GLENN B. VOSS, MITZI MONTOYA-WEISS, and ZANNIE GIRAUD VOSS* In this study, the authors integrate theories of innovation diffusion, relational exchange behavior, and organizational learning to explain the roles of innovation, product exploration experience, promotion, and market sophistication in determining firm performance. They test the research questions using objective measures of financial performance from a sample of 124 firms in the nonprofit professional theater industry. The results suggest that the independent variables interact in systematic ways to influence firm performance across two different customer segments: relational and transactional. The findings lend empirical support to two theoretical perspectives that have received little prior empirical examination: (1) Innovation performance is determined by characteristics of the overall marketplace and target market segments, and (2) product exploration experience enhances organizational learning and performance.
Aligning Innovation with Market Characteristics in the Nonprofit Professional Theater Industry Research suggests that innovative firms outperform their competitors in terms of market share and profitability (Leonard-Barton 1992), but empirical research to date has failed to consider fully the importance of aligning innovation and marketing strategies with external market characteristics. A key challenge is to develop an optimal level of innovation within a multiproduct portfolio that targets a multisegment market. From the firm’s perspective, the portfolio should balance exploration of new competencies with the exploitation of current competencies. From the market’s perspective, the portfolio should provide distinct and varied offerings that satisfy dynamic and heterogeneous markets. Achieving the appropriate balance of innovation within the product portfolio can influence firm performance directly and indirectly. A direct and immediate impact arises from matching the innovativeness of the firm’s current product portfolio with the characteristics of the marketplace and the firm’s target market segments. Product explo-
ration activities also produce intangible learning outcomes that may have future, indirect effects on firm performance (Leonard-Barton 1992). Although theory links cumulative organizational exploration and knowledge accrual to competitive advantage and superior performance, to date, little research has successfully operationalized and tested this link. We address these issues by examining the impact of innovativeness on firm performance in the context of the overall product portfolio. To explore strategic fit between innovativeness and the marketplace, we incorporate the overall level of market sophistication and performance in two distinct customer segments: relational and transactional. We extend prior research by examining indirect learning effects associated with product exploration. The resulting model captures curvilinear and moderated relationships between market segment revenues and the level of product portfolio innovativeness, promotion expenditures, and product exploration experience. In the following sections, we present the conceptual model, describe an empirical study that features objective, firm-level data for 124 firms in a creative industry marked by dynamic and perishable products, and discuss the theoretical and practical implications of our findings.
*Glenn B. Voss is a visiting associate professor, Kenan-Flagler Business School, University of North Carolina, Chapel Hill (e-mail: Glenn_Voss@ unc.edu). Mitzi Montoya-Weiss is a professor, College of Management, North Carolina State University (e-mail:
[email protected]). Zannie Giraud Voss is an associate professor, Department of Theater Studies, Duke University (e-mail:
[email protected]). This material is based on work supported by the National Science Foundation (Grant No. SES0217874). The authors also thank Theatre Communications Group for its support.
© 2006, American Marketing Association ISSN: 0022-2437 (print), 1547-7193 (electronic)
CONCEPTUAL FRAMEWORK By integrating theories of innovation diffusion, relational exchange behavior, and organizational learning, we propose that performance is influenced by the fit among the product
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Nonprofit Professional Theater Industry portfolio characteristics, market sophistication, the firm’s communication efforts, and individual segment characteristics. We also expect that accumulated product exploration experience enhances organizational learning and current product development activities and performance. We now develop our research questions more fully. Product Portfolio Innovativeness and Relational and Transactional Market Segments We define product portfolio innovativeness as the number of offerings in the current product mix that are new-to-theworld products compared with the number of existing, incremental products. We propose that firm behaviors and market segment characteristics influence the relationship between product portfolio innovativeness and firm performance. Firms rely on close interactions with current customers to identify and implement incremental improvements that move products ever closer to optimal levels of quality and cost. These close customer relationships enable firms to innovate along a path that is consistent with “business as usual” so that incremental innovation is the natural progression (Chandy and Tellis 2000; Christensen 1997). Although current customers may eventually adopt new-tothe-world products, these innovations tend to target emerging rather than existing market needs. On the demand side, customers adopt relational behaviors to reduce risk and simplify complex decisions, which implies that relational customers should prefer existing products and incremental extensions that build on the firm’s reputation and customers’ familiarity and trust in current products (Chandy and Tellis 2000; Golder and Tellis 1997; Sheth and Parvatiyar 1995). Relational customers may value a small amount of radical innovation that ensures variety and signals innovativeness. However, too much radical innovation would mitigate the choice- and riskreduction benefits of relational behavior and could undermine relational customers’ trust in the organization. Research suggests that transactional customers reject relational behavior and seek greater variety and actively experiment (Sheth and Parvatiyar 1995). Transactional markets likely include a higher proportion of product category innovators and early adopters, whereas relational markets include a higher proportion of the early and late majority. Thus, successful performance in transactional markets should require the development of more innovative product portfolios that attract innovative customers. Collectively, this suggests our first research question: RQ1: Does product portfolio innovativeness have (a) a curvilinear (inverted U-shaped) association with revenue from relational market segments and (b) a positive association with revenue from transactional market segments?
