Introduction

Researchers have explored and debated many issues on the proper design and conduct of experimental auctions used to elicit values for lotteries, new goods, services, and technologies. This chapter examines six essential design issues in detail – training and practice; endowment of a good versus full bidding; choosing an auction mechanism; multiple good valuation, demand reduction and field substitutes; learning and affiliation in repeated bidding rounds and negative values. For each issue, we discuss the choices available to the practitioner, outlining the pros and cons that have emerged from theoretical and empirical literature. The goal of this chapter is to make readers aware of the relevant issues so that informed and justifiable choices can be made when designing an experimental auction.

Some obvious “best practices” have emerged that should be followed in conducting auctions. For example, practitioners should initially conduct a qualitative study prior to designing an experiment such that they can learn about individuals' decision-making processes and explore how people think about the good and experimental procedures in question. Focus groups in conjunction with pre-tests of the experiment will help ensure that the study's objectives are properly met. Once a design has been settled on, it is critical that subjects properly understand the auction in which they participate and that every effort is made to ensure against misperceptions. Aside from these issues, the practitioner has some judgment calls to make.

Introduction

For auction markets to be useful in understanding demand for new products, services, or technologies, we assume people have an economic value, vi, for the good or service up for auction. This value can be positive, negative, or zero, but the assumption is that a value does exist. We now discuss exactly what we mean by the idea of economic value and how it is derived from a utility theoretic framework.

This chapter discusses the economic concepts of willingness to pay (WTP) and willingness to accept (WTA), which are the values that are elicited in an auction. The chapter lays the foundation for how to interpret a person's value using the benchmark model of rational individual decision making characterized in neoclassical economics. The chapter first considers how to derive WTP and WTA for the case when the quality of a good is known with certainty. Valuation measures are then derived for the case of uncertainty, where a person attaches probabilities to whether a good possesses particular levels of quality. For uncertain quality, we start by discussing the expected utility model, and then we consider a few non-expected utility models. The last part of this chapter considers how to derive WTP and WTA in a dynamic setting when people have the ability to delay their decision to buy or sell. Later in the book, in Chapter 9, we extend our discussion to include some of the findings from behavioral economics and psychology.

Introduction

Our choices reflect our values. People reveal their relative values when they choose to spend an extra hour at work rather than at the opera; purchase more groceries rather than extra MP3s or drop extra change into a jar promoting a charity at the check-out line rather than buying a candy bar. Economists characterize the economic value of these choices by determining the rate at which a person is willing to trade one good or resource for another. This rate is captured in a person's maximum willingness to pay to purchase a good or in their minimum willingness to accept to sell a good. Usually, these economic values are revealed within the context of an active exchange institution like a market or auction with numerous buyers and sellers. In such exchange institutions, buyers buy when their willingness to pay exceeds price and sellers sell when their willingness to accept falls below price.

But, how do people value new goods and services not currently bought and sold in the marketplace? These non-market goods and services include new private goods like cigarettes that have been genetically modified to possess less nicotine and diet cherry vanilla Coke with lime as well as public goods like cleaner air in Santiago, Chile or biodiversity in Madagascar. No exchange institution exists for buyers and sellers to make bids and offers, which would reveal people's relative values for these non-market goods.

Introduction

We now examine several methods commonly used to examine bidding behavior in experimental auctions. We focus attention on econometric models and other techniques that have direct applicability for auction data and are likely to receive less coverage in introductory econometrics and statistical texts. The chapter does not cover elementary statistical analysis such as ANOVA and ordinary least squares regression since numerous sources already exist for interested readers (e.g., see Greene, 2000).

Censored regressions with auction bids

One strength of experimental auctions is that they provide continuous measures of individuals' valuations; one drawback is that these bids are often censored. Censoring occurs when bids are transformed to a single value when they exceed or fall below a particular threshold. A common form of censoring occurs in auctions where people are not permitted to bid below zero. Participants transform negative bids to $0.00. It is helpful to contrast censoring with truncation. Censored data are observed but their observed values take on restricted values, that is, $0.00. In contrast, if a dependent variable is truncated, observations will be unobserved in particular ranges.

To make concrete these ideas, consider a latent, unobserved variable y* that can take on any value on the real line, but where y is the variable actually observed. For example, y might represent observed auction bids censored from below at zero in auctions that do not permit negative bidding.

