Agency relationships in distributor marketing viewed through transaction-cost analysis lens.

1. Mark Bergen, Shantanu Duytta &
Oroville C. Walker, Jr.
Journal of Marketing, July, 1992
Presented by: Doroteia Văduva, Yenita Mulia, and Theodore Hile
MF455 Distribution Strategies
November 5, 2010

2.  May improve understanding of—
• Why organizations exist
• How organizations work
• This viewpoint may be arguable, however...
 What is clear:
• Agency theory is applicable to marketing
management

3.  Anagency relationship is present when
one party is dependent on another for
some action on the Principal’s behalf.

4.  The hiring firm, or manager representing
the owner’s interests, is the Principal.
 The employee is the Agent.
 Multiple
employees in multiple levels within
marketing organizations require
management of agency relationships.

5.  Facilitating
agencies—specialists in
implementation of marketing programs:
• Advertising agencies
• Public warehouses
• Research suppliers
 “Exchange-transaction” facilitators:
• Wholesalers
• Retailers
• Franchisees
• ...and even...customers!

6.  Agency theory uses metaphor of “contract”
to describe relationships where one party
delegates work to another
 Focus of theory is on determining the most
efficient contract to govern the relationship,
given participant nature and any
uncertainty in environment

7.  “Contracts” can be either....
• Formal and explicit, written documents
• Informal and implicit, “social contracts”
 Over-riding assumptions—
• Efficiency is determined from the Principal’s point
of view
• The Principal is the dominant party in the
relationship
• Contracts are implemented to deliver the best-
possible outcome for the Principal

8.  Pre-Contractual problems—
• Focused on Agent capabilities, skills
• Principal seeks to determine Agent suitability
• Principal must use good judgment and good
information strategy to make Agent-selections
• Environmental conditions and uncertainty are
constraints on action and solutions
• Goal: Develop framework for dealing with
problem of “hidden information”
 This is “Hidden Information Model”

9.  Post-Contractual problems—
• Occur after contract-relationship is created
• Concerns about Agent performance and rewards
• Motivation toward Principal’s goals important
• Information system for Agent evaluations essential
• Creating appropriate Agent compensation and
incentive programs--
• Goal: Address problem of “hidden action”
 This is “Hidden Action Model”

10. Post-Contractual Issues
between Principal and Agent
in Marketing Management

11.  Assumptions about Principal and Agent—
• Both are motivated by self-interest
• Both are interested in maximizing profits/utility
• It is possible to include social goals in this context
(“the double bottom-line”)
 Principals have incomplete information
• Principal’s knowledge of Agent actions imperfect
• Self-interested Agent holds information Principal would
like to have—
• Self-interested Agent may be reluctant to share data,
may send false information to Principal

12.  Realized outcomes are—
• Partly determined by environmental factors:
 Competitor’s actions
 Technological changes
 Agent behavior
• Uncertainty is present because...
 Factors change over time
 Changes are difficult to predict
 Changes are outside control of Principal and Agent
• Uncertainty makes it impossible to craft a good
contract with minimal risk to Agent

13.  Agent acts to maximize his/her utility by
choosing the best action available
 Action may conflict with Principal’s goals
• Principal’s desired actions may be costly to Agent
(in terms of time, resources, effort)
• “Shirking” is a risk when Agent’s own goals conflict
with Principal’s desires
 Thereare two possible paths to follow to
gain Agent’s action toward Principal’s
desired goals...

14.  Monitoring Agents...
• Principal can monitor and reward Agents based on
information about their behavior--
 Call reports, attaining other activity goals
 Sales-related activity (presentations, etc.)
• Drawbacks to this approach--
 Quality of activity can be questionable
 Collecting information can be costly
 Information asymmetry can still inhibit most efficient
contract performance

15.  Motivating Agents:
• Principal can motivate Agent with rewards biased
toward performing actions with —
 Higher realized profits or better sales-volume outcomes
• Necessary conditions--
 Goals must align with individual rationality of Agent
 Desired activity payoff must be enough to beat
reservation utility of other opportunities
 “Feed the dogs what they will eat”—this is incentive
compatibility (Agent and Principal both get what they
want)

16.  Ultimate Principal’s goal:
• Design a contract that will obtain the “constrained
best” outcome that is incentive compatible for the
Agent
 Problem:
• Outcome based contracts shift substantial risk
from the Principal to the Agent...
• This can be costly for the Principal if the Agent is
highly risk-averse

17.  Heart of “Hidden Action” model problem—
• Designing a contract that provides an efficient
trade-off between:
 Costs associated with shifting risk to Agent...
 Reducing probability of Agent’s “shirking”...
 The solution is dependent on level of environmental
uncertainty, and...
 ...tasks assigned to Agent, and...
 ...goals and risk preferences of the two parties

18. Pre-Contractual Information Asymmetry
between Agent and Principal
in Marketing Management

19.  Tackles problems arising from—
• Information asymmetry between Principal and
potential Agent
• Occurs prior to establishing a contractual
relationship
 The Principal knows:
• Nature of tasks Agent must perform
• Personal characteristics Agent needs to perform
those tasks
 Problem:How does a Principal establish
whether an Agent has desired traits?

