Targeting and salesforce compensation: When sales spill over to unprofitable customers

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Author Information : Alex P. Thevaranjan, Martin J. Whitman School of Management, Syracuse University

Sumitro Banerjee, Grenoble Ecole de Management

Year of Publication : Quantitative Marketing and Economics (2019)

Summary of Findings : When sales spill over to unprofitable and unidentifiable customers, firms should adjust price and incentives to screen them out in some environments and simply accommodate them in others.

Research Questions : Why are some customers who are willing to buy the product at the price at which it is offered, unprofitable to serve?

When the firm decides to target the profitable customers, when and why do sales spill over to the unprofitable customers?

How should the firm modify the sales incentives and price to prevent a sales spillover?

Should the firm ever serve the unprofitable customers?

How should the firm modify the sales incentives and price if it wants to accommodate sales to the unprofitable customers?

What we know : It may seem that with the advances in information technology, a simple solution to the sales spill over problem is to facilitate salespeople to ‘spot and serve’ only the targeted customers. Such a strategy, however, suffers from several pitfalls.

First, turning away non-target or even unprofitable customers may be considered distasteful. “Dumping” non-target customers risks developing a notoriety as evidenced from a survey across industries such as IT, manufacturing, health care, finance, and professional services (Mittal et al. 2008).

More importantly, as typical under such situations, attempts to identify customer type creates incentives for non-target customers to masquerade which makes identification even harder to achieve.

This may lead to miss-categorization of customers across segments which in turn can damage a firm’s reputation even among its target customers.

In addition, in industrial markets, a customers’ valuation of a firm’s offering may change due to changes in the environment. That a high-value customer in one period may become a low-value customer in another makes it difficult to identify and target only high-value customers.

Consequently, identification using technology is unlikely to solve the spillover problem in many situations. Instead, we ask and address five research questions stated below.

Novel Findings : Lowering the price to solve the spill over problem is surprising and goes against the common wisdom to increase the price to drive out unprofitable customers. Such increase in prices however will also lower the units purchased by the target customers and make such a move sub-optimal, a surprise finding.

Novel Methodology : We incorporate into the traditional principal (firm) - agent (salesperson) model the purchase decision of a customer to address the spill over problem.

Implications for Practice : The prospect of targeting customers of higher profitability may drive firms to reach customer segments with higher profitability and employ salespeople with higher ability as a means to increase sales and charge higher prices. It may seem that the higher prices will automatically make the product unattractive to unprofitable customers.

In contrast, we show that these are the very conditions which also result in higher selling efforts that lead to higher prices. As such, the increase in utility from higher selling efforts more than compensates for the decrease in utility from higher prices, thereby attracting even the unprofitable customers to purchase the product.

This subtle effort-price trade-off that occurs while targeting profitable customers, going unnoticed in markets, may have caused the reported instances of sales spillover (e.g., in case of Starbucks, loans and mortgages, wine tasting, test drives and Best Buy).

Implications for Policy: A common reported tendency of firms facing the spillover problem is to resort to information technology as a means to ‘spot and serve’ target customers. However, as already mentioned in the Section 1, for various reasons such as disaffection among misidentified targets, attempts by non targets to evade identification, and ethics of discrimination, this approach is unlikely to succeed under many situations.

Another traditional approach to deal with this problem is to screen unprofitable customers by increasing the price. Indeed, in a market without a salesforce where no value-adding information is provided before every sales transaction, screening of unprofitable customers may be achieved by setting the price sufficiently high at which that they do not want to buy the firm’s product (e.g., Tirole 1988, Chapt. 3). In contrast, we show that when a firm hires a salesperson, such an increase in price is not the optimal way to screen the unprofitable customers. More importantly, we show that screening of unprofitable customers may not always be the optimal solution to the spillover problem.

Implications for Society: Refusing to serve unprofitable customers is not only socially undesirable but can also be economically sub-optimal.

Specifically, when the profitability of target customers and the ability of the salespeople are very high, such a socially preferable accommodation strategy is indeed the economically optimal solution.

