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Incentives make the world go round 🌎
Dilemma of Incentives - Understanding it - Getting it right
Son - Dad, did you see the match last night?
Dad - No
Son - It was the craziest match ever. Side A didn’t score a single goal inspite of 11 shots at the goal.
Dad - How come? Who took the shots at the goal?
Son - All 11 of them
Dad - 🤯🤐
This would be the most likely scenario if a coach decided to award every goal scorer a bonus of USD 100,000 each. A fantastic incentive to score, but the trade-off is worse. No one would make passes and there would be no team.
This is the dilemma of designing incentives, and it impacts us on a daily basis. Let’s explore this fascinating subject by digging further.
An incentive is something that motivates or encourages someone to do something. And there is no shortage of incentives for people to get things done right and on time e.g. employment, reputation, monetary gains, respect, global reach, recognition, and more. But at the same time, there is no shortage of demotivated people, sharing the many reasons that make them victims or disadvantaged.
Something is amiss here.. Incentives don’t seem to be working as intended, or is it plain difficult to design them well enough?
Let’s look at a few cases to find out what’s wrong -
A wealthy businessman is planning for succession and has 2 choices: give away his entire wealth to charity or transfer the same to his children. The problem with option 1 is that he will have children who hate him for their entire lives. The problem with option 2 is that the children are deprived of any ambition whatsoever since they have everything at their beck and call.
In his seminal book Drive, Dan Pink tells the story of a motivation study conducted in a classroom of first graders. Some of the kids already loved to read in their free time. Some didn’t. For one month, everyone was rewarded for the number of pages they read. Then, at the end of the month, the rewards stopped. What do you think happened? The kids who used to read for pleasure… stopped. Once they’d be trained to read for rewards — that experience extinguished their internal motivation.
During British colonial rule of India, the government began to worry about the number of venomous cobras in Delhi, and so instituted a reward for every dead snake brought to officials. In a wonderful demonstration of the importance of second-order thinking, Indian citizens dutifully complied and began breeding venomous snakes to kill and bring to the British. By the time the experiment was over, the snake problem was worse than when it began. The Raj government had gotten exactly what it asked for. - sourced from fs.blog
What’s gone wrong is the incentive has caused unintended consequences. What began with good intentions, has morphed into a gamified system that benefits a few in the short term, while worsening the situation overall.
Most of humanity is short-term in their thinking. It’s not intentional, it's just biological. One has to fight their own conscious fabric to play the long game, or to think hard about the consequences of their choices. Hence, people regret their decisions in retrospect, but nothing seemed wrong when they were doing it all wrong.
Just imagine your kid, who just turned 3 last month, and you are at Disneyland and there is a ride that your kid would love to get on. You're at the ticket counter and the pricing is as follows :
Below 3 years - Free ticket
Everyone else - USD 20
Now the ticketing agent will be asking you for the age of your kid. What would you answer? Will answer the truth? Or will you be tempted to skim off a few months of your kid's age to get a free ticket? Tricky choice, especially when you have only a few seconds to make a judgment call.
If you were honest, you land up paying USD 40 for both of you and life moves on. Lovely.
But if you were dishonest about your kid's age, then 2 things could happen -
Your kid might consider it normal to lie for personal gain. And at that age, this thought process becomes ingrained in one’s psyche, making it a permanent trait for many.
It might allow you to slip again, and again, whenever you face choices that benefit you now, in the short term. But at some time, the lies will be discovered, and you and your family may pay the heavy price for it.
Look at all the people that got caught up in frauds of gargantuan proportions e.g. Bernie Madoff, Trevor Milton (Nikola), Kenneth Lay (Enron), Elizabeth Holmes (Theranos), Nirav Modi (Indian Jeweller), and Vijay Mallya (Kingfisher). You will see a common thread between all of them. Their lies caught up with them. But if you think deeper about it, that habit would have been formed way earlier in their lives, when a lie would have allowed them an incentive of some kind, and they got away with it fine.
Until it wasn’t fine anymore.
Incentives also create a perception for the people/company doling out the incentive. And it's that perception that could create harmony and good vibes, or it could ruin the same. Let’s look at a few good examples -
Pret a Manger had an incentive of USD 50 for the best employee of the month. But the condition was to spend that USD 50 on a colleague. This had 2 benefits - the winner got to enjoy the respect and adulation that comes with the recognition, and the shared monetary benefit created camaraderie between employees and higher satisfaction.
