Combining Value and Price to Make Purchase Decisions in Business Markets James C. Anderson James B. L. Thomson Finn Wynstra* December 2000 * James C. Anderson is the William L. Ford Distinguished Professor of Marketing and Wholesale Distribution, and Professor of Behavioral Science in Management, J. L. Kellogg Graduate School of Management, Northwestern University. He is also the Irwin Gross Distinguished ISBM Research Fellow at the Institute for the Study of Business Markets (ISBM), located at Penn State University, and a Visiting Research Professor at the Department of Technology Management, Eindhoven University of Technology. James Thomson is Director of Strategic Consulting for Pyramid Research, the Internet and Telecoms Consultancy of the Economist Group. Finn Wynstra is Assistant Professor at the Department of Technology Management, Eindhoven University of Technology and a research fellow at Jönköping International Business School. The authors gratefully acknowledge the financial support of the ISBM and the helpful comments of William Blankemeier, Greg Carpenter, Dawn Iacobucci, Ann McGill, Vikas Mittal and Brian Sternthal, and the colleagues of the Accounting, Finance and Marketing Group at Eindhoven University of Technology. We also want to thank the three reviewers and the editor for their helpful comments and suggestions. Send correspondence to: James C. Anderson Department of Marketing Northwestern University 2001 Sheridan Road Evanston, IL 60208 (847) 491-2724 (847) 491-2498 (fax) jc-anderson@nwu.edu Forthcoming in International Journal of Research in Marketing.
Combining Value and Price to Make Purchase Decisions in Business Markets ABSTRACT The authors investigate how purchasing managers combine information about product offerings values and prices to make purchase decisions. The results of two field studies show that managers do not regard monetarily-equivalent changes in value and price to be the same. Using reference dependent theory, the authors show that, rather than a single utility function, separate functions for value and price appear to underlie purchasing managers decisions. The authors also address means of inducing managers to choose higher-valued, higher-priced product offerings.
Combining Value and Price to Make Purchase Decisions in Business Markets Nowadays people know the price of everything and the value of nothing. -- Oscar Wilde, The Picture of Dorian Gray (1891) In business markets, offerings from competing suppliers often have different prices and different performance in a customer firm s application. Further, over time, a given supplier will make changes in the price and changes in the performance of its product offering. Value expresses in monetary terms the total functionality or performance of a product offering in a given customer application (Anderson, Jain and Chintagunta 1993; Anderson and Narus 1998). Thus, each product offering can be viewed as having two elemental characteristics: its value to the customer and its price. An intriguing question is: How do purchasing managers combine these two characteristics, and changes in them, to make purchase decisions? These questions are especially relevant as many firms reexamine their purchasing strategies and practices, changing from buying to supply management (Keough 1993; Van Weele 2000). As both value and price are expressed in monetary terms, combining value and price in making purchasing decisions may seem to be a simple issue. However, as we demonstrate, it is not so simple. Imagine a purchasing manager who purchases pumps as a component part for refrigeration compressors, where unacceptable profitability forces his longtime supplier to replace its current product offering with two alternative pumps. The first pump has the same price as the pump the purchasing manager has been purchasing but would now require his firm to provide a fitting and perform the seal weld on the end connection, adding total costs of $10 in his firm s application. The second pump has a $10 lower price than the current pump but would now require his firm to provide the fitting, perform the seal weld, and also install a relief valve, adding total costs of $20 in his firm s application. Would this purchasing manager be indifferent between these two alternative pumps, regarding them as monetarily equivalent, or would he prefer to purchase the first or the second pump? Building on research in reference dependent theory (e.g., Fox and Tversky 1995; Kahneman and Tversky 1979; Tversky and Kahneman 1991) and marketing (e.g., Qualls and Puto 1989; Thaler 1985), we contend that purchasing managers regard value changes differently than monetarily-equivalent price
2 changes. Despite accurate assessment of value, we posit that purchasing managers perceive value as relatively more ambiguous than price. An interesting issue then becomes whether there are any mechanisms that can negate this perceived difference. We develop a conceptual framework that suggests contingent explanations for how purchasing managers integrate value and price to make purchase decisions. We then test several hypotheses derived from this framework in a series of field experiments in two studies. Our intention is to gain a better understanding of how purchasing managers in business markets make choices among product offerings. An overview of our paper is as follows. To understand better our focal concepts of value and price, we begin by considering their meaning in business markets and develop a framework for how purchasing managers combine value and price to make decisions. We next provide the hypotheses and supporting rationales, the field research methodology, analyses and results, and discussion for the three experiments in our first study. We then discuss our second study, which focuses on mechanisms that may counter the ambiguity that appears to hinder value. Finally, for both studies, we discuss the implications of the results for theory development, managerial practice and future research. VALUE AND PRICE IN BUSINESS MARKETS Value is a concept that has been used in various ways, leading to some confusion about what is meant by the term. 1 Thus, we adopt a specific meaning for value in business markets. Value in business markets is the worth in monetary terms of the economic, technical, service, and social benefits a customer firm receives in exchange for the price it pays for a product offering, taking into consideration competing suppliers offering and prices (Anderson, Jain and Chintagunta 1993; Anderson and Narus 1998, 1999). These benefits are net benefits, where any costs a customer incurs in obtaining the desired benefits, except for purchase price, also are included. Value changes occur in business markets in two fundamental ways (Miles 1989). First, a product offering could provide the same functionality or performance while its cost to the customer changes (where price is not considered in this cost). Second, value changes whenever the functionality or performance provided changes while the cost remains the same (again, where price is not a part of this cost). Note that