This is because in this environment, the loss incurred from targeted customers by trying to screen the unprofitable customers is more than the loss incurred by accommodating the unprofitable customers.

Implications on Research: The problem of sales spillover beyond target customers is in fact more general. Our model can be easily extended to show that the problem may exist even in markets where firms do not have the freedom to set prices. In fact, the implication of our results extend even beyond the salesforce context. Wherever there is an outlay of pre-sales resources on every customer, it is possible that the spillover problem identified here could occur.

The paper also leads to several testable propositions for empirical research. First, unprofitable customers are more likely to be attracted to the firms offer when firms can monitor selling efforts than when they cannot. Second, when firms cannot monitor selling efforts, the spillover problem is more likely when the incentives are high-powered. Third, when spillover sales do occur, firms are more likely to screen out the unprofitable customers when the incentives and the fraction of profitable customers are at intermediate levels. Fourth, firms are more likely to accommodate unprofitable customers when the incentives are very high-powered and the fraction of profitable customers is fairly high.

The basic insights of this paper may also be further extended in several ways. We have considered a static (steady state) model where the customer’s intrinsic valuation is exogenous. A dynamic model where customer’s intrinsic valuation of a firm’s offer at any instance depends on her previous interaction with a salesperson of the firm may offer the firm an opportunity to “convert” unprofitable customers to profitable ones instead of costly screening which also reduces the sales to profitable customers as our paper suggests. Moreover, such a model may also shed light on how a firm should stagger sales incentives over time or alter the targeting strategy over time.

One of the reasons why the lows are unprofitable to serve is that they have the same sensitivity to selling efforts as the highs but a valuation for the product which is lower than the marginal cost of production. An interesting possibility to analyze is when customers who value the product lower place a higher or lower value on the selling effort. If customers having a lower valuation for the product place a higher value on the selling effort, on the one hand sales spillover may occur even at lower levels of salesperson’s ability. On the other hand, at higher levels of ability, sales to customers having a lower valuation of the product may even become profitable! Moreover, under such conditions, firms may be able to price discriminate to serve both types of customers, a possibility worthy of analysis.

Similarly, another interesting extension of this model would be to consider two customer segments having different but positive valuation of the product which are both greater than the marginal cost. The firm may then offer a menu of salesforce contract to price discriminate sales across the two segments of customers. While we have already shown that salesforce incentives can be used as instruments of targeting, it remains to be seen whether they can also be instruments for price discrimination.

Full Citations : Online version:
https://link.springer.com/article/10.1007%2Fs11129-018-9208-2

Printed version:
Banerjee S and A. Thevaranjan (2019). Targeting and Salesforce Compensation: When Sales Spill Over To Unprofitable Customers,
Forthcoming in Quantitative Marketing and Economics

Abstract : Targeting selling efforts towards profitable customers is widely known to increase sales and allow firms to charge higher prices. In this paper, we show that targeting of selling efforts may also inadvertently lead to sales spilling over to unprofitable customers when they are not identifiable. Such spillover sales are more likely when the ability of the salesperson and the profitability of target customers are above a threshold. We also show that firms can solve this problem by lowering the sales incentives as well as the price to make their offer unattractive to the unprofitable customers, a strategy commonly referred as screening. When the ability and profitability are both very high, however, the firm is better off allowing sales to unprofitable customers because the cost of preventing sales from spilling over is excessive. This is because the reduction in profits from the target customers that results under screening exceeds the loss from allowing sales to unprofitable customers. Such an accommodation strategy becomes more attractive as the fraction of unprofitable customers in the market decreases. Finally, we show that the spillover problem is even more acute when firms can monitor the selling efforts of a salesperson.

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When sales spill over to unprofitable and unidentifiable customers, firms should adjust price and incentives to screen them out in some environments and simply accommodate them in others.

Alex Thevaranjan

Professor Thevaranjan is an associate professor of accounting whose research revolves around agency theory and organizational control. The main contribution of his research has been in extending the principal-agent framework to study issues pertaining to ethics and effort allocation.
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