Using stochastic frontier analysis for performance measurement and benchmarking

Abstract

Historically standard regression has been used to assess performance in marketing, especially of salespeople and retail outlets. A model of performance is estimated using ordinary least squares, the residuals are computed, and the decision-making units, say store managers, ranked in the order of the residuals. The problem is that the regression line approach characterizes average performance. The focus should be on best performance. Frontier analysis, especially stochastic frontier analysis (SEA), is a way to benchmark such best performance. Deterministic frontier analysis is also discussed in passing. The distinction between conventional ordinary least squares analysis and frontier analysis is especially marked when heteroscedasticity is present. Most of the focus of benchmarking has been on identifying the best performing units. The real insight, though, is from explaining the benchmark gap. Stochastic frontier analysis can, and should, model both phenomena simultaneously.

Citation

Parsons, L.J. (2002), "Using stochastic frontier analysis for performance measurement and benchmarking", Advances in Econometrics (Advances in Econometrics, Vol. 16), Emerald Group Publishing Limited, Leeds, pp. 317-350. https://doi.org/10.1016/S0731-9053(02)16013-0