The Moderating Role of Market Sophistication Overall characteristics of the marketplace, particularly the degree of readiness to adopt an innovation, can also influence the relationship between innovativeness and firm performance. Market sophistication reflects the readiness of the overall marketplace to adopt innovation; sophisticated marketplaces exhibit more experience, activity, and involvement in the focal product category. Although sophistication can be conceptualized at a general level, the conceptualization of sophistication at the product-market level offers
297 greater insight. For example, New York might be among the most sophisticated markets for winter fashion, but Los Angeles might be more sophisticated for summer beachwear. Sophisticated markets recognize the benefits of innovations earlier and have higher expectations about innovationrelated benefits (Morrison, Roberts, and Von Hippel 2000). We also expect that sophisticated markets are more receptive to innovation and consume more new-to-the-world products than less sophisticated markets. This suggests that market sophistication moderates the impact of a firm’s product portfolio innovativeness on firm revenues, such that the relationship is more (less) positive in markets that are characterized as more (less) sophisticated. Our second research question is as follows: RQ2: Does market sophistication moderate (enhance) the relationship between product portfolio innovativeness and revenue from (a) relational and (b) transactional market segments?
Product Exploration Experience and Promotion Expenditures Firms accumulate product exploration experience when they engage in research and development, prototyping, market testing, and launching new-to-the-world products. Exploration is a probe-and-learn process that generates market feedback for the purpose of (re)directing the product development and marketing programs. Product exploration can lead to tangible benefits in the form of new product introductions and intangible benefits associated with organizational learning and the development of novel competencies (Miner, Bassoff, and Moorman 2001). Research indicates that organizations change their behaviors in response to learning experiences (Levitt and March 1988) and that exploration and exploitation are complementary activities (Cho and Pucik 2005). It follows, then, that accumulated product exploration experience should enhance current product development activities and performance and lead to more effective exploration of emerging-market needs as well as exploitation of current markets. This should translate into higher revenues from both relational and transactional markets. We summarize this reasoning with the following research question: RQ3: Does product exploration experience have a positive association with revenue from (a) relational and (b) transactional market segments?
Consistent with resource-based theory and related empirical findings, firm performance should be positively related to promotional expenditures on advertising, public relations, and personal selling. Product exploration experience also should enhance the positive association between promotion expenditures and revenues from both relational and transactional market segments. Exposure to new stimuli enhances knowledge flows to other activities (Moorman and Miner 1997; Schilling et al. 2003), so that learning associated with product exploration experience can spread to complementary marketing activities. Product exploration experience forces firms to experiment with and develop creative promotional messages that effectively sell new-to-theworld products. This probe-and-learn experience should ultimately lead to more effective promotion expenditures. This suggests the following research question:
298 RQ4: Does product exploration experience moderate the association between promotion expenditures and revenue from (a) relational and (b) transactional market segments?
