Threshold Incentives and Sales Variance, Production and Operations Management
In this paper we analyze the impact of threshold-based incentive schemes, commonly used in the automotive industry, on both expected sales and sales variability. We model the effect of such incentives in two specific scenarios: an exclusive dealership selling products for only one manufacturer and a non-exclusive dealership selling products for multiple manufacturers. For an exclusive dealer we show that a threshold contract, with a positive bonus on crossing the threshold value, not only increases the expected sales, but more importantly, decreases the variance of the orders placed by the dealer. We show that if the manufacturer associates a positive cost with sales variance, a threshold-based incentive, with a positive bonus, is superior to other schemes without a bonus offering. We then show that manufacturers continuing to offer such incentives to non-exclusive dealers may experience increase in variance and a decrease in expected profits. This implies that when manufacturers must compete for dealer effort, threshold-based incentives can hurt manufacturers. In such instances it may be beneficial to switch to a constant margin incentive scheme.
Milind Sohoni, Sunil Chopra, Usha Mohan, Nuri Sendil
Sohoni, Milind, Sunil Chopra, Usha Mohan, and Nuri Sendil. 2011. Threshold Incentives and Sales Variance. Production and Operations Management. 20(4): 571-586.