How Incentives Can Make or Break Your Business

What's up, everyone. This is Alex Lieberman, Co-Founder and Executive Chairman of Morning Brew. Welcome back to Founder's Journal, my personal audio diary where I give you, the business builder, the tools you need to think better in order to build better, whether that's building a business, a team, or a new product. Today, I'm talking about the power of incentives. Let's hop into it. As I've spent more time in and around business, I have realized that few things are more important than incentives. Sounds boring, but they're super important.

The right incentives can accelerate a business. The wrong incentives can literally sink a business. That is not an exaggeration. And so what that means is one of the most underrated jobs of a business leader, not just a CEO—managers, VPs, Senior VPs—is to create a set of incentives across your team and your company that drives the right behaviors. Intuitively this makes sense, right? All humans are self-interested. As much as we don't want to believe it, that is the case. We all seek love, we seek success, safety, connection, validation. And whatever gives us an opportunity to do that, time has proven over and over that we will do, even if it's at the detriment of a business or someone else.

And because incentives are all around us, I think the best way to show you their power is just to provide some really concrete and interesting examples of incentives gone wrong, and some of incentives gone right. I want you to leave this episode with a renewed appreciation for the power of incentives, as well as things you should think about as a leader when creating incentives for people on your team. I'm going to tell six quick stories, four stories about incentives gone wrong, two stories about incentives got right. Let's do it.

Incentives Gone Wrong: The Cobra Effect

The first story I call The Cobra Effect. So, back in the day, Britain was ruling India and the city of Delhi was infested with cobras. And so what the government did about this cobra infestation was they enlisted the public to help out. And so what they basically said was, "We need to eradicate the snakes. You, the public, if you bring cobra skins to us to prove that you have killed cobras, we'll give you a bounty, we'll pay you for it." And things started well. Citizens were killing off the snakes, they were bringing the skins to the government, people were getting paid. But then some enterprising citizens of Delhi created a cottage industry of cobra farming. People were smart and they basically said, "Hey, the more cobras that we kill, the more we get paid. So let's make as many cobras as humanly possible so we can get paid more." People were literally breeding cobras for their skins.

And so the British paid out more and more money, but the cobra infestation did not abate and cobra farming only added to the problem. What ended up happening was authorities finally got smart about this, they realized the scam that was happening, and they withdrew the bounty. And the farmers, when they were no longer incentivized to kill the cobras, ended up letting the cobras free. They no longer kept them in captivity. Ironically, because of a perverse incentive, there ended up being more cobras on the streets of Delhi after the bounty program than before.

Pervasive Incentive #1: Hanoi’s Rat Infestation

A similar thing happened in Vietnam in the early 1900s. So in 1902, in Hanoi, basically Vietnam was under French colonial rule and the colonial government created a similar bounty program where they paid a reward for each rat that was killed because there's a rat infestation, similar to the cobra infestation. And to collect the bounty, people would need to provide the tail of the rat, again as proof, similar to the cobra skin. Well, what ended up happening was government officials ended up seeing rats running around Hanoi with no tails. What was happening is Vietnamese rat catchers would capture rats, they would cut off their tails, they'd bring their tails in, and they would release the rats back into the wild so they could produce more, have more supply to then cut more tails and turn them into the government.

Pervasive Incentive #2: The Wells Fargo Account Fraud Scandal

And there's a proverb that perfectly describes both of these stories that are so similar in many ways. And that proverb is: "The road to hell is paved with good intentions." It's so true, and we don't just see that good intentions lead to bad outcomes with random animal infestation stories. We see it all the time in business as well. Just look at the Wells Fargo account fraud scandal that happened a few years ago and it led to a $3 billion fine that the bank had to pay. So what basically happened was in 2011, officials started noticing that Wells Fargo customers were being charged unanticipated fees, and they were receiving credit cards or lines of credit that they didn't sign up for.

And this led to a many year investigation, which ultimately revealed that Wells Fargo and its employees opened up more than 3.5 million fraudulent accounts between the years of 2011 and 2016. And the reason these accounts were opened is no different than the cobra or the rat story. It's all perverse incentives. So Wells Fargo had this culture where bankers and bank managers of individual branches were given absurdly aggressive sales quotas that they had to hit. And beyond that, employees received bonuses for opening new credit card and checking accounts and enrolling customers in products like online banking.

