Involving Sales Managers in Sales Force Compensation Design

Link: https://doi.org/10.1177/0022243720969174

For over 30 years, the dominant paradigm in sales force incentive compensation theory has involved a firm (principal) seeking to design an optimal compensation plan for a salesperson (agent) without being able to observe the salesperson’s selling effort. However, this treatment of the firm as a single decision-making entity masks the interesting and important role commonly played by sales managers, who hold valuable territory-level information and may benefit from misrepresenting that information given their own incentives.

The paper helps Chief Sales Officers answer two key questions about sales force incentive design:

1. How can a firm efficiently leverage a manager’s true knowledge?
2. What are the conditions under which involving the manager is optimal?

The proposed “request mechanism” offers an efficient, reliable alternative to approaches often used in practice to incorporate managerial input, such as internal negotiations and behind-the-scenes lobbying. The study then identifies the conditions under which this mechanism outperforms the well-established theoretical approach of offering the salesperson a menu of contracts to reveal territory-level information.

The proposed “request mechanism” offers an efficient, reliable alternative to approaches often used in practice to incorporate managerial input, such as internal negotiations and behind-the-scenes lobbying. The study then identifies the conditions under which this mechanism outperforms the well-established theoretical approach of offering the salesperson a menu of contracts to reveal territory-level information.

The study proposes a mechanism by which a firm delegates a salesperson’s incentive parameters to his manager subject to tight constraints, such as limits on the salesperson’s salary or incentive pay. The manager can submit a request to relax those constraints by meeting requirements imposed by the firm. Relaxed constraints always benefit the manager since they incentivize the salesperson to work harder, thereby increasing her own expected payout. However, the firm can always set the requirements for such requests such that the manager will make a request only when doing so is best for the firm given the available information. Thus, the firm can replace internal negotiations and lobbying with an efficient, reliable process that reveals the manager’s true information.

The findings provide the following key insights for Chief Sales Officers who are aiming to improve their sales force compensation design.

• When a firm is less informed than its sales managers about individual salespeople or their territories, the request mechanism is an efficient, reliable replacement for internal (e.g., top-down / bottom-up) negotiations.
• The request mechanism increases the firm’s expected profit when
  • the firm’s best possible menu of contracts results in some types of salesperson exiting and/or
  • the manager’s incentive pay is not too large.
• The request mechanism can entice the manager to invest in acquiring additional information when it most benefits both the manager and the firm.