THE RESEARCH PROGRAM We examined the research questions in the context of the nonprofit professional theater industry. To understand the relevance of this industry to innovation studies, it is important to distinguish between presenting theaters and the nonprofit professional theaters that we examined. Presenting theaters purchase performances of shows that are developed elsewhere and “trucked” in as a finished product (e.g., touring company of Phantom of the Opera), including stage managers, sets, and actors. The presenting house has no involvement in design and production and merely books the shows and markets them to local customers. Nonprofit professional theaters are involved in intensive new product development, introducing new plays approximately every six weeks. Consistent with Henderson and Clark’s (1990) conceptualization of incremental product modification, most are classic or contemporary plays that are based on an established script that prescribes core components (e.g., the play’s characters) and the linkages among these components (i.e., the plot). Nonprofit professional theaters also create new-to-the-world plays that may be adopted by other theaters or by commercial producers, who may develop them into film or Broadway projects. The theater may commission a play directly from a playwright and conduct preliminary readings and workshops—activities analogous to research and development and product prototyping—in which the playwright, director, designers, and actors improvise and suggest improvements. Consistent with Henderson and Clark’s conceptualization of radical product innovation, the development of new-to-the-world plays is an evolutionary process that involves ongoing improvisation and changes to the core components. Measures We implemented the empirical study in conjunction with Theatre Communications Group (TCG). As the largest service organization to the nonprofit professional theater industry, TCG collects fiscal and operating data from its member theaters and corroborates the reported data with external financial audits. The TCG survey provided objective measures for the number of product prototypes, new-to-theworld plays, incremental product modifications, promotion expenditures, and ticket revenues. These measures were taken from fiscal year 2001 operating data, with the exception of product exploration experience, which was operationalized over a two-year period from 1999 to 2000. Missing data reduced the sample size to 124 theaters, which averaged $5.2 million in annual revenue and $255,254 in net income, based on 314 performances, a seating capacity of 897, and an average ticket price of $22 in 2001. Descriptive statistics for the variables of interest appear in Table 1. Market segment revenues. We used objective revenue measures for two distinct market segments. Single ticket revenue comes from transactional customers who purchase tickets for a single performance. Subscriber ticket revenue comes from relational customers who prepurchase a package of plays, typically an entire season. Twelve theaters did not offer subscription packages, which reduced the sample
JOURNAL OF MARKETING RESEARCH, MAY 2006 Table 1 DESCRIPTIVE STATISTICS FOR VARIABLES OF INTEREST Variable Single ticket revenuea, b Subscriber ticket revenuea, b Promotion expendituresa Market sophistication Product portfolio innovativenessc Product exploration experiencec Single ticket price Subscriber ticket price Percentage of classics in the product portfolioc Product qualityd Population
M
SD
7.50 7.12 6.15 31.1 23.7 35.8 22.7 21.9
4.79 5.12 4.31 27.6 23.6 28.5 8.9 8.3
9.2 5.59 3.00 million
18.40 0.92 2.90 million
0
aWe express revenue and expenditure variables as dollars per available seat. Overall ticket revenue per available seat would be equal to single ticket revenue plus subscriber ticket revenue. These nonprofit theaters earned 40% of total revenue from ticket sales; other revenues came from contributions (49%); education and outreach (4%); royalties and investments (1%); and rentals, advertising, and concessions (6%). bThese are variables that we log-transformed to improve distribution before testing. cWe express these ratio measures on a scale of 0–100. dWe measured managing director responses to the following statements on a seven-point scale, anchored by “strongly disagree” and “strongly agree”: “The quality of our productions is significantly higher than that of our peer institutions,” and “The artistic elements of our productions are of the highest caliber.”