So, what do you think happens when bankers, bank managers, and employees of Wells Fargo are put into really stressful positions to hit sales quotas and are heavily incentivized to open new accounts? Well, employees were literally opening banking services and ordering debit cards for customers without customers' consent in order to hit these extremely high sales goals that were based on new account openings and cross-selling existing customers into new products. And so one way that we know this was done was through a process called pinning, where branch bankers, branch bank managers would open up new client accounts and they would make the four digit account pin number—you know, how we all have, you know, these four digit pin numbers for bank accounts?

They would make the four digit account pin number a quadruple zero, 0 0 0 0 0, so that the banker could control the client account because they knew the easy password and enroll them in new programs like online banking without the customer knowing. And this is such a powerful example in business of having a well-intentioned goal of growing your customer base, literally that was the goal, was user acquisition. It's like the goal of every business, but they developed an incentive system that led to horrible, immoral, completely unintended consequences. And these are extreme examples, right? Cobras in Delhi, rats in Hanoi bank accounts with a $3 billion fine, but I've seen this occur in small ways at Morning Brew, literally in the company that we built.

Pervasive Incentive #3: Morning Brew’s Ambassador Program, Part 1

With Morning Brew's college ambassador program, which acted as the lifeblood for growing our email subscribers for many years, we toyed with all sorts of incentives to encourage our college ambassadors to get people signed up on their campus where they went to school. And there are two examples where incentives led to bad outcomes. The first example was, I think it was in our second year of running the ambassador program, basically we were giving away swag, we were giving away Mac Book Pros, like cool products to ambassadors who were getting the most signups at their school. Well, I remember this, I remember this, like it was yesterday. One week we saw, let's say the average week we grew by, I don't know, 500 email subscribers in the early days.

Well, on like, a Tuesday, we saw our subscriber count grow by like 4,000 people. And then as we looked at our subscriber list, something looked wrong. Every single one of those 4,000 subscribers had an @lakeforest.edu email address. And what we ended up finding out happened was one of our college ambassadors, a student who went to Lake Forest University, a school that has 4,000 college students, they decided to scrape their entire student directory and sign up every single student without their consent. Again, they were just doing their job, which was getting more email subscribers, but it was done in a totally immoral way where we were going to get subscribers that weren't going to read Morning Brew because they had no idea they were signed up for it, and it was completely counter to what we were trying to do.

Pervasive Incentive #4: Morning Brew’s Ambassador Program, Part 2

Second example for most of the history of Morning Brew's ambassador program, we would compensate our ambassadors with swag—with Morning Brew, sweatshirts, t-shirts stickers, bottle openers. And we, we said to ourselves, maybe our ambassadors will do better if we actually pay them, if we pay them 25 cents or 50 cents a subscriber. Well we were incredibly wrong about this. Once we started paying our ambassadors to get subscribers, they were less effective and the relationship when so downhill between us and them. It led to ambassadors spending way more time negotiating with us what their price per subscribers should be because they didn't necessarily feel like twenty-five cents or 50 cents per subscriber was fair.

And these people went from being fans and, and evangelists of their product on their campus— whereas it was literally a badge of honor for them, it became a job. They felt like an employee and they started interacting with us like they were employees. So those are two examples that hit close to home.

Effective Incentive #1: FedEx’s Nightshift Employees

Now, two quick stories for you on the opposite side of the table, this is where incentives went right? This is where we should learn about what can we do to make incentives right to drive the right behaviors in our businesses. So one great example that Charlie Munger of Berkshire Hathaway talks about is with Federal Express, FedEx. And basically, what it comes down to with FedEx is that to provide great customer service, FedEx needed to rapidly shift packages from one airplane to another airplane in a central airport each night.

And if employees do not shift the packages in a timely manner, it messes up the whole chain of delivery where customers ended up being really unhappy because they get their packages late. And FedEx spent so long trying to figure out, "How do we get the night shift to do the right thing and transfer packages quickly so that we can service our customers in the right way?" Because for the longest time, employees were really slow in the night shift and it was killing customer service. And finally, someone had a brilliant thought. What they realized was employees of FedEx were being paid by the hour. And what this employee said was instead of paying people by the hour, the incentive that was, that FedEx was trying to create was not to spend as much time as humanly possible, because if you spend more hours at work, you get paid more.

