The Impact of Channel Governance Forms on the Selection of Channel Performance Measures

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1 The Impact of Channel Governance Forms on the Selection of Channel Performance Measures Autoria: Thomas Brashear, Aurea Helena Puga Ribeiro, Virginia Izabel de Oliveira, Daniela Ferro de Oliveira, Iêda Lima Pereira ABSTRACT Transactions in organizations have occurred in several forms, depending on the characteristics of the channel related to them, and the value added to the business involved. This study argues that different governance forms are a reflection of different types of value that companies look for in a relationship. In order to effectively assess the extent to which a company has captured different types of value from different relationships, companies tend to use different performance measures. Using theoretical perspectives about organizational performance, the authors developed a typology of performance financial and non financial measures, matching the typology with three different governance forms market, hierarchical and bilateral governance to develop a framework that can be used as a criterion for selecting different and the best types of performance measures. 1. INTRODUCTION Supply and distribution channels are changing very rapidly and channel leaders are beginning to view their distribution channels more strategically than they did before (TAN et al. 1998). New technologies and business processes (GUNASEKARAN et al. 2004), relationship marketing (MORGAN and HUNT, 1994), changing customer demands (WEBB and HOGAN 2002), global factors (GUNASEKARAN et al. 2004), and the increasing importance of intangible assets, are all creating fundamental shifts in the nature of marketing channels. Because supply and distribution channels have changed dramatically, companies are now searching for new and more complete measures of channel performance yet limited scholarly work has been done to conceptualize the performance construct (SPRIGGS 1994) or to address the criteria for selecting performance measures in the channels literature (KUMAR et al. 1992). Financial performance measures have come under a lot of criticism in the academic literature (eg JEAN-FRANCOIS, 2004; KAPLAN AND NORTON, 1996; RUST et al. 2004) yet a review of the marketing and channels literature shows that mostly financial measures are used to measure channel performance (KUMAR et al. 1992; SPRIGGS, 1994). To overcome the shortcomings of traditional financial measures, many firms have begun to emphasize non traditional financial measures such as customer satisfaction, loyalty, and quality, as integral parts of their performance measures (KAPLAN and NORTON, 1996). Although these performance measures are traditional outcomes of governance structures in the channels literature, very little work has been done in the literature to link performance measurement to governance types. This study links performance measures to different types of governance. Using the three forms of governance: market, hierarchical, and unilateral detailed by Heide (1994), the study argues that different governance forms are a reflection of the different types of value that companies look for in a relationship. For example, a market form of governance is used when the main goal of a relationship is short term economic gain, whereas bilateral governance forms are used when longer term relationships and other non financial value are important. To effectively assess the extent to which a company has captured the different types of value that they expect to get out of a relationship, they will use performance measures that accurately reflect the different goals and value that they look for in that relationship. Since different governance forms are a reflection of different types of value that companies place on a relationship, companies will use different types of performance measures in different governance environments. 1