size to 112 for the subscriber ticket revenue analysis. To control for firm size effects, we divided the revenue measures by the theater’s total annual seating capacity, that is, the total number of seats available at all performances during the year. Product portfolio innovativeness. To operationalize product portfolio innovativeness, we first categorized the plays that theaters produced in the current year as follows: (1) New-to-the-world plays are those that have not been produced before, the rights to produce them are obtained directly from the playwright, and the production often involves the playwright making ongoing changes to the script during the rehearsal period; (2) incremental product modifications are plays that have been produced elsewhere, including contemporary plays (e.g., a recent Broadway success) or classics (e.g., a Shakespeare play). We operationalized product portfolio innovativeness as the percentage of new-to-the-world plays produced in the current year, that is, the number of new-to-the-world plays divided by the total number of plays produced in the current year. Promotion expenditures. Promotion expenditures included all expenses dedicated to increasing attendance and revenues, including advertising, direct mail, telemarketing, and personal selling efforts. We also divided promotion expenditures by total annual capacity to control for firm size. Product exploration experience. To operationalize product exploration experience, we summed the number of readings and workshops of new-to-the-world plays plus the number of new-to-the-world full productions in the prior two years. We then divided that number by the total number of productions during the same period to control for theater size. We included two years of reading and workshop activity because the cycle time associated with developing a new
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play from a reading or workshop to a full-scale production can take two to three years. We included full-scale productions of new-to-the-world plays to capture the experience associated with seeing new product development through to market introduction and rollout. Market sophistication. We used secondary measures of market sophistication that Money magazine compiled for its 2001 annual ranking of the “Best Places to Live in America” (see http://money.cnn.com/best/bplive/bplive_form. html). Rankings are available for a variety of categories, including an index compiled for the strength of the community’s arts programs, such as symphonies, theater, dance, and opera. This index assigned a score from 1 to 100 for each city. Scores for our sample ranged from 2 to 100. Control variables. We included five variables to control for current-year marketing-mix characteristics, market size, and selection bias. Current-year marketing-mix characteristics were the average ticket price for each segment, the percentage of classic plays included in the product portfolio, and the overall performance quality during the current season. We included quadratic terms for the price and percentage-of-classics variables to allow for curvilinearity. The theater’s managing director provided a two-item measure of product quality (α = .67). Market size was the local market population reported in the 2000 Census. Because larger theaters were more likely than smaller ones to provide complete data over the three years under examination, we implemented Heckman’s (1979) two-step procedure to control for selection bias. Using promotion expenditures, total expenditures, and product portfolio innovativeness as explanatory variables, we used probit regression analysis to create a selection control variable (i.e., the inverse Mills
ratio) that captures the effect of all unmeasured characteristics related to the selection decision. Testing Moderation Our research questions suggest that performance is determined by direct (linear and curvilinear) and moderating effects. To control for the possibility of parabolic curvilinearity, we included quadratic terms for all lower-order terms. The resulting model is as follows: (1)
Revenue = b0 + b1PPI + b2PPI2 + b3MS + b4MS2 + b5PPI×MS + b6PEE + b7PEE2 + b8PE + b9PE2 + b10PEE×PE + b11… CVs … + e,
where PPI = product portfolio innovativeness, MS = market sophistication, PEE = product exploration experience, PE = promotion expenditures, and CVs = control variables. We test RQ1 by examining direct and quadratic effects for product portfolio innovativeness (b1 and b2), RQ2 by examining the product portfolio innovativeness × market sophistication interaction term (b5), RQ3 by examining direct and quadratic effects for product exploration experience (b6 and b7), and RQ4 by examining the product exploration experience × promotion expenditures interaction term (b10). Results We present the results in Table 2 (significant effects are in bold for visual clarity). We subjected each model to a
Table 2 MODEL ESTIMATION RESULTS Subscriber Ticket Revenue
RQ1
RQ2 RQ3
RQ4
Intercept Product portfolio innovativeness Product portfolio innovativeness squared Market sophistication Market sophistication squared Market sophistication × product portfolio innovativeness Product exploration experience Product exploration experience squared Promotion expenditures Promotion expenditures squared Product exploration experience × promotion expenditures
Control Variables Average ticket price Average ticket price squared Percentage of classics in the product portfolio Percentage of classics in the product portfolio squared Product quality Population Heckman control factor Adjusted R2 N
Single Ticket Revenue
Coefficient
t-Value
Coefficient
.68 .14 –1.61* –.26 –.28 –.66 –.28 .97 .06** –.01** .06*
(1.43) (.30) (–1.76) (–.60) (–.38) (–.58) (–1.23) (1.26) (2.66) (–2.69) (1.69)
.75* –.61 1.45* –.04 –.63 2.41*** .33 .78 .11*** –.01*** .06*
(1.69) (–1.56) (2.02) (–.10) (–.95) (3.55) (1.63) (1.16) (5.23) (–3.39) (1.81)
.08*** –.01*** .62 –2.23*** .11* –.00 .62*
(8.61) (–4.85) (.93) (–2.41) (1.95) (–.10) (1.86)
.01* –.00 –.52 1.44* .12* –.06* .51*
(1.81) (–.81) (–.89) (1.75) (2.19) (–2.22) (1.86)
.75*** 112
*p < .05. **p < .01. ***p < .001. Notes: Significant results are in bold. We report unstandardized regression coefficients and t-values for each estimated path.
