Investigating the Strategic Influence of Customer and Employee Satisfaction on Firm

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
Stable URL: http://www.jstor.org/stable/40864672
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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

Investigating the Strategic Influence of Custome

Employee Satisfaction on Firm Financial Perform
Jeffrey P. Dotson
Owen Graduate School of Management, Vanderbilt University, Nashville, Tennessee 37203, jeff.dotson@owen.vanderbi

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,

1. Introduction lead to a misallocation of firm resource

in response
Marketing managers face increasing pressure to models can be effectively
modeling
demonstrate the impact of their actions on firm finan- the joint distribution of both
cial performance. In practice, linking action toIn this paper we propose a hierarch
out-
model that allows us to study the str
come poses a variety of methodological challenges.
ence
The influence of marketing intervention is often of satisfaction on firm financial
com-
plex and can include multiple intervening, We model unit-level revenue product
mediat-
ing, and moderating effects, whose resultstion
may of
be managerially controllable inputs
latent
manifest on different timescales. Managers, for exam-levels of customer and employee
ple, can directly influence sales through theexert an indirect influence on financia
use of
byincen-
short-term (i.e., tactical) activities like price and altering the factor productivity of the
tive promotions, or, rather, they can indirectly term actions. Structure is imposed upo
influ-
ence sales by modifying consumer attitudes ters of our model through the estimatio
toward
the firm through the use of long-term (i.e., of simultaneous supply and deman
strate-
explicitly
gic) actions like advertising, service climate improve- deals with the potential for e
the
ments, or increasing customer satisfaction. To capture input variables and produces man
the effects of tactical and strategic actions, sonable
models parameter estimates. By reason
are needed that can integrate data from a variety estimates
of that satisfy managerial expec
sources. the algebraic sign of price elasticity or
Response models calibrated using market data
of diminishing marginal returns. In th
must also account for the presenceduction functions, reasonable paramete
of endogenously
determined covariates. If managers guarantee the presence
set the inputs of of diminishing r
a marketing response model, X, with in the an expectation
input variables, thus allowing for
of how they will influence the outcome, of an optimal, interior solution to the r
y, the inputs
can no longer be treated as exogenous to the sys-
tion problem.
tem of study. Endogeneity violates the Our paper contributes
assumptions of to the literat
standard estimation approaches, which ways. First,
leads we advance the literatur
to mis-
estimation of the true relationshipcally betweendetermined
X and y.covariates by allowi
Resulting actions taken on the part ple,of multiplicative
managers can inputs in a produc
895

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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

framework with multiple budget In this section we develop a hierarchical

constraints. This Bayesian
approach allows us to make inference about
model that integrates the of
estimation allo-
the effects of mul-
cation procedure of the firm (i.e., tiple marketing
does the activities
firm through simultaneous anal-
engage
in centralized versus decentralized decision
ysis of panel making).
and cross-sectional data. Implicit in our
Specifically, we are able to assess approachhow efficiently
is the notion the
that firms face two fundamen-
firm coordinates the utilization of resources across
tal types of decisions: short-term (i.e., tactical) and
its various subunits. Second, we extend the liter- long-term (i.e., strategic). By relating these decisions
ature linking customer satisfaction to firm perfor- to a scalar outcome we are able to formally assess the
mance by conducting analysis at a more microlevel. trade-offs associated with engaging in tactical versus
Extant satisfaction-performance research has primar- strategic marketing activities.
ily focused on demonstrating the connection between Our general modeling approach consists of the fol-
aggregate measures of customer satisfaction and lowing two major components.
firm-level financial indicators (e.g., Tobin's Q, stock
returns, etc.; Anderson et al. 1994, 2004). Third, we 2.1. Demand Model
examine the influence of both customer and employee
We begin by specifying a response model that re
satisfaction in-line with recent research emphasiz-
short-term marketing activities to a unit-level finan
ing the role of customer co-production, where the
outcome. We express revenue, yit, realized by un
production process is influenced by both variables
in time t as a multiplicative function of k operat
(Bendapudi and Leone 2003).
inputs, {xkit}. Although we restrict our attention
We apply our model to data provided by a
revenue generation process, yit in Equation (1) co
national financial services firm where we integrate
represent a variety of outcomes like unit sales o
unit-level (i.e., banking branch) data from three inde-
number of new customers acquired:
pendently conducted studies. We show that customer
and employee satisfaction have both direct and indi-
rect effects on branch-level revenue production. Our
model allows us to assess the relative benefits of y,t = Ju4!ti)ee". (i)
Nfc=l /