2 Using theoretical perspectives of organizational performance this paper develops a typology of performance measures, made up of both financial and non financial measures. The paper matches this typology with the three different governance forms to develop a framework that can be used as a criterion for selecting different types of performance measures in different governance environments. This paper makes two primary contributions. First, it draws on a multi-disciplinary literature to develop a classification of channel performance measures that includes both financial and non financial measures, thus providing a more holistic view of the performance of the marketing channel. Second, it creates a framework that helps practitioners and academics alike to determine the most effective performance measures to select under different channel conditions. 2. LITERATURE REVIEW Financial measures have been and continue to be the most widely used means of measuring performance and measures like market returns (HITT and IRELAND, 1985), profitability (POWELL, 1996), ROI (GALBRAITH and SCHENDEL, 1983) and sales targets (GASKI and NEVIN, 1985), are widely used by practitioners and academics alike. Despite the widespread use of financial measures, arguments are being increasingly made for the use of non financial measures to supplement financial measures of performance (CHAKRAVARTHY, 1986; SKAGGS and SNOW, 2004; VENKATRAMAN and RAMANUJAM, 1986). Jean-Francois (2004) identifies eight limitations of financial measures. According to him financial measures are: 1) Backward observation, 2) Unable to explain future performance, 3) Reward incorrect short term behavior, 4) Result in the lack of timely signals, 5) Not actionable, 6) Ineffective in guiding managerial action, 7) Do not reflect cross-functional processes, 8) Do not adequately evaluate intangible assets. Other researchers have also criticized the use of financial measures. Rust et al. (2004b) criticize financial measures for measuring only the historical performance of a firm whiles Kaplan and Norton (1996) criticize financial measures for not expanding enough to incorporate the value of new business trends. Survey results show that corporate executives find both financial and non financial measures to be important in evaluating performance (LIBBY et al. 2004) and other research findings show that analysts who rely more heavily on non financial information produce more accurate results than those who don t (LOW and SIESFELD, 1998). Recognizing the limitations associated with financial measures, and the increasing value of non-financial measures, McNair and Mosconi (1987) called for integrated performance measures that stress the need for the alignment of financial and non financial measures. One of the most recent analysis of performance in marketing channels was performed by Kumar et al (1992) and recognizing the limitations of financial measures, they developed measures of performance that combine both financial and non-financial measures. Kumar et al (1992) developed scales to assess reseller performance from the perspective of the supplier. Building on Quinn and Rohrbaugh s (1983) model of organizational effectiveness, they identified eight performance measures: contribution to profits, contribution to sales; reseller competence, reseller loyalty, reseller compliance, contribution to growth, reseller adaptability, and customer satisfaction (KUMAR et al. 1992). They concluded that while all the scales they developed were suitable for measuring reseller performance, the decision about which scale to use should depend ultimately on the objectives or purpose of the evaluation (KUMAR et al. 2

3 1992). They also called for more research to be done on performance in the channels literature including the need to develop criteria for selecting different performance measures A Typology of Performance Measures To develop the criteria for selecting performance measures under different governance environments the authors first develop a typology of performance measures. Reviews of the literature on organizational performance indicate the prevalence of three perspectives: the goal approach, the systems resource approach, and the process approach, (FORD and SCHELLENBERG, 1982). Using these three perspectives as a theoretical framework, this paper develops a typology of channel performance measures. The first perspective, the goal approach is the most widely used approach in the organizational performance literature (CAMERON, 1981). This approach is usually associated with short term goals and economic measures and it defines performance in terms of the attainment of goals set by the organization (JEAN-FRANCOIS, 2004). Since this perspective emphasizes the measurement of economic goals, we identify economic performance measures as one of our performance categories. New perspectives in marketing including CRM, Market Orientation and the Service Dominant logic all emphasize providing dual value (customer and shareholder value) as the main goals of a firm. Since economic measures are usually used to measure shareholder value, companies will also determine whether they have achieved their other major goal of providing customers value. On this basis, we also identify customer based performance measures as a performance category that reflects the goal approach. The second perspective of Ford and Schellenberg (1982) is the systems resource approach, which emphasizes the relationship between the organization and its environment. The strategy literature, particularly since the introduction of the resource based view (RBV), focuses on how companies use their strategic resources to exploit their environment and create a sustainable competitive advantage (BARNEY, 1991). Since the systems perspective emphasizes the importance of measuring how well a company s strategy is enabling it to compete with other players in its environment, we identify strategic performance measures as an important performance category. Another performance category that we identify, based on the systems resources perspective, is the relational performance category. Relationship marketing is extremely important in marketing and channels research (MORGAN and HUNT, 1994) and companies are making efforts to develop strong relationships with their trading partners, and other important players in their environment. To determine the quality of the relationships that a company is building with other players in its environment, companies will measure the strength of these relationships. On this basis, we also identify relational performance as a key category of performance. The third approach, the process approach, defines performance in terms of the behavior of the participants involved. The focus of this approach is on quantifying the efficiency of internal processes and participant behaviors (JEAN-FRANCOIS, 2004). On the basis of this approach, companies will develop operational measures to determine how well processes are working and participants (both internal and external) are behaving. We therefore identify operational measures as an important performance category. 3

