫺.27 ** (⫺3.73) PERCEIVED PERCEIVED DEPENDENCE COST ON SUPPLIER REDUCTIONS .02 (.29) .28 ** (3.72) .13 * (1.90) PERCEIVED LOW PRICE R-squared .45 ** (5.76) .15 .23 .00 .35 CHI-SQUARE (DF) = 202.61 (94), p < 0.00, CFI = 0.91 RMR = .12 RMSEA = 0.06 GFI = .93 a = standardized regression coefficient b = t-values, notes: one-tailed tests are used because we identify the strength of the hypothesis * significant at the .05 level ** significant at the .01 level The initial proposition of this paper is that extendedness motivates the actors to cooperate in order to reduce costs beyond the effect of a low price, but also affects the structure of the buyer-seller interface. As predicted in hypothesis H1, buyer’s repurchase intentions have a positive and significant effect on supplier’s information exchange, supporting H1 (g11 = .38, p < .01). Furthermore, buyer’s repurchase intentions positively affect the perception of having obtained the lowest price from the supplier, giving support to H2 (g21 = .27, p < .01). For H3, predicting that buyer’s repurchase intentions would affect the structure of the relationship by increasing buyer’s dependence on the supplier, this relationship is not statistically significant (g31 = .02). Thus, H3 is not supported. Our expectation in H4 was that supplier’s information exchange would affect positively the buyer’s perception of having obtained the lowest price from the supplier, which is also statistically supported (b21 = .20, p < .01). Consistent with H5 that supplier’s information exchange Harald Biong and Ragnhild Silkoset 51 will contribute to the buyer’s cost reduction of energy utilization, the effect is positive and significant, supporting H5 (b41 = .28, p < .01). Turning to hypothesis H6 and H7, the effects of dependencies in the buyer-seller interface are analyzed. First, our expectation in H6 was that perceived dependence on the supplier would decrease the buyer’s perception of having obtained the lowest price for the commodity. The results show a negative and significant effect (b23 = ⫺.27, p < .01) and H6 is supported. Second, in H7 we predicted that dependence on supplier would have a negative effect on the supplier’s contribution to cost reductions. Contrary to our expectations, the test reported a significant positive effect (b43 = .13, p < .05). Hence, H7 is not supported. Finally, the results show that the perception of having obtained the lowest price positively affects supplier’s contribution to cost reductions, supporting H8 (b42 = .45, p < .01). Taken together, our results also support our initial proposition that even for commodities the price may not be the main concern for efficient procurement. As an additional test for that statement, a simultaneous evaluation of the effect of price versus information exchange and dependence on cost reductions was performed by means of constraint analysis (Bentler, 1993). The test indicates that the influence of price does not exceed that of information exchange (test of price versus information exchange: c2(1) .83, p < .36), whereas information exchange and price exceeds that of dependence ((test of info exchange versus dependence: c2(1) 20.51, p < .00), (test of price versus dependence: c2(1) 14.05, p < .00)).6 Thus also the constraint analysis suggests that factors other than price matter for efficient procurement of commodities. Summing up, six of the eight hypothesized effects of extendedness and supplier cooperation on value creation in terms of total cost reductions were supported. The findings are summarized in Table 5. The model explained 35% of the variance of supplier’s contribution to buyer’s cost reductions. DISCUSSION The main objective of this study was to examine how buyers of a commodity, in this case electric power, could benefit from supplier cooperation with respect to economizing on total costs of utilizing the commodity. In particular, we examined how professional buyers by means of offering an extended purchasing period could motivate suppli- 52 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING TABLE 5. Hypotheses and Findings Dependent variable Independent variable Hypothesis Findings H1: REPURCHASE INTENTIONS INFORMATION EXCHANGE + + H2: REPURCHASE INTENTIONS PERCEIVED LOW PRICE + + H3: REPURCHASE INTENTIONS PERCEIVED DEPENDENCE ON SUPPLIER + ns H4: INFORMATION EXCHANGE PERCEIVED LOW PRICE + + H5: INFORMATION EXCHANGE PERCEIVED COST REDUCTIONS + + H6: PERCEIVED DEPENDENCE ON SUPPLIER PERCEIVED LOW PRICE - - H7: PERCEIVED DEPENDENCE ON SUPPLIER PERCEIVED COST REDUCTIONS - + H8: PERCEIVED LOW PRICE PERCEIVED COST REDUCTIONS + + ers of this commodity to cooperate and by this change a potential Prisoner’s Dilemma situation into a cooperative relationship. In addition, we examined whether extendedness could change the structure of the relationship by increasing dependence on the supplier with consequences for price and cost reductions. Although the managerial purchasing literature has reported beneficial effects of long-term contracts on cooperation and total cost efficiencies, to