3 even if the functionality or performance of a product is lowered, it may still meet, or even exceed, a customer s specified minimum requirement. Price in business markets is what a customer firm pays a supplier firm for its product offering. It is not total cost, because price does not include, for example, acquisition costs or conversion costs. 2 In business markets, the value provided nearly always exceeds the price paid. Anderson and Narus (1998, 1999) define this difference between value and price as customer incentive to purchase. 3 Thus, raising or lowering the price of a product offering does not change the value that the offering has in the customer s application, only the customer s incentive to purchase that offering. Further, the value of an offering can change without affecting that offering s price (cf. Woodside and Vyas 1987). In this way, price and value are the two elemental characteristics of a product offering that purchasing managers use as the basis for making purchase decisions. 4 COMBINING VALUE AND PRICE IN PURCHASE DECISIONS Judgments about product offerings are not made in isolation; they occur within some context. For example, a customer may evaluate changes in a given supplier s product offering within the context of its present offering: the reference product offering. Reference dependent theory (Kahneman and Tversky 1979; Tversky and Kahneman 1991) provides a behavioral foundation for understanding how individuals make decisions. Reference dependent models have three distinguishing characteristics: reference dependence, loss aversion, and diminishing sensitivity. Reference dependence captures the notion that individuals define alternatives that they consider as gains and losses relative to a reference point, rather than in an absolute sense. Loss aversion means that individuals will valuate differently alternatives that represent opposing deviations of the same magnitude from the reference point; the negative deviation will be seen as more of a loss than the positive deviation will be seen as a gain. Finally, diminishing sensitivity means that individuals will place smaller marginal value on same-size, incremental changes in prospects as differences from the reference point become greater. Reference dependent theory defines a value function of preferences for alternatives (Kahneman and Tversky 1979; Tversky and Kahneman 1991). To avoid confusion, we refer to this value function as a utility function.
4 Drawing on reference dependent theory, we next propose a conceptual mechanism to explain why purchasing managers regard value and price differently. We then develop a series of hypotheses that investigate its effects on purchasing managers choices among product offerings. The Notion of Separate Value and Price Functions Although it is thought that purchasing managers attempt to maximize the value the company receives relative to the price it pays (Heinritz, Farrell, Giunipero and Kolchin 1991), we contend that purchasing managers do not regard value and price in the same way. This is a relevant issue as purchasing managers often consider product offerings that simultaneously represent both a gain and a loss relative to a reference offering. For example, an alternative offering s value increases (a gain), but its price also increases (a loss). Yet, this has not been studied in business market research. 5 We conceptually capture the difference in value and price with separate utility functions. Our rationale for this is as follows. Purchasing managers are more knowledgeable about using price and price changes as a basis for selecting product offerings than value and value changes. In business markets, the price of each product offering is almost always stated or understood (Heinritz et al. 1991). The same cannot be said about value. Even when the value of a product offering is known, purchasing managers likely will have far greater experience using price information than value information. Related to this, Heath and Tversky (1991) found support for their competence hypothesis, which holds that individuals prefer a prospect about which they are knowledgeable over a chance prospect, even though the probability of the chance prospect is the same as the subjective probability for the judgment prospect. Moreover, we contend that purchasing managers may regard value as more ambiguous than price in that they have some doubt as to whether their firm actually will realize the stated value. Ambiguity aversion refers to individuals preferences for prospects that are less ambiguous (Heath and Tversky 1991). Fox and Tversky (1995; Tversky and Fox 1995) have offered the comparative ignorance hypothesis as the explanation for ambiguity aversion, and find empirical support for it in a series of experiments. The comparative ignorance hypothesis suggests that when people are asked to price an uncertain prospect in the context of another certain prospect, they become sensitive to the contrast in their knowledge of the two