engaging in short-term versus long-term marketing

activities. In addition, our results differ from a Logarithmic
simple demand models have been used
sively
analysis that indicates that customer satisfaction has in both economic and marketing appl
a negative impact on revenue production. (Lilien et al. 1992). These models enable us to c
The remainder of this paper is organizeddiminishing
as fol- returns to scale in the inputs and
lows. Section 2 presents the general formus ofto interpret the {ki} as elasticities. We view
our
model, the likelihood, and estimation strategy. lection
In 3 of [ki] in Equation (1) as a joint repres
we describe the data and setting used to empiri-of the firm's technology (Varan 1992); [ki] ful
cally demonstrate our model. Alternative models acterize
are the expected relationship between ope
outlined in 4. Results are presented and discussed
or tactical inputs, {xkit}, and a realized outcom
in 5. Final thoughts and areas for future research are to marketing actions that alter the cond
We refer
offered in 6. distribution of yit ' {xkit' through the response
cients [ki] as strategic (Mela et al. 1997).
2. Model We allow long-term strategic actions to infl
The relationship between marketing activity the revenue
and generation process in Equation (1)
financial performance has received extensive atten- a hierarchy on {j,}:
structing
tion in the marketing literature (Gupta and Zeithaml
2006, Rust et al. 2004). Existing models are often con- ft = I>* + 77, (2)
structed using what are referred to as chain-links of
where
effects. The service profit chain, for example, attemptsi ; is a K + 1 vector of respons
to trace the influence of managerial action andto a* is a vector of S + 1 variables t
firm
performance through its influence on employee observable
and characteristics of the prod
customer satisfaction (Maxham et al. 2008,(e.g., product attributes, average adver
Kamakura
etc.) models
et al. 2002, Heskett et al. 1994). Although these or unobservable constructs like cu
are useful in the sense that they provide tion or brand equity:
directional
evidence that constructs like customer and employee
satisfaction are, in fact, positively correlated with sales/*; = [i I Mlf I - - 1 /*
production, they do not impose the sort of struc-
The former,
ture on the response process required to optimize the if can be measured dir
firm's utilization of resources. the latter, /*, can be assessed through th

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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 '

/if~N(/Z,ig, (5) ax E E A> 1

Sf-IW^il). (6) {Xkit] i t ' 'k=' / *=i / (7)
subject to J^TsPkitXk^Mk'
i t
We recognize that the use of multivariate normalit
in Equation (4) is a strong assumption, particularly
where pk is the cost and mk deno
the case of survey data. straint
However, for inputit is k.important t
The first term
note that /, is the estimate we are most
responds to the revenue generat concerned
with, as it feeds forward byinto
Equation the (1),
hierarchical dis-
and the second
tribution for {j}. By assuming normality
total cost of in Deri
inputs {xkit'. Equ
tion (4), we are able to derive (in closed form)
model from the constrained ma
full conditional distribution forin
presented /x2 that (7)
Equation is provides
also no
mal. The assumption of normality for the latent
mechanism for studying the coor me
of the satisfaction distribution ix is justified throu
across both units of analysis and i
the use of the central limit theorem.
mately, this will The
allowadvantage
us to make
employing Equation (4) rather than simply imputin
structure of decision authority (i.
the calculated average value for eachwithin
decentralized) unit theis that
firm. lar
values of 2 indicate unit-level survey
The ideal solutionresponse item
to this alloc
with large variance whose effects are downweighte
obtained by first expressing the au
in inference about F in presented
Equationin (2).
Equation (8) and then
Collectively, Equations of(l)-(6) form
{xlit} that the
jointly basis of
maximize this
model of integrated decision making, where the inf
ence of strategic action is manifest through the hyp
parameters of a hierarchical response model. We ar
informed about influence of tactical decisions on firm
performance from within-unit variation across time
-kEVh' E E PkitXkit
/ t /
(Equation (1)), whereas learning about the effects of
strategic decisions occurs across units (Equation (2)).
This is accomplished by sol
tions presented in Equation
2.2. Supply Model
and time period:
Response models calibrated using market data must
account for the possibility that the operational inputs
are endogenous to the system of study (Yang et al. 2003). ^=0 Vk,i,t. (9)