4 Although these perspectives are sometimes used separately, they are not necessarily different and can be used in combination (FORD and SCHELLENBERG, 1982). By combining the different categories of performance measures that we identified using the three performance perspectives, we developed a typology of performance measures made up of five categories of performance measures. The measures are: Strategic, Customer, Operational, Relational, and Economic SCORE. Because the SCORE performance typology was built on organizational performance theories, we wanted to determine if it reflects performance measures in the channels literature. Table 1 identifies some of the major research in the channels literature that use performance as a dependent variable and matches them with the SCORE categories. The table shows that the performance measures used in the extant literature can be categorized into performance categories that reflect the SCORE typology. Table 1 also shows that the vast majority of channels researchers use economic measures and relatively few use non-economic measures like strategic, customer, and relational measures. 4

5 Study Frazier GL (1983) Anand and Stern (1985) Gaski and Nevin (1985) Heide and John (1988) Mohr and Nevin (1990) Noordewie r et al (1990) Kumar et al (1992) Schher and Stern (1992) Kalwani and Narayand as (1995) Bello and Gilliland (1997) Aulakh and Kotabe (1997) Contributio Reseller n to Adaptation Growth Strategic Performanc e Competitiv Jap (1999) e Advantage Janda and Sehadri (2001) Claro et al (2003) Study Coelho et al (2003) Achrol and Etzel (2003) Duarte and Davis (2003) Al-Zubaldi and Tyler (2004) TABLE 1 Performance Measures Used in Past Channels Research Types of Performance Measures Used Strategic Customer Operational Relational Customer Satisfaction Sales Customer Performanc Net Profit Satisfaction e Selling Performanc e Perceived Satisfaction Car Interfirm allocation Assistances and Delivery Reimbursem ent of warranty claims Relative Dealer Performance Inventory Turnover Percentage on Time Delivery Reseller Reseller Complianc Competence e Efficiency Quality of Cooperative Manufactur ness of the ers Reps. Manufactur Advice er's Reps Percentage Acceptable Coordinatio n Reseller Loyalty Manufacturer generated demand Sales Performance Expectancy Sales Targets Field Selling Cost/Agency Commission Satisfaction Commitmen Channel t Performance Contribution to Sales ROI Inventory Costs Economic Performance Sales Profit Contribution (Domestic) Profit Performance Effectiveness Sales Growth Rate (continues) Economic Contributio n to Profits Gross margin Sales Profit Contributio n (Foreign) Types of Performance Measures Used Strategic Customer Operational Relational Economic Profit Sales Performanc Performance e Relative Error Rate Sales Volume ROI Percentage Sales Growth Lost sales End of season stock Net Sales Zablah et al. (2005) Customer Customer Satisfaction Retention Source Elaborated by the authors. Governance costs 5

6 3. INTERORGANIZATIONAL GOVERNANCE AND PERFORMANCE 3.1. Governance Forms The term governance was originally defined broadly, as a way of organizing transactions, but was later defined more precisely as a multidimensional phenomenon that encompasses the initiation, maintenance, and termination of relationships between a set of parties (HEIDE, 1994). Williamson (1975) initially conceived of governance structures to be made up of two mechanisms; markets and hierarchies, and later expanded the concept to recognize intermediate forms of organization such as relational contracting. Building on Williamson s expanded concept, Heide (1994) identifies three forms of interorganizational governance Market, hierarchical, and bilateral. These three governance forms are synonymous with the different forms of inter firm exchanges. This study argues that different governance forms are a reflection of the different types of value that companies look for in a relationship. To determine whether a company has received the value that they expected when they initiated the relationship, they will use performance measures that accurately reflect the goals and the value that they anticipated. Since different governance forms are a reflection of different types of value that companies place on a relationship, companies will use different types of performance measures in different governance environments to determine whether they have captured the value that they anticipated going into the relationship. Although limited work has been done in the channels literature to link different governance structures, with performance measures, contingency based research in the management literature links different firm strategies to performance. Different firm strategies like prospector, analyzer, defender; and product cost leadership, differentiation; have all been linked to different performance measures (MALINA and SELTO, 2004). To develop a guide that determines which performance measures will be used under each of the different governance conditions, the paper links the different performance measures in the SCORE performance typology with different governance forms. The authors search the literature on interorganizational governance and using perspectives from numerous channels researchers, create a table (Table 2) that demonstrates the value of the different types of performance measures in different governance environments. Market Governance and Performance. Market governance is viewed as being similar to the concept of discrete exchange and is consistent with the underlying assumptions of classical economic theory (MACNEI,1981). This governance form has a short term orientation and views inter-firm relationships as a discrete relationship that terminates after every completed exchange (KEYSUK and FRAZIER, 1996). Roles are narrowly defined in terms of a minimum amount of duties required by the parties involved to complete the transaction, and since the relationship is usually limited to discrete transactions, long term planning is basically nonexistent (HEIDE, 1994). The primary focus in market governance environments is short term economic profits and the price mechanism is the primary mechanism for interfirm-coordination (DWYER et al. 1987). Measuring economic value is therefore very important since it enables companies in a market environment to determine the extent to which they have achieved their economic goals through that exchange. Because companies in market exchanges have a short term orientation, building relationships are not as important as in a bilateral exchange. According to Johnson et al (2004), market exchanges do not warrant the time, effort, costs, and additional resources necessary to maintain long term relationships with trading partners. Macneil (1981) on the other hand asserts that market exchanges do not necessarily imply the total absence of relationships. He does 6

