How to deal with unprofitable customers? A salesforce compensation perspective
AbstractWe show that prices and incentives recommended by the salesforce literature when targeting a profitable segment can attract unprofitable customers, particularly when salespeople have high productivity and low risk (i.e., risk aversion times uncertainty). Therefore, when customers are unidentifiable, unprofitable customers may also enter the market creating an adverse selection problem for the salespeople. By solving the moral hazard and adverse selection problems simultaneously, we show that firms can prevent the entry of unprofitable customers by “screening”. Although, screening generally requires a higher price to dissuade unprofitable customers, when firms hire salespeople, however, it requires lowering of both selling effort and the price. It also leads to a “sales trap” restricting the sales to the profitable segment to a fixed level. Screening, therefore, lowers firm profits obtained from the profitable customers. When salespeople are highly productive and risk tolerant, this drop in profit can be so high that “accommodating” unprofitable customers becomes the preferred strategy. Furthermore, the adverse selection problem intensifies and accommodation becomes more preferable when there is no moral hazard between firm and the salesperson. Behavior of unprofitable customers, therefore, must be an important consideration when targeting high-value customers and designing salesforce compensation.
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Bibliographic InfoPaper provided by ESMT European School of Management and Technology in its series ESMT Research Working Papers with number ESMT-13-05.
Length: 35 pages
Date of creation: 07 Jun 2013
Date of revision:
Salesforce compensation; target markets; adverse selection; screening; pooling; principal-agent models; agency theory;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-06-30 (All new papers)
- NEP-BEC-2013-06-30 (Business Economics)
- NEP-CTA-2013-06-30 (Contract Theory & Applications)
- NEP-HRM-2013-06-30 (Human Capital & Human Resource Management)
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