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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

'Lr of first-order condi-

Equation (9) describes a system
tions that can be used to determine optimal values
of 'xkit) (Zellner et al. 1966). By taking logs of this
system of equations, we can solve for the profit-
maximizing values of all input- bKit J variables, {x*t }, via
Equation (10). For a solution to "Oli-1)
exist,' Ki
the response
function defined in Equation (1) must be a legiti-
mate economic production function. ': .
That i In(x/f) (13)
is, it must
exhibit diminishing returns to scale for positively val-
u ' (iSjci-l).
ued inputs X. This is accomplished if ki > 0 for
all k and i, and J2k=iki <1. If "these
ln(A1 + 1) - In(i8of) - ln^,-)
conditions are+ In(p1/f ) "
met, Equation (1) subsumes the properties of a Cobb-
Douglas production function:

ln(x*() _ln(AK + 1) - ln(j8Ol) - ln(j8K) + ln(pKit) _

-ln(*,,)] rOSw-l) Ki Y1 Simultaneity present in the specification of Eq

tion (13) results in the nontrivial Jacobian define
Equation (14). Simultaneity in our model arises fr
Mxh)j L v 03b -1)J (10) the inclusion of a multiplicative demand mode
corresponding supply-side model derived in E
- ]n(! + 1) - iniA) - In(0lf) + ln(p1/t) " tion (10). The optimal value of each input, [xk]
x :
function of all other inputs, {x_k}'

_ 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

services firm and consist of three independently

Table 1 Descriptive col-
Statistics for Branch-Level Income Statements
lected components: a time series of unit-level finan-
Financial variables Mean Minimum Maximum
cial statements, a customer satisfaction study, and
Weeks of data 12.5 6.0 13.0
an employee satisfaction study, all collected during
Total income ($000s) 88.5 1.4 465.6
roughly the same time period. FTE 9.1 1.0 34.0
Base salary expense ($000s) 20.6 2.7 77.9
3.1. Unit-Level Income Statements
Incentive compensation ($000s) 5.7 0.0 50.8
The units of analysis in this study are retail bank-
ing branches. Income statements for approximately
13 months were made available for each of the firm's hourly wages for nonexempt employees. Incen
898 retail locations. Each income statement contains compensation consists of total monthly dollar exp
detailed information about branch-level expensesditures and in excess of base salary. As both base
revenues. Expenses include monthly outlays for incentive
base compensation are measured in dollars, t
salary, incentive compensation, training, etc. Revenuerespective costs, pkit, are equal to $1. The cost for
in retail banking can be classified into two mainiscat- unobserved in our data set. As such, we include
egories: production income and portfolio (or passive) as a control variable in the model. Summary stati
income. Production income results from the accumu- of these key variables are presented in Table 1.
lation of new business (e.g., new loans, new accounts, Although FTE, base pay, and incentive comp
etc.). Passive income accrues as a result of existing sation
loan are not variables typically studied in m
keting, we believe there are two reasons why t
and deposit balances. It is important to note that rev-
enue generated as a result of changes to existing loanshould be of interest to a marketing audience. Fir
or deposit accounts (e.g., depositing more money theto passage of the Gramm-Leach-Bliley Act in
a savings account) is classified in our data set as pas-
allowed retail banks to sell both savings and inv
sive, not production, income. Although categorized as
ment products at the same institution. As a resul
passive, changes to deposit balances can be influencedhas become increasingly profitable for banks to a
through employee effort. As such, we use total rev- aggressive, sales-oriented cultures. As such, the m
enue (i.e., the summation of both passive and produc- agerially controllable variables included in our stu
tion income) as the dependent variable in our model. fall within the domain of sales-force compensatio
Both sources of income are computed using athe topic that is of considerable interest to markete
"value method," which assigns a fixed monetary (Misra et al. 2005). Second, the boundaries of class
value to new and existing business activities and con-marketing studies are becoming increasingly blur
sumer relationships. For example, a bank may assign as additional emphasis is placed on models of serv
a value of $2,000 for every $100,000 originated in newand relationships. Conceptual frameworks like
mortgages. The value method is used in a manner service-profit chain and the cocreation of value st
consistent with the premise of cost-based accounting: the importance of both employees and customers
to distribute aggregate revenue across the specific theser- determination of successful marketing progr
vices provided by each branch. This facilitates a better
(Heskett et al. 1994, Vargo and Lusch 2004).
understanding of the marginal contribution of vari-
ous banking services to total profitability and should3.2. Customer and Employee Satisfaction Stud
therefore allow management to more easily identify Employee and customer satisfaction studies were
and reward activities of greatest importance. ducted once during the time period in question. E
consumer surveyed was asked to provide a holi
We focus our attention on three key short-term
evaluation of the bank in addition to an assessment
input variables: full-time equivalents (FTE), base
salary, and incentive compensation. The dependent
of specific service aspects of the branch they frequent
most often. To avoid confusion, the branch in ques-
variable of interest in this study is total branch-level
revenue, i.e., production and passive income. Thesetion is explicitly defined in the survey instrument.
Employee responses are grouped according to their
are, respectively, the inputs and output of the pro-
duction function presented in Equation (1). FTE pro-
branch of employment.
vides an aggregate measure of the number of full-timeDescriptive statistics for these data sets are pre-
sented
workers employed at a given branch. A part-time in Table 2. Included in this table are the
respective
employee's contribution to this measure is defined as customer and employee questions use
the percentage of hours they are employed, where variables in the analysis. An average of 37 custom
the basis is a 40-hour work week. Base compensa- responses were collected for each branch (minimu
of 6, maximum of 87). In the survey, responde
tion measures the total monthly unconditional com-
pensation for all employees at a given branch. This
were asked to rate their branch on a variety of se
includes both salaries for exempt employees and vice dimensions. Responses were recorded on a s

