Incentive for Dysfunction

Pay-for-performance incentives don’t work. In fact they make things worse.
About 4 to 5 years ago, I used to go to Jiffy Lube when ever I need a quick oil change. I like taking care of my car so I get the oil changed exactly on time as best as I can.
One day I was there and the manager came to me. He said, ‘Mr. Hauck, you need a new PCV valve.’ I said, ‘What is that?’ He explained that’s an item that helps with emissions and I really need to replace it. I said, ‘Well wait a minute. I just had the car at the dealer and they inspect everything. Are you sure I need that?’ He said, ‘Oh absolutely; look how dirty this one is.’ And he rubbed his thumb across it and showed me his thumb and it was covered with a black smudge. I said, ‘Ok, how much is it?’ ‘$15’. I said, ‘Ok, fine put it in.’
I am at the cash register and my car is ready. I handed him my credit card and I look above the cash register on the wall and it said goals for the week. It read, oil changes – so many; air filters – so many; PCV valves – so many. I said to the manager, ‘Wow, that’s interesting, the goals for the week. Where do you get those?’ He said, ‘We get them from the home office; they fax them down to us every week on Monday and we work to meet them between Monday through Saturday.’ I said, ‘Interesting. Do you get paid a bonus on those?’ He said, ‘Oh, absolutely, I get a bonus and the guys out in the shop get a bonus too.’ I said, ‘Really, interesting. How are you doing?’ He said, ‘You know, not too bad. We are a little behind on PCV valves, but we’re catching up.’
Pay-for-performance can create an environment that generates unintended consequences. The pressure to perform created by the monetary incentive to meet the goals set by the Jiffy Lube home office. In addition, the knowledge that his performance appraisal rating could suffer without meeting the goals added to the pressure. This pressure created an environment that caused the manager and employees to focus on themselves and not on the customer needs. These two policies create expensive dysfunction. We see this dysfunction over and over again in organizations. Another example includes the incentives that caused Fanny Mae, and Freddy Mack to encourage mortgages to be approved for people who could not afford the payments over the long–term. This dysfunction led to the collapse of the trust of the entire financial system in 2008.
The Interior Department’s Mineral Management Service had planned to present two safety awards at a luncheon approximately one month ago and days before the Deepwater Horizon rig exploded and sank to the bottom of the Gulf started the largest oil spill in US history. The nominee for the safety awards was non-other than BP -- which operated the oil rig that sank in the Gulf of Mexico.
The awards ceremony was supposed to recognize "outstanding safety and pollution prevention performance by the offshore oil and gas industry." BP was nominated for its work on the outer continental shelf.
The big winner of the 2009 SAFE award was Transocean, the owner of the Deepwater Horizon rig that exploded last month under BP's management. BP was also a finalist at the 2009 conference.
In 1975, Congress enacted Corporate Average Fuel Economy (CAFE) regulations to reduce gasoline consumption. Current CAFE standards require an average of 27.2 miles per gallon (mpg) for cars and 21.6 mpg for light trucks. Recent legislation signed by President Obama raises these standards. This seems like a good idea if you want reduced oil usage, a reduced dependence on foreign oil, and a reduction in greenhouse gases. These were the three major reasons to adopt the CAFÉ Standards.
Unfortunately, when you consider two unintended negative consequences you can conclude it was not only not worth it but it made things worse in other areas. The reduced cost of operation of a vehicle causes people to drive more miles. This actually does nothing to reduce oil consumption nor does it reduce greenhouse gases since the same miles driven cause the same amount of gases to be emitted (these were the two major intended outcomes of the legislation). Dependence on foreign oil has actually increased since 1975. Furthermore, to meet the CAFÉ standards, the auto industry lightened the vehicle weights causing greater damage during collisions. This caused approximately 2,000 additional deaths every year since the standards were adopted.
Instead of relying on these control techniques of pay-for-performance and the performance appraisal (or awards based on competition) an organization could instead study its processes, uncover innovative ways to improve performance. Those who rely on pay-for-performance and the performance appraisal for improvement embraces the belief that people would do nothing without incentives or threats. Unreasonable goals will create cheating or exaggeration as with Jiffy Lube. Easy goals create de-motivation. Either way we are paying more for more dysfunction. Why not just work as a team to continuously improve? Furthermore, why not embrace the belief that people are willing and able to make improvements and innovate without threats or bribes.
Be careful with pay-for-performance measures performance appraisal policies. They often do nothing to create improvement and often combine to create worse results than if you had done nothing.