Once upon a time there were two managers, from different firms, who each ran a section expending $20M per year to produce their outputs. They both wore glasses, they both spoke well at large gatherings and both were well liked by their respective senior executives. Not rising hot shots, but solid performers that no doubt will eventually earn their way into executive ranks in the not too distant future.
One morning in the shower, whilst pondering ways to improve their respective areas, they both independently come to the same insight. This idea was awesome…revolutionary…absolutely fabulous: it would save their sections not only the 5% stretch efficiency target in their personal KPIs, but a whopping 25% saving. They could reduce the costs of their section from $20M per year to just $15M per year without interrupting production and without any capital expenditure. They both could smell the executive suite leather….what an idea!
However this is where our two managers began to differ. One, named White, is totally committed to benefiting the organisation, a total team player, whilst the other, Black, thinks more in personal terms. White immediately implements the idea and is absolutely overjoyed to discover that the plan is working perfectly: costs have dived 25% and the bottom line for the company is a full $5M per year better off and will be for every subsequent year. White enjoys hearty congratulation from the executive and a full bonus for the year.
Black however decides to implement the idea but simultaneously makes other changes that decrease the efficiency of the section by $4M. This means that in the first year Black meets the stretch target of 5% by saving only $1M, but does get the full bonus and also the same hearty congratulations from executive enjoyed by White.
End of Year One
At the end of the year White sits down with the boss to negotiate next year’s KPIs. “Wow, you smashed that 5% out of the park. 25%! Well done.” Says White’s boss. “Thankyou”, says White. “So, look we can’t expect 25% every year, so I’m happy to leave the target as 5% again. That shouldn’t be a problem for a hotshot like you.” But White says “Well we are of course enjoying the 25% reduction again this year you know. Another $5M in the bank!”. But White’s boss says “Can’t rest on your laurels though…continuous improvement and all that. Should be able to find another 5% surely” White walks out a little dubious, not confident at all that another 5% is really available after cutting 25% out of the expenses last year.
Black also sits down with the boss. “Well done. You not only beat the target of 2.5%, you even hit the stretch of 5%. That’s like $1M. Well done. I hope you enjoy the bonus. So do you think you can do it again? Another 5%?” Black says “Sure, lets see if we can’t do it again.” Black walks out knowing that next year’s bonus is in the bag. Just remove some of the inefficiencies deliberately put in last year and the initial saving idea will do the rest.
End of Year 2
White tries everything during Year 2 but just can’t make a further dent in the costs: $15 M expenses again. Black, meanwhile, merely removes some of the deliberately planted inefficiencies and brings the costs down from $19M to $18M, beating the target again for the second year in a row.
White’s boss says “Well…you couldn’t even hit the base target this year. A bit slack, White. Look we all remember last year, that was great, but you’ve got to keep that up. And remember the CEO is retiring in a couple of months and the new CEO won’t remember your great year. You’ve got to at least get the base target of a 2.5% reduction. OK?” White says “But we’ve only spent $30M over two years now, when we used to spend $40M. We’ve saved $10M..which goes straight to the bottom line!” But the boss says “Look White. We can’t just have one hit wonders around here. You’ve got to show us you’re able to get continuous improvement.” White leaves the meeting feeling a little shaken, determined to find another efficiency in the section.
Black, meanwhile, is having a great meeting. “Well done, Black, you did it again. 2 years in a row hitting the stretch target.In fact a bit more this time. Another bonus. From $20M to $19M to $18M. Surely you can’t do it again? Another 5%”. Black starting to get cocky says, “Look we’ve hit 5% twice lets go for 5.5% this year as the stretch”. “Really,” says Black’s boss, “You really think you can do it”. Black says “Continuous improvement shouldn’t only be for operations, but management should get better as well”. “Ok then, if you really think you can do it, 5.5%”.
End of Year 3
In Year 3 you can guess what happens. White makes no inroads on the $15M and Black shaves another $1M off the cost base. White has missed base targets two years in a row and Black has now hit stretch 3 years in a row. Black is a hero, with growing fame and talk of fast track promotion, whilst White’s job is in jeopardy. White’s boss says “The new CEO can’t understand why I keep a manager who misses base targets two years in a row. You’ve simply got to improve White”.
End of Year 4
By the end of Year 4 White is sacked and Black is promoted, even though Black’s unit never once became as efficient as White’s. In fact, over the 4 years, White’s unit outperformed Black’s and managed to produce the same outputs for $60M (a saving of $20M), whilst Black’s unit used $70M (a saving of only $10M). Why is White sacked even though she has performed twice as well as the hero Black?
Indeed the “hero” Black has deliberately spent $10M of the company’ s money being deliberately inefficient purely for their own gain (see the lighter red section of Black’s chart). Why are the rewards for the individual so totally out of whack to the benefits to the company?
This is a simple example and the likelihood that there are sociopaths like Black deliberately manipulating performance to optimise their personal long run gain at the expense of the overall business is probably low. But it does illustrate how seemingly corporate aligned KPIs can lead to unintended counter-productive decision making amongst those measured and rewarded by KPIs.
Have you seen KPIs encourage counter-productive behaviour? Let me know your examples.