20.  Screening potential Agents—
• Observe sales personnel in action
• Administer aptitude tests
• Gain references from others about Agent
• Appoint Agent and evaluate performance later
 Potential Drawbacks:
• Adds to costs of acquiring Agents
• Hiring wrong Agent leads to unsatisfactory
outcomes
 While screening is costly, it may be
efficient compared to costs of a hiring
mistake

21.  Agent action—”Signaling”
• Potential Agent may perform actions showing “he
is right for the job”
• Actions must meet criteria of—
 Individual rationality
 Incentive compatibility
 Agent must be (in the end) better-off than if he/she had
done nothing
 Potential Drawbacks—
• Agent may send false signals
• Signals may not be clear/strong/precise enough
for differentiating among Agents

22.  Principal
Action—providing for Self-
Selection:
• Principal can invite signals from Agents that may
be available
• Other choices can be constructed that induce
potential Agents to apply for consideration

23. The Design of
Appropriate Agent Governance
and Control Mechanisms

24.  Possesses some commonality with
“Hidden Action Model”—
• However— narrowly focused on intra-
organizational control structures
• Concerned primarily with corporate managers,
and inducing behavior consistent with goals of
firm’s stakeholders
• Assumes Agents are risk-neutral instead of risk-
averse
• This assumption is also found in transaction cost
economics

25.  This model provides guidance on—
• Design of compensation plans for marketing
executives
• Contingent compensation plans involving stock or
option plans are effective
• Compensation plans with bonuses tied to
performance are effective
• These plans motivate executives to behave in
accord with a firm’s strategic objectives and
positively related to shareholder wealth

26. Some commonality, and some differences

27.  Both concepts aid our understanding of
economic organization
 Both concepts examine efficiency in
functional relationships
 Both theories assume actors are spurred
by self-interest and can engage in
opportunistic behaviour
 Both theories include outside variables
(asset specificity, risk preference)

28.  Unit of analysis:
• TCA uses the “transaction” as its unit--
 Analysis of how transactions differ
 Implications of differences for designing structures
 These items get little attention in agency theory
• Agency theory uses the individual Agent—
 Impact analysis of differences across different Agents
 Emphasis on “hidden information” model
 Use of “hidden action” model for designing incentives

29.  TCA emphasizes ex post transaction
costs arising out of “incomplete contracts”:
• Costs in transactions that are not well-aligned
• “Haggling” costs to remedy misalignments
• High costs associated with remedying disputes
• “Bonding costs” of securing firm commitments
• Reducing costs by aligning transactions with
proper governance systems is typical of TCA
• Newer work gives more attention to individual
agents and crafting incentives toward trust and
commitment

30.  AgencyTheory examines ex ante relations
between Principal and Agent:
• Proposes reducing ex post costs by ex ante
alignment of incentives
• Agency Theory pays little attention to costs from
incentive maladjustment other than to allow for
realignments to price them out
• Newer work focuses more attention on
“incomplete contract” problem, seeks ex ante
alignment of incentives

31. Sales force management,
Channel Coordination and Control,
Promotion and Market Signaling

32.  SalesManager—Salesperson link is
categorized as an agency relationship:
• Hiring, Controlling, Motivating sales personnel are
appropriate agency-theory issues
• Biggest issue in agency theory: Creating most-
appropriate compensation plans for sales
personnel
 Salary:Commission ratio lower in high-uncertainty
environment where salesperson is risk-averse
 Salary:Commission ratio higher in environments where
higher levels of non-selling activity is needed

33.  Compensation systems for different
salesperson career-cycle stages:
• Early-career, high-risk sales environments
• Mid-to-late career, risk-averse sales personnel
 Differentcompensation plans for different
kinds of selling jobs:
• Maintaining existing accounts
• Prospecting for new business, new product ideas
• “Hidden Information” model may give insights into
better employee selection, training

34.  Different reward systems:
• Pay plans based on relative performance vs.
plans based on absolute performance measures
• Job promotions, sliding-scale commissions,
bonuses, group-based incentives
• Use of mixtures of incentives
 Use of different sales channels:
• Use of sales agents, manufacturer’s reps vs.
internal sales force
• Segmentation based on customer type or range of
products used

35.  Measurement of:
• Environmental uncertainty
 Risk preferences
 Separating risk from other salesperson decisions
• Reservation utility
 Impact of availability of other jobs on salesperson
choices
• Goals and risk preferences of salespeople
 Different compensation plans for different areas of the
enterprise

36.  Distributionchannel = set of agency
relationships
 Resellers provide:
• Shelf-space
• Local advertising
• Point-of-purchase promotion
• Implementation of effective pricing strategy
 Allocation
of rewards of the relationship
can be problematic, prone to conflict

