INDUSTRIAL ENGINEERING AND OPERATIONS RESEARCH

PRESENTS

IEOR MONDAY SEMINAR

MARCH 6, 2006

"When Are Stair Step Incentives Appropriate?"

Sunil Chopra

Kellogg School of Management

Northwestern University

ABSTRACT

The auto industry has offered stair step incentives to its dealers for many decades. Under a stair step incentive, the dealers make increasing margins as they sell more. For crossing certain thresholds, they are also rewarded with lump sum payments. We show that such incentive structures may be appropriate when dealers are exclusive work for only one manufacturer) and the manufacturer has a high cost of sales variance. Over the last decade, however, dealers in the United States have become less exclusive and now sell cars from competing manufacturers. We show that as dealers become non-exclusive, stair step incentives actually increase the sales variance for the manufacturer. We show that a manufacturer, whose sales are declining, may especially be better off by switching away from stair-step incentives to a linear incentive. Some support for the results comes from Ford switching away from stair step incentives to linear incentives in a recent announcement.

TIME AND LOCATION: 3:30 - 4:30 P.M. - 3108 ETCHEVERRY HALL

REFRESHMENTS WILL BE SERVED @ 3:00 P.M.