This weekend I was reading The Big Short: Inside the Doomsday Machine, by Michael Lewis (author of Moneyball, Liar’s Poker, The Blind Side), in which he provides interesting character studies of the handful of investment experts who actually managed to make money (and oodles of it) on the subprime mortgage catastrophe that brought the world’s economy to its knees two years ago. (Two thumbs up on the book; it’s a fascinating read.) In one chapter Lewis mentions a talk that Charlie Munger, Warren Buffet’s partner, had given at Harvard Business School entitled “The Psychology of Human Misjudgment,” from which Lewis pulled two fascinating anecdotes as he tried to explain some of the human frailties behind markets, including the one that had been created to offload the risk involved in giving no interest, no doc mortgages with low teaser rates to people who never, ever should have had a mortgage in the first place.
In this speech, which given the number of transcripts of it that can be found on the Web, has become fairly famous, Munger said that if you want to predict how people will behave, you only had to look at their incentives. Now, before you say, “Well, duh,” take a look at these two examples he cites of what he calls under-recognition of the power of incentives. They are from FedEx and Xerox, companies run by supposedly smart people who should have realized that their incentives were all wrong.
At some point, Xerox had produced a newer, better, faster machine only to find that the older, clunkier, slower machine was continuing to outsell the much more efficient newer model. Finally, someone figured out the problem. The sales staff was being paid a higher commission on the old model so naturally they were pushing it more.
Early on, FedEx had a hard time meeting its promise of overnight delivery because the night shift at its central facility wasn’t working fast enough. They tried all sorts of things to boost performance until some genius realized the problem: the nightshift was being paid by the hour. They switched to paying them by the shift and, bingo, work speeded up.
So I ask you: What are your employees incentivized to do? Do those incentives match your business mission and your strategic goals? If companies like FedEx and Xerox can make mistakes in this key area perhaps you are too.