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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.

generation. To contrast Ma with models of simultaneous sup-

Retail banking provides an ideal setting to demon-
strate the proposed model. As a result of the value
method of accounting, branch managers are incen-
tivized to maximize present period profitability (e.g.,
revenue less staffing costs) in accordance with Equa-
tion (7). In addition, relationships in retail banking
tend to be sticky (i.e., there exist significant barriers
to switching service providers). As such, short-term
ply and demand we must also estimate an implied
model for the input variables, X. Model Mx assumes
that {xkit} are exogenous to the system of study. Real-
izations of the input variables 'xit) are drawn from
a multivariate normal distribution with a branch-
specific mean and covariance matrix:
xit~N(Xi,Xxi). (16)

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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

Table 3 Fit Statistics for Alternative Supply- and Demand-Side Models

Constrained
Model Description Endogenous X parameters LMD X LMD Y LMD TTL

Mi Unconstrained demand-side model for y. - - 14,709.88 1,645.71 16,355.59

Likelihood contribution of Xit ~ N(n, 1).
M2 Demand-side model with constrained parameter - X 14,709.88 1,219.62 15,929.50
space for . Likelihood contribution of Xit - A/(/x/f ,-).
M3 Simultaneous supply and demand model where X - 6,652.95 -732.18 5,920.78
supply-side is modeled as a linear function of the j8s.
M4 Simultaneous supply and demand model with X X 19,852.23 -2,943.99 16,908.24
independent (unit-level) budget constraints over all inputs.
M5 Simultaneous supply and demand model with a single X X 20,625.92 -2,889.55 17,736.38
(unit-level) budget constraint over all inputs.
M6 Simultaneous supply and demand model with independent X X 20,529.22 -4,650.15 15,879.07
(bank-level) budget constraints over all inputs.
M7 Simultaneous supply and demand model with a X X 20,261.82 -5,247.83 15,013.99
single (bank-level) budget constraint over all inputs.

Note. LMD, log-marginal density; TTL, total.

