The Profitability of Revenue-Based Quotas Under Price Negotiation

Abstract

We study how the presence of a monthly revenue-based quota impacts a retailer’s profits when prices are negotiated by a salesperson. Using transaction level data for refrigerators, we first provide reduced-form evidence that prices are impacted by the quota: the negotiated discounts are approximately 3.8% higher if the salesperson is 10% closer to reaching the quota in the final week of the month. Guided by this result, we specify and estimate a demand model that identifies the impact of the quota through two forces: the effort salespeople expend in order to sell the product and their bargaining position. Results indicate that, as salespeople get closer to reaching their quota, their effort increases regardless of the week, and their bargaining position weakens (i.e., they offer lower prices), but only in the final week of the month. We use these results to analyze the impact of the quota and find that, holding salespeoples’ total compensation fixed, eliminating quotas results in 8% lower profit for the retailer. This decrease stems primarily from the reduction in effort that outweighs any benefit from strengthening the salespeoples’ bargaining position. The change in profit is economically meaningful because eliminating both price negotiation (i.e., moving to fixed pricing) and the quota results in an up to 36% reduction in profit. This paper was accepted by Matthew Shum, marketing.