Incentive Caused Misbehaviour

Imagine this : You need to hire a person, to do things for us, on our behalf. We do this time and again, because we either don't have the skill set or time to do it on our own.

So, what do you do to get the best output? You immediately start scrounging for the best set of carrots and sticks to be used. Simple enough. In academic parlance, this is called principle of reinforcement, operant conditioning etc. And a mountain of work was done on this, by the psychologist, B.F.Skinner. He even invented the Skinner box, and made many a rat suffer, with electric shocks as punishment.

To the rats relief, Skinner finally concluded that rats and human beings change behaviour when presented with rewards and punishments. But the secondary effects, were missed out during these experiments. 

When extended to human beings, our behavioural algorithms turn clever. We start to game the system to maximise our rewards and minimise punishment. And then post rationalise that its morally correct, even when such behaviour is wrong. This in effect, is "incentive caused bias/misbehaviour", an improper behaviour caused due to incentives, but which according to us, is still right.

First, let us study a few examples of seemingly good natured incentives, but with deleterious consequences.

In a product company, that I knew, the developers and testers were rated based on the number of bugs fixed and opened. So, people with highest number of bugs opened/fixed were giving higher ratings. This incentivised, the QA folks to keep opening all sorts of bugs, trivial, extremely rare, reopen reported ones etc. The developers were more than happy to fix such ones and increase their bug fix level as well. This vicious cycle continued, till that unit was closed.

Typically, when you incentivise developers to ship a product in time, you end up with more bugs. When you insist on lesser number of bugs, then you ship too late(5). Similarly, if HR is incentivised on increasing the number of recruits per quarter, the quality of the recruits drastically drops.

So, this in effect brings out the non triviality of designing carrots and sticks. And in incentive program's, what is measurable is not always meaningful. 

Now, that we had a glimpse into this bias, let us explore around, and try to explain much of human behaviour through this lens.

Why do real estate brokers show us first the bad houses, before they show the good ones?

Why do mutual fund managers, fund houses, stock brokers always make money, while the customers lose?(3)

Why do celebrities, pose for vests, briefs, toothpastes,  and any other thing under the sun, which they themselves will not use?

Why do dealers always push their high margin products, even though it does not satisfy our needs? Early in the history of Xerox, founder Joe Wilson, couldn’t understand how their better, new machine was selling so poorly in relation to their older and inferior machine. He found out later that the commission arrangement with the salesmen gave a tremendous incentive to the inferior machine.(1)

Why do PC manufactures not sell non Microsoft operating systems? Microsoft increases the price, and gives part of the increased margin as a rebate to dealers(2)Well, so does an Intel incentivising their dealer channels.

Why do many doctors, prescribe specific drug brands, prescribe more tests than required and affiliate themselves to certain diagnostic centres? (4)

Why cardiologists refuse surgeries, for high risk patients? (8)

Why do kids cram so much of information, just before an exam, without any understanding? When their real incentive is not in the pleasure of finding things out, we have lost many a young Feynman.

Why Sony never came up with an iPod? Sony had multiple business units as silos, each incentivised on increasing their revenues and protecting their fiefdom. In 2009, they finally released two different portable players, each from a separate unit. And their third music business division, refused to share the music content, with these portable players. They did not come together, in what is  in the best interest of the user, but each did what is individually correct for them. Think Apple now.(7)

And finally, why you should never ask a barber, whether you need a haircut, more so if you are bald.

"Tell me what your incentives are, and I will tell you how you behave" - Warren Buffet

So, how do we fix this? There is a short and a long answer.

The short answer is we should stick to our moral obligations. "Do unto others, as you would have them do to you". So, don't sell anything, which you yourself will not buy. Easier to write about, but difficult to follow.

The longer answer, is understand your goals correctly, design your incentives in alignment with this and build in anti gaming features.

In the 1860s, the British Government contracted with the ship captains to transport prisoners to Australia. The survival rate of prisoners was only 40 percent, during transportation. Despite many appeals, by humanitarian groups, nothing changed. Till an economist, Edwin Chadwick, recommended a different incentive scheme. Instead of paying the captains, a fee for every prisoner entering the ship, the fee was changed to every prisoner who walked out into Australia. The survival rate increased to 98 percent.(6)

Similarly, Mayo Clinic, started paying salaries to doctors, instead of a cut in the clinic's revenue. This way, the doctors role would be to focus on what is good for the patient, rather than how to increase revenue. It also solved the unnecessary tests being prescribed issue, bringing down the medical costs.

In the same vein, the retail staff of Apple retail stores are not incentivised on up selling, cross selling  or commissions. They are just paid to help the customers choose the right product.

And finally, let us see how a cash register is an anti gaming feature. In 1889, Sam Patterson, running a couple of retail stores, lost 6000$/year due to dishonest clerks. On buying a cash register, his stores immediately went to profitability, with the same set of clerks. His tallying and accounting problem got solved. Smart, that he was, he went into the cash register business, and that is the birth of National Cash Register(NCR).

So, the next time you are about to rationalise your behaviour, because of your incentives, its time to remember this article again.

