23 Jun 2003  Research & Ideas

Building a Better Buyer-Seller Relationship

How do you turn short-term transactions into long-term relationships? Harvard Business School professor Narakesari Narayandas finds answers in mature industrial markets.

 

Buyers and sellers in mature industrial markets can turn single transactions into long-term beneficial relationships by a deeper understanding of the complex connection between the two, says Harvard Business School professor Narakesari Narayandas.

A "must-do" for the sellers, in particular, is to understand patterns of investment and reward, and effectively manage the process that defines the dynamics of buyer-seller evolution, according to Narayandas.

But how to do that?

New research he shared with other professors at the Faculty Research Symposium on May 20 described how he and other colleagues, including HBS professor V. Kasturi Rangan, have arrived at some answers for designing, developing, and managing long-term customer relationships. And this area is big business with a capital B: U.S. firms buy over $600 billion in industrial components a year, according to Narayandas and Rangan in a recent working paper.

In his talk, Narayandas explained how he has answered three questions that bedevil researchers:

1) From the supplier's viewpoint, does it pay off to be in long-term customer relationships?

2) If yes, how do you as the supplier get started?

3) If you the supplier are in an arm's-length transactional relationship, how do you move it into a fuller relationship?

For the first puzzle, Narayandas and Manu Kalwani of Purdue University teamed up for an empirical study later published in The Journal of Marketing. While other scholars examined customer benefits in great depth, there was only "pure speculation" about whether the suppliers benefited from a relationship, Narayandas said.

Even in long-term relationships, opportunism is always shown.
— Narakesari Narayandas

In their study, Narayandas and Kalwani created matched pairs of firms. They compared the firms' performance over six years. What they found: in the beginning of a relationship, suppliers enjoyed no significant difference in sales, inventory holding and control costs, gross margins, or return on investment.

But later, two of the numerous developments they saw included:

1) Suppliers increased sales over time. "If you get in with fewer customers for a long time, you get a greater share of wallet from the fewer customers" (as opposed to more mass market customers), he said.

2) Manufacturing costs went down. "Even in long-term relationships, opportunism is always shown. Customers still are opportunistic, customers still look out for themselves."

"The idea of that study was to answer the question, 'Does it pay off?' And the answer was yes." It is still the only study of supplier benefits to show empirical validation, he added.

Jump-starting a relationship

To explain how he came to answer question two—about starting a customer relationship from scratch—Narayandas first told his audience about the classic vendor-customer standoff. The vendor wants money first; the customer sits back with arms folded and replies, "Prove to me that you can do what you say."

To launch a long-term relationship, one party can "take the hit and wait it out"—usually the supplier, he said. This is what he dubbed the "all at once" approach. Or better, the supplier can attempt a "foot-in-the-door" approach, by skillfully managing the relationship.

"Rather than going after the entire volume, break up the needs into different parts, and try to initiate a relationship using one component, selling only this one component," he advised. For a foot-in-the-door product to be successful, it should boast five qualities, he said:

Modularity. There has to be a natural progression from one part to another—some connection.

  • Healing power. It has to solve an important, visible customer pain.
  • High quality. The supplier must be confident of its performance; there can be no problem. First impressions are the last impressions if they're not good ones, he said.
  • Ease of use. The customer has to be able to evaluate the product. Even if you're sure of the quality, if the customer doesn't understand what you're doing it's not going to work.
  • Fair price. It must not be too expensive for the customer.
I think the most underestimated factor in industrial or business marketing is buyer behavior.
— Narakesari Narayandas

"So you get in, and then if you do things right, what happens for the business? The customer calls you and wants to place an order. ... If you do it right, you also increase the scope of the relationship."

"This is how you can think about evolving a relationship. But does it work all the time? The answer is no," he said.

Sometimes the all-at-once approach is the only way to jump-start from zero, he observed. "I think the most underestimated factor in industrial or business marketing is buyer behavior," said Narayandas.

From transaction to commitment

To explain how he has come to answer question three—how to convert a customer from a transactional to a relationship orientation—Narayandas answered with a case and a research project.

The Wesco case is about a company whose business was very transaction-oriented—dealing in bulbs, wires, and connectors for contractors and industrial customers. Yet it managed to shepherd about a third of its customers into a relationship.

"The process always has to be initiated by supplier," Narayandas emphasized. As he learned in the Wesco experience, the road is bumpy at first. The distributor tells the customer, "I want to give you lower prices, which will come at the expense of my markets. What I want you to do is give me higher volumes." The customer, typically, does not offer higher volumes but instead begins to cherry-pick. The suppliers' costs, meanwhile, just go up. While the customer is getting more value, only one party—the distributor—is actually working at the relationship.

"But if you do things the right way, then there comes a day when the customer begins to see benefits," said Narayandas. "More importantly, the customer now begins to realize that taking a hands-off approach in the relationship is actually detrimental. Even the slightest effort they put in will lead to much more value for themselves.

