Salesforce Compensation with Inventory Considerations

Abstract

W e study a scenario in which a firm designs the compensation contract for a salesperson who exerts unobservable effort to increase the level of uncertain demand and, jointly, the firm also decides the inventory level to be stocked. We use a newsvendor-type model in which actual sales depend on the realized demand but are limited by the inventory available, and unfulfilled demand cannot be observed. In this setup, under the optimal contract, the agent is paid a bonus for meeting a sales quota. Our key result is that it may be optimal for the firm to stock more than the first-best inventory level, because this enables the firm to obtain a more precise indicator of the salesperson's effort. The possibility of stockouts due to limited inventory also leads to several counterintuitive results, including the following: (i) relative to when stockouts are not considered, it may be optimal for the firm to pay a higher bonus even though limited inventory constrains sales; (ii) as inventory becomes more expensive, thereby forcing the firm to lower its inventory, the firm may nevertheless pay the agent a higher bonus; and (iii) if there is a lower probability that the agent's effort exertion leads to high demand, rather than lowering inventory due to the lower sales potential, the firm may increase inventory.

The impact of operational decisions on the design of salesforce incentives

“…The authors in [22] find that, similar to the result of [30], the retailer should provide a higher service level to increase the benefit and consequences of learning from uncensored demand information (the so-called "information stalking"). In a single-period salesforce design problem with inventory consideration, [14] also investigates the demand censoring effect and shows that the firm needs to stock slightly more than the usual level, because it helps the firm to gain a better prediction of the agent's hidden effort. The authors of [14] also show that the presence of stockouts may lead the firm to offer higher bonuses to the agent even though the inventory might be limited.…”

“…In a single-period salesforce design problem with inventory consideration, [14] also investigates the demand censoring effect and shows that the firm needs to stock slightly more than the usual level, because it helps the firm to gain a better prediction of the agent's hidden effort. The authors of [14] also show that the presence of stockouts may lead the firm to offer higher bonuses to the agent even though the inventory might be limited. Unlike our work, in the analytical setting of [14], demand and the agent's effort only take discrete number of values, and the compensations are quota-based.…”

“…The authors of [14] also show that the presence of stockouts may lead the firm to offer higher bonuses to the agent even though the inventory might be limited. Unlike our work, in the analytical setting of [14], demand and the agent's effort only take discrete number of values, and the compensations are quota-based. Ref.…”

Financing Capacity Investment Under Demand Uncertainty

“…Our paper also builds on the principal-agent literature with risk-neutrality and limited liability (e.g., Oyer 2000, Poblete and Spulber 2012, Gromb and Martimort 2007 and more specifically that on agency in capacity choice models, notably Dai and Jerath (2013b) and Dai and Jerath (2013a).…”

“…In particular, Dai and Jerath (2013b) study a capacity choice model in which an employee must be induced to take a demand-enhancing action. They show that capacity in excess of the efficient level may be optimal for a reason akin to the demand elicitation effect in our analysis.…”