37.  Manufacturerscontrol resellers with
incentives compatible with firm’s goals:
• Pricing mechanisms--
 Quantity discounts
 Special transportation or payment terms
 “Two-part tariffs” with fixed franchise fee
• Constraints on reseller actions—
 Specific sales territories
 Resale price maintenance (not legal in some places)
• Functional incentives—
 Co-op ads, promotional allowances

38.  Other efficient control methods:
• Franchising agreements--
 These work best in uncertain environments where
monitoring reseller performance is difficult
 Increase in margin offered by direct ownership of outlet
is offset by efficiency of franchise operator
• Other mechanisms worth consideration as
channel-partner power grows—
 Better quantity discount schedules can help partner
coordination
 Allow resellers bargaining opportunities

39.  Much previous research work is static—
• Dynamic elements should be considered to
understand appropriate incentives in shifting
conditions
 Most agency models assume a single
Principal—
• Models should consider competitive issues that
occur when many Principals deal with a single
Agent

40.  Most Agency Theory models assume
resellers have no power in dealing with
Principals—
• Scanners, computerized inventory management,
(and now) the power of Web-based research tools
give both resellers and consumers power that is
skewed away from Principals
• Published work (ca. 1992) had not dealt with this
shift in power relationships

41.  As
in Sales Force Management, there are
Channel issues in measurement of:
• Environmental uncertainty--
 Risk tolerance, separating risk from Agent choices
• Reservation utility--
 Impact of presence of other options for Agent choices
• Goals and risk preferences of Agents--
 Different compensation plans for different territories or
market segments open to the reseller
• Use of secondary data impedes progress of
research efforts, measurements are imprecise

42.  Consumers seek data on alternative
brands when making buying decisions
 Information comes from—
• Manufacturers
• Distributors
• Retailers, others competing for customers
 Crucial question:
• Are costs and revenues associated with promotion
valid and efficient for signaling differentiated high
quality from lower-quality competitor offers?

43.  Agency models suggest “bigger is better”
in advertising spending to signal higher-
quality brands
 Greater ad-spending also supports higher
prices
 This has been shown to be an efficient
signal of product quality in worlds with both
“hidden information” and “hidden action”
problems

44.  Price
premiums can signal product quality
when:
• Product quality cannot be assessed prior to
purchase
• Prospective customers are quality-conscious
• Seller does not have a well-established reputation
for quality
 Thiscan be encouragement for
manufacturers to maintain product quality
over time

45.  Signals of product quality—
• Many have been examined
• Full consideration of all promotional tools available
to marketers is not complete
• Combinations of tools may offer value
 Other potential tools (variable in value):
• Extensive warranties (potential hidden action
problem inherent here)
• Consumer promotion with joint branding
 Price-Qualitysignals may change over
time as information levels improve

46.  Promotional tools may be useful for
shaping future consumer behavior
 Agency theory assumptions about
advertising efficiency ignore—
• Perception of brand image
• Product positioning
• ...other psychological factors impacting efficient
information transfer (encoding/decoding errors,
etc.)

47.  As
in Sales Force Management and
Channel Control and Coordination...
• It is problematic to operationalize and measure
the effects of promotional tools
• Product quality measurements, and the validity of
pricing signals, while important as benchmarks,
can be subjective in nature
• Objective measurement tools are needed

48.  International Marketing:
• Cross-cultural issues magnify uncertainty,
information asymmetry, and agent monitoring
• Research (to 1992) looked only at licensing and
direct investment issues
 Industrial Buying Behaviour:
• Uncertainty and risk are higher here due to limited
number of players and technical information
issues
• “Hidden Information” and “Hidden Action” issues
can find happy homes here

49.  Advertising Agency Issues:
• Relationships between firms and advertising
agencies pose a number of agency problems--
 Excessive agency turnover
 Inadequate screening and selection processes?
 Poor signals of agency quality?
 Disagreements over objectives, development of
conflicting accounts
 Inefficient incentive and control systems for agencies
 Outcome-based evaluation of advertising campaign success
as alternative to traditional commission structure?
• Another fertile field for investigation....

50.  Agency theory seems most useful:
• In examining situations with factors unique to the
theory,
• Where those factors make contracting-with and
controlling Agents especially difficult.
 Theory is best used where—
• Goal conflict exists between Principal and Agent
• Uncertainty is fairly high, triggering risk-sharing
• Information asymmetry is substantial
• Evaluating performance is difficult

51.  As an economic theory, Agency Theory is
relatively simple and dominated by price
theory and self-interest considerations—
• This may not capture all the human dimensions of
action and marketing behaviour phenomena
• There is a lack of rigourous testing (ca. 1992),
which leads to questions about the theory’s
validity and its general applicability
• Measurement issues complicate these
shortcomings

52.  Agency Theory problems can be...
• Opportunities for market researchers to add to
development of theory
 Agency-theory constructs—
• are only partial views of the world
• combining them with marketing competencies
offers potential enhancements for both
 Between marketer creativity and applied
measurement expertise, there is potential
for improved agency theory validation

53. Thank You
for your kind attention.