Why you shouldn’t link KPIs to reward or bonus systems

Summary

This script discusses the pitfalls of tying KPIs directly to rewards, as it can lead to undesirable behaviors. Examples include an airport's baggage handling team and an Indian rat eradication program, where incentives led to counterproductive outcomes. The speaker advocates for KPIs as informational tools rather than performance targets, suggesting a decoupling from bonuses to avoid negative impacts on long-term business performance.

Takeaways

• 📉 Linking KPIs directly to rewards can lead to unintended negative behaviors as employees may focus on meeting targets in ways that aren't beneficial for the company in the long term.
• 💼 CEOs and leaders should be cautious about incentivizing short-term gains at the expense of long-term business health.
• 🎯 Setting targets based on KPIs can sometimes lead to creative, but ineffective solutions, as illustrated by the airport baggage handling example.
• 🏆 The example of the Indian rat problem highlights how incentives can backfire and exacerbate the issue they were intended to solve.
• 🚫 Avoid 'hardwiring' KPIs to bonuses, as this can lead to a focus on the metric rather than overall business performance.
• 🛠 KPIs should be used as informational tools to guide performance, not as the sole determinant of compensation.
• 💡 It's important to consider broader business performance, including external factors like market conditions, when determining bonuses.
• 🔄 Shift the focus from KPIs as targets to KPIs as indicators of performance and areas for improvement.
• 🌐 Compare performance relative to industry peers to ensure bonuses are fair and reflect the company's standing in the market.
• 🏭 In large organizations, a renumeration committee can help determine bonuses based on actual business performance rather than just meeting KPIs.
• 📈 Encourage a culture where employees are motivated by overall business success, not just the achievement of individual KPIs.

Q & A

Why is linking KPIs directly to rewards or bonuses considered harmful for a business?

Linking KPIs directly to rewards or bonuses can drive the wrong behaviors. People may focus on meeting targets at the expense of overall business health, leading to short-term gains but long-term damage.

What is the potential issue with rewarding executives based on profit improvement?

Executives might improve profits in the short term by cutting costs, which could harm the business in the long run. This approach might not lead to sustainable growth or improved business performance.

Can you explain the example of the airport baggage handling KPI?

The airport set a KPI to reduce baggage handling time to 15 minutes. One team achieved this by racing the first piece of luggage to the conveyor belt, which did not actually improve overall efficiency but met the target. This highlights the risk of focusing solely on meeting KPIs.

What was the unintended consequence of the Indian government's rat-catching incentive program?

People started breeding rats to earn money from the government's incentive program, worsening the rat problem instead of solving it. This shows how incentives can lead to counterproductive behaviors.

Why should KPIs not be used as direct targets for bonuses?

KPIs should be used as information tools to guide performance, not as direct targets for bonuses. This approach avoids driving behaviors that might meet targets but are detrimental to the overall business.

What is the alternative approach to using KPIs in performance management?

An alternative approach is to use a renumeration committee that evaluates overall business performance, rather than hardwiring KPIs to bonus payments. This considers factors beyond just meeting specific targets.

How can businesses ensure that KPIs drive the right behaviors?

Businesses can ensure the right behaviors by using KPIs as guidance rather than strict targets, and by evaluating performance in a broader context that considers overall business health and sustainability.

What is the role of a renumeration committee in determining bonuses?

A renumeration committee evaluates the overall performance of the business and its performance relative to other companies in the sector, rather than just meeting specific KPIs. This helps in determining the bonus pool more fairly and sustainably.

How can businesses avoid the pitfalls of linking KPIs directly to bonuses?

Businesses can avoid these pitfalls by decoupling KPIs from direct bonus payments and instead using them as part of a broader performance evaluation process that considers multiple factors and the long-term health of the business.

What is the importance of considering external factors like oil prices in bonus determination?

External factors like oil prices can significantly impact business performance. Considering these in bonus determination ensures that bonuses are fair and reflect actual business efforts, rather than just market conditions.