Incentive Design for Operations-Marketing Multitasking
57 Pages Posted: 29 Aug 2018 Last revised: 12 Mar 2019
Date Written: March 11, 2019
A firm hires an agent (e.g., store manager) to undertake both operational and marketing activities for a product. Marketing activities boost demand, but for demand to translate into sales, operational effort is required to maintain adequate inventory. The firm designs a compensation plan to induce the agent to put appropriate effort into both marketing and operations, with the additional challenge of “demand censoring” (i.e., demand in excess of available inventory is unobservable). We formulate this incentive-design problem using a moral hazard principal-agent framework with a multitasking agent subject to a censored signal. We develop a bang-bang approach, with a general optimality structure applicable to a broad class of incentive-design problems. Using this approach, we characterize the optimal compensation plan, with a bonus region resembling a “mast” and “sail,” such that a bonus is paid when either all inventory above a threshold is sold or the sales quantity meets an inventory-dependent target. This structure implies nonmonotonicity where the agent can be less likely to receive a bonus for achieving a better outcome. Furthermore, we find the relationship between inventory and demand outcomes can be either complementary or substitutive in the optimal compensation plan. With practical implementability in mind, we approximate the optimal mast-and-sail contract by seeking simple contracts resembling it. We find a type of monotone contract without a “mast” can perform well, but only if the “sail” properly reflects the inventory-sales relationship. By contrast, simple contracts with both a “mast” and a linearized “sail” consistently achieve near-optimal performance.
Keywords: marketing-operations multitasking, retail operations, moral hazard, bang-bang control
JEL Classification: C61, D82, D86, J33
Suggested Citation: Suggested Citation