.42*** 124
t-Value
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residual analysis, which indicated no obvious outliers, homoskedasticity according to White’s test (p > .10), and normal distribution according to the Shapiro–Wilk W (p > .10). We now discuss the results for each market segment separately. RQ1a asked whether product portfolio innovativeness has a curvilinear association with revenue from relational market segments. The results indicate that the relationship is indeed curvilinear because the quadratic coefficient for product portfolio innovativeness in the analysis in which we used subscriber ticket revenue as the dependent variable is significant and negative. As we depict in Figure 1, Panel A, subscriber ticket revenue increases slightly as product portfolio innovativeness increases from 0, peaks around 25%,
and then decreases as product portfolio innovativeness continues to increase. We do not find support for RQ2a and RQ3a, but we can affirm RQ4a because the product exploration experience × promotion expenditures term is significant and positive. We conducted a split-sample subgroup analysis, which indicated that the relationship between promotion expenditures and revenue from relational markets is positive and linear when product exploration is high and curvilinear (an inverted U shape) when product exploration is low (see Figure 1, Panel B). This result is consistent with the notion of decreasing returns from promotion expenditures when product exploration experience is low but not when product exploration experience is high.
Figure 1 PLOTTING SIGNIFICANT QUADRATIC AND INTERACTION EFFECTS A: Plotting the Effect of Product Portfolio Innovativeness on Subscriber Ticket Revenuea
Subscriber Ticket Revenue
Subscriber Ticket Revenue
6
B: Plotting the Effect of Promotion Expenditures and Product Exploration Experience on Subscriber Ticket Revenue
5 4 3 2
6 5 4 3 2 1 4
1
6
8
10
12
Promotion Expenditures 0
25
50
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100 Low exploration
Product Portfolio Innovativeness
14 13 12 11 10 9 8 7 6 5 4 3 2 1
D: Plotting the Effect of Promotion Expenditures and Product Exploration Experience on Single Ticket Revenue
Single Ticket Revenue
Single Ticket Revenue
C: Plotting the Effect of Product Portfolio Innovativeness and Market Sophistication on Single Ticket Revenuea
0
25
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100
Product Portfolio Innovativeness Low sophistication
High sophistication
High exploration
14 13 12 11 10 9 8 7 6 5 4 3 2 1 4
6
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Promotion Expenditures Low exploration
High exploration
aIn our data, scores for product portfolio innovativeness ranged from 0 to 100; three theaters produced a season composed of 100% new-to-the-world plays. Notes: The vertical axes represent dollars per available seat.
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DISCUSSION Managing the firm’s innovation and marketing strategies involves balancing exploration and exploitation activities. Innovative customers may demand new-to-the-world products, whereas less innovative customers may prefer relational stability and incremental improvements. In the theater context, artistic directors may favor new-to-theworld plays that invite higher levels of creative expression, whereas managing directors, who are responsible for ensuring fiscal stability, may favor incremental over risky, radical innovation. This balancing act is complicated further if market sophistication determines acceptance of new-to-theworld products and if product exploration experience enhances organizational learning and performance. Our results offer new insights into the tensions inherent in balancing innovation and marketing decisions. The finding that revenue from relational markets is significantly lower for highly innovative firms is consistent with prior research that suggests that maintaining close relationships with customers can lead to core rigidities and inhibit innovation (Christensen 1997; Leonard-Barton 1992). The implication is that close relationships with current customers may stifle firm innovation and that high levels of innovation may compromise a firm’s ability to develop and maintain close, ongoing customer relationships. Conversely, firms competing in dynamic industries may be able to attenuate a competitor’s innovation advantage by building strong relationships with current customers. Close customer relationships may mitigate the tensions and uncertainty associated with directing an innovation strategy, while inducing inertia and reducing risk for both sellers and buyers. Our finding that product exploration experience enhances the association between promotion expenditures and rev-