The second model considered (M2) extends Models

the first M4 through M7 are the
through the a priori imposition of constraints ply and over demand
the models derived fr
parameter space. Response models provide conditions
utility to of the maximization
managers only to the extent that parameter Equation
estimates (7). They correspond to a
or functions of those estimates are deemed reason- tions regarding input budget cons
One advantage of using Bayesian
able. In this context the requirement for reasonability
is that k > 0 for all k, and the Li k < 1. In M2context
we is that it enables us to search over a wide
variety of supply-side models to better understan
impose these constraints upon the response process
the processes managers employ when making input-
through the likelihood but do not allow the supply-
side model to further inform estimation of . This
level decisions. We can compute Bayesian factors for
these alternative models to determine which one best
is accomplished by artificially inflating the variance
corresponds
of supply-side shock to be large. This is similar in to the observed data (Rossi et al. 2005,
Kass and
spirit to Allenby et al. (1995) and Boatwright et al. Raftery 1995). This applies to both nested
and nonnested model specifications.
(1999), who introduce parameter constraints through
We test a variety of supply-side models by making
the prior. Unlike these papers, we do not have strong
alternative
theoretical support to justify the imposition of con- assumptions about the collection of {A^},
the Lagrange
straints. As such, in M2 we effectively utilize the likeli- multipliers or "shadow prices'' of
hood as a computational device to achieve reasonable inputs {xk}. These parameters correspond to the
results instead of a reflection of our true belief about marginal change in the objective function (e.g., prof-
the data-generating process. itability) resulting from a relaxation of the budget con-
straint [mk)'
The third model studied (M3) is a simultaneous
supply and demand specification where X is set with
knowledge of the response parameters . This model,
however, is not derived from the profit-maximizingAlthough typically defined in terms of dollars, bud-
behavior of managers. Instead, we model X as a constraints can be specified in a variety of units.
get
linear function of . This is consistent in spiritFor example, in our application FTE is included as an
with the descriptive supply-side model introduced input
by into the production function in order to control
Manchanda et al. (2004). Although this approach for
has the size of the branch. This allows us to assess
the potential to accommodate endogeneity in the data,
the marginal increase in profitability associated with
it does not ensure the existence of a globally opti- an increase in either base or incentive compensation,
mal solution (e.g., parameters can still exhibit increas-
holding fixed the number of employees. The mon
ing and negative returns to scale) and ignores the
etary cost of adding an additional unit of FTE is a
interactive effect of the inputs. We operationalize this
function of both base and incentive compensation and
approach by extending the model in Equation (16)
is captured through the inclusion of those variable
to include the hierarchical structure presentedininthe model. As such, we define ml as a capacity
Equation (17): constraint on the total number of FTE employable at
^A'ft + ft. (17) any point in time. Budget constraints m2 and tn3 are

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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

cally different from zero (i.e., the 95% credible inter-

Model 6 (M6) defines a scenario where allocation
val contains zero). To frame this result, we estimated
decisions are coordinated across units but not across
a reduced-form model with customer and employee
inputs: satisfaction included as direct inputs into the produc-
M6: EE%<% (22) tion function. Interestingly, we found that customer
t i

Model 7 (M7) represents Table

the optimal
4 Impact scenario
of Satisfaction of Response Coefficients-r Matrix
described above, that is, allocative coordination across
Posterior Customer Employee
time, units, and inputs. Model M7 corresponds to the
mean Intercept satisfaction satisfaction
scenario where the bank engages in centralized deci-
sion making: /Vintercept 2.24 0.08 0.20
ft -FTE 0.05 -0.02 0.00
ft -Base salary 0.78 -0.02 -0.06
M7: %,< - (23) ^-Incentive pay 0.10 -0.07 0.09
k i t

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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

