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Compensation Plans in Car Dealerships

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Two months ago, the owner of a car dealership (and a current football star) significantly changed his sales manager's compensation plan. Under the old plan, the manager was paid a salary of $6000 per month: under the new plan she receives 2 percent of the sales price of each car sold. During the past two months, the number of cars sold increased by 40 percent, but the dealership's margins (and profits) significantly declined. According to the sales manager, "Consumers are driving harder bargains and I have had to authorize significantly lower prices to remain competitive." What advice would you give the owner of the dealership?

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Solution Preview

Let's first look at the sales manager:

If a $20,000 car is sold, she gets $400
If the price is dropped to $18,000 she gets $360
If a customer will not buy a car for $20,000 and the manager stays firm on price, she gets $0
If she drops the price by $2000 she gets $360.
If you were the manager, what would you do?
I'd be more willing to negotiate on price under the new ...

Solution Summary

Compensation plans in car dealerships are examined.

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Last year the owner of an auto dealership changed her sales manager's compensation plan. Previously, the manager received a fixed compensation. After the change, the manger's compensation was based on a percentage of sales. Compared to last year, sales have increased substantially but profits declined. Using economic analysis, explain the outcome and then recommend additional changes that would correct the situation.

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