Customer‐oriented employees: Blessing or curse for firms?

• Published date: 01 December 2017
• Author: Ester Manna
• DOI: http://doi.org/10.1111/jems.12232
• Date: 01 December 2017

Received: 8 December 2015 Revised: 9 December 2016 Accepted: 2 May 2017

DOI: 10.1111/jems.12232

ORIGINAL ARTICLE

Customer-oriented employees: Blessing or curse for firms?

Ester Manna

Department of Economics, Univer-

sitat de Barcelona, Barcelona, Spain

(Email: ester.manna1@gmail.com)

Iwould like to thank the editor, Ramon

Casadesus-Masanell,a co-editor, and three

anonymousreferees for very helpful and con-

structivecomments. This ar ticle is based on

the firstchapter of my Ph.D. dissertation at the

Universitélibre de Bruxelles, ECARES. I am

particularlyindebted to Georg Kirchsteiger for

hiscareful super vision and continuous sup-

port. I am thankful to TommasoAquilante,

FrancisBloch, Lídia Br un, EstelleCantillon,

MarcelloD'Amato, Alessandro De Chiara,

Florian Englmaier,Guido Fr iebel, Alexan-

derGroves, Tobias Kretschmer, Patrick

Legros,Luca Livio, François Maniquet, Guido

Maretto,Mar tin Peitz,Salvatore Piccolo,

AmedeoPiolatto, Fer nando Sanchez, Philipp

Schmidt-Dengler,Marc Teignier, Thierry

Verdier,and Montserrat Vilalta for a number of

insightfulcomments and useful obser vations.

Ialso wish to thank audiences at t he University

ofCologne, Ludwig-Maximilian-Universität

München,Universitat de Barcelona, University

ofMannheim, ECARES Seminar, Univer-

sityof Saler no, FAUErlangen-Nürnberg,

andat a number of conferences and work-

shopsfor useful comments and discussions.

Finally,I acknowledgethe financial suppor t

oft he Ministerio de Economía y Compet-

itividadand Fondo Europeo de Desar rollo

Regionalthrough grant ECO2015-66701-R

(MINECO/FEDER,UE) and the Government

ofCat alonia through grant 2014SGR493. This

papersupersedes an earlier working paper enti-

tled:“Intr insicallyMotivated Agents: Blessing

orCurse for Firms?” The usual disclaimer

applies.

Abstract

I investigate whether the presence of customer-oriented employees benefits firms in

a competitive environment. Employees are defined as customer-oriented if they are

interested not only in their wage but also in the well-being of their customers. I find

that firms may obtain higher profits by hiring self-interested rather than customer-

oriented employees. This is because the employees' customer orientation has oppos-

ing effects on the profits obtained by the firms. On the one hand, customer-oriented

employees provide a given level of quality for a lower wage. On the other hand, the

employees' customer orientation increases competition reducing prices. If the second

effect dominates, firms find themselves trapped in a prisoners' dilemma as the strategy

of hiring self-interested employees is strictly dominated by that of hiring customer-

oriented employees. Hence, the very presence of customer-oriented employees may

hurt firms. If motivated employees are merely interested in the quality of the good

provided, the effect on the price outlined before disappears.

1INTRODUCTION

Customer-oriented employees are interested not only in their wages, but also in satisfying customers'needs. It is natural to t hink

about these workers as employedin nonprofits organizations or in the public service provision, such as the health care and educa-

tion sectors (see, for example, Francois, 2000; Biglaiser & Ma, 2007; and Delfgaauw & Dur,2008). However, profit-maximizing

firms can also attract customer-oriented employees by offering them jobs that have a valuable impact or a socially oriented mis-

sion. Psychologists and marketing scholars argue that this is more likely to be the case in the service sector, where there is a

J Econ Manage Strat. 2017;26:842–875. © 2017 WileyPeriodicals, Inc. 842wileyonlinelibrary.com/journal/jems

MANNA 843

strong interaction between customers and employees.1The marketing literature also finds a positive relationship between the

employees' customer orientation and the customers' satisfaction.2For this reason, the employees' customer orientation is consid-

ered to be an important factor for service firms' economics success (see Bove & Johnson, 2000, and Sergeant & Frenkel, 2000).

Therefore, firms may want to havea customer-oriented workforce to satisfy customers' needs in an attempt to win market shares

and increase profits.

