Incentives

Chris Dixon on agency problems:

As you go higher in the organization, the incentives are more aligned with the firm’s incentives. But knowledge and authority over operations often reside at lower levels. Deciding what level to target involves nuanced trade offs.

Incentives in English Soccer

James Reade over at the International Journal of Sports Finance rebuts the concept of ‘player loyalty’ in the EPL & other sports leagues:

Of course, these are standard harking-back-to-a-mythical-golden-age type arguments. Back in these days, pre-1992, and maybe even pre-1960s, players really didn’t have much choice – their clubs held their registrations and a lot of power over them. Additionally, pre-Sky there was not a lot of money in the game. So: Players can’t move easily, and there isn’t much money about for them to want to either. Surprise, surprise, nobody moves anywhere. There’s this false sheen of loyalty, but of course it’s fake, it’s just agents responding to incentives.

Incentives are an amazing thing. They are typically disguised, and sometimes lauded, yet they are the power that moves everything in our world.

Basketball, Lean and Incentives

The NBA Finals are going on right now and one of the main story lines surround Kobe Byrant and his supporting cast. The general consensus of the national media is that despite Kobes point production, the Lakers need more from the other people to be able to win.

Sports Economists have long pointed out that NBA players are rewarded for one thing: scoring points.   Often this comes at the expense of everything else around them, including winning.  The thinking goes that if everyone tries to score as many points as possible, their team will win.  A NBA players’ financial rewards, playing time and endorsements are based on very little outside of point totals. Thus, there is a huge incentive for players to shoot as much as the possibly can, regardless of how efficient they are at making those shots.

The problem is that basketballs are scarce resources.  A shot taken by one person cannot be taken by another.  All of those shots can cause havoc to the rest of the team and actually hurt the overall odds of winning.  Missed shots and turnovers increase fast break opportunities for the opponent and give more opportunities for your opponents to score.  Last week, Kobe Bryant missed more shots than he made and had 7 turnovers. Despite that, the prevailing wisdom is that he did all he can to avoid the loss.

So what’s this got to do with Lean? One of the core principles of lean is to optimize the system as a whole and not try to optimize through decomposition. One of the best ways to do that is to get rid of individual based performance rewards and incentives. If you have those types of incentives, you’ll find people working through their tasks with the sole purpose of maximizing whatever it is they’re being measured by and rewarded on. Lines of Code written, bugs found, projects delivered on time, etc… Unfortunately, this has the tendency to create a system with tons of churn:

QA testers are “finding” bugs as quick as they can, without regards to if they actually exist.

Developers churn out more code than necessary just to pump up their LOCs count.

Project managers rush projects into deployment just to increase their numbers.

All of the behaviors just increases the thrashing within a system, which increases the load on every single resource in the system.  Development spends more time looking for bugs that might not exist. Operations spends time trying to get a possibly buggy and non-functioning system to work. QA spends time testing features and code that isn’t needed. The cycle keeps going and going.  Sure, everyone gets their bonuses. Yet the entire team / department suffers.  What’s worse is that no one has an incentive to help out anyone else, since time wasted on you is time that I can’t be working towards my bonus.  It creates a very self-serving culture and isolated team dynamic.

The old adage of “tell me how you measure me and I will tell you how I will behave” still rings true .  Make the choice to measure your team on team based goals.  Place a premium on team communication, collaboration, ownership and overall delivery.   You want people chipping in to help, even when it’s not their particular area.  If you overhear “that’s not my area” or “let operations handle it”, your team priorities are counter productive and likely weighing you down.

Puppet Sex, Negotiations and Economic Incentives

There’s a movie from the creators of South Park called ‘Team America: World Police’. All of the “actors” are marionettes. I’m not going to get into the politics of the movie. I just wanted to talk about one scene. In this scene, the love story subplot of the movie comes to a head:

Lisa: Promise me you’ll never die.
Gary Johnston: You know I can’t promise that.
Lisa: If you did that, I would make love to you right now.
Gary Johnston: <awestruck> I promise I’ll never die.