The goal was to get people to finish their job in a quality way as quickly as possible, so the shift from one airplane to the other happens quickly. And so what this employee said is, "Instead of paying other employees by the hour, what have we paid them by shift and let all of the nightshift employees go home, as soon as the planes were loaded in a quality manner." Well, then the system would work better, right? Because instead of paying people by hour where their incentive is to stay longer, to get paid more because they get paid by the hour. Now, as long as they get something done, if it takes only a minute, but they got it done in a quick and quality way, they'll get paid just as much as if they spent 10 hours in the same place doing the same exact job.

This is an example where an employee realized the incentives that FedEx wanted to accomplish with their employees and how they needed to pay them to align with the behavior they were looking for. 

Effective Incentive #2: Nucor Steel’s Compensation Structure

One final example for you, and this will leave you with three things to think about whenever you set up incentives for your team members, for your company. So, there's a company called Nucor Steel. Nucor Steel was run by this guy, Ken Iverson, in the 1960s, he was 39 when he took it over, he took it over as a small town steel business, and he grew it to be the third largest player in steel by the year 2002, and today Nucor is the number one largest steel company in America.

Now, when you think about steel, it is a really frickin hard business. Steel is a commodity. You or me, we don't make choices on products we want based on the steel that's used. We're not choosing one car over another car because of the company that made the steel. And what that means is, in a commodity business, in the steel business, where you're not going to differentiate on product or price, things like culture, motivating your people, and building a highly efficient and effective business, is that much more important. And one of the ways that Ken Iverson did this was that by developing a compensation structure for his employees that aligned incentives, got the behaviors he wanted to get, and it just worked.

Under Iverson, compensation at Nucor had two components: there was a small but meaningful base pay, and then, very simply, a weekly bonus based on the production of steel that every employee put out. And the real beauty of this system that Iverson developed is that there was just nothing to discuss. It was so simple, daily output and bonus earnings were posted on a weekly basis, so every employee knew exactly what their bonus would be before they even tore open their paycheck. There was no subjectivity, there was no negotiation, there were no surprises, it was the simplest compensation structure that was incentivizing the exact activity that Nucor Steel wanted, which is putting out as much quality steel as humanly possible.

And so using this Nucor example, there are three lessons that we can learn and take with us in terms of setting up incentives in a way that works for us versus against us. So using this Nucor example, there are three lessons that we can take with us to set up incentives in our company to have incentives work for us rather than work against us. 

Lesson #1: Incentives Must Be Dummy-Proof

The first is that incentives need to be dummy-proof. It was so glaringly obvious how someone was compensated at Nucor. Your comp was never in the hands of someone else that may or may not like you, there was not ever a reason for you, as an employee, to say that your comp is unfair. You signed up for a comp structure that was super simple, and you knew that if you put out more steel every single day, you would be compensated more. When thinking about incentive structures, pick the most important metric and make it so incredibly easy to measure and for people to understand.

Lesson #2: Incentives Must Be Meaningful and Immediate

Second: incentive systems should be meaningful and immediate when possible. The best thing about the new core comp structure is one— that the bonuses were really meaningful, they were just as much as the salary pay that workers were getting, but also, how quickly you were getting your bonus. Remember these were weekly bonuses and we as human beings, we love immediate rewards, we're really bad with delayed gratification. And so a year-end bonus isn't as good as a quarterly bonus and a quarterly bonus isn't as good as a weekly bonus, and so the fact that Nucor used weekly bonuses to keep employees motivated was a huge win.

Lesson #3: Incentives Should Not Be Gainable

The third and final thing to think about when developing incentives at your company: they shouldn't be gainable. Nucor wanted more steel, employees wanted to make more steel because they got paid for making more steel. If hypothetically, employees found a way to make more steel, but do it in a lower quality way that could jeopardize the product and then the business, because it would hurt Nucor's brand, Iverson and his team would have had to rethink the structure. When you're thinking about your incentives, think through every single possible way that this could be gamed by employees and create perverse incentives, so you're not basically becoming the cobra, rat, or Wells Fargo story all over.

TL;DR

And so in sum, the more you can make incentive, super clear, you can focus incentives on the most important metrics you can make them timely so that people get immediate gratification, and you think through all of the ways that they can be gamed, so they don't end up being gamed the more you will set yourself up for success in motivating your employees appropriately moving forward. With that, I would love to hear from you. This month is the biggest month on Founder's Journal, which means we have tons of new listeners, whether you're a new listener or an old listener that just hasn't written in yet, I would love to meet more members of the Founder's Journal community. Send an email to alex@morningbrew.com or DM me on Twitter @BusinessBarista.

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