Question

For years, the Goodyear Tire \& Rubber Company compensated its sales force by paying a salesperson a salary plus a bonus, based on the number of tires he or she sold. Eventually, Goodyear made two changes to this policy: (1) The basis for the bonus was changed from the quantity of tires sold to the revenue from the tires sold; and (2) salespeople were required to get approval from corporate headquarters in Akron, Ohio, before offering to sell tires to customers at reduced prices. Explain why these changes were likely to increase Goodyear's profits.

Short answer

The changes made by Goodyear were likely to increase the company's profits because they incentivized salespeople to sell tires at higher prices and limited the frequency of discounts, increasing revenue per tire sold and, therefore, profits.

Step-by-step solution

Understand the Initial Compensation Structure

The first step is to understand the initial compensation structure: salespeople were paid a salary and a bonus based on the quantity of tires sold. This encouraged salespeople to sell as many tires as possible, regardless of the selling price.

Analyze the Impact of the First Change

Next, consider the impact of the first change: the basis for the bonus was altered from the quantity of tires sold to the revenue from the tires sold. This change in compensation structure incentivized salespeople to not only sell more tires but also to sell them at higher prices. In turn, this would increase Goodyear's revenue from tire sales.

Analyze the Impact of the Second Change

Then, consider the impact of the second change: salespeople were required to get approval from corporate headquarters before offering discounted prices. This change likely made it more difficult for salespeople to offer discounts, leading to higher average selling prices, and therefore, increasing Goodyear's revenue.

Consider the Combined Impact of Both Changes

Finally, consider the combined impact of both changes: through incentivizing higher selling prices (via a bonus based on sales revenue) and limiting discounts (via requiring approval for reduced prices), Goodyear likely saw increased revenue per tire sold and, consequently, higher profits.

Key concepts

Incentive Structures

Incentive structures play a crucial role in driving the behavior and performance of sales teams. Previously, Goodyear compensated employees through a base salary paired with a bonus that depended on the number of units sold. This method, while straightforward, might have inadvertently focused salespeople on quantity rather than quality or profitability.

• Unit-based incentives can lead to a decrease in unit prices as salespeople prioritize moving stock, potentially neglecting customer relationships or selling strategies.
• Such structures can result in salespeople offering unnecessary discounts to close more deals, possibly reducing the overall profitability per sale.

Switching the bonus structure to be revenue-based shifts the focus from merely selling as many tires as possible to maximizing the financial outcome of each sale. This approach can encourage sales personnel to better understand their customers' needs and the value of the product they are selling. It aids in aligning the sales team's goals with the company's financial health, stimulating both higher performance and improved profit margins.

Revenue-Based Bonuses

A revenue-based bonus system shifts the measure of success from sheer sales volume to the financial contribution of each sale. In Goodyear's revised incentive structure, bonuses are determined by the revenue generated, not just the number of items sold.

• This approach helps ensure that sales staff focus on selling higher-value products, which can have a greater impact on total revenue.
• Encouraging the sale of more profitable or premium products supports strategic company goals and can elevate the perceived quality and exclusivity of the brand.

By linking bonuses to revenue, Goodyear encourages salespeople to balance the quantity of tires sold with optimally pricing strategies. This kind of structure rewards smart, profitable selling strategies and discourages unnecessary price reductions, which can erode profit margins. Ultimately, a revenue-based bonus plan can foster a more strategic and financially-driven sales culture.

Pricing Strategy

The fundamental idea behind strategic pricing is to optimize the balance between pricing and sales volume for maximum profitability. Goodyear's decision to require corporate approval for discounted pricing adds a layer of oversight and control to pricing strategies.

• This prevents salespeople from offering hasty discounts that might not align with broader company objectives or market positioning.
• It encourages them to focus on justifying the value of their products rather than immediately resorting to price cuts.

By implementing this change, Goodyear can maintain a more consistent pricing strategy and avoid a price competition cycle – a situation where products are sold at increasingly lower prices to prevent losing sales to competitors. This shift ensures that company-wide strategies are adhered to, improving profit margins. Furthermore, it provides sales teams with the mandate to build compelling customer value propositions without relying solely on discounting as a sales tool. Hence, pricing strategy becomes a vital part of aligning sales objectives with profit goals, fostering long-term sustainable growth.