12 Feb 2013Working Paper Summaries

Do Bonuses Enhance Sales Productivity? A Dynamic Structural Analysis of Bonus-Based Compensation Plans

by Doug J. Chung, Thomas Steenburgh and K. Sudhir

Personal selling is a primary marketing mix tool for most B2B firms to generate sales. Yet there is little research on how the compensation plan motivates a sales force and affects performance. This paper develops and estimates a dynamic structural model of sales force response to a compensation plan with various components: salary, commissions, lump-sum bonus for achieving quotas, and different commission rates beyond achieving quotas. Overall, the analysis helps assess the impact of (1) different components of compensation and (2) the differential importance of periodic bonuses on performance on different segments of sales people. Key concepts include:

A quota-bonus scheme used by a firm increases performance of the sales force by serving as intermediary goals and pushing employees to meet targets.
Features such as overachievement compensation reduce the problems associated with sales agents slacking off when they get close to achieving their quota.
Quarterly bonuses serve as a continuous evaluation scheme to keep sales agents within striking distance of their annual quotas.
In the absence of quarterly bonuses, failure in the early periods to accomplish targets causes agents to fall behind more often than in the presence of quarterly bonuses. Thus, a quarterly bonus serves as a valuable sub-goal that helps the sales force stay on track in achieving their overall goal.
Quarterly bonuses are especially valuable to low performers.
Overachievement commissions increase performance among the highest performers.

Author Abstract

We estimate a dynamic structural model of sales force response to a bonus based compensation plan. Substantively, the paper sheds insights on how different elements of the compensation plan enhance productivity. We find evidence that (1) bonuses enhance productivity across all segments, (2) overachievement commissions help sustain the high productivity of the best performers even after attaining quotas, and (3) quarterly bonuses help improve performance of the weak performers by serving as pacers to keep the sales force on track to achieve their annual sales quotas. The paper also introduces two main methodological innovations to the marketing literature: first, we implement empirically the method proposed by Arcidiacono and Miller (2011) to accommodate unobserved latent class heterogeneity using a computationally light two-step estimator. Second, we illustrate how discount factors can be estimated in a dynamic structural model using field data through a combination of (1) an exclusions restriction separating current and future payoff and (2) a finite horizon model in which there is no forward looking behavior in the last period.