Summer 2013 | Capital Ideas
ay you’re a paper supplier with a warehouse full of
goods, but you have more paper orders than you
can handle. You know you’re going to end up with a few
unhappy clients, and you’re not sure who to disappoint.
It may seem sensible to fill orders for the most profit-
able customers first, especially if they’re the most likely
to complain about unfilled orders. But catering only to
them could mean damaging relationships with other
customers. So who gets the goods?
Chicago Booth Professor
Mersereau of the University of North Carolina have de-
veloped a model that may be able to help. Their analyti-
cal approach to customer relations takes into account
demand, profit margins, and also customers’ memo-
ries, essentially codifying the old adage, “the squeaky
wheel gets the grease.”
The crux of the issue is that a supplier can’t keep ev-
eryone happy all the time, especially when there’s more
demand than supply. If you’re a supplier bombarded
with purchase orders, you have to decide how much of
each customer’s request you intend the fill. The objec-
tive, of course, is to maximize profits, but one must be
careful not to lose client business in the future.
Adelman and Mersereau show that a supplier tends
to provide better service to customers who bring in
higher profit margins, but there are good reasons to pay
attention to low-margin customers as well. Customers
with shorter memories—those who complain the most
about service—are most likely to switch to another
supplier or drastically reduce their purchase orders if
they feel neglected.
The researchers find that being more responsive to
those customers who have shorter memories or bring
in lower profit margins, or both, leads to larger aver-
age profits. In addition, a supplier who caters only to
the most profitable customers misleads those clients
into thinking they’ll always receive that high level of
service. If that service level isn’t sustainable, the clients
will ultimately end up disappointed. A better strategy:
expectations within a manageable range for all
Dan Adelman and Adam Mersereau, “Dynamic Capacity
Allocation to Customers Who Remember Past Service,”
Management Science, March 2013.
Relationship advice for suppliers:
Use a business planning model
or all the talk about creating better incentive plans
for employees, many proposed ideas are still off the
mark. One reason is that managers tend to ignore in-
sights from academic research, while academics do
not always focus on practical applications. In two new
research papers, Chicago Booth Clinical Professor
Michael J. Gibbs
offers insights that bridge academic
and practical perspectives.
Decide how a company should measure employee
performance. Performance evaluation is the most com-
plex issue in designing a good pay-for-performance
plan, Gibbs says, and should be determined first before
deciding how to tie performance to rewards.
Pick the best numeric performance measure for
the job. The advantage of a numeric measure is that
employees know exactly how they will be evaluated.
However, even the best numeric measure has flaws. For
example, distortions can arise if a numeric measure mo-
tivates employees to focus on activities that the metric
recognizes, but ignores hard-to-quantify activities that
aren’t part of the evaluation but are nevertheless valu-
able to the firm.
Always include a subjective evaluation of perfor-
mance, as that can address the limitations of numeric
performance measures. One way to combine numeric
and subjective assessments is to design an incentive plan
that gives employees a formal bonus based on a numeric
measure, such as profits generated, and a second bonus
based on supervisor discretion. The profit-based bonus
might distort incentives, but the promise of a supple-
mentary reward at the supervisor’s discretion can miti-
gate that distortion and motivate the employee to look
out for the company’s overall interests.
The overall evaluation—including numeric met-
rics and subjective evaluation—should be chosen to
protect employees from risks they cannot control. No
incentive in the world will give a plant manager the
power to prevent a heavy snowstorm that makes a facto-
ry roof collapse, but incentives can make sure the man-
ager keeps the roof maintained and acts swiftly to make
repairs. Performance measures can push employees to
use their own knowledge and creativity to find the best
ways to perform a job.
Michael Gibbs, “Design and Implementation of Pay for
Performance,” Oxford Handbook of Managerial Economics,
Oxford University Press: July 2013.
———. “Designing Incentive Plans: New Insights from Academic
Research,” World at Work Journal, Fourth quarter 2012.
Four ways to improve your pay-for-performance plan