The role of explicit contracts and cooperative norms on fairness in buyer-seller relationships.

Johnson, Julie T.

ABSTRACT

This research develops and tests a model that examines the effect of explicit contracts and cooperative norms on buyer's perceived fairness in the relationship. Data were collected in a business-to-business setting. Responses were received from 234 key informants. The model was tested using structural equation modeling. Findings indicate that the cooperative norms that develop in a relationship are a key indicator of buyer's perception of fairness in that relationship. However, explicit contractual agreements do not have an effect on buyer's perceived fairness in the relationship.

INTRODUCTION

Companies are beginning to focus on maintaining long-term relationships with customers. There are numerous reasons behind this trend. One reason is that long term customer relationships provide a sustainable competitive advantage (Day, 1994). Another reason is that retaining customers is more profitable than obtaining new customers (Curasi & Kennedy, 2002; Kalwani & Narayandas, 1995; Reichheld, 1994). Also, heightened competition has made it more difficult to obtain new customers. It has been suggested that existing customers should be viewed as strategic assets that must be protected (Webster, 1994). Concerted efforts to build and enhance relationships with customers are one way for firms to protect their "strategic customer assets."

Fairness in relationships has been found to be associated with customer satisfaction, commitment and loyalty to the relationship (Patterson, Johnson & Spreng, 1997; Seiders & Berry, 1998; Sindhav, 2001; Brown, Cobb & Lusch, 2005). Whether or not a customer perceives a relationship as fair can be dependent upon the customer's perception that the outcomes they receive are equitable given their contribution to the relationship (Brown, Cobb & Lusch, 2005). Firms often do spell out expectations of both parties by developing detailed explicit contractual agreements. However, it is difficult to contractually provide contingencies and solutions for every possible situation that can arise in a buyer-seller relationship. Consequently, firms develop unwritten and implicit norms that also govern the perception of fairness in the relationship. The purpose of this research is to examine whether or not customers' perception of fairness can be managed through the use of explicit and implicit contracts in the buyer-seller relationship.

EXPLICIT CONTRACTS

Explicit contracts are detailed and binding contractual agreements that specify the buying and selling firms' obligations and roles (Cannon & Perreault, 1999). They are important in structuring and controlling relationships between firms (Cannon and Perreault, 1999). Legal contracts are entered into at the corporate level (Cunningham & Turnbull, 1982) but all individuals involved in the buyer-seller relationship are bound by the terms of the contract. Explicit contracts provide two primary benefits to exchanging parties. First, explicit contracts provide the protections available through the legal system should something go wrong (Beale & Dugdale 1975). Second, they regulate the relationship by furnishing a plan for the future (Macneil 1980). For example, Bowersox (1990) notes that contracts pertaining to inter-firm logistics systems should detail contingency plans for dissolution of the relationship.

Explicit contracts may become liabilities if they reduce the flexibility of the relationship partners in adapting to environmental changes (Reve 1986). It is almost impossible for a contract between two firms to account for every possible set of circumstances and interactions that arise. This becomes even more difficult as the relationship evolves over time. Relational contracting literature stresses the importance of norms in addition to legal contracts to operationalize formal and informal governance between firms. The relational contracting paradigm has its roots in the sociology of contracts (Macneil, 1980). With relational exchange, contracts are not able to be specific in terms of every possible specific with regard to fulfillment of obligations. Non-specific contracts leave room for organizations to interpret the requirements differently (Gundlach and Murphy, 1993). When this happens, disputes can arise. Explicit contracts enable the parties to resort to legal means of dispute resolution. However, reliance on legal means to enforce agreements can be costly in terms of time, resources, and stress on the buyer-seller relationship (Gundlach and Murphy, 1993; Kaufmann and Stern, 1988). Fortunately, extra-legal means of governance can be used to maintain relationships (Macaulay, 1963). Cooperative norms are an important mechanism of extra-legal governance (Macneil, 1980).