the best of our knowledge, not many studies have documented how extended purchases affect various aspects of value-adding cooperative buyer-supplier relationships (for an exception, see Heide and Miner, 1992). As such this study represents a contribution to our understanding of how value is created in such relationships (Anderson, 1995). Theoretical Implications Overall, our study provides a strong indication that price may not be the only concern for efficient procurement of commodities. Consistent Harald Biong and Ragnhild Silkoset 53 with both the theoretical (Axelrod, 1984; Heide and Miner, 1992) and managerial (Dyer, 1996; Newman, 1988) literature our results show how expectations of future business can promote cooperation in a buyer-seller relationship even when a commodity is exchanged. This is noteworthy, our context taken into account, where the general assumption is that preexisting commitments or structural traits would not favor cooperative outcomes. On the contrary, selecting the lowest bidding supplier and organizing the transactions in short-term arm’s length relationships has traditionally been a recommended strategy for cost efficient procurement of commodities. Under such conditions, suppliers have few incentives to invest in specific value-adding capacities for the buyers (Williamson, 1983). Our study rests on the assumption that commodity suppliers to a varying degree have expertise that can be applied for value adding purposes, such as cost reductions, for the buyer. The buyers then have the option to buy either the core product without further involvement with the supplier or a bundled product consisting of both the core commodity and the supplier’s expertise (Anderson and Narus, 1991). In the first case the buyer derives value only from buying the properties of the core product. In the second case value is obtained from the bundle of the core commodity and value-adding services. The results from our study show how buyers by offering repeat purchases (and thus communicate cooperativeness) can provide insurance against appropriation of the supplier’s intellectual property by unbundling the offering, while the prospects of obtaining a low price and added value in the sense of further cost reductions are incentives for the buyer to provide this insurance. Taken together, the anticipations of future cost reductions, lower prices, and repeated business contribute to create a self-enforcing contract (Telser, 1980). In addition to the positive effect of extendedness on cooperative processes, such as information exchange (Heide and Miner, 1992), our results also support previous findings that suppliers reciprocate repeat business with low price (Dyer, 1996; Fram, 1995; Kalwani and Narayandas, 1995). Further support for this finding can be drawn from results of the qualitative prestudy. After the market deregulation, buyers typically searched for lower prices by collecting bids from at least three suppliers. Then the lowest price offering was presented to the incumbent supplier with a promise of remaining as a customer if the incumbent could match the offer. Most often the supplier accepted and reduced its price. Buyers reported of price reductions up to 30 percent by this exercise. 54 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING Contrary to our prediction, the results did not show that repeat purchases would have structural effects by increasing the buyer’s dependence on the supplier. In the next place, our results show that processes (Zajac and Olsen, 1993), price, and structure (Buchanan, 1992; Ghosh and John, 1999) matter for value creation in the sense of production cost reductions. Consider the effect of the supplier’s information exchange on price and cost reductions. Our results support the prediction that extensive information exchange from the supplier has a significant impact on the buyer perception of having obtained the best price, all considerations taken into account. As discussed previously, markets for raw materials often are characterized by fluctuating prices reflecting expected future supply and demand as well as there might be price variations among suppliers. The specific context of this study underscores the complexity for buyers both to select the lowest price contracts and suppliers. Under such circumstances information exchange could help designing the best contracts with the buyer’s needs and expectations taken into account. Similarly, extensive information exchange is needed when value creation builds on coordination of activities and solutions that cannot be specified ex ante (Milgrom and Roberts, 1992; Stabell and Fjeldstad, 1998). Cost reductions might then be the effect of solutions tailored to the buyer’s needs. Our results add to the literature by showing that information exchange contributes to reduce the buyer’s production costs, as perceived by the buyer. In contrast to our predictions, the findings show a positive effect of dependence on supplier contribution to cost reductions. Two explanations for this result are