5 events, and as a result price the vaguer prospect lower than the more familiar prospect. Thus, when purchasing managers consider a product s value alongside its price, we would expect differential ambiguity for price versus value, with value ambiguity being greater. In summary, purchasing managers evaluate alternative offerings on value and price in comparison to the reference offering and to each other. Purchasing managers will be made aware that they are more knowledgeable about price than value, and that they have more uncertainty about value than about price. Because of this, we posit that purchasing managers will act as though they place lower decision weights on obtaining value than price (for monetarily-equivalent amounts). This differential weighting would produce two, similarly-shaped utility functions slightly rotated from each other about the origin, like those in Figure 1. The origin represents the reference offering and the two curves reflect the posited differential knowledge and uncertainty for changes in value versus price. [Insert Figure 1 about here] Hypothesis Development In two studies, we test several hypotheses derived from this conceptualization of value and price. In Study One, we build a framework for understanding how purchasing managers combine value and price information. We examine differences between predictions of our framework and the predictions of singlefunction, reference-dependent models. In Study Two, we extend this framework to focus on mechanisms to induce purchasing managers to choose higher-value, higher-price product offerings. To understand whether preferences are affected by the different compositions of value and price changes, we first consider how preferences for simple changes versus mixed changes may depend on whether the simple changes are either in value or price. We next examine some compositional effects of different mixed changes. Finally, we introduce supplier value guarantees as a mechanism to eliminate the differential ambiguity associated with realizing the stated monetary amounts. Table 1 gives an overview of the various product offerings we use as illustrations and in the actual experiments. [Insert Table 1 about here] Simple Changes Versus Mixed Changes. A simple change is a change from the reference
6 offering in either value or price, but not both. Hence, a simple change produces either a single gain or a single loss. On the other hand, a mixed change involves changes in both value and price relative to the reference offering. A mixed gain results from either a value increase taken together with a relatively smaller price increase, or a price decrease taken together with a relatively smaller value decrease. A mixed loss is composed of either a value increase and a relatively larger price increase, or a value decrease and a relatively smaller price decrease. Consider product offering A, which has a $10 higher value than the reference offering, and product offering C, which has a $20 higher value (gain) and a $10 higher price (loss). Both offerings represent a net $10 increase over the reference offering. Although the $20 value increase is higher on the value utility function than the $10 value increase, this difference is more than offset by the difference in the price utility function for a $10 price increase relative to the reference offering (because of the greater aversion for losses). Thus, in general, when purchasing managers compare two offerings where one represents a simple gain and the other represents a mixed gain, even though each offering provides the same net change in monetary terms, we predict that they will prefer the simple gain (cf. Thaler 1985). The rationale for simple losses versus mixed losses is similar: the greater magnitude of loss in the mixed loss relative to the simple loss cannot be offset by the gain component in the mixed loss. We contend further, though, that this effect for simple versus mixed changes will depend on whether value or price constitutes the changes. For example, product A represents a simple gain where value has increased $10 relative to the reference offering (a $10 gain); whereas product D is a mixed gain where price has decreased $20 (a $20 gain), but value also has decreased $10 (a $10 loss). The effect of simple changes would suggest that A would be preferred to D because A is a simple change, while D is a mixed change. On the other hand, if the value versus price effect is stronger, D may be preferred to A, as D has the lower price (for an equivalent net change). To determine when, if ever, the value versus price effect outweighs the effect of simple versus mixed changes, we would need to know the relative weightings for value and price that determine their utility functions. Nonetheless, from our conceptualization of these functions, we can specify some comparisons where this crossover is more likely. For example, product D
7 would more likely be preferred to product A than it would to product B, which is a simple $10 price decrease (gain). Hence, we contend that there are interaction effects for both losses and gains. Formally, we propose that: H 1a : For product offerings that differ in equivalent monetary amounts from the reference offering, purchasing managers will prefer offerings that represent simple changes to those that represent mixed changes composed of a value increase and a price increase. H 1b : For a mixed gain and a simple gain that represent equivalent monetary changes from a reference offering, the mixed gain composed of a value decrease and a price decrease will be preferred to the simple gain of a value increase. H 1c : For a mixed loss and a simple loss that represent equivalent monetary changes from a reference offering, the mixed loss composed of a value decrease and a price decrease will be preferred to the simple loss of a value decrease. The Character of Mixed Changes. Mixed gains that represent equivalent monetary changes from a reference offering can be composed from different combinations of value changes and price changes. The same applies to mixed losses. Separate value and price utility functions would suggest that combining value and price in different ways will result in different purchase intentions. Consider, for example, our earlier product D ($10 value decrease and $20 price decrease) and product C ($20 value increase and $10 price increase). Because of purchasing managers relatively greater knowledge of price than value and greater value ambiguity, we anticipate that they would prefer D to C. The $20 price decrease in D will have a greater positive effect than the $20 value increase in C, while the $10 value decrease in D will have a lesser negative effect than the $10 price increase in C. We would expect that these two combined effects would lead product D to be preferred to product C. Formally, our hypotheses for these value and price compositional effects are: H 2a : When selecting among monetarily-equivalent mixed gains, purchasing managers will prefer a mixed gain composed of a value decrease (loss) and a price decrease (gain) over a mixed gain composed of a value increase (gain) and a price increase (loss). H 2b : When selecting among monetarily-equivalent mixed losses, purchasing managers will prefer a mixed loss composed of a value decrease (loss) and a price decrease (gain) over a mixed loss composed of a value increase (gain) and a price increase (loss). Mixed changes also provide us with a context to test differences in predictions about perceptions of gains and losses. We can contrast predictions from our conception of separate utility functions for value
