Side Payments in Marketing
Authors: Hauser John R. , Simester Duncan I. , Wernerfelt Birger 
Published: October 2008

Side payments, known politely as gainsharing and pejoratively as bribery, are prevalent in marketing. Indeed, many management schools have added ethics modules to their basic marketing courses to discuss these issues and there is much discussion of side payments in the literature (e.g., Adams 1995, Borrus [Borrus, Amy. 1995. A world of greased palms. Business Week (November 6) 36–38.], Mauro [Mauro, Paolo. 1997. Why worry about corruption? International Monetary Fund. Washington, D.C.], Mohl [Mohl, Bruce. 1996. Auto dealers color surveys to polish image: Buyer's say salesmen tamper with makers' questionnaires. Boston Globe (August 11) B1, B6.], Murphy [Murphy, Kate. 1995. Corporate gifts: What's naughty or nice. Business Week (December 11) 122.], Peterson [Peterson, Barbara S. 1996. Taxing question: Will the government make you pay for your next travel benefits? Frequent Flyer (February) 27–30.], and Rose-Ackerman [Rose-Ackerman, Susan. 1996. Bribes and gifts. Proc. Conf. Economics, Values, and Organization, April 19–20. Yale University, New Haven, CT.]). We seek to provide insight with respect to one class of marketing side payments. We hope that our analyses clarify some of the issues and suggest how these side payments affect marketing activities.

We begin by focusing on one common example of potential side payments—salesforce ratings of internal sales support. We derive two formal results and speculate on how these results generalize. The two results are (1) that having one group of employees rate another implies that there are almost always incentives for side payments, but (2) the side payments need not reduce the firm's profit. At least in theory, the firm is always able to revise the reward system to factor out these side payments. The first result, based on a straightforward proof, has important practical implications for managers who may wish to preclude side payments. They may be unable to design a ratings-based reward system that does not have inherent incentives for side payments. The second result, in our opinion, is quite surprising. It suggests that marketing managers might be advised to invest more time into understanding how side payments affect employee reactions to reward systems. They might want to reconsider costly efforts to monitor, police, or preclude such side payments. While our results do not substitute for a moral discussion of side payments, we hope that the formal structure for one common marketing situation provides valuable insight.

The system we analyze is based on a practical managerial problem we have observed. The salesforce evaluates a sales support group with a real-valued rating. The sales support group is rewarded based on that rating, whereas the sales-force is rewarded based on outcomes, such as sales or customer satisfaction, that indicate incremental profits to the firm. The reward to the salesforce might also depend upon how it rates sales support. For example, the salesforce might be held to a higher standard whenever it rates sales support as “excellent.” (We argue in the paper that the firm will want this to happen.) In addition, the salesforce might ask for a side payment from the sales support group as compensation for high ratings.

We cast the practical problem as a formal game and incorporate the following issues: (1) incremental actions taken by the salesforce and by sales support are perceived to be onerous, (2) the measure of incremental profit is a noisy measure, (3) both the salesforce and sales support are risk averse, (4) given the reward system imposed by the firm, both the salesforce and sales support will maximize their well-being, and (5) given the structure of the reward system, the firm will seek to maximize expected profits.

We first show that there are almost always incentives for side payments. Specifically, we demonstrate that sales support is better off with a side payment, while the salesforce is no worse off. This is not surprising because the reward to sales support is increasing in the rating, while in the absence of a side payment, the salesforce will select a rating such that its net marginal returns to increasing the rating are zero. The exception occurs when the rating is constrained by the firm to be less than this “optimal” rating, but even then there might be incentives for side payments.

We next show that the firm can anticipate these side payments and design a reward system to factor them out at no loss of profit. The intuition is straightforward. The firm first adjusts the marginal returns in the reward functions for sales support and for the salesforce such that they will each take the “optimal” actions even though they engage in side payments. Then the firm adjusts their fixed compensation so that the firm extracts its full profit. The proof is difficult because we must show that adjusted reward systems exist and we must show that they allow the full profit to be extracted.

Throughout the paper we discuss the practical implications of our results. We close by highlighting future research opportunities.