Many successful startups pay their employees to quit their jobs and start a business if they’d like to. This is a genius incentive program. The ones that are not happy will opt for the start-up capital and leave the company. This keeps only motivated employees working for shared goals, raising the productivity and the morale of the whole team. As for the one that took the start-up capital, he doesn’t want to look like a fool in front of his ex-colleagues and hence is motivated to succeed as an entrepreneur. It’s a win-win for all involved i.e. company, current employees, and ex-employee.
The bad incentive programs could inflict massive damage to reputation and even threaten the survival of countries, companies, or corporate careers. A few rotten apples are shared below -
Wells Fargo had to fire 5000 employees for opening 3 million + fake bank accounts. The root cause wasn’t that the employees were evil in their orientation and came up with the idea to manipulate accounts at scale. It actually was the system that rewarded you only if you had new accounts opened, in the absence of which you were guaranteed to lose any reward or recognition. The system was so rotten, that even if you mustered the courage to report that account opening was being gamed, you stood a chance of getting fired.
Time and again we see politicians promise freebies to their voters, only because winning elections on the back of austerity or practicality is too much stress for both parties. So why not tread the easy path, and let the government in power down the line deal with the mess created by the largess donated? I see this time and again in almost all countries. The repercussions of these myopic policies can be seen in the ruins of economies like Pakistan, and Sri Lanka.
Hence an incentive system has to be designed in a way that rewards all involved, without gaming the system or causing harm. And if there is a possibility, then creating fear of a severe punishment works. The old-school carrot and stick always work, and it always did.
Few examples -
In UAE, if you are caught drunk and driving you could be imprisoned or even deported back to your country. This forces many of us to take a taxi back home instead of driving and keeps the roads safe for all.
Many billionaires have decided to give away a major portion of their wealth, while keeping single digit % for their families, which also runs into millions of dollars, keeping enough and more for their lifetimes. Some even design a structure to distribute a fixed percentage annually to their heirs, instead of gifting it all in one go. This keeps the chances high for the family to get along well, without getting corrupted by insane amounts of wealth, and power or freedom that wealth brings along.
I have paid my coach at the gym for 36 sessions and slotted the dates and times for it. If I miss any single session, the money paid for that class is gone wasted, and I also create an impression of not being serious about my health. Missing my workouts have 2 disincentives that will push me towards staying on course. And this works, irrespective of how motivated I think I am. Losing money or reputation, or both in a worst-case scenario, is not desired by anyone. The only exception is if I am out of the country.
So next time you are designing incentives yourself, ask yourself the following questions to steer towards programs that are win-win -
Incentivize for things that matter, not only things that can get measured e.g. students who got incentivized for participation in health drills, performed better at other subjects.
Small incentives don’t work. Either pay enough or don’t pay at all.
Definitely avoid paying for anything related to charitable work, as donors don’t like an exchange of freebies of any kind. Even a free coffee mug as a token of appreciation has been found to reduce further participation from donors.
Don’t create an incentive which is a moon shot i.e. having minuscule odds of hitting the goal. This demotivates, instead of motivating. It also creates an impression that you don’t have the intention to pay for performance, which leads to even more unhappiness and loss of productivity in the lives of the people you manage or lead.
And lastly, think of incentives from the point of levers, and finalize on the one that pulls many levers at once e.g. Pret a Manger example shared above.
The best move you can make in negotiation is to think of an incentive the other person hasn't even thought of - and then meet it. - Eli Broad
Recommendations for the week #
Sahil Bloom wrote a beautiful piece on The Paradox of Effort and I highly recommend it. It covers a very interesting idea called ‘sprezzatura’. I will not steal the surprise away. Please dig in and discover for yourself. It’ll be worth it, especially when you know that Warren Buffet & Charlie Munger inspired this piece from Sahil.
Tom Morgan from Sapient Capital wrote a piece on the traits of a successful investor and he hints at many qualities e.g. Curiosity, Skepticism, Independence, Humility, Discipline, Patience, and Courage. But there is one quality that is missing here, and it’s this one that most aspiring investors get trapped in and overwhelmed by i.e. Intelligence. This piece covers these traits in a very unique manner and provides you a glimpse into accessing wisdom and implementing it, instead of just accumulating knowledge with no results to demonstrate.
Wishing you all a fantastic weekend ahead.
Sending you loads of love and luck 🧿