Thursday, December 01, 2005

Merry Incentives, Baby

The most important book I have read in the last several years is Freakonomics by Steven Levitt. For those who haven't read it, the premise of the book is that most economic decisions are based on incentives, or the avoidance of a negative incentive. In the book, Levitt gives several examples of microeconomic questions that seem very difficult to answer, but upon looking at a seemingly ambiguous set of data the riddle is explained quite well. The book is written very well, and is aimed not at highly educated types, but at the normal "joe". I actually bought the audio version and listened to it on my way to and from work.

After listening to that book I decided to start looking at the way my customers and employees act and trying to explain those actions using Levitt's simple premise that decisions are based on incentives. I'll be damned - he is right. As a matter of fact, I think that solving that riddle of incentives is the way for my business to take itself to the next level.

Think about it for a minute. If you are in any business and you are courting a customer and he does not buy from you - why is that? Incentives or the avoidance of a negative incentive. I will give you a perfect example that relates to me and my business. I sell a certain item, we will call it a widget. The widget manufacturer, we will call them the BiG company, has assigned manufacturers representatives to sell their product to wholesalers (me) who in turn sell that product to the end users. In certain cases such as national accounts (me) or if the home office that gets the bill is outside of the representative's territory (also my case) the rep will not receive credit for the sales he has made. The rep that gets the credit is the rep where the bill is sent. This is a VERY BIG disincentive for that rep in my territory to do any work for me or to even call on me to show me new products or give technical seminars. He is not getting compensated, so there is no reason for him to help me - all it does is take away sales from my competitors that he does receive credit for. Him not calling on me is a classic example of trying to avoid a negative incentive. Also, he can refer end users to my competitors, who he receives credit for when the end user purchases that widget. Obvoiusly, a positive incentive. I am not saying the rep is doing anything wrong - I would do the same thing. But this is a great example why when you are stuck on a problem or wonder why something just isn't going right that maybe a little thinking outside the box and keeping your thoughts incentive based may help you solve the riddle and, in turn, come up with a solution to that riddle.

This applies to my customers as well. If I have a widget in stock for around the same price as my competitor and my customer chooses to buy it elsewhere, what is his incentive? Price? If price is this person's only incentive, I usually will shy away from him. I don't want these types of customers as they take a lot of time and can be taken away as easily as gained. Maybe he has a friend over at my competitors. Maybe his kid goes to the same school or is in the same church group as the kid of my competitor. This would be the avoidance of a negative incentive - not wanting to get the raspberries from his buddy if he purchased the item somewhere else. I have found that it is my job to provide incentives like lightning quick service, honesty and correct billing (yes, these are incentives in my world) or to find out why that customer is not buying from me, find that incentive or avoidance of negative incentive and make a play on that.

I just took delivery of a new vehicle and found a few new ways to show you how big a part incentives play on economic decisions. During the wheeling and dealing process rather than give me money off of the new vehicle I was buying, the dealership was willing to give me more money for my trade. It didn't make any difference to me, but I wondered why they were doing this? For what reason would they give me money off the total purchase, but only want to do it by assigning the discount as giving me more money on the trade in?

Not being in the car business I have again used Levitt's book to come up with a couple of possible solutions. One may be that they knew right off the bat how much they could get for my used vehicle and had wiggle room in there for dealing. Another solution may be tax issues, of which I have no clue when it comes to vehicles. The most appealing solution to me, however, is that the new car sellers are run separately from the used car lot next door, even though the used car lot was a part of the same company. The profit and loss for the new car portion may be run in a completely separate space, thus the performance and bonus pay for the new car employees is probably calculated separately than the guys over on the used car lot. Could it be that the guys in the new car portion simply didn't give a damn about the guys over at the used car lot even though they worked for the same company and therefore didn't care about the discounts they gave to me in the form of more money for my used vehicle? I would say yes. Incentives.

The other thing that bothered me about buying my new vehicle was the "survey". At least five times, maybe more, salesmen, title persons and managers begged me to give them "completely satisfied" checkmarks when the manufacturer of the vehicle sends the survey to me. This seemed very odd to me. When I bought my last vehicle the dealership (different dealership) did the same thing. I even told the salesman in joking that if he had a 12 pack in the back seat for me when I picked up the vehicle that I would give him "completely satisfied" marks - he actually did it!!! Anyways, why would so many people ask me so many times to give them high marks on this survey? It was the one bit of control that I absolutely knew I had over them to make the dealership jump through hoops for me. But why? Why is the survey so important to them? There must be an incentive here. So I googled it. Take a look at this article. Some highlights below, keeping in mind my premise of incentives or avoidance of a negative incentive:

Regardless, auto makers reward and punish dealerships based on their survey results. Auto makers do that using financial incentives, inventory preferences and opportunities to acquire additional dealerships.
"When CSI surveys started 30 years ago, dealers were told they wouldn't be used for rewards and punishments," says Starling. "Now they are."
"When you tie customer survey scores to financial rewards, then you have people chasing the scores rather than pursuing true customer satisfaction," Starling says.
He explains, "Say a customer buys a truck from me, and a couple of weeks later the auto maker puts a much more generous incentive on that vehicle than that customer got. Then he gets a survey. The dealership had nothing to do with the incentive, but the customer is going to take it out on us.
Among flaws he cites: The surveys are too long. "How many people do you know like curling up at night with an 8-page customer satisfaction survey from an auto maker?" Customers are inundated with them. "A lot of people suffer from survey fatigue." Customers unhappy with vehicle quality often take it out on the dealership when filling out the surveys. Disgruntled customers are the ones most likely to return a completed survey, skewing results.

Well, I think this proves my point. You can see from the article that in fact, the survey is used by the manufacturer to reward or punish the dealer - and that trickles down to the lobby person, the salesman, the title guy, everyone. That is why EVERYONE at that dealership begged me to give them completely satisfied marks, no matter what. Well screw them, I will fill it out as I choose, if I have time. Something more important may demand my time. Something more rewarding than filling out a survey - something with more incentive.


Carl from Chicago said...

One thing that Freakonomics didn't dwell on was "tit for tat". Basically, if you have a re-occurring relationship with someone, you are more likely to behave in a "scratch my back, I scratch your back" method. But, since you are unlikely to buy a new truck for several years, you have no incentive to "scratch their back" via good ratings. If you had to buy a car every week or even every year, your attitude might be different...

Dan from Madison said...

How often, in the retail world, do people buy new cars every week or year? The salesman knew it was a personal vehicle. I will give you that in a situation like a business where you may be buying fleets of vehicles there may be incentive to warm up to a salesman. But for a personal vehicle? What incentive would there be for me to give them good ratings if they do not deserve them? Odds are the guy who sold me that vehicle won't be around for the next one.

Carl from Chicago said...

My point was that since you DON'T have a re-occuring relationship with these people you don't care if you (potentially) screw 'em by not filling in their forms. That is why they are going out of their way to beg you for help. Under tit-for-tat you would have a stake in this relationship and you don't right now.