In: Economics
Kempton owns a plumbing repair service company that has been in business for thirty years in Shreveport Louisiana (population 198,675). The company employs 50 repairmen and repairwomen that work in two person teams doing plumbing repair jobs. Kempton’s son Myron is going to be taking over the business and has lots of ideas about improving incentives. Equipped with what he has learned in the MBA program at LSU, he has established that (1) customer satisfaction, (2) capacity utilization (the plumbing repair service people need to be working when they are on the clock) and (3) the profit margin of the service (some repairs involve more parts than others and the mark up the customers on the parts is high) are the company’s profit drivers.
Myron has decided to implement a program where the plumber’s bonuses are based on a formula that has 40% weight on customer satisfaction (measured by post-service customer satisfaction surveys), 30% weight on capacity utilization (measured by number of jobs completed) and 30% weight on profit margin (measured by number of high mark-up jobs completed).
Explain to Myron why, while he would like to see improvements in the plumbers’ performance on all three dimensions, he is more likely to see significant improvement on one dimension and little or no improvement on the other two dimensions.
Explain to Myron why, while he would like to see improvements in the plumbers' performance on all three dimensions, he is more likely to see significant improvement on one dimension and little or no improvement on the other two dimensions.
In a nut shell, this comes down to where the employee will get the most cash. In this sense, employees will focus on dimension 3, that is, 30% weight on profit margin (measured by number of high mark-up jobs completed).
In general, markup refers to the cost that is added, in this case, to the service. Myron employees will attempt to increase these costs by spending more than normal time completing work and/or replacing parts that still have useful life. By increasing the markup, the cost for the service will increase, the customer will have to pay more, Myron will make more money and the employees will receive more cash.
Under this scenario, Myron will not see significant improvement in customer service, on the contrary, in the long term, the tendency will be to lose more customers due to high service costs.
As for the capacity utilization dimension, it won't be of much help to Myron either. It will be much more attractive for the employees to complete fewer jobs where they can increase the costs of service, and as a result increase profits, than to strive to complete more jobs which implies more work, physical wear and pressure to receive the bonus.