COOPERATIVE NORMS

Implicit in relational contracting is the expectation that firms cooperate during the performance of the contract (Collins, 1986, p. 160). Cooperation is necessary in matters which are not explicitly spelled out prior to entering into the contractual agreement (Collins, 1986, p.160). An expectation of cooperation exists over the lifetime of a contract (Collins, 1986, p.160). Cooperative norms are defined as the expectations, attitudes and behaviors the buying and selling firm have about working together to jointly achieve mutual and individual goals (Cannon & Perreault, 1999). They are based on mutuality of interest and are designed to enhance the well being of the relationship as a whole (Heide and John, 1992). Cooperative norms are critical for the establishment and maintenance of long-term buyer-seller relationships. They create value in the buyer-seller relationships for both customers and suppliers (Frey and Schlosser, 1993). Cooperative norms reflect expectations the buying and selling firm have about working together to achieve goals. As defined here, cooperative norms do not imply one party's acquiescence to another's needs but rather that both parties behave in a manner that suggests they understand that they must work together to be successful (Anderson & Narus 1990).

Fairness

Fairness theory suggests that when unfairness is perceived by customers, they will try to determine who is to blame for the offense and what the motives and intentions were of the offending party (McColl-Kennedy & Sparks, 2003). Suppliers will perceive fairness if buyers have a process and procedure to resolve disputes that is consistent, accurate, and ethical. Fairness encourages companies to behave well (Ryals & Rogers, 2006). In applying fairness theory to buyer-seller relationships, there are several issues that must be considered. First, does the explicit contract provide details about the performance of both parties? If the contract provides explicit details, and the buyer lives up to those promises, then the customer should perceive the relationship to be fair. When situations arise over which the selling firm is perceived by the customer to have some control, the buyer is likely to hold the selling firm responsible for its actions (McColl-Kennedy & Sparks, 2003). If the selling firm's actions are perceived to be consistent with normative rules of behavior, the buying firm is likely to perceive the selling firm's behavior as being fair. Consequently, the following hypotheses are offered:

H1: The greater the extent to which explicit contracts govern the relationship between the buying and selling firm, the more likely the buyers are to perceive the relationship as being fair.

H2: The greater the extent to which cooperative norms govern the relationship between the buying and selling firm, the more likely the buyers are to perceive the relationship as being fair.

RESEARCH DESIGN

The hypothesized model was tested empirically by gathering data from business customers from a division of a Fortune 100 firm. The division sells a complex product. A customer mailing list was provided by the division of the Fortune 100 company. The lists included names of customers who are in an established relationship with the sponsoring firm.

Data was gathered using mail questionnaires. Before designing the questionnaire, depth interviews and focus groups were conducted with salespeople, sales managers and staff mangers in the supplier firm. In addition, depth interviews were conducted with customers who purchase the firm's products or services. The questionnaire was pre-tested on several customers prior to the final version being mailed. Changes to the questionnaire were made based on feedback received from the interviewed customers. The final version was sent to four hundred randomly subjects.

In order to increase response rates, the following steps were taken. All customers were sent a prenotification card. Three days later, a questionnaire was mailed. Each questionnaire had a one dollar incentive attached. Questionnaires were coded with the customer's name and business. Non-respondents were sent a follow-up questionnaire one week after the return deadline. Nonresponse bias was assessed by comparing early respondents with late respondents. Armstrong and Overton (1977) suggest that one way nonresponse bias can be assessed is by comparing the first one-third respondents to the last one-third. No significant differences were found on any of the constructs used in the study (p > .10). Two hundred and thirty-four individuals responded to the questionnaire, for a 58.5% response rate.

The respondents spent, on average, $1,000,000 with the Fortune 100 company each year. Most of the respondents' firms conducted business on a national or international basis. Respondents generally had a long-term relationship with their salesperson from the Fortune 100 firm. Over half of the respondents had conducted business with the same salesperson for two years or longer.

Scale Development

Previously validated scales were adapted to create the measures for this study. All of the scales were measured on a Likert format ranging from (1) "strongly disagree" to (7) "strongly agree". Cooperative norms (scale composite reliability = .71) and explicit contract (scale composite reliability = .78) measures were basaed from Cannon and Perreault (1999). The measure of fairness (scale composite reliability = .92) was based on Anderson & Weitz (1992).

RESULTS

Analyses were conducted using LISREL 8.5 in accordance with Anderson and Gerbing's (1988) two-step approach. The covariance matrix was computed using PRELIS 2. The measurement model was analyzed using all 9 items. All items performed well and were retained in the model. The chi-square of the measurement model was 28.01 with 24 degrees of freedom (p < .260). Other goodness-of-fit indices indicated that the model achieved a good fit as well (GFI = .96; AGFI = .92; standardized RMR = .05; CFI = .99; RMSEA = .03).