7 however accept that relationships are more important in the other exchanges than in a market exchange. In market exchanges, enforcement mechanisms are external to the relationship, usually consisting of the use of the legal system, and market mechanisms and continuous control or monitoring of trading partners is considered to be of limited necessity (KAUFMANN and STERN, 1988; NOORDEWIER et al. 1990). Strategy By virtue of its emphasis on discrete transactions, planning is limited or nonexistent TABLE 2 SCORE and Types of Governance Structures Market Hierarchical Bilateral Comment Source Comment Source Comment Source Long term relationships can be used to create Macneil (1981), Focus more on processes Lusch and Brown competitive advantage by Frazier et al (1989), and less on long term (1996) creating product Heide (1994) strategies differentiation and barriers to switching Because of short term nature, need for flexibility and adjustments is limited or non existent Heide (1994) Strategic planning less Gundlach and Murphy important than in relational (1993) exchange The relationship is seen as a strategic one and planning is also jointly done Dwyer et al (1987), Ganesan (1994), Johnson et al (2004) Macneil (1981), Heide (1994), Lusch and Brown (1996) Customer Operations Relationships Economic Focus on short term profits so developing relationship with customer is not very important Prices determined by competition and marketplace. Creating relationships with customers and other partners is of limited importance Roles are narrowly defined in terms of minimal level of duties required to complete transaction Limited control, monitoring of behavior of trading partners, and administrative apparatus necessary Do not warrant time, effort, costs, and additional resources necessary to maintain extensive relationships Limited interdependence, lower reliance on social agreements, and relatively shallow concern for whole system performance Channel members' primary focus is short term economic profits. Price mechanism is likely to be primary if not sole mechanism for inter-firm coordination Keysuk and Frazier (1996) Anderson and Weitz (1989), Gundlach and Cadotte (1994) Kaufmann and Stern (1988) Kaufmann and Stern (1988), Noordewier et al (1990) Anderson and Weitz (1989), Gundlach and Cadotte (1994), Johnson et al., (2004) Goldberg (1976), Ouchi (1979), Dwyer and Oh (1988), Heide and John (1994), Yilmaz et al (2005) Goldberg (1976), Dwyer et al (1987), Keysuk and Frazier (1996) Goldberg, (1976) Williamson (1991), Keysuk and Frazier (1996) Source Elaborated by the authors. Creating relationship and satisfying trading partner's customer could reduce dependancy and create competitive advantage In customer driven supply chains, supply base of even the very large, has an impact on ultimate customer satisfaction Active supervision and close operational surveilance is used to ensure performance Governed by contracts that contain explicit specifications of duties Neither party has much stake in relationship so there is very limited relational behavior Reliance on maintaining good social relations is virtually eliminated. Price comparisons and economic performance are used as a way to monitor the effectiveness of an exchange Focus on economic benefit of powerful party Ganesan (1994) (Gunasekaran et al. 2004) Ouchi (1979), Noordewier et al (1990) Williamson (1991), Heide (1994) Lusch and Brown (1996) Ring and Van de Ven (1992) Ouchi (1979) Lusch and Brown (1996) Oriented toward strong lasting customer relationships Morgan and Hunt (1994), Dwyer et al (1987), Ganeson (1994) Satisfying your trading partner's customer is very Dwyer et al (1987), important and can lead to Ganesan (1994) barriers to exit Roles become multidimensional and more complex. It is important to test ability of partner to deliver promised output Parties monitor partners through socialization processes leading to: shared values, internal control, minimized opportunism, and commitment. Relationships are so important that they are the cornerstone of the system Rewards based on commitment to the system and Individual goals are influenced by the longterm goals of the whole system Business relationships still aimed at achieving economic gains Interested in long term economic well being of the whole system Ganesan (1994) Barthon and Jepsen (1997), Bello and Gilliland (1997) Dwyer et al(1987), Morgan and Hunt (1994) Ouchi (1979), Heide and John (1992), Heide (1994), Claro et al (2003), Claro et al (2003) Heide (1994), Claro et al (2003) 7

