Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Friday, October 07, 2005

Incentive-Compatible Compensation Schemes

Craig Newmark linked to this posting about how different compensation schemes affect the incentives facing employees, e.g. those on commission at Best Buy. The nuances are complex, but they appear to have a big impact (at the margin).

The posting suggests a way to get a really low price on a big-ticket item (this is a vague outline summarizing the strategy):
  1. Agree to buy all the high-margin add-ons that sales reps used to get bonuses for pushing.
  2. Negotiate a package price (see the sales manager, if possible, to do this).
  3. Several days later return the high-margin add-ons, which will likely be on the receipt at full price.

Several commenters say the compensation schemes have changed, so this strategy doesn't work any more. It apparently was changed because the original reward system was not incentive-compatible with maximizing profits.

Get past the normatives. When strategies like this are possible, some people will take advantage of them, despite the moral questions. The result is that compensation schemes must take people as they are, not as someone thinks they ought to be.

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