That scene always cracks me up. Not only because of the marionettes, but because of the obvious incentive Gary has to simply tell Lisa what she wants to hear, regardless of the reality of the situation.

Now that I have your attention, I’d like to tell you about a similar situation I ran into last weekend. We were thinking about switching credit card processing providers for Awardable. Currently we use Amazon Flexible Payment Services, but I had heard very good things about Braintree. Navigating to their site, I couldn’t find a price list. Strange. So I filled out the ‘Contact Us’ link hoping to be emailed a price list.

A short time later, a representative from Braintree contacted me via email:

Hi Griffin,
Thank you for contacting us. Can you share some additional details about your business processing needs including what product/service you are selling and current or expected monthly processing volume?

I responded:

Hi,
Could you give me some more information about your pricing structure?

Which I thought was strange. Every other merchant solution we’ve investigated ( Authorize.Net, Google Checkout, Paypal, Amazon FPS, etc.. ) has their price list, by tiers, on their product website. Why would Braintree be different?

Hi Griffin,
Thank you for the quick response. I would be happy to send you pricing but I need you to answer the questions in my previous email before I send pricing. (Can you share some additional details about your business processing needs including what product/service you are selling and current or expected monthly processing volume?)

Hmm, strange response and not at all what I was expecting.

Hi,
Sorry, not sure why you need to know that. Every other credit card processing solution has their prices on their site, including pricing per tiers based on volume. I’m a little leery about a service that needs to be tailored per customer.

At this point, I’m not really interested in Braintree anymore. It seems like they’re either going to be too expensive for us or there’s going to be some other catch. Then comes this response:

Hi Griffin,
I am sorry to hear that. There are hundreds of different interchange rates that Visa/all other cards charge. So I don’t know what my cost is until I know what you sell, how you sell it, and your volumes. Volume is also important because I can give you lower pricing if your volume is higher. The other reason we ask for information is we need to know if you are even compatible with our company. There are industries like the adult industry that we simply can’t work with. I would like to know if we are compatible before we start sending pricing and other information so I don’t waste your time. I do need that information to proceed.

The part about adult services sounds plausible, but still, why not just put that on your site? It’s not like you’re going to be confused about if you sell porn.Also, the part about interchange rates seems a little off. Every other merchant has figured this out except for Braintree. Either they’re banking on screwing over the smaller volume clients or they just aren’t big enough to beat the other services I mentioned above.

Hi,
No problem. I just have a hunch that from your questions we wouldn’t have the volume to get your competitive rates. No matter, well stick with Amazon, Auth.net, google and the like.

He ends with this:

Hi Griffin,
Our rates are very competitive, and we do bring on many new merchants. I just need to understand what I am pricing before I price it. I will close things out on my end, but if you decide you would like to see what we offer please let me know.

What does this have to with incentives? Well, from my POV, the rep made two critical errors.

First, he’s made it pretty clear that their prices are based on volume. More volume == lower prices. But what about if you don’t know the volume? As a new merchant, I would have to guess. However, if they want a quote to base my rates off of, isn’t it in my best interest to be wildly optimistic about our expected volume in order to get the lowest quote? Since we’re so new, it’s just a guess anyway and if I’m guessing, why would I low ball my guess when it will result in higher rates from them? In this case, he created the incentive for me to tell him what he wanted to hear.

Second, he never explains why other companies can put list their prices up front but Braintree can’t. If he needs a expected volume guess and a services overview, I’m sure he’s just throwing those into a spreadsheet. He’s not going to treat me differently for any reason. If that’s the case, why not just formalize the spreadsheet and toss it online? What are they gaining by adding the bottleneck of a salesman? If we come in under the expected volume, I’m assuming there’s a penalty. If so, then they’re rates must be formalized, so why hide them?