In the economics literature, the impact of employees' customer orientation on the customers' satisfaction and on the firms'

profits has not yet been studied. Although it may come as a foregone conclusion that profit-maximizing firms would be better

off if their customers are more satisfied, this relationship is in fact far from being obvious. The main contribution of this article

is to show that in the presence of competition the strategic interaction between firms may lead to surprising results concerning

the desirability of hiring customer-oriented employees. Firms may obtain higher profits by hiring self-interested rather than

customer-oriented employees. However, they find themselves trapped in a prisoners' dilemma as the strategy of hiring self-

interested agents is strictly dominated by that of hiring customer-oriented agents. In other words, firms end up hiring customer-

oriented employees even when they would prefer to coordinate and hire selfish employees, but they cannot credibly commit

to that.

To model competition, I use a Salop model where profit-maximizing firms offer both horizontally and vertically differentiated

products3and decide whether to hire selfish or customer-oriented employees. While the utility function of a selfish employee

only depends on his “egoistic” payoff (given by the difference between the wage and the cost of exerting effort), the utility

function of a customer-oriented employee also positively depends on the customers' well-being. The baseline model is analyzed

under the assumption of perfect information on the employees' type. But the main results are robust when this assumption is

relaxed.

The employees' customer orientation has conflicting effects on the firms' profits at the equilibrium. On the one hand, the

presence of customer-oriented employees has a positive effect on profits due to a wagereduction. Customer-oriented employees

provide goods of a given level of quality for a lower wage. This is because the agent's customer orientation reduces the agent's

marginal cost of eliciting effort. On the other hand, it has a negative impact on profits through a reduction in the price of the

products offered by the firms. When the employees care about the customers' well-being, the employees' utility decreases if the

firm decides to charge a higher price. The agent's customer orientation makes employees more sensitive to prices and qualities,

thus forcing firms to compete more fiercely and to lower their prices. This latter effect can be large enough to outweigh the gain

generated by lower wages.

When the negative effect on the profits dominates, firms find themselves trapped in a prisoners' dilemma, and the presence

of customer-oriented employees hurts firms. Which effect dominates is crucially affected by the degree of competition in the

market. Specifically, the prisoners' dilemma is more likely to occur in markets with less substitutable products and fewer firms.

Therefore, when the market is more concentrated, firms would be better off hiring selfish agents.

As for the impact of the employees' customer orientation on the customers' welfare, this is unambiguously positive when the

number of firms is exogenous. A higher degree of employee's customer orientation increases competition reducing the price

charged by the firms. However, this positive effect of the employees' customer orientation on the customers' well-being may be

mitigated or become negative when the number of firms is endogenous. This is because fewer firms enter the market when the

gross profits obtained by hiring selfish agents are higher than those obtained by hiring customer-oriented agents. Because of

horizontal differentiation, a wider variety of goods is beneficial to customers.

It is important to notice that a monopolistic firm always benefits from hiring a customer-oriented employee. A higher customer

orientation induces the monopolistic firm to increase both quality and price. For each unit of the product which is sold, the firm

is able to charge a higher price to reflect the higher product quality.Cr ucially, the monopoly is also able to attract new customers

and enjoys an increase in the demand. In contrast, when there is competition, by offering a more valuable product, firms do not

attract additional customers. This is because firms follow the same strategy and, as a result, they share the demand in the market.

The key assumption of this article is that motivated employees are not only interested in their “egoistic” payoff but also in

the customers' well-being. In other words, these employees have altruistic preferences toward their customers.4More specif-

ically, in my model, motivated employees exhibit pure altruism because they internalize in their own utility the effects that

both prices and quality entail for customers' utility. When this is the case, employees also care about the price charged

by the firms and the firms can extract a lower amount of surplus from their customers for any given level of quality.

This stands in contrast with impure altruism that would lead to a model where motivated employees derive utility from

the quality of the good they provide. If motivated employees were merely interested in the quality of the goods/services,

the strategic effect on the price outlined before would disappear. Therefore, whether these motivated employees have pure

or impure altruistic preferences lead to dramatically different conclusions concerning the desirability of hiring a motivated

workforce.