Introduction

This chapter addresses the question of whether experimental auctions are valid in the sense that they accurately measure the theoretical notions of values laid out in Chapter 3. Determining whether a measurement instrument is valid is a complex concern for social scientists – made more difficult in that the theoretical constructs we seek to measure are latent and unobservable. Validity refers to the extent to which a measurement instrument actually measures what it purports to measure. We must be clear about the object of measurement in experimental auctions. Many psychologists have attacked traditional economists' view of preferences arguing that valuations are malleable, contextual, and even constructed on the spot (e.g., see Bettman, Luce, and Payne, 1998; Gunnarsson et al., 2003). This argument is about the appropriateness of a given theoretical model or construct; not with the validity of a measurement device per se.

We follow the economists' notion of value as the theoretical construct of interest (e.g., Chapters 2 and 3) and we seek to determine the validity of experimental auctions in measuring these latent variables. Our goal is to explore whether experimental auctions provide an accurate measure of value and whether elicited values respond in ways predicted by economic theory. Our focus on economists' views of values and preferences serves as benchmark behavior against which one can assess the validity of experimental auctions.

Customer relationship management at Electronics, Inc

Jim O'Connor, the sales manager at Electronics, Inc., a leading manufacturer of electronic equipment, had devised a strict policy for developing profitable relationships with the firm's key clients. He was convinced that the future of the firm depended on its capacity to implement a customer-oriented strategy. The program consisted of an intensive and rigorous training program with two major objectives: (1) sensitize salespeople to the importance of developing strong customer relationships; and (2) teach them the methods for developing and maintaining these relationships over time.

In spite of the training program, it became evident to Jim O'Connor that after two years, the customer loyalty rate had not significantly improved. A few divisional sales managers attributed these results to the poor quality of the training program. Others pointed to the almost impossible task of keeping customers loyal when they were constantly submitted to strong pressure from competitors.

Jim O'Connor did not find these explanations convincing, so he undertook an analysis of the relationships that every salesperson had developed with his/her clients. These proved to be illuminating. First, the sales force turnover rate had averaged 25 percent per year over the last few years. As a result, sales territories had to be adjusted frequently, and customers were constantly reassigned to new salespeople. Very few customers had dealt with the same person over an eighteen-month period.

A salesperson's constant fear: the unexpected loss of a key account

Jim Harris, one of the most appreciated salespeople employed by the Heavy Duty Division (HDD) of an international manufacturer of automotive products had been negotiating an important contract for some time. This involved the replacement of the larger part of the truck fleet at a major transport company, a long-term client of the truck manufacturer's division. The contract involved the sale of about 200 vehicles, to be delivered over a six-month period. The deal was estimated at several billion euros. Two suppliers had made it to the last round of negotiations for this important contract, and discussions were tight. The customer's choice was going to be made on essentially economic criteria. A key decision criterion used by Tom Hilton, the procurement manager, was the transportation cost of one ton of goods per one hundred kilometers. These costs included operating and maintenance costs as well as the depreciation costs of the vehicles over their life expectancy.

Jim was about to obtain the contract. Although the offer was quoted at a price somewhat higher than most of the competing offers, the price premium could be explained by the high engineering quality of their trucks and by the strong reputation the firm enjoyed in this market. The vehicles' average life expectancy was substantially longer than those of competing trucks, and maintenance costs over a truck's expected life were considered lower for the HDD products.

Performance indicators to watch

Recently, the sales manager of a leading paint product manufacturer that distributed its product through wholesalers to retail outlets, major retailers (such as do-it-yourself chain stores and supermarkets), and directly to building contractors, was given the mission to make a major inroad in the market segment of professional builders and substantially increase the firm's market share in this segment.

The sales manager developed a program for the sales force that included contests and bonuses for salespeople who could reach the highest sales volumes in this market segment over a one-year period. After one year, management proudly claimed that the firm's market share objective had been reached and even surpassed. Given the success of this incentive program, the sales manager decided to keep it running for another year. Quite unexpectedly, the sales to building contractors showed a sharp decrease the following year.

The sales manager decided to investigate and analyze the situation to find out why this sharp sales decline had happened. Salespeople, clients who had ordered that year, as well as those that had not ordered, were questioned. It quickly became obvious that the market share increase gained the previous year had been the result of hard-sell tactics from a sales force that had been motivated to reach the highest sales volume possible. To that effect, salespeople had overstated the quality of the products and promised delivery times that could not possibly be met by the production department.