Interview with David Simon of ‘The Wire’

The Wire is the greatest piece of TV I’ve ever seen and probably the best contemporary narrative to come out in the last half century. Its creator, David Simon, is a recent MacArthur grant winner and probably one of the smartest people out there:

Bill Moyers: But here’s the problem for journalism. When we write about inequality, we use numbers that are profound but numbing. I mean, here’s something I just read: over the past twenty years, the elite 1 percent of Americans saw their share of the nation’s income double, from 11.3 percent to 22.1 percent, but their tax burden shrank by about one-third. Now, those facts tell us something very important: that the rich got richer as their tax rates shrank. But it doesn’t seem to start people’s blood rushing.

David Simon: You start talking about a social compact between the people at the bottom of the pyramid and the people at the top, and people look at you and say, “Are you talking about sharing wealth?” Listen, capitalism is the only engine credible enough to generate mass wealth. I think it’s imperfect, but we’re stuck with it. And thank God we have that in the toolbox. But if you don’t manage it in some way that incorporates all of society, if everybody’s not benefiting on some level and you don’t have a sense of shared purpose, national purpose, then it’s just a pyramid scheme. Who’s standing on top of whose throat?

Incentives. Incentives. Incentives.

As for his beloved newspaper industry:

You know, for twenty years, they looked upon the copy as being the stuff that went around the ads. The ads were God. And then all of a sudden the ads were not there, and the copy they had contempt for. They had actually marginalized themselves.

Having worked for a period of time for the Cerberus known as Gannett, Tribune and Knight Ridder, I saw this first hand. I actually sat in on meetings with with executives who debated how to make their online offerings less attractive to users so that they would go back to the hard copy papers.

Stellar interview.

Aligning With Your Investors

( When I was writing this, Steve Blank put out a great piece titled “VC’s Are Not Your Friends“. Highly recommended since it echos the message below. )

The startup community was set aflutter last week with news that Russian investor Yuri Milner has offered every startup in the current Y Combinator class $150k in convertible debt. It’s quite an incredible offer. The news coverage of this offer is overwhelmingly positive as it should be.

However, the offer also brings into question some of the lesser talked about aspects of fund raising, entrepreneurship and investing. That is that founders are not always aligned with investors when it comes to a )what the end game is for their company and b) the path to get there. Take this quote from the WSJ linked above, which makes an interesting comparison:

This blanket approach is akin to an index mutual fund where a money manager will invest in all 500 companies in the S&P 500, for example. SV Angel and Milner are assuming that there will be at least a few, if not more, big hits in each batch that will more than make up for the cost of investing in the others.

Now, what does a mutual fund have to do with aligning with your investors? When an investor runs a fund, that investor is investing in several companies with the expectation of returns. The size of the funds & investment dictate the desired returns. In general, though, the investor is hedging their bet that one or two of the aggregated investments will outperform all of the other ones, thus making back their desired returns. This is similar to how a mutual fund manager manages their fund. They can take certain risks knowing that unless they’re very, very unlucky, some of their risks will pan out and make up for the ones that don’t.

This strategy of a few successes canceling out all of the other failures pushes investors to steer & direct the company into becoming one of those successes. No problem there, that’s what they should be used for. The best investors bring more than cash to the table, they bring contacts, experience and credibility. However, they could, in fact, be detrimental to the individual company. They don’t need every risk to succeed, just 1 or 2 of them. While that sounds good to the investor, what about the risks that don’t pan out (for whatever reason ) ?

In other words, if an investor puts money into 10 companies and 2 are successful enough to get him his returns, that’s a good day. However, what about the other 8 companies with less than ideal returns? Some companies could just slow to bake. Some others will never attain the scale that most investors would like. Some could just be bad ideas or have bad execution. Some of those could be enough for the founders, but not for the investors. Hence the importance of being aligned and cognisant of what your investors want. Investors want exponential returns and that usually means growing & scaling the business. If the VC is prematurely pushing a company to grow, grow, grow without being able to sustain itself, the company could burn out quickly and lose its identity in the process.

Think of this like Intel or AMD overclocking their chips to see how fast each individual one can go. If they have to throw out a few that burn out, so be it. It’s worth it to find the ones that exceed their expectations. Good for them, bad for the chips that didn’t need the overclocking to work just fine. It’s great for you when you’re one of the former, bad when you’re one of the latter.

