We do what is rewarding and avoid what we are punished for. Are incentives very important? Let us see what Charlie Munger thinks

From all business, my favorite case on incentives is Federal Express. The heart and soul of their system – which creates the integrity of the product – is having all their airplane come to one place in the middle of the night and shift all the packages from plane to plane. If there are delays, the whole operation can’t deliver a product full of integrity to Federal Express customers. And it was always screwed up. They could never get it done on time. They tried everything – moral suasion, threats, you name it. And nothing worked. Finally, somebody got the idea to pay all these people not so much an hour, but so much a shift and when it’s all done, they can all go home. Well, their problems cleared up overnight.

I always wondered why in some organizations it takes a long time to get the work done? It is because of the way in which incentives are setup. The only input criteria for an employee in these organizations to get promoted is the duration of their stay at work. It does not matter if you finish the work in 1 day or 1 week. Then why would anyone be motivated to finish it early?

Sometime back I worked on a Product Feature which did not get adopted by our customers. The product had a lot of great features. The reason why the adoption was not there is because the sales people did not have the motivation to sell it. Why are they not motivated? It turned out that the incentives were not setup correctly. The sales commissions were not predictable and it was paid after several months depending on the product usage. All the other products were prepaid and sales people got the commission as soon as they were sold and it was completely predictable. This was later fixed. This could have been avoided if we had learned about what happened in Xerox

Early in the history of Xerox, Joe Wilson, who was there in the government, had similar experience. He had to go back to Xerox because he couldn’t understand why this new machine was selling so poorly in relation to its older and inferior machine. When he got back to Xerox, he found out that the commission arrangement with the salesmen gave a large and perverse incentive to push the inferior machine on customers, who deserved a better result.

Why do people steal?

People will steal if they couldn’t get caught. In Charlie Munger’s words:

The worst abuses come where people have the greatest temptations. If we make it easy for people to steal, they steal(and bad behavior will spread).

We had a servant maid who always stole items from our house. We have caught her several times and warned her. In spite of all that she continued her stealing. Why?  It is very simple.

  1. We made stealing very easy.
  2. We did not cashier her when we caught her the first time.

Charlie Munger tells us how bad policy can become the norm.

In the New York Police Department, they have a simple system. Your pension is based on your pay in your final year. So when anyone reaches the final year, everybody cooperates to give him about 1,000 hours of overtime. And he retires – in some cases after a mere 20 years of service – with this large income. Well, of course his fellow employees help him cheat the system. In substance, that’s what happened. But the one thing I guarantee you is that nobody has the least sense of shame. They soon get the feeling they’re entitled to do it. Everybody did it before, everybody’s doing it now – so they just keeping doing it.

Doctor Visits

In the US I go to the Doctor more often than needed. I did this less frequently in India. Why? One reason is I am older now. But that does not fully explain it. In the US all I had to pay is the copay of $10 for every doctor visit. In India for all outpatient visits the entire money comes from my pocket.  This reminds me of what Aristotle said:

That which is  common to the greatest number gets the least amount of care. Men pay most attention to what is their own, they care less for what is common.

Frequent rewards

Frequent rewards feel better. It feels better to gain $50 twice than $100 once. For losses it works in the reverse order. It is better to lose $100 once than $50 twice since every loss is painful. Now you see so many people go to casinos. You get a lot of rewards some time small and some time big and the main factor there is the unpredictability and the near misses. People keep on playing anticipating big rewards and they end up losing money.

What should I do

Reward individual performance and not effort or length in organization. Remember the reward should be after and not before their performance. Always think about the role of Incentives in every decision and make sure you set this up correctly. Charle Munger adds:

An example of a really responsible system is the system the Romans used when they built an arch. The guy who created the arch stood under it as the scaffolding was removed. It’s like packing your own parachute.