Get a superpower: Understand incentives!

In his brilliant paper/speech ‘The Psychology of Human Misjudgment’ Charlie Munger said:

“Never, ever, think about something else when you should be thinking about the power of incentives.”

In terms of impact on my way of thinking, I think this is one of the most powerful sentences I have read. In simple terms, ‘people will act according to their interests’ – sounds obvious, right? But you will be surprised how frequently this simple rule is ignored.

I can bet that some or even all of the below will sound familiar:

  • An operations/delivery head feels that sales personnel should commit timelines only after consulting the delivery team. They don’t understand why sales personnel don’t seem to understand that this is critical to customer success.
  • A leader is surprised to find that a lot of employees don’t feel committed to the organizational vision.
  • No matter how hard an org tries, some of the employees just don’t seem enthusiastic about participating in training and other up-skilling initiatives.
  • A recruiter is offended by the fact that a candidate is aggressively negotiating for a higher salary – even though the recruiter’s organization is a fantastic place to work.
  • A CEO is surprised that her departments don’t share personnel and resources on demand.

All the above behaviors are completely governed by incentives. Here is how incentives are at play:

  • Why should a salesperson consult with operations? After all, even if they don’t consult, client delivery will still get done in the timeline they committed. No company has the luxury (or b****) to leave money on the table (that’s the organizational incentive at play). If you can’t leave money on the table, then organization will make sure that delivery team, whatever it takes, will meet that timeline. Also, sales personnel are usually evaluated on the revenue they bring in. If consultation with delivery organization is going to stop a sale or even delay the sale– this ‘consultation’ clashes with their incentives and so they are not going to do it.
  • Similarly, I urge leaders to think about why their employees should feel committed. You are the leader- your incentive is making your organization successful and you truly believe that your vision is the best way to make that happen. Your incentives of success and path to that success are aligned. However, is that true for your employees? If your employees don’t know how that vision contributes to their own success or growth, their interest in that vision will be minimal. So stop being surprised or, worse, offended – figure out how you can translate that organizational vision into individual success and growth.
  • Think about why some employees don’t seem to care about upskilling. What incentive do they have (or lack)? If you deep dive, you will find that your employees don’t really believe that upgrading their skill set is necessary. Because even if they do gain new skills, your organization doesn’t have opportunities to put those to use. Their progress or growth in your organization is not dependent on learning new skills – so why should they put in that effort? There is of course an incentive – that it’s good for them! In this case it’s not about if there is an incentive – it’s just that your employees don’t see the incentive. They are only viewing upskilling or training through lens of success in your organization. Re-framing this need to upskill because it’s good for them will be much more powerful.
  • The recruiter taking offense taking continues to surprise me. The candidate, as of negotiation, hasn’t joined your organization. At this point your culture, state of art product, opportunities to travel, etc. are all abstracted for them. The only thing they know before they commit to your organization is the salary they will join at, so that’s the only thing they will care about, i.e., that’s their only visible incentive. So why shouldn’t they negotiate? It’s their right to negotiate – just as it is your right is to negotiate back. Once they are an employee of your organization, building non-monetary exit barriers is easier – but before they join, it’s all about the money (or title, responsibility, etc.).
  • The last one is a classic because it’s so common! Many leaders assume they are in some sort of utopian world where everyone is collaborative, supportive, united towards a common goal, etc. The reality is also not (hopefully) an organization that has backstabbing, doing harm, completely dysfunctional and so on. Most common state is that all teams have their KPIs or OKRs or equivalent and they are engaged in meeting those – it’s as simple as that. So why should department A share a bunch of their personnel with department B? It’s unrealistic to expect that department A will put their goals at risk to help department B. They are not going to be rewarded for that sharing nor are they going to get punished if department B does not meet their goals. I know it sounds cynical, but this is the reality. If departments in an organization do share personnel or resources, they are not doing it out of goodness of their hearts. They are doing so because they have an incentive to do so. The incentives could range from non-official ones like close friendship between department heads or it could complex ones like being recognized as ‘collaborative’ in a company that explicitly values collaboration. So, if your leaders are not sharing personnel or resources and you want them to– create those incentives for them.

Why is this so powerful though?

  • Better responses: If you always evaluate actions of others from the lens of incentives, your own responses/reactions will much more effective. For instance, let’s say someone in your team is not committed to collecting and tracking productivity data. Instead of lashing out, you might want to ask yourself if their KPI includes clearly defined productivity metrics. Ben Horowitz in his excellent book What you do is what you are gives an example of one of their invested companies. The CEO calls him up and tell him that she is facing challenges in cash collection – which is obviously important to survival of the company. The advice that Ben gives, and she follows, is to start a meeting every morning with the question “Where is my money?”. The collections doubled in a few days! What she did was create an incentive for her team by clearly stating that cash collection is CEO’s top priority.
  • Forecasting success/failure: Understanding incentives is also a great way of forecasting success/failure of organizational initiatives. Let’s say your organization appoints someone to build products but without captive developer capacity. The expectation is they will borrow developers from, say, the delivery team. It’s a classic case of mis-aligned incentives. The product team’s incentive is to build products, delivery team’s incentive to deliver client solutions on time with quality. The delivery team has no incentive to let product team borrow its precious developer time. They know that pulling back developers in case of surge in their output is much harder, far better to never lend out developers. If you are appointed in such a role, insist on captive developer capacity. Or, let’s say, your manager feels that a great way to ensure higher margins would be to make sure that your delivery team vets all sales proposals to ensure that nothing unusual is promised to client. Having someone who is not responsible for revenue having an effective veto over sales proposals is simply untenable. Never stand between a salesperson and their numbers! It’s much better to figure out how to get involved before a proposal is written.
  • Empathy: If nothing else, at the minimum, this will save you a lot of frustration. Once you understand incentives, you will start realizing that the behaviors that frustrate you are actually completely rational – they are just not rational for you. So, understanding incentives gets you closer to one of most desired traits in a leader – empathy.

So remember the following by Benjamin Franklin:

“If you wish to affect change, appeal to interest, not to reason”

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