Incentive Design for Operations-Marketing Multitasking

57 Pages Posted: 29 Aug 2018 Last revised: 12 Mar 2019

See all articles by Tinglong Dai

Tinglong Dai

Johns Hopkins University - Carey Business School

Rongzhu Ke

Hong Kong Baptist University - Department of Economics

Christopher Ryan

University of Chicago - Booth School of Business

Date Written: March 11, 2019

Abstract

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

Dai, Tinglong and Ke, Rongzhu and Ryan, Christopher, Incentive Design for Operations-Marketing Multitasking (March 11, 2019). Available at SSRN: https://ssrn.com/abstract=3235866 or http://dx.doi.org/10.2139/ssrn.3235866

Tinglong Dai (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://carey.jhu.edu/faculty/tinglong-dai-phd

Rongzhu Ke

Hong Kong Baptist University - Department of Economics ( email )

Hong Kong

HOME PAGE: http://econ.hkbu.edu.hk/eng/faculty/admin-details.jsp?id=rongzhukeHKB&cv=00069&cid=186&cvurl=

Christopher Ryan

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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