HBR Blog: When Your Incentive System Backfires

userpic-841-100x100The author goes to an Asian city and tries to get on the bus.  The bus keeps passing by.  Why?  Because the bus driver’s bonus is connected to being on time, not servicing customers, resulting in a behavior that is opposite to that which would be optimal.  This model is the focus of the article.  Conclusion: be careful about identifying what’s important and how you drive participation.

The way that FairSetup addresses this issue is through reinforcing expectation as the foundation of communication, with subsequent use of how people meet expectation to calculate impact of every participant.  If compensation is then tied to both impact and outcomes, and outcomes are linked to the purpose of the business unit at hand, the result is a natural alignment for all participants.

When Your Incentive System Backfires

by Vijay Govindarajan and Srikanth Srinivas  |   2:00 PM February 21, 2013

How many times have you seen an incentive system produce the exact opposite of the desired behavior? Why is that? And why can’t organizations see, let alone fix, the problem?

For example, I (Srikanth) went to visit a client in an Asian city. I stayed in a hotel in the middle of the city, and had to meet the client at his factory location that was quite far away. The client suggested that I catch the bus and gave me instructions. I went to the bus stop and waited. Several buses came close to the stop, but they all whizzed by without stopping. It wasn’t that the buses were full. In fact there were plenty of empty seats. After half a dozen buses came tantalizingly close but without stopping to pick up passengers, I finally caught a cab. Upon my later than planned arrival at the factory, I apologized to the client and told him the cause for my delay. The client laughed and said, “The driver’s bonus depends on whether or not he reaches his destination on time. So during peak traffic when they find they are running behind, they don’t bother picking up passengers!”

Here was the height of insanity — an incentive system that succeeded only in defeating its original purpose. At peak time, exactly when more passengers need to be picked up, it was better for the driver to go empty. Frustrated citizens, lost revenue and increased costs all thanks to the incentive system and the driver’s desire to maximize his individual gain. Further, every “man on the street” seemed to know the problem, but not the organization that ran the buses. Or, equally baffling, they knew it and chose to ignore it.

Ever since this incident, we have become more attuned to seeing the misalignment between what people do (reach destination on time) and their underlying purpose (carry passengers to their destination). It turns out this misalignment is far more wide spread than we realized:

  • Bankers maximize their bonuses and forget about the health and integrity of the financial system;
  • Call center employees hurry you up or transfer you so they can meet their quota of number of calls per hour;
  • Sales people maximize their commissions and forget about what best meets client needs (they “upsell,” “supersize,” or promote what has the best commission potential), or what is best aligned with firm capabilities (they sell what doesn’t quite yet exist, as has been the case with many software firms). And when it is the “C” level executive incentivized to maximize their bonus and options, the result is “channel stuffing” — overloading retailers with goods just prior to the end of reporting periods, as was the case with Sara Lee;
  • Wherever production is incentivized on units produced or unit costs, organizations produce in bigger batches. As a result, there is more inventory, more cash tied up in inventory and, at the same time, there is less flexibility to cope with changing demand.

Read the entire article…


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