"Never, ever, think about something else when you should be thinking about the power of incentives.”
Charlie Munger
Incentives matter a lot. They really do. Mess up in setting them properly, and you're going to have a hard time dealing with the consequences.
I can’t count how many times in my personal or professional life I’ve encountered situations where improper incentive settings generated pathological behaviors or fierce battles between teams that should theoretically cooperate to achieve the same goal.
Remember the Wells Fargo Fake Accounts Scandal from 2016? Employees at Wells Fargo created millions of unauthorized bank and credit card accounts without customer consent. This behavior was driven by intense pressure to meet unrealistic sales targets and the incentive structures that rewarded such sales figures.
That’s one of the cases where poorly designed incentive systems led to destructive and unethical behaviors, encouraging individuals or organizations to pursue personal immediate gains.
As Charlie Munger outlined in his work 'The Psychology of Human Misjudgment,' the first thing in management is to 'Get the incentives right’.
WHAT EXACTLY ARE INCENTIVES?
Though definitions you may encounter vary widely, I prefer to keep it simple:
An incentive is anything that motivates or encourages a person to take action.
Consider the example of Scooby-Doo, who, despite his profound fear of ghosts, can be persuaded to chase them if a Scooby Snack is involved. This simple treat motivates him to take actions that he would otherwise avoid.
Now, if we start digging deeper, the next thing we need to break down is what motivates people. Is it always a Scooby Snack?
As you probably feel under your skin—it’s not. We are not identical characters who come out of some magical machine with the same needs and desires. We differ from one another, and thus what motivates us also varies from person to person.
Hey, even Scooby-Doo won’t always do everything for a Scooby Snack. If a task is too hard (e.g., he’s scared too much), Scooby won’t move a bit.
It’s even more complex—our desires and needs are not fixed for a lifetime. We change; we evolve over time: when we're young, we seek adventures and new experiences. As we age, we begin to value stability more and heavy drinking parties may not be what we think about on a Friday evening.
Understanding our desires is something we should start with if we want to begin working on specific incentives. Will Smith, discussing his approach to acting, mentioned that before he plays a character, he tries to understand their deep desires because these desires influence how the character behaves. The same line of text can be delivered in different ways and with different emotions. The differences must come from within, rooted in our desires
If you want to get incentives right, firstly you need to understand what motivates people, and to do that, you must grasp what really drives them. Once you thoroughly understand motivation, you can craft incentives that effectively influence behavior.
But then a second question arises:
Where exactly do we want these incentives to lead?
This brings us to the crucial second phase of developing incentives — specifying the desired actions.
WHY DO YOU BEHAVE THIS WAY?
In our lives, we often encounter behavior from others that seems confusing. Frequently, this behavior isn't a reflection of the person's character, but rather the result of incentives that lead them to act in a certain way.
This understanding is especially vital in professional settings, where poorly calibrated incentives can lead to undesirable outcomes.
Consider the following scenarios:
A marketing team is incentivized to generate the maximum number of leads, regardless of their quality, creating frustration for the sales department.
A development team's performance is measured by the number of features they deploy, rather than the actual value these features add to the product.
Sales personnel are evaluated based on the number of calls or meetings they schedule, not the results of these activities.
A purchasing department is rewarded for cutting costs annually, potentially at the expense of quality or supplier relationships.
Companies focused on short-term profits might overlook long-term value creation, leading to strategic misalignments.
These misalignments illustrate that while departments might meet individual targets, the overall company objectives can remain unmet.
It's also important to consider the incentives driving others' behaviors.
A common saying illustrates this well: "I've never seen a management consulting report that didn't conclude recommending more consulting hours."
When you get advice, think about why it’s being given, kind of like asking, "Mr. hairdresser, do I need a haircut?" This helps you figure out if the advice is really for your benefit or for the benefit of the person giving it. Just as a hairdresser might say you need a haircut to make more money, others might suggest things that help them more than you.
Always check if the advice really helps you.
When encountering difficult-to-understand behaviors, always ask:
What drives this person?
What does he/she desire?
Understanding these factors can help you predict behaviors more accurately and design incentives that truly align with your long-term goals.
Navigating the complexities of human motivation and incentive alignment is challenging but essential. Done correctly, it can significantly enhance both personal and organizational effectiveness.