FUTURA

Sales representatives gather information about likely future orders and convey that information back to the regional sales managers. Sales managers then create sales forecasts, which are used as the basis for manufacturing schedules. Sales forecasts are always too low. Sales representatives are compensated on a salary plus a percentage of revenue and sales managers are compensated based on salary plus a percentage of how much regional sales exceed the forecasted budget.

A bad decision is submitting sales forecasts that are too low. Submitting sales forecasts that are too low hurts the owners because the sales forecasts form the basis for manufacturing schedules and when sales greatly exceed the forecasts then the firm must scramble to increase output. When the firm scrambles its efficiency decreases and the prices of inputs increase. The reduction in efficiency and increases in prices of inputs makes profits lower than they would have been if the forecasts and scheduling had been more accurate.

Let's walk through the three questions:

Who has the decision rights? The sales managers have the rights to determine the sales forecasts.

What information did they have? Presumably they have good information from the sales representatives because the representatives have close contact with buyers.

What incentives do they face? The incentives they face encourage them to have low sales forecasts. Their commission is a percentage of the difference between actual sales and the forecast.

The answers imply that the deciders face incentives that encourage them to make decisions that are not in the interests of the owners.

The answers suggest two types of solutions.

One solution is to move the decision rights to someone with good incentives. If the new deciders do not have good information, the solution must also move the information to them.

A second solution is to change the incentives facing the deciders.

Use the Rational Actor Paradigm to identify changes in the organizational design that would reduce the chance of repeating the low forecasts.