enue from both transactional and relational segments lends empirical support to the theoretical views that exploration is a learning process (Miner, Bassoff, and Moorman 2001), that long-term competitive viability depends on the exploration of new competencies and markets as well as the effective exploitation of existing competencies and markets (Leonard-Barton 1992), and that exploration complements exploitation (Cho and Pucik 2005). We believe that intensive product exploration forces marketing personnel to develop creative promotional approaches and expertise because audiences have few, if any, reference points for new-to-the-world plays, compared with the level of audience familiarity with classics and contemporary plays. The finding that market sophistication moderates the acceptance of innovative portfolios by transactional but not relational customers is intriguing and deserves further study. We interpret this result to indicate that the relational customer base in this industry may be relatively similar across markets but that transactional customers in sophisticated markets are far more open to innovation. If accurate, this interpretation has widespread implications for the selection of markets for testing new product introductions and rollouts. It is worth noting the results for one of the control variables (i.e., percentage of classics in the product portfolio) because they complement the results for product portfolio innovativeness. We did not specify a research question for this variable, because it was not clear how the effects might generalize. The results indicate that relational customers respond to portfolios with some mix, but not a preponderance, of classics but that transactional customers respond more favorably to theaters that feature a program of 100% classics (see Figure 2). Coupled with the product portfolio
Figure 2 PLOTTING THE EFFECT OF PERCENTAGE OF CLASSICS ON SUBSCRIBER AND SINGLE TICKET REVENUE
Revenue
RQ1b proposed a positive association between product portfolio innovativeness and revenue from transactional markets, and RQ2b proposed that market sophistication would enhance that association. In support of RQ2b, the market sophistication × product portfolio innovativeness term is significant and positive, which means that the direct effect of product portfolio innovativeness on transactional market performance must be interpreted as being contingent on the level of market sophistication. To facilitate that interpretation, we plotted the relationship between product portfolio innovativeness and single ticket revenue for low- and high-sophistication markets (see Figure 1, Panel C), and we conducted a split-sample subgroup analysis. The analysis confirmed that product portfolio innovativeness has an increasingly positive association with single ticket revenue in sophisticated markets, but the association is nonsignificant in less-sophisticated markets. RQ3b proposed a positive association between product exploration experience and revenue from transactional market segments. It received weak directional support (p ≈ .05). Consistent with RQ4b, the coefficient for the product exploration experience × promotion expenditures term is significant and positive. A split-sample subgroup analysis confirmed that promotion expenditure is positively related to single ticket revenue in both groups and that product exploration experience enhances that positive effect (see Figure 1, Panel D).
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14 13 12 11 10 9 8 7 6 5 4 3 2 1 0
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Percentage of Classics Subscriber tickets
Single tickets
Notes: In our data, scores for percentage of classics ranged from 0 to 100; five theaters produced a season composed of 100% classics. The vertical axis represents dollars per available seat.
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innovativeness results, these results point to distinct preference patterns for relational and transactional segments. Whereas relational segments seek out generalists that offer a balanced portfolio of classics and innovations, transactional segments favor specialists that exclusively feature classical or (in sophisticated markets) innovative portfolios. In other words, relational segments seek variety from a single provider that offers a balanced portfolio, and transactional segments seek variety by patronizing different specialists. Collectively, our findings are consistent with research that integrates the resource-based view of the firm and the strategic market positioning perspective. The results point to two strategic patterns to direct the deployment of firmspecific resources to build positional advantages in specific product markets. A competitor that implements a prospector strategy should emphasize product exploration and innovation and target transactional customers in highly sophisticated markets. A competitor that implements a defender strategy should target relational customers and offer a balanced portfolio that features innovative, incremental, and classic products. Although our study demonstrates the value of incorporating market sophistication and performance in two distinct customer segments, the theaters in our sample also manage revenue streams from various other sources, including government agencies, corporate, foundation, and individual donors, and royalties from other producing organizations (Voss, Cable, and Voss 2000; Voss, Voss, and Moorman 2005). Fully capturing the tensions and conflict inherent in managing such divergent stakeholders will require increasingly complex conceptualizations that explore wide-ranging antecedents to various performance measures. In short, conceptualizations and models must capture the complexity of the manager’s world. REFERENCES Chandy, Rajesh K. and Gerard J. Tellis (2000), “The Incumbent’s Curse? Incumbency, Size, and Radical Product Innovation,” Journal of Marketing, 64 (July), 1–17.
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