Hope that managers for bonuses will make your company more successful is like hoping that your child learns to play violin on their own for the sake of a new iPhone.
Jeremy Shapiro, Ph. D. in philosophy and director at MIT, said, «If you don’t measure something, you cannot manage it.» Many years ago, when I was a young green CEO, this saying inspired me. Even a quick glance at company records was enough to understand — I was not controlling a lot.
I have started to measure anything. I have expended great efforts on creating management tools, which would quickly and conveniently give any needed numbers, whether the inventory turnover or the dynamic of profit margin in a concrete sales channel and the productivity of each company branch.
But then, being an inexperienced executive, I have made a classic mistake — I have decided to make a KPI grade based on the data I got from invented management tools. I wanted to link the employee’s salary with individual performance, using their KPI results. It seemed logical to me. Unfortunately, this approach appeared to be more disappointing than helping.
Many business speakers talk about company digitization. And they are right. There is nothing worse than the executive making the decision blind without using analytics. But analytics are good only for decision-making. As soon as we start to use it as a management tool to link employees’ income with performance indicators, we are on shaky ground. When managing a business using only performance incentives and metrics, it reminds the situation when you choose a remedy with a side effect exceeding its treatment benefits.
This idea is met with incomprehension, rejection, and even a storm of protest by many executives and business owners. The reason is that staff performance stimulation based on the KPI system became an undoubted dogma and a Zen zone for business. However, I never met any executive or employer fully satisfied with the used incentive system. «Calibration of the system» is viewed as an answer for them. «We should make it work better here and there, improve this or that, and then everything will work» — what they said.
Alas, this approach has so many flaws that no «precise calibration» will fix them. Basing on KPI targeted on performance incentives is a very rough and imperfect way of business management. I hope this mini-book will throw doubt on customary tools and will highlight more sophisticated but effective methods.
Part 1. Clients and money
22 August 2006, the «TU-154», aircraft of the Russian air company «Pulkovo» making flight Anapa — Saint-Petersburg, crashed near Donetsk, Ukraine. The entire crew and 160 passengers were killed, 45 of them children. The cause of the crash is listed as a crew mistake. When the plane faced a storm front, the pilot-in-command decided to get above it instead of making its way around. For this purpose he tried to go up to 12 kilometers; however, he could not control the plane, which went into a flat spin. The crew did not manage to recover from the reel.
In the informal comments of the media, many experts claimed that pilots had been pushed for such a decision by prescribed KPI «fuel economy», the source of their salary bonuses. The crew would have burned more fuel if they had flown the storm around. The commentators claimed that the pilots had lost their lives, unwilling to lose a bonus.
Don’t you think it is awfully familiar? Does this situation happen every day in other businesses all over the world? Shareholders demand net profits KPI performance from the directors. The directors «cascade» (or «decompose») this indicator on employees, creating a complex KPI net, which permeates the business to the very bottom. Some companies have almost no employees whose income is not related to at least one KPI.
Fortunately, it rarely leads to the tragic loss of human life. Nevertheless, more frequently than it seems, it causes dramatic consequences for the business. This book is about them.
Wells Fargo bank defined a strategy with a clear target: to sell more products to the existing customers. The company translated a corporate strategy into KPIs, and defined a KPI on cross-selling with a target of 8 products sold per customer. Wells Fargo invented a catchy motto: Eight is great. Only many years later, in 2016, the company found out that they had chosen a wrong incentive that led to creating more than 2 million fake accounts. Employees tried to attain their personal KPIs and found the easiest (but, definitely, not the best) way to do so. It resulted in $185 million fine, and the reputation of the bank suffered seriously. This is one of the examples of the «dark sides» of the KPI concept. I will show you more in the following chapters.
Chapter 1. The navigator and more
Have you ever faced bad or quite terrifying service? Poor goods quality? The question is, surely, rhetorical. We suppose that negligence is a reason for bad service, consumer fraud and low quality of goods. Either incompetence of business owners who failed to set up processes or employees who ignore the rules.
Perhaps you will be quite surprised to learn that poor quality of client service is the result of all efforts for improvement made by business owners as well as diligence of employees to perform scrupulously. Owners tried to improve results with the help of KPI system, employees tried to comply with this system.
I often go on business trips to Moscow and drive by car around the city. I use the local and very popular analog of Google Maps, the app called «Yandex Navigator.» When I set out, I open this app and check how long the estimated route will take and how to get there faster.
I often use «Yandex Navigator» and draw my attention to the difference between the estimated time of arrival and the actual one. The results always surprise me. The app makes mistakes by 10—15 minutes, even with short routes (like 30—40 minutes) on Sunday morning. That is 35—50% inaccuracy. It is rather inefficiently, to say the least, for the app developed as early as 2012. Over the past nine years, it was used hundreds of millions of times, so the high-technology company «Yandex» could offer higher accuracy to its clients.
You may object that Moscow is an enormous city with unpredictable traffic and three million cars on the roads every day. Car accidents, traffic lights breakdown, rain or snow — all of these can happen in 40 minutes on your route. A pair of careless drivers are also possible reasons for traffic jams. That’s true.
However, I have the objection too. Firstly, in nine years, Yandex has accumulated not just «big» data — it is already gigantic data, enormously big data. I am not an expert, but my mathematics education allows me to suppose that the app could calculate the risks of possible delays before giving an estimated arrival time. I’m sure there are more precise methods. 35% — 50% inaccuracy — what is the point of using an application like this? I’ve been driving in Moscow since 1999, and I can predict travel time with the same precision — just from experience, for a modest fee.
Secondly, the app rarely mistakes downwards. I can’t remember the situation when «Yandex Navigator» predicted arrival at 15:30 and I arrived at 15:15 de-facto.
