Rethinking the Incentive Structures at Your Firm
While it wasn’t a huge audience who heard the speech at Harvard in 1995, what Charlie Munger shared that day spread very quickly. It got picked up and reshared by so many people that he decided to revise his talk a decade later, after thinking more about the subject. I found reading both versions to be a good investment of time.
The talk was titled “The Psychology of Human Misjudgment”. What everybody seems to remember about this talk, though, is something that he never actually said:
“Show me the incentive and I will show you the outcome.”
I’ve searched both transcripts, and while it’s true that he never actually said that, he did articulate that statement later, and it’s a very apt summary of what I want to talk about: the incentives in how you’re running your firm, and thus what outcomes you can expect.
At the end of this article I’m going to share what I would consider the most remarkable counterpoint to “incentives” and “outcomes” but let’s work through some examples first.
Where Incentives Distort
Just in case you’re scratching your head wondering what I’m talking about, here are some examples of the bad incentives in this industry.
- “Let’s hire a firm to get us new business meetings with potential clients.” Of course, missing from that equation is the promise of meetings with potential clients who are really looking to hire a new agency. So what do you end up with, instead? Lots of meetings. And meetings that shouldn’t happen are the scourge of the earth.
- “We’re going to incentivize your efforts for the year with an annual bonus that will even out the ups and downs of the four quarters after we know what we’ve accomplished together. This bonus will be paid on January 15th following the year covered.” So when do people quit? You know the answer to that.
- As the principal, you proudly announce an open door policy, urging team members to keep the communication open so that you can make quick adjustments to keep reaching the goals you’ve set. The message is, “tell me the truth, and early.” But the last time Jennifer mustered enough courage to tell you the truth about some client, you were dismissive and curt. That removes the incentive to tell the truth, because you’re more in love with the idea of hearing the truth than actually hearing the truth.
- “Culture is really important around here. In fact, our philosophy and what we believe and who we want to be is so critical that it’s featured prominently on our website because we want everyone to know this.” And then, whispered at home with your spouse, “I’m not sure what to do about Tom. He’s not the team player that others are and he doesn’t fit our culture, but he is solid with our biggest client. I’m finally feeling the freedom I’ve longed for in not having to deal with daily client issues, and I’m not really excited about taking that over again, so I’m just going to have to live with it.” The outcome is an inconsistent culture because the incentive is to make money for the firm, even if it tramples on the stated cultural values.
Siloed teams with separate goals. Hourly billing that rewards inefficiency when we are paid more for taking longer. Personas and buyer segmentation to reward complexity even when it doesn’t move the needle. And one of my favorites: getting paid as a percentage of total spend on media buys.
I’m not as familiar with other industries, but it wouldn’t surprise me if we’re uniquely bad at this stuff, probably because we “follow” industries more than we “lead” them.
Competing Incentives: An Example
Timesheets. Yeah, timesheets. The practice that is mandated from the top, followed by the least compliant group obeying that mandate: those same people at the top.
But think about what happens when your firm is struggling. In fact, struggling so much that you’re contemplating some layoffs and everyone knows it. Under that sort of pressure, timesheets provide a perverse incentive: individual team members overstate the time required to complete a task in order to appear essential and engaged. “I’m very busy, and you’re going to lay me off?”
And then what happens when the firm is doing fine and you’re looking for more efficiency? Or that newer employee is under pressure to stay within the budget? People understate how long they are spending on individual projects to meet your expectations. “Yeah, I stayed on budget and got that part of the project done within the time allotted.”
So you’ve mandated timesheet completion, but you’ve set this incentive on top of that: “what I want from you is more important than honesty on your timesheets.”
(I want to say soooooo much more about timesheets, but that’ll turn into a sermon.)
An Example in New Business
Another example comes from new business, surely the most incentivized position at any firm. You incentivize a sales person to close sales, but you don’t pay enough attention to the quality of those closes, and so what happens? You get revenue, but it’s not quality revenue.
The sales person makes money when prospects are dragged across the line, regardless of their quality. That sales person, who loves wins and recognition, drops this new client on your lap, and you’re hesitant to discourage their efforts, so you try to make the most of what they brought you.
The solution is more carefully crafted incentives (if you even want to use commissions at all): “you get a commission if the first project is at least $40,000 in fee revenue. You can bring something smaller, and we’ll monitor it and catch you up if that client turns into the sort of client we are looking for.”
The Solution? Maybe?
The role of incentives is so obvious that it’s actually pretty easy to overreact, too. While we used to think that “nudges” in human behavior were going to solve a lot of this, most of that thinking has been debunked. It’s yet another example of popular laziness in consumer research. But still, here’s the big point:
If you are not getting the results you want at your firm, look at the incentive structures.
That’s it. It’s that simple. Manage actively. Be open to making foundational changes. Heck, even be very different in how you explain this to clients.
Most importantly, leaders exist to do what the team cannot or will not do for itself. That includes charting slightly new courses when the incentive structure is twisting the outcome. Often, incentives are what leaders do because they think it will relieve their management burden, freeing them from messy decisions.
I don’t have a lot of answers for you on this topic, so I’m just going to end with a simple question: looking back on just this last week alone, what behaviors did you reward on your team?
And now what I promised at the outset: the most significant counterpoint under this heading of incentives and outcomes. You know what the most powerful example is of someone doing great things for which they have virtually no incentives? That’s that person on your team who isn’t an owner…but thinks like one, acts like one, and whose performance is indistinguishable from your own. Tell them thanks!