What knowledge should sales managers have acquired in order to properly carry their missions? What qualities should they possess? These are questions that are addressed in Part I of this book. As underlined in Chapter 1, a sales force must be managed at two levels. A sales manager must attempt to influence market and customer behaviors through the sales force and salespeople. Three chapters of Part I (Chapters 2, 4, and 5) are devoted to a description and analysis of the behaviors of the three main actors of the dynamic sales management process: buyers, salespeople, and sales managers. Chapters 3 and 5 assess the roles of these actors in building and maintaining strong and lasting relationships. The rationale for this structure is provided in Figure I.1.

Chapter 2 describes the key actors of the sales management process that salespeople attempt to “influence,” that is at a basic level, customers and prospects whose behaviors must be understood, predicted, and influenced, and at an aggregate level, the whole sales territory.

Chapter 3 analyzes the role salespeople play in developing relationships with clients and in managing their own sales territories. In order to establish business relationships between suppliers (through their sales representatives) and customers, a number of interactions must take place. Salespeople as well as sales managers cannot properly accomplish their missions unless they understand their customers' purchase and selling behaviors and grasp the influence and persuasion mechanisms that are activated during the selling and negotiation processes.

A frequent problem for large sales forces

The sales manager of an international firm selling office supply equipment followed a policy of promoting the best salespeople to managerial levels. The firm's human resource manager explained that there were several reasons for this policy. First, the prospect of being promoted was a powerful motivational device. Second, the newly promoted managers enjoyed high credibility with their salespeople because they were known to be among the best in the sales force. Third, as they were salespeople themselves, they had a thorough understanding of the job and the people they supervised.

However, when the sales manager formally assessed the performance of those people who had been promoted, it became clear that not all of them were being successful. In a significant number of cases, it became clear that the firm had exchanged one of its best salespeople for a poor regional sales manager!

Several causes could be attributed to this problem. First, the qualities that are essential for being a successful salesperson are not the same as those required for an effective leader and manager. There was no a priori reason why the promoted salesperson should have those required qualities. Second, promoted staff have only partial and incomplete knowledge to carry out their new duties effectively. Although they typically knew their own territory and had some knowledge of the other members of the sales force, they generally had insufficient information about the sales force, the firm, and its markets.

Case study 1: myopic sales force management at an Industrial Mechanics Corporation

A few years ago, the Industrial Mechanics Corporation (IMC), a large firm selling and leasing mechanical equipment to building contractors for use on construction sites, implemented a new compensation plan for its sales force. The objective was to provide its salespeople with a more motivating plan than the current one which was based on salary plus commission on sales volumes. The principles of the new plan were: (1) to reduce the proportion of fixed salary in the total remuneration, (2) to slightly reduce the commission rates on sales, and (3) to compensate for the decreased remuneration level by adding an individual bonus. The salespeople could earn a substantial bonus by meeting an individual annual sales target. Sales quotas were set in such a way as to be higher than the sales volumes realized the previous year in a given territory, but at levels that were deemed both realistic and achievable.

Several months after its implementation, the new plan was considered a success. By the end of the first year, most salespeople had met or exceeded their targets. The average remuneration paid to sales staff had slightly increased. At the same time, company sales and profits had increased substantially – management attributed these positive outcomes to the new compensation structure.

Soon after, however, the situation in the sales department started deteriorating. The morale of the sales force declined, several top salespeople resigned and joined competing firms.

Effect of personal objectives and preferences on salespeople's behavior

Salespeople's reactions are likely to depend on their personal characteristics and preferences. This is the lesson that the management of a branch of an international corporation has learned the hard way (Darmon 1974). The International Agricultural Machine Corporation (IAM), an important producer of agricultural equipment, decided to increase its sales force motivation to improve its sales and profits. For that purpose, sales management increased the remuneration rates, partly linked to sales volume and partly to gross margins. Before it was implemented on a full scale basis, the reaction to new compensation plan had been tested by asking the opinions of a selected group of salespeople. They had been selected according to their co-operative attitudes, as perceived by their respective supervisors. Most of them were senior. As the test group recorded a unanimous favorable reaction, the new compensation plan was duly extended to the whole sales force.

The outcome of this new motivation program after a six-month period was extremely disappointing. The total sales volume was about the same as before. The compensation paid to the salespeople had substantially increased, and consequently, the total company profits had dropped.

Because of these unexpected results, the marketing manager asked an external expert to find out why the new compensation plan had failed and to propose a new solution which would effectively motivate the sales force.

The expert analyzed each individual's reactions to the new compensation plan. The results were illuminating.

