Friday, July 29, 2011

Metrics and Incentives - Some Examples Part 1

In his most recent post, James Evanoff discussed the Lean Consumption Harvard Business Review article by Womack and Jones.
This article cites an example that is relevant to our prior posts on Metrics and Performance Management. In those posts we concluded that “you get what you pay for” and “we measure what is easy”.
In the article it discusses an IT firm who wins a call-center contract. Under normal terms in the call-center industry, these contracts take the form of price per call or complaint basis. This, however, creates no incentive for the call-center provider to innovate or suggest solutions to problems. If we are paid on a per-call basis, we want more customers to call with more problems – we make more that way. In truth, since not all people are ethical, we should not be entirely surprised to find that the call-center firm’s repair dispatches were confusing or incorrect in some manner. If the repairman does not show up, the customer will make another call!
In this case, by restructuring the contract as more of a fixed fee, the call-center firm actively contributed to solving customer problems since the fewer calls would mean lower costs and therefore higher income since revenues were set. The firm hiring the call-center provider did indeed get what they paid for.
The prevalence of the per-call contract basis in the industry vs. the set-fee contract is indicative of a change in the nature of work, which I will tackle in another session.
Another quick example is investment banking fees. If we hire a firm to advise us on an M&A transaction as a buyer, and the investment bank is paid if the transaction is successful on a percentage of purchase price basis, is it to the investment bank’s benefit to advise us to overpay or underpay for the transaction? If we bid too little we will not win the bid and there will be nothing for the bank. If we bid too high, the bank wins. How can we consider them to be aligned with our interests in this scenario?
I would love to hear your thoughts about incentives or your stories on this topic if you have them.
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