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Financial Performance
Author(s): Jeffrey P. Dotson and Greg M. Allenby
Source: Marketing Science, Vol. 29, No. 5 (September-October 2010), pp. 895-908
Published by: INFORMS
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Marketing Science in'ili'iM
Vol. 29, No. 5, September-October 2010, pp. 895-908
ISSN 0732-2399 1 eissn 1526-548X 1 10 1 2905 1 0895 doi 10.1287/mksc.ll00.0584
2010 INFORMS
Greg M. Allenby
Fisher College of Business, Ohio State University, Columbus, Ohio 43210, allenby.l@osu.edu
ability to demonstrate the impact of marketing action on firm financial performance is crucial for
uating, justifying, and optimizing the expenditure of a firm's marketing resources. This presents itse
formidable task when one considers both the variety and potential influence of marketing activity. We pr
hierarchical Bayesian model of simultaneous supply and demand that allows us to formally study the f
impact of a variety of marketing activities, including those that operate on different timescales. The s
side model provides insight into how the firm allocates resources across its various subunits. We illustr
approach in a services context by integrating data from three independent studies conducted by a large n
bank. Our model allows customer and employee satisfaction to influence firm profitability by moderat
conditional relationship between the bank's operational inputs and its proclivity to produce revenue.
Key words : customer satisfaction; employee satisfaction; endogeneity; resource allocation
History: Received: July 1, 2008; accepted: April 13, 2010. Published online in Articles in Advance July 29,
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
896 Marketing Science 29(5), pp. 895-908, 2010 INFORMS
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
Marketing Science 29(5), pp. 895-908, 2010 INFORMS 897
data. Estimates of unobservable or latent constructs This occurs if managers set the inputs, X, with an
can be related to observed data through Equationexpectation
(4): of how they will affect the response out-
come, y. The presence of endogenously determined
M covariates has been show to yield parameter esti-
mates that are both biased and inconsistent (Villas-
zlh^N /,.= : ,2f , (4)
Boas and Winer 1999, Berry 1994). We address this
issue by constructing a model that reflects our belief
V L^siJ /
about the managerial decision process that gives rise
where zih is a vector that contains survey responsesobserved input variables X. Joint modeling of both
to
thei,inputs X and output y of the response process
to multiple questions for individual h in unit
S denotes the number of items in the survey instru- has been shown to solve the issue of endogeneity,
ment, and x{ is the estimated vector of interest yielding consistent estimates of model parame-
thus
ters (Otter et al. 2009, Manchanda et al. 2004).
included in Equation (3). Note that each element of the
vector jjl corresponds to the estimated mean responseWe implement this approach by specifying the
supply-side
of a particular question for unit i in the survey instru- model for X defined by Equation (7).
In this model we assume that managers have
ment, and 2/ captures covariation across questions.
This is done in anticipation of our empirical applica-least an implicit knowledge of the response pro-
at
tion where we connect cross-sectional employee andcess defined by Equation (1) and set levels of mar-
keting inputs {xkit} to maximize firm profit over a
customer satisfaction data to a time series of opera-
finite time horizon, T, subject to a budget constraint.
