Allocation of Inventory Risk and Sales Effort in Direct Selling: Theoretical Predictions and Empirical Evidence
Publication Date
10-19-2023
Abstract
In this paper, we study the impact of inventory risk allocation on the sales effort decisions of independent agents in a direct selling network. We start by building a model of a seasonal product whose demand is uncertain, and compare the optimal sales effort, sales volume and firm profitability under two types of inventory systems: an “Order-Taking” system in which agents have the flexibility to place orders after demand uncertainty is realized vs. a “Direct-Sales” system where they are required to precommit to orders prior to demand being known. Subsequently, we test the key theoretical predictions using a novel dataset to understand the key drivers of the firm's and agent's decision-making process. In contrast to the extant literature, we show that systems that impose inventory risk on agents can sometimes induce more effort, and help generate greater sales and firm profits. This is because when the agents' sales ability is high, they are able to better manage the inventory risk through their sales effort choices. Our empirical analysis, which uses multi-year cookie sales data from a large local council of the Girl Scout organization, first estimates the sales ability of girl scouts and then validates the key theoretical predictions regarding the relationship between an agent's sales ability and a firm's inventory policy. We find that a direct-sales system widens the individual sales performance gap between two Girl Scouts who are separated by one standard deviation (183 boxes) of sales ability by approximately 58 boxes, a 62% increase compared with the order-taking system. Additionally, activities that pose higher inventory risk have the effect of widening this performance gap. Finally, we find that the optimal incentive mechanism should not only reward performance but also motivate ongoing participation. These findings have important implications for direct selling firms that offer unique products through non-traditional distribution channels.
Document Type
Article
Keywords
sales effort, game theory, inventory risk, direct-selling, incentives, girl scouts cookies
Disciplines
Business Administration, Management, and Operations
DOI
10.2139/ssrn.4184022
Source
SMU Cox: IT & Operations Management (Topic)
Language
English