This rambling caution is just that: caution. It’s not a rant against investment, investors or the capital raising process. It’s simply the plea for entrepreneurs to understand the system they’re in, the deals that they make and who has what incentives. Simple economics argues that both parties in a deal will be self-serving first, collaborative second. It’s when one party misunderstands the others incentives and motives thats when things get dicey.

“The stock market is for suckers”

Fantastic article from Canada about the US stock market and the various craziness that awaits investors.

“For those in the burgeoning secondary market for private company shares, like SecondMarket, this all points to increased demand for their services. “There are problems in the public markets that are not going away,” says Mark Murphy, a spokesman for SecondMarket. “If they can avoid having to deal with high-frequency trading, short-term thinking and Sarbanes-Oxley, private company CEOs are saying they’d rather stay private and build something long-term.”

Once again, incentives rule.

How Not To Negotiate Your Salary

Most people hate to negotiate, especially when it involves money. That’s a shame, because it’s such a critical part of life, especially business. At a minimum, everyone will be involved in at least one very important, money related, negotiation in their life: their salary. That’s why it pains me when I hear this old adage brought out:

Your first salary is also the basis for your salary history. When you change jobs, that salary history becomes part of negotiations with your new employer. If you talk your first employer into a 5% during the initial negotiation, that increased salary will stay with you throughout your life.

This is crap, pure and simple, for two reasons:

  • How much an employer is willing to pay to fill a position and how much you’ve made in the past are different things that have no bearing on each other.
  • We live in a capitalist economy, with a free market. Free markets have no memories with it comes to pricing. Pricing is determined by supply & demand.

So why is this such a bad thing? It limits your future earnings. If relegate yourself to incremental increases in your earnings throughout your life, you’ll never be motivated to grow your skills. That makes it difficult to negotiate a market wage for a job that’s a lateral move or even a promotion. If you’re a teacher, but learning to program on the side, you’re not going to walk into your first programming interview and settle for your old teaching salary.

So, the next time you negotiate your salary, keep two things in mind:

Never just randomly throw out numbers. If you throw out a number during an interview, you could be artificially capping what the employer would pay to fill the position. If an employer expects to pay a market wage of $80k and you say that you won’t take a penny under $60k, you’ve just cost yourself $20k. This is a form of something economists call ‘information arbitrage‘. As a side note, this is exactly how sites like priceline.com make their money. You toss out a price and they find you a hotel at a lower price and pocket the difference.

“Wait, what should I put on the application where it asks for ‘Previous Salary’?”

Nothing, leave it blank. When they ask you about it, tell them what salary you’re expecting and move on from there. Don’t be afraid if they say they’ll just call your old position. These are little tricks that companies use to try and get the upper hand on employees. Previous employers can’t legally disclose your salary ( as well as other information ) to anyone. They can only confirm your employment status. This means your previous salary becomes a part of the negotiations only if you make it.

It also means that you should ask for something that’s credible and be able to back it up. Don’t ask for $200,000/yr if you’re right out of college and other people with your level of experience are making $50k. However, if you know that Sr. XYZ specialists are making $100,000/yr, ask for that. If your qualified enough for the job, your qualified enough for the market wage.

Never let anyone else negotiate your salary for you. No one cares about your money as much as you. This is common when you’re being placed at a company through a recruiter. They’ll try and tell you that it is SOP for the recruiter to handle all negotiations and you’re just supposed to let them know what you want. This is bad for two reasons:

  • The recruiters goals & incentives don’t match yours. They want to create a lasting relationship with the client first and place you second. That can lead them to be less than firm with your salary requirements. Also, because they’re probably being payed as a % of your salary, getting that “last $5000” you’re asking for has very little impact on them. They could push you to agree as quickly as possible or advise you they can’t get what you want. They want to close the deal as quick as they can. As long as the position is unfilled, the greater the chance of someone else besides them placing someone.
  • The relationship between you and your new employer is going to be lasting. It could forever be seen through the eyes of your initial interactions & communications. Don’t leave that in the hands of someone else, especially someone you don’t even know. You don’t want to let someone else sour that because of a miscommunication. You and your employer could also end up on different pages. It’s better remove as many middle men as possible to make sure there’s no confusion.

