On Incentives Going the Wrong Way
Every so often in a meeting, you find out information that makes you shake your head in wonder. I had one such meeting this morning.
Our customers have been requested to provide a price for some work to a large Australian, publicly listed company. Great.
The issue is that the price they put in was some 55% over the price the company had received from another business.
OK, but, when you receive two prices that are aboutthe same from different providers and another price that is significantly lower than them (over $500,000 less), you would more than likely pause to consider whether the significantly lower price was, well, realistic. Or whether the price was submitted to get the job in the hope that other work will crop up once the contractor is entrenched on site..
The trouble is, the managers of this publicly listed company are incentivised to under-spend their capital budgets each year – the more money they save against their budget, the bigger bonus they get.
As our customer said this morning – “they will end up with a pile of crap that won’t do the job but the manager doesn’t care as he got his bonus”.
The incentive program any business uses needs to align itself to the needs of the business and the staff but also, fundamentally, to the long term goals and strategies of the business. Where there is no alignment, you run in to significant problems on a number of fronts.
Firstly, you want the incentive to encourage the type of behaviour you want to see. If short term profit is the focus on the business, build your incentives around that. However, the focus on short term profit is, to my way of thinking, myopic. Getting a longer term strategy is far better for everyone concerned. There are some notable people who like longer term strategies. People like Warren Buffett.
Secondly, the incentive needs to match the motivators of the person being incentivised. Using cash bonuses is fantastic however, the bonus can take other forms which might not cost as much but which may be far more highly valued than cash. By aligning the bonus to what actually matters to your people you are also showing that you care for them as people rather than using a blunt force (cash) for everyone. For example, a cash bonus is terrific but if you were to pay for a family holiday for your staff member, or give them some extra time off as a bonus (especially when they have a young family), this can have far higher value to them than anything else.
Finally, think about how you might face your shareholders/financiers where you had to explain how your business was so focused on short term thinking and behaviour that the investment decision made in plant and equipment spend was solely based on price and not quality or longevity.
They might, on hearing this information (however it is packaged) cause to question your thinking and ability to act as a custodian for their interests. I seem to recall a similar approach was adopted by some banking institutions during the 2000’s. That really didn’t end well.
The current business environment is very challenging for a lot of businesses. There is a lot of competitive pressure due to a lack of consistent activity – especially in commercial construction. This causes many businesses to try and “buy” work – price it with little or no (or, occasionally, negative) margin. All they succeed in doing is making their exit from the market more rapid and they tend to deliver incomplete jobs as they go broke before the job is finished.
If your incentive program gives your team tacit or explicit approval to seek lower and lower prices – at any price, the quality of what you purchase will decline and will end up costing you more.
A friend put it beautifully many years ago “I am not rich enough to buy second best”. When you are designing and implementing your incentive program, make sure it delivers what you really want – not a facsimile of what you think you might like.