8 and price with those from a single-function, reference-dependent model. Consider product J, a combination of a $10 price decrease and a $10 value decrease relative to a reference offering. If there were a single underlying utility function, purchasing managers should perceive J as a loss because of the reference dependence model characteristic of loss aversion. Yet, under separate utility functions, the difference between value and price functions potentially could be large enough to offset the differential steepness between gains and losses. So, managers would view the confluent result as a gain, not as a loss. Thus, we hypothesize that: H 3a : Purchasing managers will regard a product offering composed of a value increase and a price increase of equal magnitude as a loss over a monetarily-equivalent reference offering. H 3b : Purchasing managers will regard a product offering composed of a value decrease and a price decrease of equal magnitude as a gain over a monetarily-equivalent reference offering. Note that although H 3a is consistent with a single-function, reference dependent model, H 3b provides a contrasting prediction made from a separate value-and-price-function model. Guarantees. We have offered comparative knowledge differences about value and price, and value ambiguity as an explanation for separate value and price utility functions. In an attempt to eliminate this value ambiguity, we propose the introduction of a supplier value guarantee, where a supplier firm gives an assurance that a stated value change in its product offering will be realized in the customer s application. In practice, suppliers in business markets sometimes use guarantees as a mechanism to overcome customer concerns about realizing supplier product performance claims. Supplier value guarantees should negate purchasing managers preference for price decreases over value increases and value decreases over price increases. Finding this would provide support for our proposed underlying explanation of separate value and price functions: value ambiguity. Thus, with a supplier guarantee in place, a single utility function should adequately capture both value and price effects. Formally stated: H 4 : Under the condition of a supplier value guarantee, the value versus price effect will not be significant. The relative mix of gains and losses will solely determine purchase intention. The compositional mix of value changes and price changes will have no significant effect.
9 STUDY ONE We conducted three field experiments in Study One. To manipulate the experimental factors in a field setting, we constructed purchasing scenarios. Past field research in business marketing (e.g., Puto 1987; Qualls and Puto 1989) has successfully used scenarios to study managerial decision-making. Method Research Participants. We constructed the sample frame from the membership of a chapter of the National Association of Purchasing Management (NAPM). We then conducted a mail-telephone-mail survey of purchasing managers. We contacted 342 purchasing managers, who each previously had received a letter from us informing them about our research and requesting their participation. Of these 342 purchasing managers, 288 individuals agreed to participate and were sent surveys. After the initial response and subsequent follow-up phone calls, these research participants returned 153 complete and usable surveys, providing a response rate of 53%. Research Procedure. During qualitative field research, we observed that there is a tendency for purchasing managers to stay with their current suppliers, even when the purchasing managers are aware of noticeably superior alternative product offerings. Therefore, we constructed the experimental scenarios (Choffray and Lilien 1980) so that the incumbent supplier always provided the reference offering and the alternative offerings. In addition, to minimize ambiguity, we extensively pretested the scenarios with purchasing managers, painstakingly revising the scenarios to reflect the managers understanding and usage of terms and phrases (Hilton 1995). To equalize any potential order effects, we counterbalanced the order of presentation of value and price information. To establish how the value of each offering was known, each scenario informed the participant: In order to determine product value, your firm uses a crossfunctional team to conduct an internal value analysis on each of these four new products. 6 We randomly assigned the research participants to three groups: each group participated in a single experiment. This ensures independence of response among the three experiments, which might not have been otherwise the case, because of the similarity of the scenarios and dependent measures. To make certain that research participants understood critical terms such as value and price in the way that we were