8 Since market exchange is seen as a series of discrete transactions whose focus is on short term economic gain, companies in this environment are more likely to use economic performance measures and less likely to use strategic, customer-based, operational and relational measures. The study therefore proposes that: P 1 : Companies in a market governance environment will have a high instance of using economic measures to measure the performance of their channel partners. Unilateral/Hierarchical Governance and Performance. Unilateral governance is a non-market governance form in which there is power asymmetry, and one partner has the ability to develop rules, give instructions, and in effect impose decisions on the others (LI and DANT, 1997). Exchanges are governed by contracts that contain explicit specifications of duties to ensure that the required behaviors are performed (WILLIAMSON, 1991). Contracts containing standard rules, monitoring mechanisms, and terminating clauses are frequently used as a governance mechanism (OSBORN and BAUGHN, 1990) and incentive systems are designed to reward observed behavior (HEIDE, 1994). Since behaviors and processes are highly valued in unilateral exchanges (NOORDEWIER et al. 1990) operational performance measures are important in this governance environment. In unilateral governance, economic performance is important since the relationship exists so long as it provides economic benefits to the powerful party (LUSCH and BROWN, 1996). Price comparisons and economic performance are used as a way to monitor the effectiveness of the relationship and companies, particularly the powerful players, continuously measure the economic value of the relationship to determine if they are receiving the economic value that they expect out of that relationship. It is quite common for powerful companies to use these economic measures to put pressure on their trading partners and demand reduction in the prices of products and services that receive from their less powerful partners. Long term strategic planning is less important here than in relational exchanges (GUNDLACH and MURPHY, 1993) and there is very little relational building between trading partners (LUSCH and BROWN, 1996). Relationships are terminated when the contracts expire and the powerful party usually is the one who makes the decision as to whether to renew the contract or not (HEIDE, 1994). Since companies in unilateral exchanges are less interested in creating long term relationships; and developing joint strategic plans; but are more interested in monitoring the behavior of their trading partners; creating satisfied customers; and ensuring that they maximize their individual profit potential; the study proposes that: P 2 : Companies in a unilateral governance environment will have a high instance of using: (a) Customer related measures to measure the performance of their channel partners. (b) Operational measures to measure the performance of their channel partners. (c) Economic measures to measure the performance of their channel partners. Bilateral Governance and Performance. Bilateral Governance is associated with relational exchange and relationships are based on social processes, norms, and cooperation across both parties (LI and DANT, 1997). Relationships are the cornerstone of bilateral governance and evaluative processes involve the assessment of not only skills but also general beliefs, attitudes and values (DWYER et al. 1987). Since developing strong relationships are 8

