Intrinsic Vs Extrinsic Incentivation – how to Motivate Successfully

Moving on to describing and assessing external incentivation, almost all measures, depending on the definition used, can be summed up under one term: ‘money’. Whether it is the base salary, the bonus, the commission, the pension plan, health benefits, or the company car – it all can be boiled down to a monetary value that is provided to the individual by an external entity. The aim of theses monetary rewards is to refund the individual for the efforts he is taking on in pursuing a goal on someone else behave and motivating him to do that in an efficient and effective way to his best means. This is the playground of classical principal-agent theory and has become one of the main research fields in motivation research. The goals of company owners, management, and the firm itself have to be aligned with the personal goals of each individual to create a consistent frame for activities. Controlling and reducing the ‘agency costs’ inherent in the principle-agent relationship to a minimum is a key aim of external incentivation.

Beside intrinsic motivation, which was discussed in the previous section, external incentivation is especially prominent in the context of managing a sales force as the principal-agent conflict is strong in these settings. One important reason for this connection is the relative detachedness of the sales representatives ‘on the road’ from the rest of the organization. However, the transaction based nature of the sales process also makes it easy to track and reward performance, which in turn is one important instrument in handling the problem. The obvious question that large amounts of research have dealt with is, how to archive the alignment of interest, the transformation of external goals into personal goals of the individual, by using external incentivation in a meaningful and most efficient way. In the next paragraphs we will provide a brief overview of the research results aiming at answering this question and give some practical insights into how to apply these findings in practice.

Principal-Agent Theory

Principal-agent theory in principal discusses problems arising in settings where a person X, the principal, hires person Y, the agent, to perform a task that is in the interest of person X. If this task is for some reason not in the interest of person Y as well, he has an incentive to deviate from performing the task in the way intended by the principal. In theory the principal could deal with this problem by writing a complete contract specifying that the agent is receiving a payment, which is higher than the agent’s alternative choices, for performing the task as intended by principal and in all other cases the agent receives nothing. The underlying problem now becomes obvious when we consider that, first, there is nothing like a complete contract in real live and not all possible states of nature in the future can be captures already in a contract today and second, that the concept of complete and perfect information is just a theoretical construct rather than observable in reality.

Most of the issues evolve around asymmetric information between the two parties with the agent normal having an information advantage. For example, the principal has no exact information about the pay-out structure of the agent’s different options and he often also cannot observe the agent’s efforts level in executing the assigned task directly (Eisenhardt, 1989). These issues create a huge problem for the principal as he is exposed to the risk of conflict of interest and moral hazard by the relationship with the agent. Managing this relationship in an efficient way to reduce the imposed risk and create an optimal outcome for both parties is therefore essential as the backup option of the principal in walking away from the relationship completely is in most cases a suboptimal outcome for both parties with lower overall welfare (Eisenhardt, 1989). Fortunately, research around the agency dilemma has produced several strategies of coping with principal-agent problems. Often cited tools with regard to employment relations are pay-for-performance/bonus-based incentives, promotion-based incentives, profit sharing, performance measurement/evaluation and bonding contracts/performance bonds (Baker, Jensen, & Murphy, 1988). Further concepts discussed within the context of the agency dilemma are, among others, efficiency wages and the threat of employment termination as well as transaction costs dynamics.

The general idea of most concepts trying to mitigate agency costs, as mentioned before, is to reach an alignment of the self-interests of the principal and the agent so that by fulfilling the task assigned by the principal, the agent is also acting within his own best interest. To reach such an outcome, the economic benefit for the agent in fulfilling the assigned task must be larger than his outside options. In addition, the principal generally expects the agent to invest high effort in carrying out the task, as the probability for a successful completion of the task is higher for high effort then for low effort. Investing a high effort in the completion of assigned task can be seen as the simplest definition of high motivation of an agent and thus, constitutes the link between the agency dilemma and motivation science (Bagozzi, 1980). However, for the agent, investing a high effort is costlier than just investing minimal effort in the task and the principle cannot observe directly if the agent is investing a high or a low effort (which is the standard case of information asymmetry). Therefore, the principal has to not only consider the outside options of the agent, but also the different behaviour options inside the organisation when defining a way to overcome the principal-agent inefficiency.