10 intending, we provided a cover sheet explaining the terminology in the survey: Before beginning the survey, we would like to explain some of the terminology that we use: Value refers to the performance of a product offering expressed in monetary terms. By product offering, we mean the product and any supplementary services (e.g., technical service, warranty, delivery) that are included. The value of a product offering can increase two ways: 1) by increasing your total cost savings (because of lower acquisition costs, conversion costs, or disposal costs); and 2) through superior performance above your stated specifications that your firm finds desirable. Conversely, the value of a product can decrease by increasing your total costs, or by way of a lower performing product. As we have defined value, a product offering s VALUE and PRICE are independent of each other. Internal Value Analysis refers to an assessment of a product offering that is conducted by a cross-functional team within the customer firm, typically with representatives from engineering, purchasing, manufacturing, R&D, and accounting. The team: 1) examines the product offering in terms of the specific functionality or performance it provides; 2) finds the total costs associated with providing the specific attributes; and 3) attempts to identify lower-cost alternatives that provide the same or greater performance. Experiment 1. We used a 4x2 mixed design to test H 1a, H 1b, H 2a and H 4. The four-level, withinsubject factor was the four alternative offerings. We constructed each of the four offerings to represent a monetarily-equivalent net gain of $10 from a reference product: two simple gains and two mixed gains (offerings A, B, C and D in Table 1). The two-level between-subject factor was the presence or absence of a supplier value guarantee. We randomly assigned participants to the guarantee versus no-guarantee conditions. In the supplier value guarantee condition, the participants were informed: A representative from your supplier also participated in your firm s value analysis process. Because of this, the supplier is so confident in the value analysis results that the supplier guarantees you that the value found for each of the four new products will be realized in your application. (You are involved in determining what any possible guarantee payoff would be.) The scenario informed participants that the supplier was discontinuing the offering that the participant was using currently, and in its place, was offering four alternatives. After reading the scenario, participants ranked the four offerings in terms of their purchase intention (termed purchase likelihood rankings). 7 For further detail, we provide the scenario that we used in Appendix 1. Experiment 2. In order to test H 1a, H 1c, H 2b and H 4, we used nearly the same 4x2 mixed design as Experiment 1. The only difference between experimental designs is that, in Experiment 2, we constructed each of the four offerings to represent a monetarily-equivalent net loss of $10 from a soon-to-be-
11 discontinued reference product: two simple losses and two mixed losses (offerings E, F, G and H in Table 1). The two-level between-subject factor was again the presence or absence of a supplier value guarantee. We randomly assigned participants to the two conditions. The instructions and dependent measures that we gave to the participants were the same as those for Experiment 1. Experiment 3. In order to test H 3 (and H 4 ), we used a 5x2 mixed design. The five-level, withinsubject factor was four alternative offerings, plus the reference offering. We constructed each of the four alternative offerings to represent a monetarily-equivalent, zero net change from the reference offering (offerings I, J, K and L in Table 1). The two-level between-subject factor was the presence or absence of a supplier value guarantee, to which we randomly assigned participants. As before, we clarified that although each of the five products met the participant s minimum product specifications, because of different total cost considerations, the product values may be higher or lower than the original product s value. Unlike Experiments 1 and 2, in this experiment, we asked the participants to provide their purchase intentions for all five offerings. This enabled us to assess purchasing managers perceptions of gains and losses relative to the reference offering. We provide the scenario that we used in Appendix 2. Analyses and Results Hypothesis 1. To test H 1a, H 1b, and H 1c, we analyzed the data at the individual level to determine each research participant s purchase intention ordering for product offering comparisons of interest. We then aggregated these purchase intention orderings across research participants as the basis for subsequent statistical analyses. To evaluate each part of H 1, we calculated a series of binomial tests to assess the significance of the difference in proportions of research participants preferring one product offering to another. 8 We present the results in Table 2, both for Experiment 1 (gains) and Experiment 2 (losses). Products A, B and E,F represent simple changes from the reference offering, while Products C, D and G, H represent mixed changes. [Insert Table 2 about here] For both losses and gains, there is strong support for H 1a. Observe that simple gains A and B each are significant preferred to mixed gain C, which is composed of a price increase and a relatively larger
12 value increase. Similarly, simple losses E and F each are significantly preferred over mixed loss G, which is composed of value increase and a relatively larger price increase. For H 1b, we find no significant difference between mixed gain D and simple gain A. Finally, we find strong support for H 1c ; mixed loss H is significantly preferred to simple loss E. Hypothesis 2. Hypothesis 2 concerns preferences for mixed changes of differing compositions, drawing on our contention that there are separate utility functions for value and price. Specifically, we posit that for both mixed losses and mixed gains, participants will prefer offerings composed of value decreases and price decreases over offerings composed of value increases and price increases. To test H 2a, and H 2b, we used the same procedure as for H 1 ; the results also are in Table 2. We find support for H 2a. Mixed gain D is preferred significantly to mixed gain C (p<.05). We find even stronger support for H 2b ; mixed loss H is significantly preferred to mixed loss G (p<.01). Hypothesis 3. Whereas in Hypotheses 1 and 2 we were making comparisons among alternative offerings, Hypothesis 3 focuses on comparisons of alternative offerings with the reference offering. We tested H 3 with Experiment 3. For H 3a, the reference offering was compared to the two offerings composed of a value increase and a price increase. For H 3b, the reference offering was compared to the two offerings composed of a value decrease and a price decrease. We again performed a series of binomial tests for product offering comparisons of interest. The results for H 3a and H 3b appear in Table 3. Product K and Product L have higher value and higher price than the Original Product (reference offering), while Product I and Product J have lower value and lower price. As predicted in H 3a, the Original Product is preferred to Product K and Product L (p<.01). Of greater interest, we also find strong support for H 3b. Product I and Product J actually are preferred to the Original Product (p<.01). 9 [Insert Table 3 about here] The H 3a results support the notion that some sort of utility function describes the preferences of participants. The H 3b results support the notion that a single utility function is not sufficient to describe the behavior of participants who are dealing with alternatives composed of a monetarily-equivalent value