possible. First, both Kumar (1996) and Heide and Miner (1992) note that an important dimension of cooperation is restrictions in use of power. In this vein, the study of Heide and Miner (1992) shows that extendedness has a positive effect on the other party’s restricted power exercise. Second, starting from a point where all bargaining power is assigned to the buyer, transferring some power to the supplier means balancing the relationship making it more symmetrical (Heide and John, 1988). In this case buyer dependence on the supplier does not necessarily mean a unilateral dependence (Bonoma, 1976), but rather a proxy for a more symmetrical relationship. This argument is supported by Buchanan (1992) showing how suppliers contribute to a buyer’s profitability when the parties are highly interdependent. More generally, while both parties are interdependent they have an incentive to make investments in specific activities that are mutually beneficial (Buchanan, 1992; Webster, 1992). Harald Biong and Ragnhild Silkoset 55 Next we consider the effects of dependence on perceived price. Unlike the positive effects of extendedness and information exchange, buyer dependence on the supplier showed a negative effect on the perception of having obtained the lowest price. Intuitively, this can be ascribed to a potential lock-in effect. Our results might support this explanation. However, the fact that the results generally support cooperativeness initiated by extendedness suggests a second explanation. As Buchanan (1992) notes, the supplier’s expertise represents a valued resource for which there is competition from other buyers, so the buyer might pay a price to benefit from this resource. Hence, the price paid for the commodity might be a trade-off between paying the lowest possible price for the core commodity and a higher price for the supplier’s expertise, but still a total price low enough to contribute to the buyer’s total cost reductions for product application. In sum, our study shows how cooperativeness in the sense of repurchase intentions communicated by the buyer, enhances the processes and prices which in turn affects value creation measured by perceived cost reductions. Managerial Implications When engaging suppliers in fierce price competition in order to achieve low purchasing prices other costs might be overlooked. There are search costs for the buyer to find the lowest price supplier, and calculating bids also incur costs for suppliers. This is consistent with the theses of Coase (1937) and Stigler (1961) that there exist costs, which in some cases might be substantial, associated with using the price system. These costs have ultimately to be recovered through the price. Recent developments in procurement practices have therefore turned the attention to total costs in the application of input factors rather than merely on focusing on lowest price. This practice usually requires a cooperative approach with active supplier involvement instead of the distant arm’s-length relationships of the competitive model. Our study shows that a cooperative approach in order to reduce total costs might work also for commodities. However, due to the specific properties of the core commodity with high interchangeability, the main managerial challenge is to make such arrangements work and avoid the parties regarding their relationship as a potential Prisoner’s Dilemma situation. One mechanism that comes readily to hand for the buyer is an extension of the purchase period. This mechanism could be especially applicable for commodities where pre-existing structural ties do not usually 56 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING exist (Heide and Miner, 1992), as also our study indicates. Vice versa, supporting the findings of Buvik and John (2000), our results suggest that suppliers considering value adding services as an element of a differentiation strategy should ask for a long-term contract as a safeguard for their intellectual property before engaging their expertise. A concern to purchasing managers could be the increased dependence resulting from repurchasing. Our results do not support this concern. Still, a commitment from the buyer could be a prerequisite to engage the supplier in cost reduction activities. If this is the case, the buyer might be prepared to pay a price in order to benefit from that resource. LIMITATIONS AND FURTHER RESEARCH Some limitations of the present study should be pointed out. First, in a real repeated game the cooperative outcome is the effect of a sequence of interactions in which the parties develop a history of being cooperative (Deutsch, 1960; Gulati, 1995; Macy and Skvoretz, 1998) as well as being motivated by the rewards of future transactions (Axelrod, 1984; Telser, 1980). In our study, within the constraints of the survey method, the effect of future events is discounted in the present. Therefore, our results provide insight into what a buyer can do to initiate a cooperative relationship and indications of subsequent courses of action, while insight into