Optimal Salesforce Compensation with General Demand and Operational Considerations

Abstract

Problem definition: We investigate the optimal salesforce compensation scheme in the context of private information and unobservable actions, considering common operational factors encountered in practice, including inventory costs, contractible versus censored demand information, and controlled versus delegated ordering. Methodology/results: Based on an agency model with general demand and cost functions, we derive optimality conditions for implementable contracts that can achieve the second-best outcome in all scenarios. The contracts are in the forms of a menu with linear compensation for demand or sales, incorporating inventory costs. Moreover, the contracts feature adjustments in compensation corresponding to the ordering level if it is delegated. Managerial implications: Our study reveals that, under reasonably mild conditions, optimal salesforce contracts can still maintain relatively simple forms, even when confronted with common operational factors and generalized demand and cost functions. However, the contracts must be tailored to suit the operational settings. Intriguingly, neither the loss of demand information nor the delegation of inventory decisions would compromise system efficiency at optimum. Funding: H. Song is partially supported by the Key International Cooperation and Exchange Projects of the NSFC [Grant W2411062] and the Foundation for Innovative Research Groups of the NSFC [Grant 71821002]. Supplemental Material: The online appendix is available at https://doi.org/10.1287/msom.2022.0400 .