13 decrease and price decrease. Hypothesis 4. To test for supplier value guarantee effects, we used the data from Experiments 1, 2 and 3 on purchase intention ratings, employing a mixed-design analysis of variance (Keppel 1991). The supplier value guarantee should mitigate the effect of value ambiguity, rendering value conceptually equivalent to price. Thus, we expected a significant value guarantee by product offering interaction. For Experiment 1 (gains), we obtained a significant main effect for product offering (F (3,135) = 6.42, p<.001), but no significant effects for either supplier value guarantee, or the supplier value guarantee by offering interaction (both F s < 1.0). For Experiment 2 (losses), we again obtained a significant main effect for product offering (F (3, 174) = 19.74, p<.001), but no significant effects for either supplier value guarantee, or the supplier value guarantee by offering interaction (again, both F s < 1.0). Finally, for Experiment 3 (equivalent zero net changes), we obtained a significant main effect for product offering (F (3, 144) = 15.73, p<.001), a significant effect for supplier value guarantee (F (1,48) = 4.46, p<.05), but again no significant supplier value guarantee by offering interaction (F (3, 144) =.38, p>.05). So, we were unable to find any significant support for H 4. Post hoc research. To better understand our lack of results for the supplier guarantee factor, we recontacted a random subsample of the participants in the value guarantee conditions. We sent each of forty participants the same scenario that they had earlier seen, and asked the open-ended question: How did you regard the supplier value guarantee in this scenario? A second, scaled question asked, How would you react in practice to a supplier that touted a value guarantee such as this to your firm? The two response measures were seven-point scales: one ranged from much less concerned to much more concerned about their offering s quality and performance ; the other ranged from much less likely to much more likely to buy from them. We received feedback from twenty participants. Some reacted positively to the supplier value guarantee, commenting that it would help to protect the buyer ( The buyer could charge back the supplier for a value less than guaranteed. ). Other participants commented that the value guarantee did not affect their purchase decisions ( The guarantee has no bearing in my analysis. ). Still other participants remarked
14 that without our internal value analysis, I would have very little confidence [in the supplier value guarantee]. Surprisingly, some participants even appeared to be somewhat negative toward the use of supplier guarantees ( I regarded the supplier guarantee as useless! ). As further evidence of the diversity of how participants regarded the value guarantee, the quality and performance concern measure had a mean of 4.90 (slightly more concerned) with a standard deviation of 1.74, and the likelihood of purchase measure had a mean of 4.55 (slightly more likely to buy) with a standard deviation of 1.50. The large standard deviations reflect the diversity of response, which ranged from 1 to 7 for each scale. Discussion Our results strongly suggest that a single utility function cannot explain the purchasing managers decisions, and that separate value and price utility functions provide superior explanation. Purchasing managers preferred a mixed loss, composed of a value decrease and a smaller price decrease, over a simple loss of a value decrease (H 1c ). This is contrary to the prediction of a single-utility-function model, and is congruent with a separate-value-and-price-function model. Not finding this effect for gains (H 1b ), though, suggests that the value versus price effect is not as great in the positive domain, so that it cannot offset the loss aversion effect of reference dependent models. Finally, H 1a results demonstrate that simple gains or losses are preferred over mixed changes composed of a value increase and a price increase. Our contention of separate utility functions for value and price received further support from the results on mixed changes of differing compositions. Specifically, we hypothesized that purchasing managers would prefer offerings composed of value decreases and price decreases over monetarilyequivalent offerings composed of value increases and price increases. We found strong support for mixed losses (H 2b ) and somewhat less strong support for mixed gains (H 2a ). Again, this suggests that the value versus price effect may not be as great for positive deviations from the reference point. Having purchasing managers make comparisons of alternative offerings with the reference offering in Experiment 3 enabled us to determine how purchasing managers interpret changes from it. Adding still further support for an elaboration of reference dependent models in business markets are the results for the