9 extremely valuable in bilateral relationships, companies are more likely to measure the strength and quality of these relationships. In bilateral governance, relationships are seen as strategic and planning is jointly done, decentralized, flexible, and exhibits lower levels of specificity (LUSCH and BROWN, 1996). Individual goals are reached through joint accomplishment and influenced by the long-term goals of the whole system (CLARO et al. 2003). Since relationships are viewed as strategic and long term goals are valuable, companies in such an environment will evaluate the effectiveness of their strategies and long term plans. Effective customer relationship management is also important in bilateral exchanges and companies do not only create strong relationships with their trading partners but also develop strong relationships with their customers and their customer s customers. Since bilateral exchanges are oriented towards strong customer relationships (DWYER et al. 1987), measuring the extent to which they have effectively managed those relationships is valuable. Parties monitor their partners through socialization processes that lead to shared values, promote internal control, minimize opportunism, and rewards partners based on commitment to the relationship (BARTHON and JEPSEN, 1997). The need for explicit enforcement is low since expectations of future business represents an incentive to abide by the norms and serve as an enforcement mechanism on its own (HEIDE, 1994). Although the need for enforcement is low, companies in bilateral relationships will measure the operational effectiveness of their partners in order that they can jointly work towards solving any operational problems faced by their partners and work towards continuous improvement of their processes. Measuring operational performance is therefore important in bilateral governance environments. In bilateral exchanges business relationships are still aimed at economic gains and the partners are interested in the long term economic well being of the whole system (CLARO et al. 2003). It is therefore important to measure the financial well being of the system and the extent to which economic goals have been achieved. Since companies in bilateral exchanges see their relationships as strategic relationships; are very interested in satisfying customers; monitor their members using socialization processes; are interested in creating long term relationships; and also aim at providing long term economic benefits for all members of their system; we propose that: P 3 : Companies in a bilateral governance environment will have a high instance of using: (a) Strategic measures to measure the performance of their channel partners. (b) Customer related measures to measure the performance of their channel partners. (c) Operational measures to measure the performance of their channel partners. (d) Relational measures to measure the performance of their channel partners. (e) Economic measures to measure the performance of their channel partners. In 2006, a research center in Brazil specialized in business to business studies conducted a research about tendencies and challenges in business relations between B2B companies. This study collected the opinions of several market specialists, revealing that there are some performance indicators that prevail according to each existing strategy value (commodity, added value, performance value, co-creation). Companies whose revenues are mainly from commodity strategy, adopted indicators like profits by clients, brand knowledge, commercial perspective e delivery on time. Sustainability, Research & Development costs, brand knowledge, distribution, turn over capital and active 9

10 clients are indicators related to the companies whose revenues come mainly from added value. The indicators found for companies with revenues coming from performance value strategy were: effectiveness, distribution, active clients, emotional involvement with the brand, client s business knowledge, and employee s satisfaction. Finally, for those companies whose revenues are mainly from value co-creation strategy, the indicators found were turn over capital, client s business knowledge and participation in strategic clients purchases. 4. SUMMARY AND CONCLUSION The rapidly changing nature of supply and distribution channels due to new technologies; globalization; and the increasing power of the consumer; have resulted in the need for new measures of channel performance. Researchers including Kumar et al (1992) and Spriggs (1994) have all called for the development of new measures of channel performance yet not much work has been done to conceptualize the performance construct or to develop criteria for selecting performance measures. A comprehensive review of the channels literature shows that mostly financial measures have been used to measure channel performance although financial measures have come under a lot of criticism in the academic literature (eg KAPLAN and NORTON, 1996; RUST et al. 2004). Using theoretical perspectives of organizational performance this paper develops a typology of performance measures, made up of both financial and non financial measures. The authors also link this typology of performance measures to three different types of governance forms to develop a framework that can be used to select performance measures under different governance conditions. The paper argues that different governance forms are a reflection of the different types of value that companies look for in a relationship and to effectively assess the extent to which a company has captured the different types of value, they will use different performance measures. This paper makes two primary contributions. First, the paper develops a typology of channel performance measures that includes both financial and non financial measures. This typology provides managers and academics with a comprehensive classification of channel performance that they can use to develop a more holistic view of the performance of their channel. Second, it creates a framework that helps practitioners and academics alike to determine the most effective performance measures to select under different channel conditions. This paper is a preliminary effort to create a typology of performance measures in the channels literature and also to develop a criterion for the selection of channel performance measures. Further research needs to be conducted to empirically test the propositions developed in this paper. More research should also be conducted on channels performance to help researchers and academics alike develop more measures of channels performance (both financial and non-financial) that can overcome the limitations of existing financial measures. REFERENCES ACHROL, Ravi S and ETZEL, Michael J (2003), "The structure of reseller goals and performance in marketing channels," Academy of Marketing Science. Journal, 31 (2), AL-ZUBAIDI, Hassan and TYLER, David (2004), "A Simulation Model of Quick Reponse Replenishment of Seasonal Clothing," International Journal of Retail & Distribution Management, 32 (6),

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