01 Sep 2003
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Incentives and Operational Excellence


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Operational problems can be the cause of an organization’s demise. Often they can be traced to poor controls in interorganizational settings, according to HBS associate professor V.G. Narayanan, a specialist in measurement systems and incentives. Narayanan’s presentation focused on some problems common to both major corporations and mom-and-pop shops, and offered practical solutions based on his research.

One case Narayanan used to illustrate his point involved a family-owned video store. Generally in the past, he said, as many as 25 percent of rental customers would be disappointed when the video they wanted was out of stock. Retailers typically buy videocassettes from studios for $45 each and rent them for $4. Tapes are disposed of for $5 after three months, so the retailer must rent the tape at least ten times to break even.

The incremental cost for studios to put an additional tape on the retailer’s shelf, however, is less than $3. Demand for an individual movie is highly uncertain and usually declines rapidly after the first few weeks, Narayanan said. One contracting solution to bridge the divide between studios and stores was for the studios to sell tapes at a lower price — say $3 — in return for a share of the revenues, typically 50 percent. This allowed the retailers to break even with just one or two rentals. Monitoring and technology, however, are key to implementation of the plan, and the new system couldn’t work without the help of a third company, Rentrak. Rentrak kept track of the scanner data and performed audits and spot-checks to ensure compliance with the revenue-sharing contracts, thus enabling the new system to thrive.

“In this case,” said Narayanan, “the solution was win-win-win. The customers, the retailers, and the studios all benefited.”

Excerpted from HBS Working Knowledge: www.workingknowledge.hbs.edu.

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