sustainable cooperative management is restricted. For example, skeptics may warn against anticipation of future interactions as the only mechanism for inducing cooperation (Zagare, 1984). Without an enforceable contract, promises can be broken. The buyer, therefore, can pretend to be cooperative by making a promise to repurchase but defect by going to a lower price bidder (Jackson, 1985; Williamson, 1983), or it can renegotiate terms (Tirole, 1986) once the cost-saving solutions are known. Unfortunately, our study cannot with safety eliminate these outcomes. Studying the sequential development of buyer-seller relationships would provide valuable insight into that question. The monadic data, representing only the buyer side, may also represent a limitation. In a game, like the Prisoner’s Dilemma situation, the parties are interdependent in the sense that the outcome for one party partly depends on the decisions and actions made by the other and that these actions are correctly interpreted, as noted by Gulati, Khanna, and Nohria (1994). In our context, the cooperative move from the seller depends on its understanding that repurchases have been offered. As it is now, only the Harald Biong and Ragnhild Silkoset 57 buyer’s perception has been measured. In this vein, paths of causality are debatable as previously noted. Even if our qualitative prestudy supports the predicted causal relationship between repurchase intentions and price, the reverse relationship cannot be rejected. Second, ongoing cooperation within a repeated game context is theoretically motivated by the rewards of infinite future transactions rather than by past gains (Telser, 1980). It should be recalled that cost reductions constitute the primary buyer motivation for involving the supplier in the cooperative arrangement of our study. In practice, it could be conceived that the potential for cost savings is limited. If this is so and there are no more costs to save, the relationship turns into an end-game solution in which past results will dominate future benefits, unless the potential for other future rewards is identified (Kranton, 1996; Telser, 1980). This may put the cooperation in jeopardy and change the relationship into a non-cooperative arrangement. For instance, the buyer may switch supplier or revert to arm’s-length exchanges. On the other hand, it could be argued that the information acquired by the supplier represents a source for future value adding activities (Glazer, 1991) preserving the cooperative relationship beyond its initial purpose. Investigating the circumstances under which a cooperative relationship can be maintained, or whether it will turn into a non-cooperative end game might be an interesting avenue for further research. Third, cooperation is a multidimensional phenomenon, and we limited ourselves to examining one dimension, namely information exchange. While this dimension has been identified as an important aspect of cooperative relationships (Dyer, 1996; Frazier and Summers, 1984; Morgan and Hunt, 1994), future research should be directed toward exploring the value creation effects of the other dimensions identified by Heide and Miner (1992); both their main effects and their inter-relationships should be studied. Fourth, price is generally considered to be a splitting variable with zero-sum properties (Williamson, 1985). The buyer wants to pay as little as possible while the seller wants the highest possible price. However, when quality is affected by the seller and can only be assessed by experience, the buyer can motivate the seller to cooperate in delivering high quality by paying a price premium (Rao and Bergen, 1992). By doing so, paying above market price would mean a cooperative move by the buyer. In our study supplier expertise cannot readily be assessed in advance, and the willingness to apply this expertise is also under the supplier’s control. Therefore, the buyer could motivate the supplier to provide quality expertise by paying above market price for the core 58 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING commodity. Future research could therefore examine further the cooperative and non-cooperative properties of price in relationships with varying degrees of experience attributes for the core commodity and value-adding services. Finally, this study is confined to one specific commodity. To fully explore the effects of extendedness on cooperation and value creation in Prisoner’s Dilemma situations, the framework should be tested in a variety of commodities and raw materials, usually associated with arm’slength transactional exchanges. NOTES 1. Heide and Miner (1992) identified four cooperative dimensions: information exchange, flexibility, shared problem solving, and restraint in the use of power. Both our study and that of Heide and Miner (1992) explore the effect of extendedness as a motivational mechanism to achieve cooperation. While Heide and Miner (1992) theoretically discuss the effects of their four cooperative aspects on efficiency, our study investigates empirically how knowledge of the customer affects buyer efficiency (e.g., low price and cost reductions), which directs us to focus on information exchange. 