Field Note: Incentive Alignment
Date: 2024-12-15 Sector: STRATEGY Read Time: 5 minutes
If you want to understand behavior, look at incentives. If you want to change behavior, change incentives. Most organizational dysfunction is incentive dysfunction in disguise.
The Observation
Client had a sales problem. Revenue was stagnant despite aggressive targets. The sales team was working hard. Pipeline looked full. But deals weren't closing.
Leadership blamed:
- Market conditions
- Competitor pricing
- Sales team competence
We looked at incentive structures.
Sales was compensated on closed deals. Standard stuff. But the bonus kicker required hitting quota by quarter-end. Miss by one deal, no bonus.
What happens when you're close to quota on the last day of the quarter? You push. You discount. You promise things that shouldn't be promised. You close deals that shouldn't be closed.
And the next quarter starts with angry customers, unrealistic expectations, and a depleted pipeline because everything got pulled forward.
The incentive was misaligned. It rewarded closing deals, not building business.
The Principle
"Never, ever, think about something else when you should be thinking about the power of incentives." - Charlie Munger
People respond to incentives. They do what they're rewarded for and avoid what they're punished for. If you don't like the behavior, check the incentives.
How Incentives Misalign
Short-Term vs Long-Term
Rewarding this quarter's results at the expense of next year's health.
Examples:
- Sales bonuses that encourage deal-pulling
- Cost-cutting that reduces training investment
- Production targets that sacrifice maintenance
Individual vs Collective
Rewarding individual performance at the expense of team success.
Examples:
- Commission structures that discourage collaboration
- Performance rankings that create internal competition
- Recognition systems that highlight stars over teams
Metrics vs Outcomes
Rewarding the measurable proxy instead of the actual goal.
Examples:
- Call centers rewarded on call duration, not resolution
- Teachers rewarded on test scores, not learning
- Engineers rewarded on lines of code, not working software
Activity vs Results
Rewarding effort instead of outcomes.
Examples:
- Points for attending meetings
- Recognition for hours worked
- Rewards for activities regardless of impact
Diagnosing Incentive Problems
Follow the Money
What gets rewarded with compensation, promotion, and recognition? That's what people will do.
Find the Workarounds
When people game the system, they're revealing the gap between stated goals and actual incentives. The workaround is a symptom; the misalignment is the cause.
Ask "Why Would Smart People Do This?"
If smart people are doing something that seems dumb, they're probably responding rationally to incentives you haven't understood.
Map the Trade-offs
Every incentive creates trade-offs. What behavior does the incentive encourage at the margin? What gets sacrificed?
Fixing Incentive Problems
Align Time Horizons
Include long-term metrics. Clawback short-term bonuses if long-term results don't follow. Create continuity between periods.
Balance Individual and Collective
Mix individual rewards with team and organizational components. Make collaboration visibly rewarded.
Measure Outcomes, Not Proxies
Get closer to what you actually want. If you can't measure the outcome directly, at least use multiple proxies that triangulate.
Build in Quality Checks
If you reward quantity, add quality gates. If you reward speed, add accuracy requirements.
Test for Perverse Incentives
Before implementing, ask: "How could someone maximize this metric in ways we wouldn't want?"
The Resolution
We redesigned the comp structure:
- Extended bonus period to six months
- Added customer retention component
- Included deal quality metrics (margin, contract terms)
- Created team-based accelerators
Quarter-end chaos subsided. Customer complaints dropped. And revenue actually increased because the team was building sustainable relationships instead of chasing quarterly bonuses.
The Meta-Lesson
People aren't problems. Incentives are problems. Change the incentives, change the behavior.
When you find people doing something that doesn't make sense, don't conclude they're stupid or malicious. Conclude that you don't understand their incentives.
Show me the incentive and I'll show you the outcome.