15 two alternative offerings composed of value decreases and price decreases. While a single utility function model would predict that purchasing managers also should view these offerings as losses relative to the reference offering, a separate-value-and-price-function model would predict that they should be viewed as gains. A significant proportion of purchasing managers did indeed view these offerings as gains, even though all of the offerings were monetarily equivalent (H 3b ). Because of possible shortcomings in the supplier value guarantee, we may not have adequately tested our explanation for separate value and price utility functions. Our post hoc research has given us some ideas on how to strengthen our supplier guarantee factor. Yet, supplier guarantees themselves, no matter how they are constructed, may not overcome purchasing managers significant ambiguity about value. Thus, we also searched for another conceptual mechanism that might counter this ambiguity. STUDY TWO We sought to further understand the value and price effect, and mechanisms that would induce purchasing managers to purchase higher-value, higher-price product offerings over lower-value, lowerprice alternative offerings. We first consider how to strengthen value s effect on purchase intention. We then present the methodology for Experiment 4, followed by the analyses and results. Strengthening Value s Effects on Purchase Intention We made some changes in Study 2 so that we would able to rule out possible operationalization explanations for value s lesser effect on purchase intention relative to price. We first revisit our definition of value and the product scenarios that we provided to research participants. We next explain how we strengthened our supplier guarantee manipulation. We then introduce incentive to change as another conceptual mechanism to counteract purchasing managers ambiguity about value. Value Definition. In retrospect, we were not as specific as we might have been in Study One about how exactly value was calculated. The customer firm would realize the savings in price at the time of purchase, whereas value would be realized over time during the use of the offering. Although this time value of money is implicitly a part of the economic net benefits in the definition of value we provided, purchasing managers may not have considered this. So, to make this economic difference an explicit part of
16 the calculation of value for the customer firm, we added this sentence to our scenarios for Study Two: The [cross-functional] team has discounted the future expected cost savings at your firm s cost of capital in order to express all cost savings in current dollars. This sentence should alleviate purchasing managers concerns about the economic difference in realizing price changes at the time of purchase while only realizing value changes in the future. Product Scenarios. In retrospect, another operationalization shortcoming that may have contributed to the greater ambiguity of value relative to price was vagueness about the product offerings in the scenarios. Previous research in business markets has found that the importance of price in purchasing decisions varies widely. The impact the product has on existing routines at the purchasing firm, the product complexity, its dollar value, and its judged strategic importance to the purchasing firm each can affect the importance given to price in the purchase decision (Kraljic 1983; Lehmann and O'Shaughnessy 1974; Lehmann and O'Shaughnessy 1982). By selecting an actual product offering that many firms purchase regularly, and strengthening the level of detail we provide about how alternative offerings deliver value, we should minimize ambiguity that is due to our operationalization. Maintenance, repair, and operating (MRO) items are purchased regularly and have the further advantage that price or value changes accrue to the customer firm itself and not downstream. To accomplish this, we enlisted the support and advice of W.W. Grainger, the leading North American distributor of MRO supplies. Working with Grainger managers, we selected a replacement product that many firms regularly purchase, and that could be sufficiently described in a short scenario so that purchasing managers could understand it, whether or not they actually purchased that product themselves. We also wanted a product of sufficient price and criticality that purchasing managers typically would actively consider alternatives prior to making a purchase. Finally, we wanted a product where all of the alternatives would meet minimum customer specifications, yet there were meaningful value differences across alternative because of the differential cost savings that they produced. We chose 10-horsepower replacement motors. It turns out that this choice of product is timely, in that suppliers have started offering lines of premium-efficiency replacement motors, which provide greater
17 cost savings and have higher prices. Grainger managers helped us write scenarios that specifically conveyed actual sources of cost savings (e.g., differences in vibration, temperature rise). Guarantees. In Study One, we introduced supplier value guarantees with the intent of eliminating the effect of value ambiguity. We used what we now classify as a back-end guarantee: a purchasing manager was able to get a payback from the supplier if she did not actually realize the promised amount of value. However, the purchasing manager still had to pay the higher price for the higher-value product offering at the time of purchase. In subsequent field interviews, purchasing managers related to us that they would be more inclined to purchase higher-value, higher-price product offerings if they would have to pay the difference in price only when they had actually realized the higher promised value. So, in Study Two, we constructed what we term an up-front supplier value guarantee, whereby the purchasing manager pays the lowest price for any of the offerings at the time of purchase, and then pays the incremental price for the offering he selected only when his firm actually receives the differential value. Because the purchasing manager does not pay for higher value until he realizes it, we expect that purchasing managers will prefer an up-front guarantee to a back-end guarantee. With the reworking of our scenarios on how value is calculated, we also expect the back-end guarantee to be more effective than the guarantee we used in Study One. So, the up-front and back-end guarantees should provide a much stronger manipulation of supplier guarantee. We test H 4 again using this stronger manipulation. Incentive to change. The results from Study One indicate that purchasing managers are willing to select lower-value, lower-price products. The challenge for suppliers, though, is to find a means of inducing purchasing managers to select higher-value, higher-price products. Anderson and Narus (1999) argue that even after all specific cost and value differences are accounted for in a value assessment, including any specific identifiable risks in changing from the reference offering to an alternative offering, there remains a reluctance to change. Thus, to induce purchasing managers to purchase a higher-value, but higher-price alternative offering over the reference offering, the supplier must give some additional portion of the incremental value to the customer, a pricing tactic that they call incentive to change. Although the size of