2. As discussed in the introduction buyer-seller situations as described may provide buyers with incentives to defect. It might not be so evident why suppliers should. A case could be made when a supplier exploits a buyer’s competence in order to bolster its own competitiveness for example by developing products, services, or processes to get a better foothold in the market. By doing so, the supplier directly or indirectly reduces the incumbent buyer’s competitiveness by developing the competitiveness of the buyer’s competitors. Leakage of a company’s intellectual property to its competitors through consultants or other suppliers is an example of this (Hutt et al. 2000). 3. However, according to Selten and Stoecker (1986) experimental behavior does not conform to this theoretical prediction. Their results, which are consistent with other studies, show that subjects in supergames of ten periods cooperated until shortly before the end of the supergame. Furthermore, Deutsch (1960) showed that participants cooperated in a finite game when they were instructed to be cooperative. 4. Do repurchase intentions cause price reductions or do price reductions cause repurchase intentions? Evidence from the car industry as referred to suggests the first causal path. However, the inverse relationship cannot be rejected. The issue of causality will be further addressed when discussing the results of our study. 5. In markets with limited production capacity, as in the context of this study, price maximization rather than increasing sales volume might be the sellers preferred action. We thank an anonymous reviewer for this argument. 6. The constrained model treating the absolute value of the coefficients as equivalent provides beta coefficients for price and dependence of .49 (t = 5.69) and .28 (t = 5.69), and for information exchange and dependence on .32 (t = 4.44) and .21 (t = 4.44). In the unconstrained model, the beta coefficients for price and dependence are .53 (t = 6.67) and .13 (t = 1.88), and the unconstrained beta coefficients for information exchange and dependency are .47 (t = 5.48) and ⫺.01(t = ⫺.19), respectively. Harald Biong and Ragnhild Silkoset 59 REFERENCES Anderson, Erin and Barton A. 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APPENDIX A Scale Items Items: BUYER'S REPURCHASE INTENTIONS 1 X1 To what extent do you want your company to continue to buy energy from this supplier X2 To what extent do you want your company to buy the same or a larger share of its energy consumption from this supplier for the next one to two years X3 Our company’s intention is to have a long-term cooperation with this supplier of energy, where the agreement will be renewed if no dramatic changes in its preconditions occur2 1 SUPPLIER'S INFORMATION EXCHANGE X4 The salesperson gives us all information necessary for us to choose the most favorable contracts X5 The salesperson gathers or receives information about our organization’s demands for energy in the next 6-12 months X6 The salesperson gives us information if there are problems regarding interruption or voltage variation in the energy supply X7 The salesperson informs us about development of new products or new technology which can contribute to more efficient energy utilization X8 The salesperson gathers information about changes in our products, production processes, production routines and organization PERCEIVED DEPENDENCE ON SUPPLIER2 X9 It is easy to provide alternative suppliers of electricity (reversed) X10 There is no other supplier that can offer a total product, taking into account both energy and supplementary services that this supplier offers X11 Our company feels very dependent on this energy supplier X12 Our company feels that our energy supplier has a lot of power over our organization 64 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING APPENDIX A (continued) Items: PERCEIVED LOW PRICE 1 X13 The energy supplier held the lowest price in the market for our organization’s purchased volume by the time the contract was made X14 The energy supplier gave us the most favorable contract considering expected market development PERCEIVED COST REDUCTIONS 1 2 1 X15 The energy supplier contributes to both efficient and competitive operation of our organization’s electrical equipment and installations X16 The energy supplier contributes to making us more cost efficient/competitive regarding energy use and energy utilization than cooperation with other energy suppliers would have done = scale: 6 point Likert scale with anchors 1 = to a very little extent and 6 = to very great extent = scale: 6 point Likert scale with anchors 1 = totally disagree and 6 = totally agree Harald Biong and Ragnhild Silkoset 65 EXECUTIVE SUMMARY Due to its commodity status, the electric power industry is regarded to be well suited for deregulation and competition. The underlying assumption is that competition