tional measures through a set of shared parameters in
Managers identify optimal values of {xkit} by solv-
Equation (2). We allow for cross-unit heterogeneity by
ing the constrained optimization problem presented
specifying a distribution of random effects for both the
in Equation (7):
location and covariance matrix of Equation (4):
/ / K ' K '
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
898 Marketing Science 29(5), pp. 895-908, 2010 INFORMS
_ ln(AKJ =+
Eft-i 1)
(i4)
-+X k='
We allow o
fromIt is important
the to note that Equationop(13) can on
[Cut) into
be evaluated th
for values of ki > 0. Furthermore,
tion (7). Sub
Jacobian in Equation (14) creates a ridge in the lik
occurslihood surface as
exactly equal to 0 awhen Y!k='kir
for each
As such, Equations (13) and (14) in
effectively bo
across inpu
the parameter space to include only reasonable va
Ckite^kit =
of , or values of that would (p
give rise to a solu
fromto Equation
a(10). varie
input prices
Bayesian estimation proceeds by recursively gen
expenses, etc. ating draws from the full conditional distribution
all model parameters (Rossi et al. 2005). The inclu
2.3. Likelihood and Estimation
of the Jacobian term in Equation (11) prevents us f
We employ a full-information Bayesian approach to
utilizing standard conjugate results to implement
estimate our model, where the likelihood can be
efficient Gibbs sampler for model estimation. Inst
expressed as follows: we rely on a hybrid sampler where a subset of
parameters are drawn using the Metropolis-Hasti
/(data | else) = Y'Y'ir{'n{yit) | 'n{{xkit)))ir{'n{[xkit)))
i t algorithm (Chib and Greenberg 1995). Although t
is simple to implement, the sampler substanti
= UU^hM{U) h (H) increases the computational burden of the rou
i t -*ln(x) The estimation algorithm for our proposed m
of simultaneous supply and demand is provide
The quantities eit and Extensive
the appendix. {kit) are
simulation studiesdef
were c
tions (12) and (13),
ducted to respectively, an
assess both the efficacy and mixing pro
Jacobian term that
ties ofcaptures
all estimation routines. dependenci
ping of -^ln(x). The Jacobian result
change of variables from s -> ln(y) is t
toi: 3. Data
Empirically, we study the strategic effec
faction on firm performance in the contex
sit = ln(y,,) - (ln08oi) + E ki Info*)) banking.
, (12) Data are provided by a national
V k=' /
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
Marketing Science 29(5), pp. 895-908, 2010 INFORMS 899
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
900 Marketing Science 29(5), pp. 895-908, 2010 INFORMS
competitive
Table 2 Descriptive Statistics for Employee and effects are not as important
Customer as they may
Satisfaction Studies
be in other settings, thus justifying their exclusion
Variable No. of branches Mean Std. dev. from the model. Retail banking is also a relatively
homogeneous industry. Product offerings tend to be
Customer measures (1 to 10 scale; 1 = unacceptable,
very similar across firms and are virtually identical
10 = outstanding)
across units within a given firm. At the branch level,
Overall branch rating 898 8.9 1 .6
(proxy for customer satisfaction) managers are primarily responsible for the effective
Rating of the courtesy and 898 9.1 1 .4 utilization of their staff. As such, FTE, base salary,
friendliness of branch tellers and incentive compensation are the only short-term
Evaluation of time required to 898 7.9 2.2 (i.e., tactical) variables under the control of the branch
wait in line for service
manager.
It is
Employee measures (1 to 10 scale; 1 = very dissatisfied, important to note that in many service set-
10 = very satisfied) tings it is likely that changes in base compensation
Overall job satisfaction 898 7.7 1.9 will also have an impact on employee satisfaction,
Decision-making authority 898 8.1 1.8 thus exerting both a strategic and tactical influence
required to do job effectively
on firm performance. In retail banking, however, base
Fair evaluation of job performance 898 7.7 2.0
Clear link between job 898 6.8 2.4 salary increases are often a function of tenure at the
performance and compensation bank, and base salary reductions rarely (if ever) occur.
Satisfaction with rewards program 898 6.9 2.1 In our data set, the variation we observe in base
(pay, bonus, 401 (K), etc.)
compensation is a reflection of the number and type
Opportunities for personal 898 7.9 1.8
growth and development
of employees utilized in a given month (variability
in part-time hours, temporary (e.g., peak-time) help,
overtime of salaried employees, etc.) and not actual
of 1 to 10, where 1 and 10 denote, respectively,
changes to the base compensation rate. Because these
"unacceptable" and "outstanding." conditions
An averageare part of
of the negotiated terms of employ-
seven employee responses were recorded
ment, we dobranch
per not believe they will have an impact on
(minimum of 5, maximum of 19). employee
These responses
satisfaction and thus allow base salary to
were also scaled from 1 to 10, where 1 and
exert 10 indicate,
a purely tactical influence on firm performance.
respectively, "very dissatisfied" and It
"very satisfied."
is important to note that structural changes to the
To maintain consistency in the data and
termsease the inter-
of employment (e.g., increasing or decreasing
pretation of results, both customer and employee
the average wagedata
rate across all employees) could
were rescaled onto the 0-1 interval, where
have 1 repre-
strategic consequences that would need to be
sents the maximum possible positiveincorporated
response.into the model.
