The early years of my research career were largely focused on supply chain contracting with some focus on the auto industry. I am consequently a sucker for any good story about how automakers use their terms of trade to bend dealers to their will. Thus I read a recent Automotive News article on stair-step incentives with interest (GM stair-step aims to juice Chevy sales, Aug 19). Stair-step programs are dealer-based incentives based around quotas. A car manufacturer may offer a dealer three targets, say, 50, 100 and 125 units. If the dealer sells 50 cars in a specified time period (often a month), he will get, say, $500 per car rebated back to him. If he gets to 100 units, he would get something like $1,000 back per unit and then a bigger number if he goes over 125. So stair-step schemes offer bigger and bigger rewards as sales go up. The actual mechanics of plans can differ. For example, the increased rebate from crossing higher and higher levels may go back to early sales. For example, crossing from 124 to 125 in my example, may mean getting the top reward on every car sold that month. The other complication is what actually counts toward the target. Stair-steps may apply only to some models or to a wide set of models. The article notes that Chevy’s current program is exceptionally broad.
Sales of 2014 and 2013 Impalas, Camaros, Cruzes and Sonics are eligible under a GM stair-step program for August. The program pays dealers escalating bonuses as they hit factory-set sales thresholds. Sales of 2013 Malibus also are included; the 2014 model of the mid-sized sedan goes on sale this fall. …
Dealers say it’s unusual for GM to include so many nameplates in one stair-step program. Some also were surprised that the incentive includes the redesigned 2014 Impala, which has won critical praise since its May debut, including being rated the top sedan by Consumer Reports.
So why are stair-step programs interesting?
One reason is that they can significantly alter a dealer’s behavior. Imagine sitting at 124 cars sold in my example. Getting to 125 creates a huge windfall if that added bonuses gets tacked on to every unit. If ever there was a reason to call up your brother-in-law’s golfing buddy with a great deal on a Malibu, this is it. That said, stair-step plans can be hard to set up. The targets have to vary across dealerships. It’s a lot easier to move 50 Chevrolets in a month in suburban Chicago than in rural Idaho. But if those targets aren’t set appropriately they can bomb. If a dealership perceives a stair-step threshold as being out reach, they should ignore the incentive. (For more on this, check out this paper by my colleague Sunil Chopra.)
The other interesting aspect of stair-step schemes is how they affect competition across dealerships. If you and I own competing dealerships across town, I have a serious leg up on you if I am the first to reach a threshold. I can price more competitively since I know that I am guaranteed to get a rebate while you are still striving to make the threshold. Note this makes everything all that more sensitive to how individual dealer thresholds are set. If mine were skewed low while yours were too high, it’s game over and I eat your lunch.
As the article notes, this ability to “destabilize” local markets makes these schemes unpopular with dealers.
Stair-step programs are controversial among retailers. Some complain that they disrupt local market dynamics as stores chase bonus payments through artificially low pricing. Some dealers say that the pricing gyrations hurt customer satisfaction.
Also check out this column on Edmunds.com.
I know of no formal model that examines this problem. A model could help answer the question why a manufacturer would prefer a stair-step program over a simple price cut. I suspect that the race to get ahead of a competitor gets dealers to price more aggressively than they would if the manufacturer were to just cut the wholesale price.