18 this incentive may vary by situation, based on some qualitative research with purchasing managers, Anderson and Narus (1999) offer 5-7% as a rough heuristic. So, if the reduction in price or gain in value is less than this, Anderson and Narus contend that purchasing managers are unwilling to even investigate changing from the reference to an alternative offering. This concept of incentive to change is consistent with reference dependent theory. An alternative offering that has monetarily-equivalent increases in value and price from a reference offering would be perceived as a loss. Yet, incentive to change provides a mechanism for affecting perception of this kind of offering, moving a loss to a gain. Note that this effect, if we find it, would follow from either a single or separate utility function model. And, although we could construct an incentive to change as a price decrease that is incrementally larger than the value decrease from a reference offering, our interest is in an incentive to change where the value increase is incrementally greater than the price increase. Finally, as the diminishing sensitivity characteristic of reference dependent theory would predict, an incentive to change that is a constant monetary amount will decrease in effectiveness as alternative offerings increase in both value and price from the reference offering. We posit that: Method H 5a : Purchasing managers will have significantly higher purchase intentions for the reference offering and lower-value, lower-price offerings than for higher-value, higherprice offerings, where each alternative offering s value and price differences from the reference offering are of equal magnitude. When a monetary incentive to change equal to a small percentage of the purchase price of the reference offering is added to the value of the higher-value, higher-price offerings, purchasing managers instead will have significantly higher purchase intentions for the higher-value, higher-price offerings than for the reference offering and lower-value, lower price offerings. H 5b : A monetary incentive to change that is a constant amount added to the value of highervalue, higher price for higher-value, higher-price product offerings will have significantly less effect on purchase intentions as the value and price of alternative offerings increase from those of the reference offering. Research Participants. For the second study, we constructed the sample frame from the membership of a chapter of the NAPM. Using a cover letter from the local president of the NAPM, we sent survey packages to a random sample of 243 purchasing managers. After the initial response and subsequent reminder cards and follow-up phone calls, these research participants returned 81 complete and usable
19 surveys, providing a response rate of 33%. Research Procedure. We randomly assigned the research participants to six groups: each group evaluated a different scenario involving one type of guarantee and one incentive to change condition. In our new up-front guarantee condition, the participants were informed: Because of its participation, your supplier is so confident in the results of the value analysis that your supplier offers you an innovative up-front guarantee in writing. Regardless of which motor you select today, you pay the price for the lowest priced motor now. If you realize the cost savings found in the value analysis for the motor you bought, only then do you pay the difference in price between the lowest priced motor and the motor that you bought. You and the supplier also agree how to measure those expected cost savings, and on the time frame for measurement and payment of realized savings. For our back-end guarantee condition, we informed the participants that: Because of its participation, the supplier is so confident in the results of the value analysis that, for each of the four new motors, the new supplier specifically guarantees to you in writing that your maintenance and energy costs will not be different from those found in the value analysis. You and the supplier also agree how to measure those expected cost savings; this will enable you to determine what is the guarantee pay-off in hard dollars if, in fact, you do not realize these cost savings. As in Study One, we provided a cover sheet that defined critical terms such as value and price. Experiment 4. We used a 2x3x5 mixed design to test H 4 and H 5. The two-level between-subject factor was the presence or absence of a monetary incentive to change on the two offerings that were highervalue, higher-price than the reference offering. The three-level between-subject factor was the type of supplier value guarantee: no guarantee, an up-front guarantee, and a back-end guarantee. The five-level, within-subject factor was the four alternative offerings and the reference offering. The unit price for the reference product was $1000. In the no incentive-to-change condition, the corresponding price and relative value amounts for the four alternative offerings were: $900 and $100 less value (M), $950 and $50 less value (N), $1050 and $50 more value (O), and $1100 and $100 (P) more value. Each alternative represents a zero net monetary change relative to the reference offering. In the incentive to change condition, we added $75 more value to the two highest-value, highest-price product offerings (O and P), resulting in $125 and $175 greater value, respectively, than the reference offering. This incentive to change amount is 7.5% of the reference-offering price. As we mentioned, the recast scenario focused on the purchase of 10 horsepower replacement