"That's when they begin to invest. At some point, the customers begin to give more volumes." Wesco's costs began to go down, not just due to volumes but also efficiency. For the customers, value increased, thanks to price reduction and the fact that the customers began to see the value of collaboration.

Trust forms between people, between individuals. But commitment forms between firms.
— Narakesari Narayandas

"It doesn't happen from day one, much as you want it to," he said. "A lot of work and planning need to go into it. So make sure you get through the investment phase at the beginning—investing in skills and systems—and figure out how long to invest and pull out [if necessary]. In Wesco's case, about a third of relationships migrated through; two-thirds fell in the trap."

"The Wesco case shows that it's not just about the product. You also need to have an understanding of the pattern of investments, and more important, an understanding of the process of how relationships evolve over time," he said.

Buyer-seller evolution

To study how relationships evolve in mature industrial markets, Narayandas and HBS professor V. Kasturi Rangan took an in-depth look over time at three buyer-seller relationships, all in commodity markets. The three pairs represented different parts of the value chain: supplier-manufacturer, manufacturer-distributor, and manufacturer-customer.

"People have always argued that depending on where you are in the demand chain, the dynamics might be different. What we found is that there are many commonalities," he said.

Together they developed a process model of relationship development, described in their working paper, "Building and Sustaining Buyer-Seller Relationships in Mature Industrial Markets".

Previous work by other scholars had focused on two paths: competition, the study of how each actor leverages its own position ("with the obvious answer," according to Narayandas: "the more powerful you are, the more you're able to improve things for yourself in any contract"), and collaboration, the study of trust and commitment.

None of this work could explain how relationships that began as unbalanced, with one player holding most of the cards—as is typical in industrial markets—could evolve from adversarial to collaborative.

"In any relationship, the dependence that each side has defines the initial balance of power in the relationship," he said.

In their paper, they developed nine propositions and identified five processes. They found that the contract stage in industrial markets leads to a performance evaluation stage. Performance evaluation affects two elements: trust and commitment.

"The interesting thing we found, unlike what others have done in marketing, is that trust and commitment form at two different levels. Trust forms between people, between individuals. But commitment forms between firms."

A positive feedback loop can be the result. "Once people begin to trust one another across the buyer-seller firms, they begin to take actions that begin to achieve balances in the contract terms on a routine basis," he said.

Even though firms may start out on an uneven playing field, as they wrote in their paper, "We believe that less-powerful firms can structure and thrive in equitable relationships with more-powerful partners."

Ideally, it may even lead to a match made in business heaven.

Keys to Long-Term Relationships

by Narakesari Narayandas and V. Kasturi Rangan

In their working paper, Narayandas and Rangan advance nine ideas, or propositions, for long-term relationships in industrial markets. They also identified five processes such firms may undergo.

Nine propositions:

P1: The more-powerful party will not always seek a formal agreement that protects its power base; under certain circumstances, it will avoid a formal agreement that protects the weaker firm's power base.

P2: Formal safeguards pursued by the weaker party using its own power bases, because of Proposition 1, are likely to be only weakly enforceable.

P3: When buyers' and sellers' expectations are only loosely formed, extra-contractual efforts can help to frame them and jump-start a relationship.

P4: Performance outside an agreement can supplement, but not substitute for, performance within the terms of the agreement. That is, when expectations within the terms of a contract are met, extra-contractual efforts further enhance performance evaluation. When expectations are not met, extra-contractual efforts can, at best, only partially mitigate the other side's poor performance evaluation.

P5: Trust (or distrust) is formed between individuals on the two sides of a dyad, commitment formed and formalized at the level of the organization.

P6: Whereas trust between individuals facilitates the development of commitment at the organizational level, lack of interpersonal trust diminishes commitment of the respective organizations.

P7: Inter-organizational commitment might precede the execution of transactions, but its existence or lack thereof ensures neither the development nor destruction of interpersonal trust.

P8: Benevolent actions outside the terms of an agreement influence the development of trust and can catalyze a relationship to higher performance as long as the initial promises within the contract are perceived to have been fulfilled.

P9: Trust between two individuals in a dyad is not transferred automatically to other individuals in that dyad even when there are no changes in inter-organizational commitment.

Five processes:

Process A: Leveraging the relative positions and power of the two parties to define initial agreement terms.

Process B: Evaluating the other party's performance in a relationship and converting it to interpersonal trust and inter-organizational commitment.

Process C: The transfer of interpersonal trust to inter-organizational commitment.

Process D: The process by which increases in interpersonal trust result in a balancing of initial contract terms.

Process E: The process by which increases in inter-organizational commitment result in a balancing of initial power asymmetries.

Excerpted with permission from the HBS working paper "Building and Sustaining Buyer-Seller Relationships in Mature Industrial Markets" by Narakesari Narayandas and V. Kasturi Rangan, April 2003.