11The Effects of Customer Rebates and Retailer Incentives on Manufacturer Profitability and SalesResearch with Özgül Baysar, Özgün Çalışkan Demirağ, and Dr. Pιnar Keskinocak2MotivationA Brief History of Incentives in Auto Industry¾ Henry Ford promised rebates on Model Ts in 1912¾ After the 1973 oil embargo, became more widespread¾ American auto manufacturers: customer rebates, Japanese auto manufacturers: retailer incentives¾ To get the most benefit from promotions:What kind of promotion ?Under which conditions ?23Dealer Incentives and Cash Rebates in the Automotive Industry Aggregate incentives (US, April 2006): $3.39 billion, Edmunds.com.4Customer Rebates as a Percentage of Vehicle Cost to Dealer0%1%2%3%4%5%6%7%Jun-00Aug-00Oct-00Dec-00Feb-01Apr-01Jun-01Aug-01Oct-01Dec-01Feb-02Apr-02Jun-02Aug-02Oct-02Dec-02Feb-03Apr-03MonthsPercentageAmerican (Averages of 4 highest sales volume utility vehicles)Japanese (Averages of 3 highest sales volume utility vehicles)Nov ’01 change likely due to low financing promotions offered35Motivation: Dealer Incentives and Cash Rebates in the Automotive Industry Aggregate incentives (US, April 2006): $3.39 billion, Edmunds.com. Largely fixed production and labor costs “The problem is that Detroit's costs are roughly the same whether a plant is churning out as many cars as it can or standing idle part of the time -so the Big Three [GM, Ford, Chrysler] produce more cars than their market share justifies, creating gluts that force them to offer large cash incentives to move the excess." Jakobson (2005)6Customer Rebate as a Percentage of Vehicle Cost to Dealer 0%1%2%3%4%5%6%7%8%Jun-00Aug-00Oct-00Dec-00Feb-01Apr-01Jun-01Aug-01Oct-01Dec-01Feb-02Apr-02Jun-02Aug-02Oct-02Dec-02Feb-03Apr-03MonthsPercentageOEM 1-American (Averages of 2 highest sales volume utility vehicle models)OEM 2-American (Averages of 2 highest sales volume utility vehicle models)Cross correlation=0.8747Motivation: Dealer Incentives and Cash Rebates in the Automotive Industry Aggregate incentives (US, April 2006): $3.39 billion, Edmunds.com. Largely fixed production and labor costs “The problem is that Detroit's costs are roughly the same whether a plant is churning out as many cars as it can or standing idle part of the time - so the Big Three [GM, Ford, Chrysler] produce more cars than their market share justifies, creating gluts that force them to offer large cash incentives to move the excess." Jakobson (2005) Competition. Every manufacturer offers some kind of incentive “Ford's new rebate program could cause some manufacturers to increase their incentives programs on select models in response to Ford's actions," Joseph Amaturo, analyst, Calyon Securities. Incentives are becoming so ingrained that they're really counted into the price of the car to begin with.” Mark McCready, director, CarsDirect.com.8Relevant Work Gerstner, Hess, and Holthausen (1994) Customer rebates  High and low customer segments, competing retailers Kim and Staelin (1999)  Manufacturer allowances (retailer incentives), pass-through rates  Busse, Silva-Risso, and Zettelmeyer (1999)  Information asymmetries involved in incentives and rebates, pass-through rates Bruce, Desai, and Staelin (2005, 2006)  Promotions of durable goods manufacturers59Our Work Promotions analyzed:¾ Customer rebate: per unit payment to the end customer¾ Retailer incentive: lump sum payment to the retailer Settings: No Competition (Monopoly) and Competition in Automobile Industry with price-discriminating retailers No Competition: (Baysar, C-Demirag, Keskinocak, and Swann (2006)) Which promotion is more effective (higher sales and revenues) for the manufacturer under which market conditions? How is the dealer’s ordering decision affected by the manufacturer’s promotions?Competition: (C-Demirag, Keskinocak, and Swann (2006)) What are the manufacturers’ wholesale price and promotion decisions when manufacturers offer only customer rebates? manufacturers offer only retailer incentives? manufacturers offer different promotions?10Knowing the Unknowable Things we know Differences among manufacturers Dealers know more Things we don’t know Causality Customer behavior Things that Matter Price discrimination with dealer margins Decentralized systems611Model Characteristics¾2-stage supply chain¾Manufacturers and retailers are risk neutral and maximize their own profits¾First-degree price discrimination by the dealers¾Dealers price discriminate through car model, market-specific properties, and the type of purchase transaction such as first-time purchase and trade-in, Goldberg (1996). ¾Constant wholesale price by the manufacturers¾“..manufacturers rarely vary published retail and invoice prices of a particular model over the course of the model year.” Busse et al. (2006) ¾“..manufacturers hold wholesale prices constant even when capacity is scarce.”Cachon and Lariviere (1999)¾Stackelberg Game: Manufacturer leader, retailer follower¾(Competition) Cournot Game: Manufacturers move simultaneously followed by simultaneous move by dealers¾Backward Induction to find sub-game perfect Nash equilibrium12Demand Characteristicsm : fixed marginw : wholesale pricec : production costQaMonopolyprice sensitivity (b)=slopemarket potentialQuantity soldPrice713No Competition: Order of DecisionsEnd CustomersManufacturer Dealer Wholesaleprice, wIncentive (Kh, Kl), Rebate (Rh, Rl) or noneOrder(sales) quantity, (Qh, Ql)Manufacturer learns demand state 14DCBAF GENo Competition: Promotion EffectsAmount of lump sum incentive used by the retailer to increase demand (EFG)Total amount of rebate given to the customers (ABCD)QRa+RQKP(Q)aw+mQQO815Analysis:1) Deterministic Demand2) Uncertainty in Market Potential 3) CompetitionFor each model we analyze three cases:a) No promotionb) Retailer Incentivec) Customer Rebate3) Data Analysis16Model 1: Deterministica+RP(Q)aw+mQ917GFEDB CAModel 1: DeterministicAmount of lump sum incentive used by the retailer to increase demand (ABC)Total amount of rebate given to the customers (DEFG)QRa+RQKP(Q)aw+mQQO18Model 1a) Deterministic-No Promotion¾ Sequence of decisions: ¾ Manufacturer determines wholesale price ¾ Retailer determines the order quantity¾ Retailer’s Problem:Equilibrium Solution¾ Manufacturer’s Problem:maximize profitsatisfy marginmaximize profitpositive sales1019Model