Latent levels of aggregate customer and employee
satisfaction are estimated using Equation (4) and
are incorporated into the response4.modelAlternative Models
through
Equations (2) and (3). As presented We explore the(4),
in Equation results of seven alternative mod
responses to all survey questions are Model descriptions
modeled as real- and characteristics are provi
in Table 3.normal
izations from a heterogeneous multivariate The first model (M^ is a three-in
demand
distribution with a branch-specific mean andmodel defined by Equation (15) without
covari-
ance matrix. A benefit of the assumption of multi-
informative supply-side model for {xkit}:
variate normality is that it allows us to easily derive,
for example, the conditional distribution of customer yit = oi4l^mes", (15)
satisfaction given its determinants or drivers. This
simplifies the process of tracing the where xlit, x2it,
influence and x3it are, respectively, FTE, base
of spe-
cific changes in the service climate salary
(e.g.,in customer
thousands of dollars, and incentive compen-
wait time) through the response process sation in
tothousands
revenue of dollars.
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
Marketing Science 29(5), pp. 895-908, 2010 INFORMS 901
Constrained
Model Description Endogenous X parameters LMD X LMD Y LMD TTL
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
902 Marketing Science 29(5), pp. 895-908, 2010 INFORMS
5. Results
defined as bounds on total dollar expenditures for
base and incentive compensation.
Table 3 presents descriptions and fit statistics
Estimates of {A*.} inform us about
models the degree
Mx through M7. We to
compute Bayes fact
which allocation decisions are coordinated across the
for the respective models using the Newton-Rafte
bank. Given the existence of a budget constraint, approximation
opti- to the log-marginal density (Newto
mal bank-level behavior would be achieved when and Raftery 1995). Fit statistics are provided for
(provided all inputs are measured in the samemarginal
units) distributions of both y and X implied
the model under investigation, in addition to the jo
d7T*
distribution of the same.
- =A Vfc,U, (19)
In terms of the joint distribution of both X and y,
we find that M5 outperforms all other models, includ-
where tt* represents bank-level profitability over all
ing the statistical model, Mv This suggests that
time periods, as denoted by the top half of Equa-
resources are optimally balanced within but not
tion (7). That is, the marginal increase in profitabil-
across units, or that the bank engages in decentral-
ity resulting from an increase in {xkit} is balanced
ized decision making. Within any given branch, the
across all inputs k, units i, and increase
marginal time in periods t. If from a
profitability resulting
these conditions are met, we would conclude that
relaxation of the budget constraint is identical for both
marketing resources are optimally allocated across the base salary and incentive compensation. Results for
organization. the marginal distribution of X indicate that the simul-
A variety of deviations from optimal coordination taneous supply and demand models allow us to better
are also possible. The following are alternative model explain variation in the input variables relative to the
specifications defined in terms of the budget con- model of exogeneity presented in Equation (16). For
straint. As noted above, we include FTE as a control
example, the log-marginal density for Ma is 14,709.88
for branch size in our model and therefore only inves- as opposed to 20,625 for M5. This result supports our
tigate optimality in the coordination of base salary premise that managers set X with an expectation of
and incentive compensation. how it will influence y or that X is in fact endogenous.
Model 4 (M4) presents a scenario where allocation A key object of interest in the Markov chain Monte
decisions are made at the branch level, and separate Carlo (MCMC) output is the estimate of F, the coeffi-
budget constraints (and corresponding Lagrange mul- cient matrix for the distribution of random effects for
tipliers) are defined for each unit i and each input k: defined in Equation (2); F informs us about the rela-
tionship between customer and employee satisfaction
M4: Exkit<mki. (20) and the firm's technology (i.e., ). Posterior means for
t
estimates of F for M5 are presented in Table 4. Param-
eter estimates with 95% of their mass above or below
Allocation decisions in model 5 (M5) are still made
at the unit level but are coordinated across inputs. A zero are presented in bold.
