11The Effects of Customer Rebates and Retailer Incentives on Manufacturer Profitability and SalesResearch with Özgül Baysar, Özgün Çaliskan Demirag, and Dr. P?nar Keskinocak2MotivationA Brief History of Incentives in Auto IndustryØ Henry Ford promised rebates on Model Ts in 1912Ø After the 1973 oil embargo, became more widespreadØ American auto manufacturers: customer rebates, Japanese auto manufacturers: retailer incentivesØ To get the most benefit from promotions:What kind of promotion ?Under which conditions ?23Dealer Incentives and Cash Rebates in the Automotive Industryn 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 Industryn Aggregate incentives (US, April 2006): $3.39 billion, Edmunds.com.n Largely fixed production and labor costsq “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 Industryn Aggregate incentives (US, April 2006): $3.39 billion, Edmunds.com.n Largely fixed production and labor costsq “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)n Competition. Every manufacturer offers some kind of incentiven “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.n 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 Workn Gerstner, Hess, and Holthausen (1994)¨ Customer rebates ¨ High and low customer segments, competing retailersn Kim and Staelin (1999) ¨ Manufacturer allowances (retailer incentives), pass-through rates n Busse, Silva-Risso, and Zettelmeyer (1999) ¨ Information asymmetries involved in incentives and rebates, pass-through ratesn Bruce, Desai, and Staelin (2005, 2006) ¨ Promotions of durable goods manufacturers59Our Workn Promotions analyzed:Ø Customer rebate: per unit payment to the end customerØ Retailer incentive: lump sum payment to the retailern Settings: No Competition (Monopoly) and Competition in Automobile Industry with price-discriminating retailersn 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?n Competition: (C-Demirag, Keskinocak, and Swann (2006))¨ What are the manufacturers’ wholesale price and promotion decisions whenn manufacturers offer only customer rebates?n manufacturers offer only retailer incentives?n manufacturers offer different promotions?10Knowing the Unknowablen Things we know¨ Differences among manufacturers¨ Dealers know moren Things we don’t know¨ Causality¨ Customer behaviorn Things that Matter¨ Price discrimination with dealer margins¨ Decentralized systems611Model CharacteristicsØ2-stage supply chainØManufacturers and retailers are risk neutral and maximize their own profitsØFirst-degree price discrimination by the dealersØDealers price discriminate through car model, market-specific properties, and the type of purchase transaction such as first-time purchase and trade-in, Goldberg (1996). ØConstant wholesale price by the manufacturersØ“..manufacturers rarely vary published retail and invoice prices of a particular model over the course of the model year.” Busse et al. (2006) Ø“..manufacturers hold wholesale prices constant even when capacity is scarce.”Cachon and Lariviere (1999)ØStackelberg Game: Manufacturer leader, retailer followerØ(Competition) Cournot Game: Manufacturers move simultaneously followed by simultaneous move by dealersØBackward 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 PromotionØ Sequence of decisions: Ø Manufacturer determines wholesale price Ø Retailer determines the order quantityØ Retailer’s Problem:Equilibrium SolutionØ Manufacturer’s Problem:maximize profitsatisfy marginmaximize profitpositive sales1019Model 1b) Deterministic-Retailer Incentiven Retailer’s