Pricing and Incentive Structure in Indirect Retail Channels

This project is part of a research collaboration with one of Canada's financial institutions. The project consists of two research papers funded by three external grants, summarized below.

Funding Summary:
• SSHRC Doctoral Fellowship, 2019 (CAD $20,000)
• Ontario Graduate Scholarship, 2018 (CAD $15,000)
• Ontario Centre of Excellence TalentEdge Internship, 2018 (CAD $10,000)

Optimizing Pricing Delegation to External Sales Forces via Commissions: An Empirical Investigation

In this paper, using data from indirect auto lending and a structural model of external sales representative (ESR) behavior, we investigate i) the role of commissions as a potential tool to influence ESRs’ pricing decisions under limited authority, ii) the impact of optimized commissions on firm profitability and iii) the implications for customer welfare. The results provide strong evidence for ESRs being strategic (vs. myopic) in their pricing and effort decisions; and in both cases, strategic behavior is inversely proportional to customer risk. Moreover, once optimized, commissions are an effective tool for firms to bridge the profitability gap between centralized pricing and pricing delegation. Our analyses on social justice and fairness reveal that customer groups along the dimensions of customer risk, income class, and gender, which have been traditionally marginalized in society, suffer from inequities in the indirect-lending ecosystem. While, the optimization of commissions does not intensify these biases, we found females to be the exception, and that the inequities due to gender bias not only persist in the optimized regime, but also deepen. Through counterfactual simulations, we propose two policies for firms to minimize social inequity, which helps them balance immediate profit-maximizing goals with responsible AI initiatives.

The Impact of Discriminatory Pricing Based on Customer Risk: An Empirical Investigation Using Indirect Lending Through Retail Networks

Purpose: To understand the profit implications of analytics-driven centralized discriminatory pricing at the headquarter level compared to sales force price delegation in the purchase of an aftermarket good through an indirect retail channel with symmetric information.

Design/Methodology/Approach: Using individual-level loan application and approval data from a North American financial institution and segment-level customer risk as the price discrimination criterion for the firm, we develop a three-stage model that accounts for (i) the salesperson’s price decision within the limits of the latitude provided by the firm, (ii) the firm’s decision to approve or not approve a sales application, and (iii) the customer’s decision to accept or reject a sales offer conditional on the firm’s approval. Next, we compare the profitability of this sales force price delegation model to that of a segment-level centralized pricing model where agent incentives and consumer prices are simultaneously optimized using a quasi-Newton nonlinear optimization algorithm (i.e., BFGS).

Findings: The results suggest that implementation of analytics-driven centralized discriminatory pricing and optimal sales force incentives lead to double digit lifts in firm profits. Moreover, we find that the high-risk customer segment is less price sensitive and firms, upon leveraging this segment’s willingness to pay, not only improve their bottom-line but also allow these marginalized customers with traditionally low approval rates access to loans. This points out the important customer welfare implications of the findings.

Originality: Substantively, to the best of our knowledge, this paper is the first to 1) empirically investigate the profitability of analytics-drivensegment-level (i.e., discriminatory) centralized pricing compared to sales force price delegation in 2) indirect retail channels (i.e. where agents are external to the firm and have access to competitor products) 3) taking into account the decisions of thethree key stakeholdersof the process, namely, the consumer, the salesperson and the firm and 4)simultaneously optimizingsales commission and centralized consumer price.