A field study of the impact of changes to a net sales-based incentive plan and centralized inventory management

ABSTRACT

Although empirical studies have shown an increase in store sales following the implementation of performance-based incentive plans for the salesforce, they rarely consider inventory decisions and do not clarify the consequences of organizational design choices. Using data from 78 retail stores in a case study of a firm’s accounting records from January 2013 to December 2014, this study examines how store managers reacted to changes in (i) performance measurement choices in contracting and (ii) authority over inventory decisions after the mandatory adoption of the International Accounting Standards 2 (IAS 2), which increased the visibility of high inventory costs, and whether the underlying changes improved the gross profit percentage. The case firm switched from a sales-based incentive plan for store managers with a decentralized inventory structure to a net sales-based incentive plan combined with centralized inventory systems. Under the net sales-based incentive plan, store managers can receive bonuses only if losses on inventory valuation were deducted from sales revenue. The empirical evidence shows that performance measurement choices related to salesforce compensation in conjunction with inventory management systems result in increases in a retail store’s gross profits and decreases in losses on inventory valuation.

KEYWORDS:

• Sales-based incentive plan
• performance measurement choices
• inventory management

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Organizational process change can be classified as being either continuous or discontinuous. The intent of a continuous organizational process is to improve firm performance through small gradual improvements that are implemented within individual departments or through activities. In contrast, discontinuous organizational process change is associated with economic crises or regulatory changes and is intended to increase organizational performance through large fast improvements that are implemented across several departments or activities (Romanelli and Tushman 1994; Rowe, Birnberg, and Shields 2008).

2. Losses on inventory valuation were almost 3,700,000 US dollars at the end of 2013. One U.S. dollar is equivalent to roughly 30 New Taiwanese Dollars.

3. The rapidly growing markets in the telecommunications industry forced the case company to implement strategies to become more efficient and increase profitability during the 2009–2014 period.

4. The salesforce had no control over pricing decisions.

5. The IT department is responsible for implementing the ERP system in the case company. Salesforces were only in charge of inputting sales data, so they were not affected by this change very much.

6. In the case company, the compensation structure of the salesforce contains a fixed salary, with a quarterly bonus and annual bonus. Here, the annual bonus is equivalent to one month’s salary. The store manager’s quarterly bonus is 30% of his/her total compensation, and the salespeople’s bonus is 20% of their total compensation. The shift from sales-based measures to net sales measures applies to both store managers and salespeople (the salesforce).

7. Although salesforces need to be responsible for inventory costs, most of the managers we interviewed said they were used to following the company’s policy, so they accepted the change without much resistance. This can be explained by the collectivist culture popular in Asia.

8. In the original incentive plan, merchandising managers at the corporate headquarters are evaluated based on profits but are not responsible for inventory turnover.

9. Although the corporate headquarters could access accounting information for each store in 2012, we excluded data in 2012 because the quality of the data was not stable until 2013.

10. Several interviews confirmed that the CEO of the field firm realized there is a trade-off between the issue of overstocking and dysfunctional behavior resulting from disregarding the controllability principle. However, because the enforcement of IAS 2 resulted in huge losses on inventory valuation, the firm adopted a net sales-based incentive plan and a centralized inventory structure at the same time to solve the issues of overstocking inventory resulting from the delegation of inventory management decisions. In this way, store managers and merchandising managers at the corporate headquarters can communicate more and cooperate with each other to solve inventory-related issues. In addition, the centralized inventory systems allowed the firm to collect precise inventory cost information by which to evaluate store manager performance based on the net sales-based incentive plan.

11. Accounting research studies have depended on both level and change models to investigate the association between variables of interest and performance (e.g. Banker, Lee, and Potter 1996; Román 2009). If the impact of the treatment variable (i.e. the new system) on performance is expected to be permanent, then the level model could be more suitable. If the treatment variable has a gradual impact on performance measures, then the use of the change model can be supported.

12. We could not use the number of employees to control for differences in the size of the stores because the number of employees in each store was similar.

13. One U.S. dollar is equivalent to roughly thirty New Taiwanese Dollars (NTDs).

14. In order to ensure robust results for the univariate tests, we further conducted annual t-tests (e.g. January 2013 vs. January 2014, etc.). We found that each-month PROFITABILITY in 2013 was significantly less than that in 2014, based on the significance at the 0.01 levels.

15. Previous studies have indicated that there are negative returns to scale (Hise et al. 1983; Ratchford and Stoops 1988) for retail firms. In addition, Drury (2013) describes a situation in which sales increase but profitability decreases due to absorbing more cost.

16. Due to the perfect collinearity between each store and the area in which it is located, the results do not contain parameter estimates for METROPOLITAN in the fixed-effects regression model.

17. Operating margin here refers to the ratio of net operating incomes after SG&A divided by sales.

18. We thank the anonymous reviewer for providing this direction.