Sunday, October 12, 2008

Analogy #213: Wait for the Votes

In election years, the media seem to take great pleasure in declaring winners before all the votes are counted. Heck, they like to declare winners before the voting has started. What if other businesses did the same thing?

What if race tracks declared winners before the race was over? The race track would pay off betters based on their estimates of how the race would end up based on only half of the race being finished. Is that fair?

Or how about if Olympic gold medals were handed out based on estimated outcomes when only part of the competition was completed? Taken to an extreme, they could even pass out the medals before the competition even begins, based on projected performances.

In Tennis, the athletes are seeded in order based on estimated abilities. Why not skip the tennis matches and just give out the awards based on the seeding?

As another example, we could tip the service staff at a restaurant before the meal, based on the reputation of the staff or how they were rated by a restaurant critic.

Well, I think we know why we don’t do these things. First of all, people do not always live up to your expectations. The favored horse doesn’t always win; the best athlete can have a bad day. You can end up rewarding the wrong person if you reward too quickly. Second, if you reward people before they perform, they may not be as motivated to excel at finishing the performance well. Why give excellent service if you get the tip in advance?

No thank you. I’ll think I’ll wait until the results are in before I declare winners, pay off bets, hand out awards, or give out tips.

It seems a little ridiculous to give out rewards too early in the game, perhaps even unjust or criminal. Yet we seem to do that in the business world all the time.

For example, there has been study after study throughout the decades concerning the success rates for acquisitions. Depending on the study methodology, somewhere between 60 to 90% of these deals fail. In other words, most of the deals will destroy value.

In spite of all the potential for failure, we pay investment bankers huge funds at the moment the deal is consummated—as a “reward” for helping us get the deal done. Since most deals fail, why are we rewarding these investment firms so well for very likely helping us destroy value?

Don’t you think we’d get better service from investment bankers (and have a higher success rate) if we withheld payment until it was known whether or not they were winners in helping us do a successful deal? Why do you think all those investment houses got into trouble in the current financial meltdown? I think a lot of it had to do with a system that provided them with huge financial rewards before all the votes were in on the quality of their performance. Why only do good work if the bad work is equally rewarded? It was about quantity, not quality.

The same goes for the home mortgage crisis. We rewarded the people writing the loans at the moment the papers were signed. This was too early in the race…it was not known yet which loans would be winners. Why try to win a race if you are rewarded every time you simply enter the race? As a result, we ended up with a lot of loser loans.

In the legal profession, there are many lawyers who only get paid if they are successful in working on your behalf. In other words, rewards aren’t handed out until we know who the winner is. Wouldn’t it be a novel idea to try something like that with the reward system in your company?

The principle here is about linking rewards to success. Now you may be saying to yourself, “Of course I link rewards to success. Bonuses are only paid out if we successfully achieve the numbers.”

The problem is that the bonus cycle tends to be shorter than the strategy cycle. Getting a strategy successfully in place and then adhering to it/strengthening it can take years. Bonuses are paid out much sooner, before one knows whether:

a) The Strategy is Successful;
b) Whether the Strategy Has Been Successfully Implemented.

This is like paying off on bets before the horse race is over.

Here are some tips to help ensure that the rewards are going to the true winners.

1) Set Goals Around Success Rather Than Task Completion
The mortgage lenders were rewarded for signing up loans. The investment bankers were rewarded for doing a deal. In other words, they were rewarded for completing tasks. It didn’t matter how well the task was done. Rewards came whether the ultimate result of the task was successful or not. Bad mortgages and bad deals were rewarded the same as good ones, because they required the same task.

Just because a task is completed does not mean one is any closer to the goal. For example, I can think up all kinds of ways to temporarily boost sales which could end up obliterating the strategy—or worse yet, destroy the company. Does Enron come to mind?

