To ensure that the correct size of heart valve is available for heart surgery, Heart Plus, the maker of the valves employs salespeople to place and maintain inventories at hospitals in its market. After a valve is used in surgery, Heart Plus, bills the patient’s insurance company and credits the sales person with a sale. Each sales person earns a commission based on a percentage of revenue of the sales in her territory.
Because Heart plus does not get paid until it sells its valve, it must bear the cost of holding the inventory calculated as the cost of capital (12%) times the wholesale cost of the valves placed in the hospital.
OK here is the problem:
Heart Plus faces a cost of holding inventory that is higher than its competitors. The salespeople are clearly overstocking hospitals in their territory. They have asked you to figure out how to fix the problem.
Is there any incentive to make a good decision and why?