References

1. Psychology of human misjudgement talk by Charlie Munger

2. Jean-Louis Gassée on why PC manufacturers don't sell non MS products ( http://lists.essential.org/info-policy-notes/msg00005.html )

3. Where Are the Customers' Yachts: or A Good Hard Look at Wall Street (Wiley Investment Classics)

4. The Cost Conundrum - What a Texas town can teach us about healthcare

http://www.newyorker.com/reporting/2009/06/01/090601fa_fact_gawande

5. Marc Andersson on The Psychology of Entrepreneurial Misjudgement

6. For more on this example, see Robert B. Ekelund, Jr., and Richard Ault, Intermediate Microeconomics: Theory and Applications (Lexington, Mass.: D.C. Heath and Company, 1995), pp. 21–22.

7. Why Sony missed the iPod?

http://www.mediapost.com/publications/article/99726/#axzz2ZVyXLOpd

8. When Doctors slam the door

http://www.nytimes.com/2003/03/16/magazine/when-doctor-s-slam-the-door.html?pagewanted=all&src=pm

My Reflections on Steve Jobs

There are already a ton of articles, interviews, videos and books on Steve Jobs. And I don't intend to add to that clutter. This blog is purely personal and will focus on only what I liked the best about him - break rules and conventions, when it matters.

But before I get into that, a few things about, when I got to know about him or Apple. Before 2010, I had heard a few mentions about Apple and Steve Jobs. At that point, I was blissfully unaware of an iPod or that an iPhone existed. No, No, I am an earthling only, but such was my naïveté and innocence. 

By chance, when I heard about the iPad introduction in 2010, it stuck a chord in me. Such was a device, that I wanted for a long time, a personal always on Reader. Slowly, my google searches on Steve Jobs and Apple grew, till I sucked everything online and in books about them. I have read about many business turnarounds, but Apple from 1997 to now, is the most fascinating, from close to bankruptcy to 130billion dollars+ cash reserves.

Break rules

Well, when I refer to rules here, they refer to best practices, safe and time tested procedures, guidelines, conventions etc. which develops in every field over long periods of time.  And not to principles like ethics, breaking law, breaking into your neighbours house etc. So, please don't read me wrongly, and blame me later.

Typically, most of us grow up with this list of dos and donts and prefer always the beaten path. These rules works on us so subconsciously that, we think we are different, when we are not. This practice becomes more acute, when we enter schools or graduate and becomes a disease for people with higher degrees. If you ever happen to be an expert in your field, then this is a chronic problem for you. Please contact your nearest doctor immediately.

That is why, breaking rules is easy for people with no degrees. Bless the souls, who don't pass out from colleges. Whether, they become thought leaders or not, they do not have any thought barriers.

Will just pick a few examples for illustration.

Well, after his return, Apple was losing cash. So, what will you do?  Cutting costs, trimming product lines are normal. This was done by cutting products from 20 to 4. But he did one more thing, which knocked me off. 

Apple released an ad, 'Think Different' and spent heavily on it. This ad was not even about Apple products or could earn revenue in any way. This ad, which echoed Apple's core value of innovation, was released for all who supported Apple through its thick and thin, their loyal fan base and employees. Why on earth would someone do that? Which business book or rule will talk about this?

This was to reassure all its stakeholders, mainly its loyal customer fan base, that Apple was back to its innovation mode. This was when, Apple was months away from bankruptcy. This actually bought Apple more time, till they came out with new products.

Next, in 2000, when the entire world was going online, they came out with their retail stores and hired Ron Jonson from Gap for this. The retail stores, was a way to control the last mile customer experience of purchase, support, advice etc. This was when Apple was a  failing computer company, with zero experience in retail. This was, when top retail companies, like Gateway were on their way down, Dell was getting everything online and when all jargon was about core competence.

Moreover, the retail stores had expensive materials,  their location was in high foot movement areas ( again expensive ), hardly 4 products to show off at that time, with retail staff incentivised on customer experience, rather than sales. Cutting costs out of bankruptcy is one thing, but innovating out of bankruptcy is a different ball game. 

I was equally surprised to know that Steve Jobs was replying to all sorts of customer issues and even calling up customers and talking to them. This was not a CEO's job. They are supposed to be 30000 feet thinkers, tinkering with the vision and mission statements of a company. This showed an amazing amount of passion for the products, which other CEOs talk about, but do not mean it. This made his inbox overflow with customer complaints, that Apple started using these as data points for their internal use(1). An excerpt below,

"Yeah," Jobs said. "I just wanted to apologize for your incredibly long wait. It's really nobody's fault. It's just one of those things."

"Yeah, I understand."

Then Jobs explained that he expedited the repair. "I also wanted to thank you for your support of Apple," Jobs said. "I see how much equipment you own. It really makes my day to see someone who enjoys our products so much and who supports us in the good times and bad"

And he really understood desire. How to kindle people's emotions, create a fan following, create blogs and news around every Apple move and make people wait in queues to buy a mobile phone. Apple's cult of secrecy about product launches, creates a so called Streisand effect. The less they talk, the more they are written about. Why do people give Apple free marketing space? When others pay for it, but don't get noticed.