Getting sales today which destroy your image, disappoint customers, involve illegal or immoral acts, move the company towards selling the wrong thing, or cause you to sell at a great financial loss are not successful sales. Similarly, not all near-term profits are a sign of long-term success. A profit “at any cost” is too high a cost. If I sell off the resources needed to create future profits today, how do I create profits tomorrow?

If all you do is reward people for completing tasks, the tasks will indeed get done. However, you may not like the long-term results caused by how the tasks get done. By contrast, if you reward success (both strategic and financial), people will find the proper tasks to reach the success. In other words, if you reward the right outcome, the process will take care of itself, but if you reward the process, you can get a horrible outcome.

Therefore, once a strategy is created, determine the key drivers of strategic success. Put a measurement to key drivers, and reward on that measure.

2) Link to the Big Picture
I believe that any reward system needs to not only reward people for the things they have complete control over, but also for achieving broader success for the entire organization. Success usually requires cooperation between business silos. If you only reward silo optimization, then the cross-functional necessities will get missed.

The big strategic picture should be important to everyone. People should be able to see how their function helps in achieving the big strategic picture. And part of the rewards need to be dependent on getting the entire company closer to that strategic goal.

You’d be amazed at how much indirect control/influence an area has in helping the get the cross-functional big-picture goals achieved, IF you put it into the reward system. Remember, it really doesn’t do you a whole lot of good to have one area humming along at full speed if the rest of the company is dragging you into failure. We’re all in this together.

3) Put Patience Into Your Payout
The problem with many reward systems is that it is easy to “game” them. In other words, people find ways to trick the system so that they can get rewards without really doing the things that lead to success.

One of the common ways to game a system is to take advantage of the difference between the timing of the bonus cycle and the strategy cycle. For example, if a strategic initiative takes two years and the reward is paid annually, one could game the system to push all of the “problems” into the second year, so that one could get a big reward in the first year. Granted, this would probably not get one a big reward in the second year, but if you averaged out the weak performance over the two years, it might have been less than the big bonus gained in the first year through gaming the system.

One way to get around this is to put some of the annual reward into a “bank” and only pay it out once it is determined that the strategic initiative was ultimately a success. If the long-term results are a failure, the money in the bank is forfeited back to the company. It may take a year or two to find out whether you really earned that reward.

Sure, this can be a tricky process to implement. But think of all those bad deals and bad mortgages which would not have happened if patience had been put into the system so that those people only got rewarded for the good ones.

Don’t pay it all out when the deal is done or the year is over. Hold some back until it is known if the effort leads to success.

4) Watch Out for Unintended Consequences
There is usually more than one way to hit a reward target. People will tend to pick the easy way over the successful way. For example, one company wanted to encourage the strategic intent of increasing innovation. To do so, they set reward targets based on the percent of sales coming from new products. That sounded pretty good, until they found out that some areas were achieving the goal by prematurely killing off profitable old businesses. It got to the reward, but did not live true to the strategic intent of accelerating innovation. Instead, it accelerated closing down good businesses.

Therefore, when setting the targets, try to think through the potential unintended consequences in advance. That way, you can minimize their unwelcome intrusion later on. For more on unintended consequences, see the blog on the "Chisholm Trail."

Just as you wouldn’t want to reward a race horse before the race is over, you shouldn’t want to reward people in your business for actions until you know whether or not the actions lead to strategic success. One needs to set up a reward system that ensures that only the ultimate winning activities get rewarded. To do so requires: a) setting goals around successes rather than mere task completion, b) linking rewards to the strategic big picture, c) delaying some rewards until success is truly known, and d) avoiding goals with bad unintended consequences.

I knew someone who was handed a division to turnaround. There was money put into the budget to spend on repositioning the division. The person did not spend the money to turnaround the division. As a result, he got a huge bonus that year for exceeding budgeted profits, largely from not spending the repositioning money. The following year, the division was sold to an investor at a huge loss because it had not been successfully repositioned. Was that huge bonus really earned for achieving strategic success?

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