between suppliers will benefit the society by efficient resource utilization and lower prices for buyers. For example is the experience with the deregulation of the electric power industry in the UK which is generally positive with lower prices both for large and small customers. The effect builds on the assumption that the attractiveness of the customers’ business and fear of losing to competitors will force suppliers’ prices down. This reasoning goes well with the traditional and recommended strategy for cost efficient procurement of commodities by selecting the lowest bidding supplier and organizing the transactions in short-term arm’s-length relationships. While this practice undoubtedly can achieve lower prices, unfortunately, other benefits might suffer. For example, when engaging suppliers in fierce price competition in order to achieve low purchasing prices there are search costs for buyers and bidding costs for suppliers. These costs have ultimately to be recovered through prices. Recent developments in procurement practices, therefore, have turned the attention to total costs in the application of input factors rather than merely focusing on lowest price. This practice usually requires a cooperative approach with active supplier involvement instead of the distant arm’s-length relationships of the competitive model. A characteristic with such cooperative arrangements is that suppliers apply their expertise to develop more cost efficient applications and processes for their customers, and the parties then share the gains by reduced purchasing price for the commodity. Usually the suppliers offer those solutions free of charge or at a price less than its value in the prospect of selling their product. A potential danger is that buyers take the solution and assign the purchase of the product to a lower priced supplier. Especially, this might be the case with commodities where there are no quality differences of the core product across suppliers. In the short run the buyer benefits by both receiving free cost reducing advice and low prices. Unfortunately, cooperative suppliers experiencing only the costs of using their expertise and not the benefits of selling their products might stop offering their competence, only selling the core product. In the long run also buyers will lose since new solutions will not be offered. In game theoretical terms, the scenario described can be characterized as a Prisoner’s Dilemma game. In a Prisoner’s Dilemma gain both parties can benefit more from mutual cooperation than from mutual defection, but one party will bene- 66 JOURNAL OF BUSINESS-TO-BUSINESS MARKETING fit even more if it defects while the other cooperates. Unless some mechanism that can promote cooperation in such a situation is applied, mutual defection is the likely outcome, and both parties will be worse off than if they cooperated in the first place. This study builds on the scenario described above. By using theoretical insights from repeated games our study examines how organizational buyers of a commodity, in this case electric power, by offering repeat purchases can motivate suppliers to cooperate. Our results show that this mechanism generally motivates suppliers to be cooperative. More specifically, we find that suppliers reciprocate repeat business with lower prices for the commodity. Moreover, suppliers in the prospect of repeat purchases deploy their expertise to cost reducing activities for the buyer. First, such activities can take the form of helping the customer in different ways of economizing in the use of the commodity. Second, the price picture in commodity markets can be quite complicated due to variations between different contract types based on expected supply and demand and time horizons for the contract. Therefore, as shown in the study, information exchange helps the customers in finding the best prices and contract types, their purchasing volume and risk preferences taken into account. However, our results also indicate that the buyer might be prepared to pay a price for that resource. The price paid for the commodity might then be a trade-off between the lowest possible price for the core commodity and a higher price for the expertise but still a total price low enough to contribute to total cost reductions. Turning to a seller’s perspective, the findings from the study suggest that suppliers considering value adding services as an element of a differentiation strategy should ask for a long-term contract as a safeguard for their intellectual property before engaging their expertise. Finally, purchasing managers might be concerned with increased dependence and potential negative effects of being locked in resulting from offering repeat business. In our case, the results do not support this concern, as dependence on supplier is not affected by the intentions of repurchasing. In this vein, the research context, purchase of electricity, which basically is a homogenous commodity, should be taken into account.

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