What's Wrong With Metric-Based Incentives

A metric is something that gives us a measurable glimpse at the performance of something else.

  • LinkedIn Connections help measure your business network
  • Time for a Crossfit WOD helps to measure your fitness
  • Number of Calories helps to measure the impact on your energy and weight.

However, your connections, time, and calories don’t actually explain your network, workout, or diet. They are devoid of depth, lack the complexity of reality, and in general are weak indicators of the actual goals

  1. To have an engaged business network leading to opportunities
  2. To have fitness in both aerobic and anaerobic states
  3. To be lean, energized, and have great health in all of your bodies systems.

Why Metrics

Metrics can be helpful to give us a glimpse into the performance of a process, the achievement of a goal, or the level of a function. What ends up happening is that we take a glimpse and turn it into the goal. We then start to focus on the derivative outcome, forgetting the original purpose.

This has some very interesting implications in business and life with some even more interesting studies in game theory for the other geeks out there.. but I’ll stick to simplicity here.

Losing Money With High-Performance Metrics

Let me break this down into a brief example.

The backdrop

You run a business and are always looking to increase sales and cut costs - ie increase margin. You, the owner of the business are the main hustler. You don’t have to be reminded to grow your business on a weekly basis, or have your salary tied to performance - you live and breathe the business.

The problem is the people making much of the everyday decisions don’t share your business-is-life philosophy. That is just part of growing, no one will be dedicated as you.

The idea

Whenever you look into something, you often find different ways of ordering, consolidating, or changing the supply chain to cut costs. Not quality, just costs. You don’t have time to constantly check over everything everyone is doing, so you think about a reasonable target based on everything you see.

2.5% cost cuts per year

The metric

There we have it, a metric. It gives those who don’t dream about synergistic improvements something to shoot for. In focusing on that one singular thing, they should automatically search for and find those opportunities that you naturally find.

To make it stick you tie some sort of incentive to it for your buyers. This way it stays top of mind. As they create value and save 2.5%, you share 0.5% with them and net a 2% margin increase.

The problem

The issue begins with some classic Game Theory. Buyers are no longer looking for you actually want - cost-cutting, synergistic opportunities; they are instead searching for 2.5% cuts. Rarely more, never less.

The view

You start seeing almost exact cuts of 2.5% per year from your buyers. The ways this is often achieved actually adds great risk to the actual supply chain (to be talked about at a later date) increases total costs in the long run.

Besides this, there are often huge opportunities that arise. We recently came across a 20% cost cut for a $1,000,000 per year program. The truth is there was probably, even more, looking over the next 5 years.

The disconnect

When we presented the program to the procurement team, we were asked to step into the savings.


Because there would be a large cut in the first year, but they were afraid they would not meet the 2.5% objective for the following years for a while.

The revelation

You see rather than looking for cost improvement, they were looking to the metric and gaming everything based on that.

So over a 5 year period, the cost savings could have been 200K for 5 years or $1,000,000

Instead, it was $750,000.

Annual cost targets were a quarter-of-a-million dollar metric.

Some ideas for improvement

There is no perfect solution. Metrics and ratios help us quickly view and measure more complex systems and ideas.

However, sharing these widely and incentivizing them can lead to large losses and unintended consequences. Think about the quarterly earnings metric that often prevents long term investment and innovation. This is commonly becoming called short-termism.

So how can we get around this?

Here some ideas to consider

  1. Don’t incentivize derivatives - the number one way is to not incentive derivatives. Rather than incentivize your team on a ratio or metric, look to bring them into the strategy and develop a strategic plan. These take more time and are more complex, but will lead to much greater achievement in your business.
  2. Use balancing metrics - Wherever you use a metric, take a look at what happens if you take it too far. Once you find, this, create an “anti-metric” in order to balance it out. Make both the focus of the team.
    • For example, if your metric is new website visitors, you may see a surge in low-quality visits as your team pushes any and all traffic to the site. So balance this with bounce rate.
    • Let’s say onboarding a new customer costs $200. If you set a goal for the number of new customers, your team may look for small, easy to capture customers. So perhaps balancing this with average customer size would help.
  3. Replace metrics with people - by hiring someone who understands synergy and improvement, you can have them look for the opportunities that you want to be found… as a role. Rather than leaving it with the operational team themselves, create a role that specifically looks for opportunities. This captures the complexity of reality by matching it with human potential rather than more simple mathematical formulas.

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