In Part I of this book, we saw that controlling a sales force consists of establishing a set of procedures for supervising, coaching, motivating, evaluating, and compensating salespeople. In other words, sales force control involves all the means that induce salespeople to accomplish the firm's mission in its markets (Anderson and Oliver 1987). As also underlined, from a managerial perspective, the problem of the dynamic management of a sales force can be stated as follows: what are the indicators that sales managers should observe and what are the actions they should take as a result of such observations to induce salespeople to work towards the firm's objectives as closely as possible?

In fact, a process is exerted through all managerial actions taken in the framework of what has been called the sales manager's command center. Training, motivating, coaching, supporting, and compensating salespeople can be conceived as being parts of the sales force management and control tools. Managers have a number of means at their disposal to exert this control. They exert some control on sales effort levels, the sales force organization processes, and all kinds of programs for setting objectives, motivation and increasing competence levels. Part I was essentially descriptive. Part II is more normative. It is comprised of five chapters (Figure II.1).

The first four chapters are devoted to the various programs that constitute sales management's control levers: the programs designed for controlling the level and deployment of the selling efforts in the market (Chapter 7); the programs aimed at influencing salespeople's behaviors, first, under a more or less centralized control approach by providing salespeople with specific objectives (Chapter 8); second, under more decentralized or balanced approaches, by providing salespeople with directional objective and incentive programs (Chapter 9); and those programs that intend to maintain and increase salespeople's competencies (Chapter 10).

The vision of a Dynamic Sales Force Management Process that has been developed throughout this book is a general vision. It recognizes that any sales force management/control system is typically made up of several elements or sub-systems. The two major sub-systems that constitute a manager's command center are a set of control levers (or programs) and a dashboard. Control levers are constantly activated and adjusted as sales managers, the leaders in charge of the process, watch on their dashboard whether they are on track toward meeting their short- and long-term objectives. All the control center elements should be designed so as to help management achieve its multiple selling objectives, and in such a way as to directly or indirectly adjust salespeople's decision spaces, and consequently, their levels of autonomy and initiative.

Every control element may be characterized along one fundamental dimension, that is, its ability to provide a centralized versus decentralized control. The selection by management of a position on the centralized-decentralized continuum generally depends on the firm's specific sales force selling and control objectives, and on the relative availability and costs of obtaining and using the relevant information.

The proposed vision of a dynamic sales force management process has a number of implications for the practice of sales management and for sales research.

Some managerial perspectives

First, this book has proposed a vision of sales management that is still under-used in practice. This is, however, an integrative vision.

A sales force motivation program at American Express

American Express' management considers that team work contributes substantially to the firm's success. The proximity of a sales team with customers, the continuous concern for quality, the constant search for improvements, as well as the importance of every salesperson's commitment are the bases that this firm uses to motivate the sales force. When they succeed in opening a new account, a salesperson gets a bonus on top of commission that is a percentage of the amounts that the new customer deposits during the first six years. In addition, every year, the highest performing salespeople are offered a luxury holiday. In order to fall into this category, the salespersons must have been singled out for some action in which they demonstrated exceptional team spirit.

American Express does not just recognize its top sales producers. The sales managers let their salespeople know that they appreciate good performance and show that the company appreciates even modest successes whenever they occur.

The objective of this American Express incentive program is to bring salespeople's motivation to its highest possible level, to foster a spirit of team work and high morale in the sales force. Contrasting with the type of centralized motivation programs that have been discussed in the preceding chapter, American Express has developed a highly decentralized motivation program that gives salespeople the leeway to select their own performance levels.

Does better training result in an increase in sales?

Raleigh, an important independent distributor of bicycles, had just hired a new sales manager. Shortly after taking the job, this sales manager realized that in order to increase the firm's customer basis, it was essential to redefine the sales force mission. Salespeople had to become the best consultants for their clients. A prerequisite to do this was to provide salespeople with knowledge, not just about products, but also to give them some basic understanding of fields such as accounting and inventory management so they could provide their independent clients with useful advice when needed. The objective was to develop high value-added partnerships with customers.

The sales manager quickly realized that all the field salespeople needed additional education and training. The objectives of the necessary training program have been defined as “developing a basis for mutual understanding and dialogues between customers and salespeople in order to implement a more consultative approach to selling.” An external trainer was hired to provide the training. The sales manager looked at several training agencies so he could select the organization that was best equipped for providing the required service, and which could eventually provide the best follow up program.

All the regional sales managers worked closely with the trainers in order to define twelve areas in which sales staff needed to make some progress (for example, the best ways to uncover and address customers' needs and problems, or to handle customers' objections).