single budget constraint is set for the sum of both base We observe that employee satisfaction is positively
and incentive compensation. Model M5 corresponds correlated with the multiplicative intercept 0. This
to a scenario where the bank engages in decentralized implies that branches whose employees are relatively
decision making: more satisfied tend to exhibit a greater proclivity to
produce revenue, all else equal. Although the pos-
terior mean of the effect of customer satisfaction is
M5: %,<m,. (21)
positive, we are unable to conclude that it is statisti-
t k
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
Marketing Science 29(5), pp. 895-908, 2010 INFORMS 903
Figure 1 Distribution of Posterior Means for Beta for M- Demand Side Only
o-Intercept rFTE
150n ..Tl ,c -
_ . i *: - , 1 50 n :> ' ^
I I I I I ! I I I I I I I
1.5 2.0 2.5 3.0 3.5 4.0 4.5 -1.5 -1.0 -0.5 0.0 0.5 1.0
200 1 ^ 4>^~~i
i i i i i i i i i i i
- 0 ^ DO DR in 1 R _n 1 n n n 1 no n r> n a
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
904 Marketing Science 29(5), pp. 895-908, 2010 INFORMS
Figure 2 Distribution of Posterior Means for Beta for M - Simultaneous Supply and
/Vlntercept /VFTE
250^
-, ' 150-1
200- IV ..."";'"
>^ '-<*.. ' . .
c 150- v' [J ;> : ^ 100- . * - v V;
CD
CD .
I I I I I I I I I I 1
2.0 2.5 3.0 3.5 0.01 0.03 0.05 0.07
i Af' 30 -|
300 ~i SS,:,,., 250~ --
lili; ^2oo- rr;--~- 1
o 200- :|1SK: <jj '.y^'r- -'<"
S W g- 150~ KJ&h;;^, ' '
^_ d WM wm cd "^iv-v '" ' y '
2 _ S d ili ui loo- - ;; ; i^;. ;,< ^ , r^-i
^ |j| 111 || v^| fe" S'" ' '^ '
iplBAS 5" ^Sf^f:;^iL_^^
i i i i i i i i I i i
0.4 0.5 0.6 0.7 0.8 0.9 0.0 0.1 0.2 0.3 0.4
are concernedis
(y4 2 = -0.07). Incentive compensation (Gelman
less eteffective
al. 2004). Given the esti-
as a driver of revenue at branches whose customers
mated parameters, the reduced-form model (Ma) can-
are relatively more satisfied. not account for the observed behavior of the firm.
Figures 1 and 2 present a series of histogramsThe of results of M5 presented in Figure 2, are rea-
the mean of each branch's posterior distribution sonable
of . in the sense that all posterior mean estimates
Figure 1 is constructed using MCMC results fromlieMl7
on the [0, 1] interval. Closer examination of these
and Figure 2 uses results from M5. We observe con- demonstrates that our estimates of adhere to
results
siderable heterogeneity across branches in the j8s
thefor
restriction that Li k < 1.
both models. On average, the size of appears to be
larger for base salary than for either FTE or incentive
6. Conclusion
pay. In the case of the Mv we observe average j8s for
branches that are less than zero and greater than one. paper presents a new approach to relating
This
tical and strategic marketing initiatives. Specific
These results are counterintuitive and severely restrict
M/s ability to provide guidance for future manage-we model revenue production in retail bankin
rial decision making. A value of < 0 (i.e., negativea function of employee compensation, and we a
returns to scale) implies an optimal expenditure customer
of and employee satisfaction to moderate
zero dollars, whereas > 1 (i.e., increasing returns relationship
to between the same through a hierar
cal Bayesian model. We handle potential endog
scale) implies full allocation of all available resources
to that input. ity in the input variables by jointly estimati
As we do not observe corner solutions in our data, demand-side model (i.e., model for y) and supp
models that exhibit increasing or negative returns sidetomodel (i.e., model for X). Our supply-side m
scale fail the test of reasonability and are of littleis use
formally derived from a constrained optimizat
to mangers. We interpret the extreme coefficientproblem esti- where managers are assumed to maxi
mates in Mj as a strong test against its plausibility profitability subject to a budget constraint. The re
because it rules out the possibility that the inputs ing likelihood imposes a variety of constraints on
were determined as part of some goal-directed pro- parameter spaces of , thus yielding estimates co
cess. This analysis can be viewed as a type of tent pos-with the interior solutions observed in the data.
terior predictive check, where the implied allocation The structure imposed upon our model allows us to
of resources is the feature of the data with which we utilize its results to guide managers in the allocation
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
Marketing Science 29(5), pp. 895-908, 2010 INFORMS 905
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All use subject to http://about.jstor.org/terms
Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
906 Marketing Science 29(5), pp. 895-908, 2010 INFORMS
~Lt~' F (01,-1) 2i 03, "irin(xia)" (through the likelihood) to the region defined by the second
condition.