And finally, he really understood, what is effective communication. Till a few years back, I was always under the impression, that having a great product is sufficient. The world will notice it. How naive, I was. It needs communication as a bridge to connect it to the real world. People have better things to do, until you make them notice it. 

When I refer to communication, here, I refer it in a border sense. It is not just about the presentations, demos, advertisements etc. But every consumer touch point. The product's every  point of interaction with the customer has to communicate its core. Be it the hardware, software, its packaging, its documentation, the products ecosystem, the presentations and demos in product launches, the customer ordering experience, customer support experience, all come together, to give the user an engaging experience. If the communication does not create an excited user, the dollars can go missing. I am not sure, if any other company, goes to such levels of vertical integration to get this right, when on the other hand, focusing on core competence, is the flavour of the day.

So, if you have got very inspired by now and looking for the next rule to break, just hold on a bit.

The other side of the untold story is that Apple is actually a disciplined company, following a set of rules and processes during product development, be it Apple new product process plan, or the rules of the road plan. And though they proclaim that customers do not know what they want, once a product is released, they take their feedback very seriously, in further iterations.

Now, the twist, is not just on breaking rules, but on knowing which rules are worth breaking.

“In the beginner’s mind there are many possibilities, but in the expert’s there are few” 

― Shunryu Suzuki, Zen Mind, Beginner's Mind

References

1. http://edition.cnn.com/2011/11/22/tech/innovation/jobs-excerpt-customer-service

First Blog

Hi,

This is my first blog post. In this, I will introduce myself and why I started blogging.

So, first Who Am I?

Well, my name is Ashwin, working in Bangalore, but born and brought up in Chennai.

I have over 13 years of work experience in data communication and networking domain. Interestingly, my work experience has zero relationship with both my bachelors and masters degrees. 

Entered IITM to study chemical engineering, but had no initial affinity towards it. During this time, there were many subjects that I liked, but nothing so much, that I could bank my life on. So, my interests traced a complete brownian motion during this time. And finally my ionic bonding with this field broke by end of graduation. 

I lucked out and in my first job, landed up in a domain that interested me a lot and have been there ever since.

Why Am I Writing this Blog?

Over the course of time, I became deeply interested in multiple diverse areas, like value investing, finance, physics, maths, advertising, marketing, business, learning, psychology, statistics, probability and more. Have read many books in these areas and am an unabashed fan of the giants in these fields, like Warren Buffet, Charlie Munger, Feynman, Claude Shannon, Oglivy, Dijkstra, Alan Kay, Steve Jobs and more.

But over a long stretch of time, realised that my brain works like a DRAM. It keeps forgetting all that I learnt and the insights that I got very fast. Until I keep constantly refreshing it, it never stays in my conscious memory. So this blog, is going to be a placeholder for refreshing my memory. This is one of the starting points for writing this blog.

Next, I thought if I get into the habit of writing, it forces my mind to organise my thoughts, convey the insights in a succinct form and would help me in getting more disciplined. Currently, I have 100s of notes splattered across, laptop, mails and my iPad. And now, I am neither able to recollect or make sense of my notes in a cohesive manner. So, I hope now, you can really understand my pain and appreciate this reason also.

Paraphrasing Feynman, 'What I cannot write, I cannot understand' 

I not only wanted to write about what I learnt so far, but also about the mistakes that I make or I discover others making. Rephrasing Isaac Newton's quote, shouldn't we after all stand on the shoulder of giant mistakes to see further? Why do the same mistake again, when a fresh one can be done?

Also, I wanted a collection yard, where all such data can be organised and stored. This way, over time, if I can look back at these notes, I can possibly understand more about myself. And once this happens, I will rewrite the top section on 'Who Am I' again. But it's quite possible that even now, google knows more about me on this! On a side note in 10 years time, I am expecting that google searches on 'Who Am I' will be a regular spiritual feature.

So much for my philosophical underpinnings !

Well, if you have come so far thinking that this guy has  all selfish reasons and I am wasting my time on this, Do not Despair! Have saved the best for the last. Till this time, I have been a parasite on information be it from the Internet, or from books. So with this blog, I have decided to be a producer, in my own little way and contribute to this ocean of knowledge. 

How will I contribute?

One of the main things that I find abundant on the net and in books are data, unpolished, unfurnished information. The things missing are insights, which is the underlying theory that connects disparate sources of data.

And the other thing that I realised, is there is information lacking about failures and mistakes that people have done. There is too much of glorification of success and history is always written by the winners, causing a huge sampling bias.

So, this blog will focus on two things, insights in different fields and areas and the mistakes that people make, hopefully less of mine, and more of others.

If you are still confused, don't blame me for it. There are many others with average IQ, who also shared this feedback. So, if you want to change your mind, you can do so now. 

”Either write something worth reading or do something worth writing,” - Benjamin Franklin

I preferred the easier one.

Thanks for your time.