Tell them you’d prefer to handle all negotiations. They’ll still get their money & nothing would change for them. If they push you, threaten to walk. Always remember, you’re the commodity here. The recruiter needs you way more than you need them at this point. Make sure they know that and you don’t get screwed.

This may all seem like a hard stance to take and it is. However, it’s worthwhile in the long run. You’ll be happier and more content with your salary & offers in the future without having to look back and regret taking a sub-standard offer. You’ll also spend less time with employers that are looking to take advantage of new hires.

Always remember:

“You don’t get what you deserve, you get what you negotiate”

Don King ( ok, ok, originally Dr. Chester Karrass, but I liked when Don King said it better )

"I can turn a $4 million profit into a $2 million loss and get every national accounting firm to agree with me."

Professor Berri ( of The Wages of Wins fame ) breaks down the previously linked to story about the Pittsburgh Pirates & their incentive to improve.

Meanwhile, over at Slate, Phil Birnbaum ( of Sabermetric Research fame ) really nails the crux of the issue with his take. Especially telling is this quote:

As a result, Tampa Bay’s regular-season operating income declined from $22 million in 2007 to less than $1 million in 2008—which means it cost the team $21 million to transition from cellar dwellers to World Series participants. As amazing as it seems, even after adding in $11 million in postseason earnings, the Rays were more profitable when they went 66-96 than when they went 97-65.

Sobering.

Rates as a function of capacity

I recently had the pleasure of attending the June meeting of Dublin chapter of the Bootstrappers Breakfast. After the meeting there was a Q & A session with the remaining attendees. I remarked to Sean Murphy that I’ve recently moved to a new pricing model for consulting. I’ve started to adjust my pricing based on my current capacity. That is, as my schedule becomes fuller and I become busier, my hourly rates increase. That way clients can decide for themselves how important their project is. If it can wait, we push the project back a bit, my price goes down and the clients get a price break. If there is an immediate need, they will need to pay a premium and it will be a rush job.

I do this because the last few hours of my week act as a buffer for anything unexpected that should come up. If I pack my schedule to the brim, I run the risk of all sorts of chaos if/when anything unexpected comes up.

In lean terms, I’m increasing costs as my capacity decreases.

Why? A few reasons:

First, it provides an incentive to prevent me from becoming overtaxed and taking on too much work. This regulates the flow of work into my 1530 schedule and provides a sort of cadence for new work. This allows me to plan more efficiently.

Secondly, by stabilizing the work in and out, I stabilize my flow. This helps me churn out better work quicker. If you take on everything that comes your way for the same price, there’s no doubt that that you would begin to resent those last few pieces of work that you’re cranking away on any given Sunday night. With the rate increase, at least there is ability to look back and see that there is increased compensation for working later at night and into the weekend.

I should note that this obviously this can alienate clients and cause you to lose work. However, part of managing a successful service based business is to know when and how to control clients. If you simply say ‘Yes’ all of the time to everyone, you’ll quickly find yourself taking on much more work than you’re capable of. That will lead to you not being able to deliver consistently excellent work and you’ll lose clients anyway. I would rather have a healthy relationship with a client and be able to say ‘No’ as often as I say ‘Yes’. Those are the kinds of clients you’ll be able to build a sustainable business from.

BTW, this isn’t a new concept. The concept of cadence and queue management is applied in a lot of different places. For example, Chicago is entertaining the idea of rolling out congestion based pricing for its tollways that’s similar to several other tollways across the US. Comed and other electric companies employ Real-Time Pricing. These are just two other examples and there are many more.

Take a look at your own life and see if you can figure out ways to employ a form of cadence to help stabilize things.