Results of the structural model indicate the model fits well (Table 1). The chi-square of the structural model was 28.01 with 24 degrees of freedom (p < .260). Other goodness-of-fit indices also performed well. Specifically, GFI =.96, AGFI = .92, and CFI =.99, RMR =.05, RMSEA=.04. Parameter estimates and t-values for the hypothesized relationships are also shown in Table 1.

Interestingly, only one of the two hypotheses was supported. H1 which posited that the greater the extent to which explicit contracts govern the relationship between the buying and selling firm, the more likely the buyers are to perceive the relationship as being fair was not supported (t=1.24). H2 which posited that the greater the extent to which cooperative norms govern the relationship between the buying and selling firm, the more likely the buyers are to perceive the relationship as being fair was supported (t=5.5).

DISCUSSION

The results indicate that cooperative norms which develop in a buyer-seller relationship are far more important in governing the customer's perception of fairness in the relationship. These norms appear to override any effect that explicit contracts have on customer perceived fairness in the relationship. Sales managers should make sure their salesforce understands the role of cooperative norms in buyer-seller relationships. Salespeople should focus on cooperative behavior by working together to achieve goals that are important to the buying firm, without compromising the business necessities that drive the selling firm. The goal of developing and maintaining cooperative norms is to enhance the overall relationship.

Unexpectedly, explicit contractual agreements do not influence the customer's perception of fairness. One explanation for this is that customers expect performance to be completed in a manner consistent with the language set forth in the legal contracts. Meeting these expectations apparently does not influence the customer's perception of fairness. It appears that fairness in a relationship goes far beyond living up to contractual obligations. The give and take that is developed in the course of cooperation between two parties is far more important. Consequently, the legal language that is developed prior to entering in a relationship appears to set the groundwork for the expectations with the customer. Performing only at the level specified in the contract will not leave the customer with perceptions of being treated fairly, and will likely lead to customer defection over the long run.

Study Limitations

While this study makes helps us to better understand the relationship of explicit contracts and cooperative norms on perceived fairness, it is not without limitations. One limitation of this study is that data were collected from customers of one company. This limits the generalizability of this study. However, respondents represented firms from all industries (28% were in manufacturing, 7% were in wholesaling, 7% were in retailing, 30% were in a service industry, 2% were in agriculture, and 26% were in other industries). While this does not ensure generalizability, it does provide greater confidence that the results represent a cross-section of respondents.

A second limitation of this study is that data were gathered in a cross-sectional survey. Relationships develop over time. A longitudinal study would provide more insight into the formation of inter-firm structure and its subsequent effects on buyer-salesperson behaviors and relationship outcomes.

Another issue that must be addressed is the identification of key informants. They also provide information regarding the properties of the firm relationships. In fact, the key informant method is often used to measure relational properties between organizations (Heide & John, 1991). Key informants should be well positioned to provide information about the research question. While some researchers question the validity of key informants (Phillips, 1981), other researchers maintain that carefully selected informants can give reliable information (John & Reve, 1982). Key informants should be selected on the basis of their knowledge rather than randomly (Heide & John, 1991). Key informants in this study were identified by the salesforce. The salespeople interact with buying firms on a regular basis. The salesforce is in a position to know which key informant can best respond to questions regarding the external environment, inter-firm structure, buyer-salesperson behavior and relationship outcomes. Therefore, the salesforce identified key informants used in this study. Using this approach, the key informants that were targeted were in a position to knowledgeably answer the survey questions.

Areas for Future Research

Future research should focus on variables in addition to cooperative norms that influence customer's perception of fairness in a relationship. While the expectation that firms cooperate during the performance of the contract is implicit, other relational norms such as flexibility and solidarity (Cannon and Perreault, 1999) may also influence firm's perception of fairness in the relationship.

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Table 1: Summary of Hypothesized Structural Model

 Par. t- H.
Relationships Estimates Value Supported

Explicit Contracts [right arrow] 0.11 1.24 No
 Perceived Fairness ([H.sub.1])

Cooperative Norms [right arrow] 0.59 5.50 Yes
 Perceived Fairness ([H.sub.2])

 Chi
Model df Square GFI AGFI RMR CFI RMSEA

Hypothesized 24 28.01 0.96 0.92 0.05 0.99 0.04
Model