Unintended Consequences: How Suppliers Compensate for Price Concessions and the Role of Organizational Justice in Buyer‐Supplier Relations

• Published date: 01 September 2019
• Author: Scott DuHadway,Sengun Yeniyurt,John W. Henke,Steven Carnovale
• Date: 01 September 2019
• DOI: http://doi.org/10.1111/jbl.12205

Unintended Consequences: How Suppliers Compensate for

Price Concessions and the Role of Organizational Justice in

Buyer-Supplier Relations

Steven Carnovale

1

, John W. Henke Jr.

2

, Scott DuHadway

3

, and Sengun Yeniyurt

2

1

Rochester Institute of Technology

2

Rutgers University

3

Portland State University

“You get what you pay for”is one of life’s lessons that predominates in purchasing decisions individuals make in their personal lives.

The results of this study suggest this lesson should also prevail among management when price-related purchasing decisions in busi-

nesses are being made. An evaluation of over 1,700 purchasing instances across seven years of a longitudinal panel data set collected from Tier

1 production suppliers to the six major North American automotive Original Equipment Manufacturers (OEMs), Chrysler, Ford, General

Motors, Honda, Nissan, and Toyota, found that suppliers compensate for price concessions and price reduction pressure from the OEM in the

year following the concession, by reducing product quality, service support, and R&D expenditures associated with goods provided to the

OEM. This industry is particularly relevant because it is highly adversarial, yet at the same time reliant on interdependence. The results show

that supplier price concessions granted to an OEM led to compensatory supplier behaviors of reduced quality and R&D expenditures toward

that OEM. Further, the results suggest that the organizational justice dimensions of distributive justice, procedural justice, interpersonal justice,

and informational justice can ameliorate negative supplier compensatory activities. A buyer–supplier relational environment that engenders orga-

nizational justice tactics such as open and honest communication with suppliers provides suppliers the expectation of an acceptable return on

business over the long term, provides help to suppliers to reduce costs, and builds supplier trust of the OEM had generally positive effects on

quality, service, and R&D expenditures. From a management perspective, these results indicate there is a very real risk versus reward issue

associated with pressuring suppliers for price reductions.

Keywords: buyer supplier relations; price pressure; price concessions; equity theory; organizational justice

INTRODUCTION

A significant amount of research suggests that strong supplier

relationships can lead to positive outcomes. Buyers who maintain

good supplier working relations over time generate positive

returns on co-innovation for both buyers and suppliers (Yeniyurt

et al. 2014). Despite these benefits, firms often ask their suppliers

for price concessions, adding significant pressure to their rela-

tionships. Evidence further suggests that these higher supplier

price concessions/pressure can put collaborative relationships at

risk (Henke et al. 2009). For example, one study has shown that

manufacturers who exert price reduction pressures on their sup-

pliers in an adversarial manner in order to decrease costs,

increase margins, and maintain competitiveness, can cause stress

across their mutual working relationships (Henke and Chun

2010). The potential for this risk is not new and was recognized

over 90 years ago in a 1927 New York Times article (p. 18,

November 27, 1927) that reported a “Large Company Orders

Agents to Stop ‘Hard Buying,’” because “Company”executives

had come to the realization that “...any vendor supplying mate-

rial at a financial loss....is going to exhaust every means of

recouping that loss.”Terpend et al. (2008) substantiated this

belief 80 years later when their review of 151 buyer–supplier

relationship articles appearing in four prominent academic jour-

nals between 1986 and 2005 concluded that “.... practitioners

can be confident that pursing appropriate purchasing practices

will positively impact the bottom line.”More recently, Automo-

tive News Europe reported that “Partsmakers blame added price

pressure for deteriorating relations”(Stanley 2014). Furthermore,

from 2000 to 2012, during years of adversarial supplier relations

under Daimler and Cerberus management, Chrysler proceeded to

lose $2 billion annually (Henke et al. 2014).

This potentially negative impact on working relations is no

small matter. The importance of this issue becomes particularly

significant when it is realized that buyers, when pressuring their

suppliers for price decreases, concurrently ask the same suppliers

to increase product quality, increase service support, and increase

innovation/R&D (e.g., Zhang et al. 2009). Thus, the intersection

of reduced revenue (for the supplier) and increased product qual-

ity (for the OEM) renders a potentially tenuous buyer/supplier

relationship. Yet, research has yet to address suppliers’responses

to these perceived inequities in the buyer/supplier relational

dynamic. What becomes critical, then, is to identify the theoreti-

cal antecedents/mechanisms by which such adverse outcomes

can be mitigated or eliminated. Scholars have turned to equity

theory as a conceptual framework to understand supplier behav-

iors under similar conditions. Equity theory posits that actors will

consider the nature and distribution of inputs and outputs in an

exchange, determine whether or not the distribution is equitable,

and if it is not equitable, determine how to compensate for the

imbalance (Huseman et al. 1987). This theoretical lens has been

Corresponding author:

Steven Carnovale, Department of Management, Saunders College of

Business, Rochester Institute of Technology, 107 Lomb Memorial

Drive, Bldg. 12, Room 3336, Rochester, NY, 14623, USA; E-mail:

scarnovale@saunders.rit.edu

Journal of Business Logistics, 2019, 40(3): 187–203 doi: 10.1111/jbl.12205

© 2019 Council of Supply Chain Management Professionals

used to explain value creation (Wagner et al. 2010) and to

understand positive versus negative inequity in buyer–supplier

relationships (Coley et al. 2012).