satisfaction had a negative (e.g.,

impact onpenalties
prepayment revenue on loans)pro-
and nonmon-
duction, whereas the effect of
etaryemployee satisfaction
(e.g., hassle of changing accounts) costs asso-
was positive. This suggests that models
ciated with that to
switching accounts ignore
a competitor. As
strategic effects (i.e., influence
such, of satisfaction
customers on fac-
may elect to maintain their relation-
tor productivity) will fail to ship
capture the true impact
with the bank in spite of feelings of dissatisfac-
of customer satisfaction. tion. If customer satisfaction is unrelated to consumer
As a general note, we observe that employee sat- action, we would expect to observe the pattern of
isfaction appears to have a stronger correlation withresults presented in Table 4. It is certainly possible
the productivity of the firm's technology than cus-that customer satisfaction could play a more promi-
tomer satisfaction. Specifically, employee satisfaction nent role in improving the factor productivity of mar-
is significantly related to the multiplicative interceptketing action in other service contexts.
and coefficients for base salary and incentive compen-
Employee satisfaction is negatively correlated
sation, whereas customer satisfaction is only signifi-
with j2, the response coefficient for base salary
cantly related to the latter. This link from employee
(y3 3 = - 0.06), and positively correlated with /33, the
satisfaction to firm performance is interesting as it
coefficient for incentive pay (y4 3 = 0.09). As the latent
has received mixed support within the literature. Har-
mean of employee satisfaction at a branch increases,
ter et al. (2002) and Edmans (2009) find evidence of
the efficacy of base salary as a driver of revenue
a positive association between employee satisfaction
decreases while the efficacy of incentive compensa-
and financial measures, whereas Keiningham et al.
tion increases. Incentive compensation tends to be
(2006), Wiley (1991), and Pritchard and Silvestro (2005)
more effective as a driver of revenue at branches with
report either a null or negative relationship between
the same. employees who exhibit greater satisfaction, whereas
Our findings regarding the connection between the reverse is true for base compensation. This sug-
customer satisfaction and firm performance may gests that, all else equal, branches whose employees
be related to the specific service context analyzed.are relatively more satisfied would make better use
Bschken (2005) discusses how the existence of of their resources by designing employee compensa-
switching costs in service organizations can attenu- tion contracts that place greater emphasis on incen-
ate the relationship between a customer's satisfac- tive relative to base pay. Our results also indicate
tion or dissatisfaction and their relationship with the that customer satisfaction is inversely correlated with
firm. In retail banking there exist significant monetary the response coefficient for incentive compensation, 3

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

2-Base salary /^-Incentive pay

200 1 ^ 4>^~~i

150- ^tRv ;^-mm^

| mm s illf
|1O- SPpP I ^lijpfe

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 .

