- 19 Nov 2010
- Working Paper Summaries
Do Bonuses Enhance Sales Productivity? A Dynamic Structural Analysis of Bonus-Based Compensation Plans
Executive Summary — Companies generally pay their sales staff with some combination of salary, commissions, and bonuses for meeting quotas-with sales force costs averaging about 10 percent of sales revenue in the United States. This paper aims to gain insight into the most effective way to design a compensation plan, concentrating on whether bonuses boost sales productivity and whether they should be awarded quarterly or annually. Research, focusing on the sales force of a large office supply company, was conducted by Harvard Business School professor Thomas Steenburgh and Doug J. Chung and K. Sudhir of the Yale School of Management. Key concepts include:
- Bonuses do increase productivity.
- Quarterly bonuses increase sales force productivity more than annual bonuses.
- Sales people tend to give up when far away from reaching a quota, but they don't slow down once a quota is reached-especially if a firm offers commissions for overachievement.
We estimate a dynamic structural model of sales force response to a bonus-based compensation plan. The paper has two main methodological innovations: First, we implement empirically the method proposed by Arcidiacono and Miller (2010) to accommodate unobserved latent class heterogeneity with a computationally light two-step estimator. Second, the bonus setting helps estimate discount factors in a dynamic structural model using field data. This is because, quarterly and annual bonuses help generate the instruments necessary to identify both discount factors in a hyperbolic discounting model. Substantively, the paper sheds insights on how different elements of the compensation plan enhance productivity. We find clear evidence that (1) bonuses enhance productivity, (2) overachievement commissions help sustain the high productivity of the best performers even after attaining quotas, and (3) sales people exhibit present bias consistent with hyperbolic discounting. Given such present bias, frequent quarterly bonuses tied to high demand end-of-quarter months serve as pacers to keep the sales force on track to achieve their annual sales quotas.