Customer satisfaction incentives with budget constraints

• DOI: http://doi.org/10.1111/itor.12259
• Author: Tian Wang,Shiming Deng,Xingjian Chang
• Published date: 01 November 2018
• Date: 01 November 2018

Intl. Trans. in Op. Res25 (2018) 1973–1995

DOI: 10.1111/itor.12259

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Customer satisfaction incentives with budget constraints

Shiming Deng, Tian Wang and Xingjian Chang

School of Management, Huazhong University of Science and Technology, Wuhan 430074, China

E-mail: smdeng@hust.edu.cn [Deng]; wangtian3261@gmail.com [Wang]; xjchang_0321@163.com[Chang]

Received 3 March 2015; receivedin revised form 8 December 2015; accepted 9 December 2015

Abstract

We study the design of incentive contracts based on customer satisfaction (CS) surveys with reward budget

limits.We extend principal-agent models to consider budget constraints,survey response rates, and correlation

between CS measure and demand. We derive the optimal incentive contract and study the impacts of these

factors on contract performance. In contrast to the common belief thatcustomer future values are the drivers

of CS incentives, we show that CS incentives can benefit principals even in a single-period setting where

customers bring no future value. Improvements can be achieved without increasing total reward, because the

CS incentive program reveals additional information about agents’ service effort and diversifies their risk.

Such effects are overlooked in existing CS research. With consideration of correlation between sales and CS

measures, we provide a metrics selection rule regarding which reward(s)—CS, sales commission, or both—

should be included in an incentive plan. We also study cumulativeincentive schemes based on commonly used

average CS measures and show that such incentive schemes may fail to motivate agents to increase service

effort.Therefore, designing proper rewardschemes is a critical issue for effective CS management and deserves

future research.

Keywords:customer satisfaction; incentive design; reward risk diversification; principal-agent models

1. Introduction

e-Commerce allows many business-to-consumer companies to outsource the whole or a part of

their sales or service processes to affiliated agents or local service providers so that they can focus

on core competencies. For example, insurancecompanies develop web-based customer relationship

management systems to allow third-party agents to sell their products. Online flower sellers, such

as Flora and FTD Group, Inc., take orders from the Internet and broker them to local florists

for service and delivery. Telecom companies such as AT&T and T-mobile contract with online

or local stores for sales and customer service. In such decentralized systems, however, motivating

agents’ sales/service efforts and maintaining customer satisfaction (CS) is an important yet difficult

problem, because agents’ efforts are not observableto principals. The lack of observability of service

effort causes moral hazard issues (Holmstrom, 1979).

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1974 S. Deng, T. Wang and X. Chang / Intl. Trans. in Op. Res 25 (2018) 1973–1995

CS is a measure of how products and services supplied by a company meet or surpass customer

expectation. CS has been well proved to be critical for companies’ long-term profitability (Capon

et al., 1990; Rust and Zahorik, 1993; Anderson et al., 1994). CS surveys are used to gather infor-

mation from customers and gauge the degree of their satisfaction. In fact, an increasing number

of companies have started using CS surveys through online pop-ups, mail/e-mails, and mobile

messages to measure CS and monitor agents’ service effort. However, only a few companies believe

they profit from it (Ittner and Larcker, 2003). The effectiveness of CS incentive programs depends

on whether their benefits can justify their costs, which in turn depends on how managers use survey

results as a metric to reward their service providers. Hauser et al. (1994) pointed out that “Many

(companies) are struggling to design profitable customer satisfaction based management and/or

compensation programs.” Sharma (1997) interviewed 32 salespersons from two Fortune 500 com-

panies in a major southeastern metropolitan area and suggested that “the implementation and

consequences of compensation systems based on CS ratings are neither simple nor intuitive.” This

paper studies how to design a profitable incentive plan based on CS survey results.

Generally speaking, there are two types of reward schemes, cumulative and transactional. In a

cumulative reward scheme, rewards are given to agents based on their average scores in a cumulative

time period of evaluation. This scheme is commonly used in practice. Examples included monthly

salespersons’ reward at car dealers,1teacher’s yearly promotion based on student’s evaluation, and

bonus for customer representatives based on CS key performance indicators (KPI).

In transactional reward schemes, rewards are given to agents based on a cumulative score in

proportion to the total number of satisfied customers they have served. Transactional rewards

can be found in the business of restaurant, call centers, and interior decoration. For example, in

KFC stores at Suzhou in China, satisfied customers can put a sticker of excellent service under

the photo of the waitress/waiter who served them on a bulletin board. If a waitress/waiter collects

five stickers, she/he can redeem a reward.2Customer Centricity, Inc., a business consulting firm

in customer service management, reported a highly effective incentive plan in which customer

service representatives earn points for good customer service to receive a prize. The more points

they accumulate, the more valuable is the prize (Bailey, 2004). Such a transactional incentive plan

provides immediate recognition for customer service representatives, as stated by the president of

Customer Centricity, Inc., that“when employees are ‘caught’ doing something right (at exceptional

levels), you need to provide immediate recognition. If the reward is immediate, the benefits realized

will be even greater.” Advantages of transactional customer satisfaction measures are also reported

in academic research by Olsen and Johnson (2003). In this paper, we will study which scheme,

cumulative or transactional, is better in motivating agents to improve their service efforts from an

economic prospective.

The design of CS incentives has many challenges. First, traditional customer surveys through

paper and mails suffer a low response rate. Surveys using modern technologies such as e-mails,

mobile messages, and web pop-ups achieve a higher response rate. But, still not all (satisfied)

customers return the surveys. It seems unfair for agents not receiving rewards because customers do

not respond. How should the principal take into account the response rates in CS incentive design?

1http://www.edmunds.com/car-buying/why-car-salespeople-beg-for-top-customer-survey-scores.html (retrieved 1

September 2015).

2http://blog.sina.cn/dpool/blog/s/blog_67c261060100jvtl.html (retrieved 1 September 2015).

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2016 The Authors.

International Transactionsin Operational Research C

2016 International Federation of OperationalResearch Societies