Presently, the literature on suppliers’compensatory actions in

response to buyer price pressures is relatively scant. Overwhelm-

ingly, such work focuses on the conditions under which a supplier

would acquiesce and give a price concession (Henke et al. 2009),

rather than examining how a supplier will respond to such pressure

in other areas (i.e., what are the unintended consequences of price

pressure). Subsequently, this paper seeks to fill this gap by consid-

ering the following research questions: (1) In the presence of rela-

tional inequity(ies), do suppliers compensate by reducing the

quality, service, and R&D activities associated with goods that are

provided the buyer? and (2) What is the impact of buyer–supplier

working relations on such compensatory actions?

This study seeks to answer these questions by integrating equity

theory, organizational justice, and buyer–supplier relational

dynamics to understand the role working relations have on how

suppliers compensate buyers when faced with relational (i.e.,

equity) imbalances. In particular, the paper explores whether sup-

pliers respond to price concessions by decreasing their perfor-

mance in other areas. The results show that supplier price

concessions granted to an OEM lead to compensatory supplier

behaviors of reduced quality and R&D expenditures toward that

OEM. Further, the results suggest that the organizational justice

dimensions of distributive justice, procedural justice, interpersonal

justice, and informational justice can ameliorate negative supplier

compensatory actions. A buyer–supplier relational environment

that engenders organizational justice tactics such as open and hon-

est communication with suppliers provides suppliers the expecta-

tion of an acceptable return on business over the long term,

provides help to suppliers to reduce costs, and builds supplier trust

of the OEM had generally positive effects on quality, service, and

R&D expenditures. From a management perspective, these results

indicate there is a very real risk versus reward issue associated with

pressuring suppliers for price reductions.

LITERATURE REVIEW: EQUITY THEORY AND

BUYER–SUPPLIER RELATIONSHIPS

Equity theory

Equity theory, as an academic viewpoint, traces its roots back

nearly 60 years to the field of social psychology. The seminal

work in the field (see: Adams 1963, 1965) began with explo-

ration into the drivers of workplace dissatisfaction, with respect

to pay/compensation, and how to potentially mitigate the dissatis-

faction. Adams (1965) grounded the theory by examining “(1)

the nature of inputs and outcomes, (2) the nature of the social

comparison process, (3) the conditions leading to equity or

inequity and the possible effects of inequity, and (4) the possible

responses one may make to reduce a condition of inequity”

(Pritchard 1969:176). As originally conceptualized, inputs refer

to any factor either endogenous (i.e., appearance and age) or

exogenous (i.e., level of effort exerted and education) to the

social agent, which taken together affects how the aggrieved per-

son gains/perceives some personal return. Outcomes refer to

returns the social agent values (pay raises, bonuses, better work

schedules, etc.). Taken together, inputs and outcomes form a per-

ceived value ratio (i.e., inputs/outcomes), which enables the

direct comparison of the relative importance of the outcomes to

the inputs.

It is the perception of this “value ratio”that is at the heart of

equity theory. Specifically, the social comparison process occurs

between the value ratios of two social agents. When a social

agent comparing their value ratio to another agent’s value ratio

perceives their outcome is less than that of the agent against

whom the comparison is being made, then there exists an

inequity. If the outcomes are perceived as equal, then equity the-

ory suggests that equity exists in the relations between the two

parties. Although equity theory originated as a form of social

comparison between social agents, it has been shown to apply to

social comparisons made within a social agent as well. For

example, equity theory has been shown to apply when pay cuts

are initiated at an organizational-wide level (Greenberg 1990a).

In this case, though comparisons to other social agents remained

relatively similar, as the pay cuts were equitable at 15% for

every employee, the change in compensation triggered percep-

tions of inequity, which resulted in higher levels of theft. In

buyer–supplier relationships, comparisons that trigger equity the-

ory have been identified as both “‘I paid more than another cus-

tomer did,’which is a comparison between two price points, or

‘I paid more than I used to,’which is a comparison between a

price point and a price range”(Xia et al. 2004:2). Self-compari-

son serves as a natural extension of equity theory, as the infor-

mation necessary for comparing equity is immediately available

when comparing temporal changes to compensation. Further-

more, prior research suggests that self-comparison has a demon-

strable effect on behavioral changes (Greenberg 1990a).

The theoretical underpinning of (in)equity rests upon there

being cognitive dissonance between the expected outcome and

its actualization. This dissonance leads to one social actor feeling

as though “things did not go as expected”(Adams 1963:9). The

impact of such (in)equity has the potential to cause tension in

the relations of the social agents (Adams 1965). Such tension

leads one agent to seek remediation from the other to reduce or

eliminate the inequity (Pritchard 1969). Social agents can take

several avenues to reduce or eliminate perceived inequities that

generally fall into two overarching categories (Adams 1963,

1965; Pritchard 1969): internal and external responses. Internally,

that is, psychologically, the social agent can distort the percep-

tion of the inputs and/or outcomes to make the perception of the

outcome more palatable. Externally, the social agent can change

their inputs/outcomes or act to change the inputs/outcomes of the

social agent against which the comparison has been made.

Studies exploring supply chain relations and the equitable

distribution of rewards between exchange partners has been a

topic of inquiry for some time. The core question of most of

this research relates directly to the impact on the involved

firms and their supply chain relations when levels of (in)equity

are (low)high and how the firms/social agents the central tenet

to the research in this domain is to understand the role that

unbalanced perceptions of equity have on firms, as well as

supply chain relations and partners. At the firm level, equity

theory has elucidated the role that pricing plays in customer

satisfaction and brand loyalty, finding that inequity has a lar-

gely negative effect on these two constructs (Huppertz et al.

188 S. Carnovale et al.