Countermeasures for Sales Force Management

In theory, a large set of instruments to handle agency problems exists, as mentioned in the previous paragraph. However, only a few of them are actually relevant and also accepted by practitioners in the context of sales force management. Beside the efficiency wage concept and performance measurement/evaluation, pay-for-performance/bonus-based incentives is by far the most used tool in controlling agency costs (Baker, Jensen, & Murphy, 1988). The efficiency wage concept which basically argues that the payment of a wage premium above the market clearing price is economical rational due to the risk of shirking while facing high monitoring costs, the limitation of employee turnover and the bigger selection in recruitment. In contrast performance measurement/ evaluation is focusing on increasing the monitorability of the job performance of the sales representatives to reduce the issue of asymmetric information. Modern costumer-relationship-management software is able to provide the management with extensive data about the sales representative’s efforts and performance and thereby makes it easier to tie wage payments closely to invested effort level and performance. The most important instrument in coping with agency problems are, as mentioned before, pay-for-performance/bonus-based incentives. Within classical principal-agent-theory problems, when the principal can only observe an outcome that is linked to the effort level of the agent with a specific probability but not the effort level itself directly, the agent can be motivated to invest high effort by paying a bonus. For the states of nature that have a higher probability of appearance when high effort is exercised a bonus is paid and no bonus is paid when other states of nature are observed.

The bonus has to be chosen in a way that the expected value for the agent is higher for always investing high effort than for staying with low effort. It depends on the payoff structure of the principal and the agent if incentivising for high effort is optimal or if the needed bonus is higher than the expected additional profits of the principal and accepting low effort is advantageous. As the agent is normally assumed to be risk averse the effect of higher bonus payments is decreasing as he has to be compensated for the additional risk he is exposed to. In terms of sales force compensation packages that means that a high base payment is advantageous as it is valued higher by the sales representative than a risky bonus payment, as long as he is risk averse. The bonus payment should be just large enough to incentivise the high effort and commitment behaviour desired by the management.

The bonus itself should be linked to an observable outcome which has the highest possible predictive power for the chosen effort level. That is definitely not the overall firm performance and also does not have to be the contribution margin of a customer or the new customer acquisition rate – it can well be that items like ‘number of customer visits’ are the best predictor of effort. However, with the sales representative knowing the performance measure an adverse incentive to optimize just this measurement and not to generally invest high effort is introduced. Thus, it can in turn make sense to relate the bonus payment to measure that are capturing positive outcomes for the firm like customer contribution margin, or harder to manipulate for an individual like overall firm performance as an extreme. The right balance and mixture of different measures the bonus payment is linked to, is therefore an important factor for a successful compensation plan (Misra & Nair, 2011).

Another important issue that is heavily debated within the research community is whether there is a link between job satisfaction and job performance and if high job satisfaction causes high job performance or if high job performance causes high job satisfaction. This causality dilemma, which sounds at first glance similar to the question after if the chicken or the egg was first in the world, presents a real relevance to practitioners as it is a valid question if there is an advantage for management do shift resources into improving job satisfaction to achieve a higher performance or if performance should be addresses directly. In an empirical study, Richard P. Bagozzi discovered in 1980 that job satisfaction actually is correlated with performance. Sales representatives were found to be motivated by anticipating the satisfaction caused by high performance rather than by the performance itself. Therefore, the motivating factor for achieving high performance can be seen in job satisfaction, however Bagozzi concluded that… “perhaps the most striking finding is that job satisfaction does not necessarily lead to better performance. […] How, then, can one influence performance? The present study points to self-esteem as a key determinant. Management should enhance self-esteem by regularly providing positive reinforcement in the form of personal recognition and monetary rewards, as well as socially visible acknowledgement of good performance” (Bagozzi, 1980, S. 71). This statement clearly point in a very interesting direction, stating that monetary rewards are no end in itself but should be used to increase the self-esteem of the employee and to express an appreciation for the employee’s commitment. We can clearly recognize the bridge that is built by this research finding to Herzberg’s two-factor theory and Maslow's hierarchy of needs addressed in the theoretic models-part of this paper as well as to the issues and importance of intrinsic motivation discussed earlier.

References

1. Bagozzi, R. P. (1980). Performance and Satisfaction in an Industrial Sales Force: An Examination of Their Antecedents and Simultaneity. Journal of Marketing, 44(2), 65-77.
2. Baker, G. P., Jensen, M. C., & Murphy, K. J. (1988).
3. Compensation and Incentives: Practice vs. Theory. Journal of Finance, 43(3), 593-616. Basu, A. K., Lal, R., Srinivasan, V., & Staelin, R. (1985).
4. Salesforce Compensation Plans: An Agency Theoretic Perspective. Marketing Science, 4(4), 267-291. Chen, F. (2005).
5. Salesforce Incentives, Market Information, and Production/Inventory Planning. Management Science, 51(1), 60 - 75. Eisenhardt, K. (1989).
6. Agency theory: An assessment and review. Academy of Management Review, 14(1), 57–74. Kissan, J., & Thevaranjan, A. (1998).
7. Monitoring and Incentives in Sales Organizations: An Agency-Theoretic Perspective. Marketing Science, 17(2), 107-123. Latham, G. P. (2012).
8. Work Motivation. New York: SAGE Publication, Inc. Misra, S., & Nair, H. S. (2011). A structural model of sales-force compensation dynamics: Estimation and field implementation. Quantitative Marketing & Economics, 9(3), 211–257. Page 1

Cite this page