844 JOURNAL OF ECONOMICS & MANAGEMENTSTRATEGY

Since the main results of the paper crucially depend on the employees' interest in the customers' well-being rather than

just in the quality of the good provided, the analysis calls for additional empirical studies to investigate what drives employ-

ees' actions. The existing experimental evidence is mostly consistent with the assumption of impure altruism (see among oth-

ers Charness, Cobo-Reyes, & Sánchez, 2016; Imas, 2014; Tonin & Vlassopoulos, 2010, 2015). However, some experimental

and empirical studies have found supportive evidence for pure altruistic motives or for both forms of altruism (see Gregg,

Grout, Ratcliffe, Smith, & Windmeijer, 2011; Konow, 2010; Lilley & Slonim, 2014; and Ottoni-Wilhelm, Vesterlund, & Xie,

2014).

The remainder of the article proceeds as follows. In the next section, the related literature is reviewed;in Section 3, t he model

is presented and a monopolistic environment is analyzed; in Section 4, the equilibrium of the model is characterized for a given

number of firms; in Section 5, the conditions under which the prisoners' dilemma arises are illustrated; in Section 6, some

robustness checks are studied; and concluding remarks and discussion of the results are given in Section 7.

2RELATED LITERATURE

This article is related to the literature on psychological incentives and to the one on the effects of competition on manage-

rial incentives. The former focuses on the existing interaction between intrinsic motivation and monetary incentives without

considering the role played by competition in shaping the monetary incentives of the employees. The latter focuses on the

impact of competition on the incentives without considering potential differences in the agents' preferences. I bridge these two

strands of the literature by considering the interaction between monetary incentives and the agents' motivation in a competitive

environment.

The economics literature on psychological incentives showsthat employees derive nonmonetary benefits from providing some

types of services (see Biglaiser & Ma, 2007; Buurman, Delfgaauw, Dur, & Vanden Bossche, 2012; and Dur & Zoutenbier, 2014).

The idea is that employees care about the recipients of the service, that is, they are worried about the welfare of their patients,

students, or customers. This idea has mainly been referred to public service employees (see among others Bond & Glode, 2011;

and Jaimovich & Rud, 2014). In particular, most studies haveargued that public service employees are eager to serve the others

and satisfy the customers' needs (see Francois, 2000, 2007; Glazer, 2004; and Macchiavello,2008). As a result, t his literature has

emphasized how, especially in the public service or nonprofit sectors, the employers can extractlabor donations from motivated

employees (see Francois & Vlassopoulos, 2008, for a survey).5While these articles study the sorting of differently motivated

people into public sector and its consequences for optimal pay policies and organizational design, I study how the presence

of customers' oriented employees impacts on firms' profits and customers' well-being. Moreover, there are some remarkable

differences in how this “prosocial” motivation is included in the employees' utility function. In some articles, the motivation

component is represented as a function of the effort exerted by the employee with a positive first derivative.That is, an employee

directly benefits from increasing his own level of effort, or, equivalently, the employee has a lower marginal cost of exerting

effort. In Besley and Ghatak (2005), for example, the employees' effort costs are low when they share the firm's mission.6In

other articles, employees care about the quality of the good that is provided. For example, in Francois (2007), the employees

derive a benefit when the good provided is deemed socially valuable. One remarkable departure of my model from the literature

on psychological incentives is that employees can be interested in the customers' well-being rather than in the quality per se.

When this is the case, employees are more sensitive to prices and qualities, thus forcing firms to compete more fiercely and to

lower their prices. This reduction in the price can be sufficiently large as to outweigh the gain engendered by the reduction in

wages.7

This article is also related to the literature on the effects of competition on managerial incentives.8Particularly close is

Raith (2003), wherein the author examines how the degree of competition among firms in an industry with free entry and exit

impacts on the wages paid to their employees. The effect of competition on wages and effort takes place through a change in the

equilibrium number of firms in the industry. The results suggest an unambiguous positive relationship between competitionand

wages. Like Raith (2003), this article shows that competition increases the wages paid to self-interested agents. When products

are more substitutable, prices and profits decrease leading to fewer firms. Each firm produces a higher level of quality and each

agent receives a higher wage. However, when agents are customer-oriented, there is an additional effect that goes in opposite

direction. If products are less substitutable, customers are worse off and firms have to pay higher wages to customer-oriented

agents to keep the level of quality constant.

Baggs and De Bettignies (2007) also study how product market competition affects employeeeffor t and firm efficiency. They

show that the impact of competition differs depending on whether or not they are subject to agency costs. Similar to their paper,

I use a spatial competition model in which firms offer both horizontally and vertically differentiated products.