- 100- : *tyl$M | "Mt&l*

'.' Si - ,:- l: so - p ?;!; $ fe c : m '*'$

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

2-Base salary /^-Incentive pay

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

of resources, a topic of general customer

interest
and employee
to marketing
satisfaction and the variabil-
management. ity of revenue generation at a branch.
Empirically, this work contributes A secondtoissue
the that should be explored is related
literature
on customer satisfaction. We find evidence of a rela- to recent work by Dotson et al. (2008). Both the cus-
tionship between customer and employee satisfac- tomer and employee studies used in that paper pro-
tion and firm technology (i.e., factor productivity). vide sample information about the respective distri-
That is, changes in satisfaction impact firm financialbutions of satisfaction. In this paper, we relate these
performance by altering the efficacy of the firm'sdistributions
tac- to financial performance through their
tical inputs through the response coefficients {ki}. latent mean. It would be interesting to see if other
Employee satisfaction is shown to be significantly portions or percentiles of these distributions would
related to a firm's baseline ability to generate yieldrev- different results than those observed in our cur-
enue as well as the efficacy of its base and incentiverent work. Furthermore, it would be useful to explore
compensation programs. However, customer satisfac- models that do not rely on the stringent assump-
tion is shown to be inversely related to the effective-
tion of normality in the distribution of consumer and
ness of incentive compensation. These findingsemployee
are responses.
congruent with recent calls for work exploring alter-
Finally, the supply-side models developed in this
native influences of customer satisfaction (Luopaper
and were based upon an evaluation of presumed
Homburg 2007). optimal behavior, conditional upon the structure of
Although we believe our model is appropriateour for proposed model. Supply-side models are needed
the study of strategic satisfaction in the contextthat
of more accurately reflect the processes whereby
retail banking, there are a number of issues that managers actually make decisions. This could include
should be considered before applying it to other set-
situations where managers must simultaneously max-
tings. Our model does not control for the existence of
imize multiple, potentially conflicting outputs (i.e.,
competitive effects. If competition is important to the
multiple-output production functions). Rather than
context under study, it should be reflected in the spec-
searching over the space of possible supply-side mod-
ification of both the demand- and supply-side models.
els defined by the researcher, it would be useful to
Particular attention should be paid to determining if
elicit managerial input during model construction.
the effect of competition is tactical, strategic, or possi-
This could be efficiently accomplished through closer
bly both. Our model also assumes that both demand
collaboration between researchers and managers. We
and supply are independent across branches. If cross- leave these issues to future research.
unit dependencies (e.g., proximity effects) do exist,
they should be formally incorporated into the struc-
ture of the model. Finally, our model assumes Appendix.
that Estimation Algorithm for M5
Bayesian estimation for the simultaneous supply and
tactical actions (e.g., changes in base compensation)
demand model proceeds by recursively generating draws
do not have a long-term impact on the strategic vari-
from the full conditional distributions of all model parame-
ables (e.g., employee satisfaction). As such, we cannot
ters. The nonstandard nature of our model prevents us from
interpret the estimated relationship between satisfac-
relying exclusively on conjugate results. As such, we imple-
tion and firm technology as causal. Although inter-ment a hybrid sampler and draw a subset of the model
esting, the study of this issue would require repeated
parameters using the Metropolis-Hastings algorithm. We
cross-sectional measures 'of satisfaction. Relaxation of
divide the MCMC sampler into six distinct blocks and alter-
these assumptions would all be interesting avenues
nate parameter draws within and across units. We define the
for future research. following quantities to simplify exposition of the algorithm.
Our work raises a number of additional questions As defined in Equation (11), the full likelihood for the
that are also worthy of future investigation. First,model can be re-expressed according to (24):
we define a strategic action to be any action that
influences the technology of a firm. Technology in /(data | else) = UU^itMiut. im. im) ht > (24)
a regression-style response model includes both the i t ^ln(x)
location and scale of the conditional distribution of
where
y'X. In this paper, however, we examine only the tt(-) denotes
influence of satisfaction on the mean of the condi- tion, and the quant
tional relationship of sales and compensation (e.g., ing
the to (25) and (26
defined in Equation
effect of satisfaction on ). It would also be interesting
to explore the relationship between satisfaction and
sit = ln(yfi) - (ln(jS
the variance a2. It is certainly possible that an inverse
relationship could exist between the latent level of + ftfln(

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 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

_'n('3 + l)-ln(0i)-ln(3i)_ n7r(li*'2if/3) Jit

t ->ln(x)

dl'it dlm dCut with a corresponding hierarch

d]n(xw) din(x2il) dln(x3il)
fA*J~N(,SA).
i _ et d2, d2it Hin
-M din(xut) dln(x2il) d'n(x3) Step 3. [of, S, :' else].
Conditional on a realizations
d3t d3it d3it
from an inverse chi-square d
|_ain(xlif) dn(x2il) cUn(x3i()J
dard draw from an Inverted
= |Ai + fo + A-i|- (27) et al. 2005, Chapter 2).
Block 2: Across Units.
The error terms for the supply and demand equations are
assumed to be distributed as follows:
Step 4. [I'X|else]..
Conditional on realizations of , fi* inference for F
and S proceeds through use of a standard multivariate
(~N(0/t7,2), (28)
regression:
~L~
X~JW(v0 + N,V0 + S),
4, ~N(0,ixi). (29)
vec(r) - N(f , X 0 (M* V* + A)-1),
-4f.
where
Conditional on initial values, the sampler proceeds as fol-
lows (repeating until convergence has been achieved): f = vecM^), M^ = (M* V + A)'1 (M* VM^ + AM),

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

A = 0.01 x /3, where /3 is a 3 x 3 identity matrix,

Y'ir{it)Tr{llit,2it,3it) ]it ,
vQ = 7,

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

cu = (Si1 + Si1 + XEVdVA + 2 Vb + S Ve), n/Wrii?'Wi7'-1>'y1|(Qrl|gc/2

2^ = (2^ + 2^ + Sa1)"1,
and the contribution for each factor A, B, and C can be expj-iTrasn-^nr1)!-
computed as follows.
Steps 11-15 are the employee analogs of customer
Factor A (Contribution from the prior): Steps 6-10 (the superscript e denotes employee). Parameter
estimation follows directly.
Ma = 0,
Block 5: Within Units.
2A = 100. Step 11. [/i% 2f |else].

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

( r /*5f i ^ References
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