Lt = A,- ()32,-l) 03, Infe,) Step 2. {A,-} | else] a ['xkil] | (&,), {A,}, 2X,][{A,) | , 2A].
.L,i L Ai li (03,-1)] Lln(%,)J
{A,} arewx
also drawn by first employing the following
change of variables: * = In (A, + 1). The transformed vari-
(26) wx
ln^-ln^-ln^,) " ables, {A*}, are drawn using a M-H step where the likeli-
- ln(A2 + l)-ln(/3o;)-ln(02,) , hood contribution is equal to
Block 1: Within Units. Iterate through each unit (i.e., S = (- ii*M)f( - >i*M) + (M, - M)'A(M - M),
branch) in the data set drawing:
Step 1. ['ki] | else] a [(y,() | 'xkit), 'ki', of'['xa' | (&,(,
and M = WiL*)-'ii*').
A}. 2-][(/8h} I r, /n?, Sp]. Standard, weakly informative priors were used for this
Draw i using a Metropolis-Hastings (M-H) step, where update:
the contribution for the first two factors of the likelihood
for unit i is equal to M = 0 isa3x4 matrix of 0s,
3x4
where the Jacobian is defined in Equation (27), and the hier-Vo = vox J4.
archical prior for beta is specified as
Step 5. [, 2A | else].
A~N(I>?,2p). Conditional on realizations of {A,}, A, XA can be esti-
mated using a multivariate regression of {A,} on the unit
Acceptance probabilities are computed using the standard vector with length equal to the number of branches under
M-H algorithm (see Rossi et al. 2005, p. 88). The step size study, ln. Full conditional distributions for the mean and
of the proposal density was tuned so that the acceptance co variance matrix follow those outlined in Step 4.
rate of draws was close to 30%. It is important to note that
Block 3: Within Units.
the likelihood for the model can only be evaluated for [ki]
Step 6. [/il Nielse].
that correspond to the first condition outlined in 2. That is,
ki > 0 for all k and i (the likelihood is undefined other- fiCi and XCi can also be drawn through the use of a multi-
wise). As such, starting values for [ki] must be selected that
variate regression of observed customer satisfaction survey
correspond to this condition as well as the second condi- responses on the unit vector, ln.
tion for economic production functions, Y=' ki < 1- It may Step 7. K | else] [tf | c,V'[z<ih 1^,2?]
be useful to reinforce these constraints in the MCMC by [ft | M, r, 2,].
proposing only values of ki > 0. We find that if the routine Inference for the latent level of aggregate customer satis-
is properly initialized the draws of [ki' will be constrainedfaction, 'x'{, proceeds by first recognizing that distribution
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Dotson and Allenby: Influence of Customer and Employee Satisfaction on Firm Financial Performance
Marketing Science 29(5), pp. 895-908, 2010 INFORMS 907
We followof
of jJLcu is proportional to the product Jen three
et al. (2007) when drawing parameters for
multivariate
normal densities: A, B, and C. We the derive
distribution ofthe
randomposterior
effects specified fordis-
2?.
tribution for ficu by re-expressing A,The B,
conditional
andposterior
C in for (Ie is IW(^of
terms + Nvc,
the (ftg"1 +
EiSr1))-
univariate normal for ficu and combining quadratic forms
as described in Box and Tiao (1973): Step 10. [i7c|else].
The posterior distribution for vc does not have a closed-
form expression and must therefore be drawn using a M-H
step, where the likelihood contribution for vc is equal to
where
Factor B (Contribution from the model for observed cus- Step 12. K I else] a [Mf |^7 V^][z]h ' il', 2f]
tomer satisfaction responses): [ftlM*,r,^].
B/oc/: 6: Across n/fs.
Mb = M; + Vl2V1 {a - fic_u),
Step 13. [fi6, y; I else].
^B - ^11 ^12^22 ^21' Step 14. [^ |else].
Step 15. [il6 1 else].
where
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