Last but foremost, the company «Yandex» owns the services «Yandex Taxi», the car-sharing company «Yandex Drive» and the service «Yandex Petrol stations». If you get in the car — in your car, in the rented minute-by-minute with the same Yandex, or in a taxi, the company will make money off you. But if you check with «Yandex Navigator» and see a fully red map that means terrible traffic, you decide to take the subway. As a result, «Yandex» makes less money or no money at all. («Yandex» also has an app «Yandex Subway», there is a paid advertisement, but taxi and car-sharing services definetely bring more income).
Certainly, I have no proof of fraud and cheating. All of this is only my opinion. I am not a journalist who investigates to expose «Yandex». I suppose that «Yandex» hires top managers and offers work based on some KPI system related to greater profits.
I do not claim that «Yandex» deceives users. However, my life experience suggests that if top managers have the ability to increase their salary bonuses by deliberately improving forecasts and encouraging you to drive a car, they at least thought about it. If that is true, I wouldn’t be surprised.
When «Yandex Navigator», Google Maps, Apple Maps or any other map application plans your route, could we know for sure — is this the best possible way, or does it go by the place of a generous advertiser? We do not know it and never shall. But if such a situation happens, we scold greedy capitalists. Although my own experience tells me that it’s just not something that capitalists would do, because they care about long-term development and not only about today’s income. Unlike the hired managers. By creating the salary bonus system based on KPI and profit records, the business owner provides grounds for deterioration of customer experience.
If you face poor service or product of low quality, it is more likely that some employees’ salary is connected with financial KPI, for example, with the growth of sales or net profit. The growth of sales and profit is not something about the client satisfaction indeed. Don’t lie to yourself.
Chapter 2. KPI and consumer
We are sitting in a meeting room with business owners and top managers. I am helping them to develop the strategy of the company. We have already had three sessions, and now we are working on the text of the strategy.
We talked a lot about consumers and their life values during the work. As well as we pointed out that business earns an income from satisfying their wants. But when we come to the section «goals», I see again only financial metrics like revenue, margin, EBITDA, net profit, etc.
— Why doesn’t the matrix contain consumer satisfaction targets? — I ask.
— Aren’t sales the best measure of satisfaction? — If you buy, you’re satisfied! — the shareholder answers.
No, they are not.
Here I will cite the author of the book «Market-based Management» Roger Best: «Customer satisfaction is a business indicator that allows us to look ahead and assess how well customers will respond to the company’s activities in the future. Other indicators of market activity, such as sales volume, show us something left behind. They point to the results which the firm has achieved in the past, but don’t show how well it will do in the future».
The production company, let us call it «Factory,» sold to other manufacturers some components. Among the clients was also a large holding company, its purchases gave more than 15% of the total revenue of «Factory».
The incentive system, which was applicable to sales managers, heads of sales and top managers, included revenue metrics, marginal profit and net profit (for C-level executives).
The investigation made with my help showed that low-lever sale managers have long known that the quality of the service and the components produced by «Factory» lags behind the market. Clients complained, and some heads of sales tried to convey the heart of the problem to the management. But they were not heard. The bosses thought the heads of sales were just justifying their laziness. Sales have been made, profits have been gained, bonuses have been paid. No one has measured customer satisfaction, no one in the company has heard about the Customer Satisfaction Index (CSI) or other metrics suitable for B2B sphere.
According to the manager who deals with that holding company, the purchasing manager of the client had long threatened to add another supplier to his portfolio. There was only one reason for not doing it — the accreditation process applied to new suppliers was too complicated in this holding. So, he didn’t want to deal with it. The new contract should have been approved a dozen times, and it was the only thing that stopped him.
However, in 2018 clients’ dissatisfaction reached a peak. Even the most loyal of them started to expand their portfolios with products of competitors. The above-mentioned purchasing manager of the holding company approved the second supplier, and the «Factory» lost 8% of profit in a blink.
20% of the fall in sales caused lost revenues and cash gaps. The management of the «Factory» had only one interest in finance and didn’t notice the problems to the bitter end. If the bosses were also interested in client satisfaction, the situation could have been prevented.
If this story didn’t convince you, remember the company Nokia with net profit more than 8 billion Euro in 2007. At this moment, more than a billion cell phones Nokia has been used all over the world. In November of the same year, Forbes magazine wondered — will someone be able to catch up with «the king of cellular communications»? We know what happened next. Can we judge customer satisfaction by sales volume? Almost never.
An incentive system based on net profit metrics might force employees to degrade consumer experience, especially if there is no immediate impact on sales.
1. The quality of the product is slightly declining due to the quality deterioration of raw materials or production processes.
2. The company hires less qualified employees working with consumers and influencing the quality of product and services.
3. The company saves on staff training in order to increase operating surplus.
4. The company uses high-pressure selling (for instant, via operators of call center using sales script). This leads to an increase in current revenues and profits, but some customers are quite annoyed with it, others who buy imposed goods or services then leave negative feedback on social media or never return.
Sales figures do not exhibit customer satisfaction. These things are related, but one does not need to be the consequence of the other. The problem is that sales and customer satisfaction belong to different time points. In the case of «Factory» dissatisfied consumers continued to buy products for some period. For example, a customer is forced to buy an unnecessary optional service or get a product which quality is far from the promises. At the moment of purchase, he doesn’t know about poor quality or doesn’t understand that services are needless. But he will be disappointed later. In order to fully understand the real satisfaction of the customer, we should measure and analyze it by means of surveys, questionnaires, or any other methods suitable for the concrete business sector.
The only sales figures which are connected with satisfaction are «repeated purchase» and «regular customer». And even then, today’s sympathy of the client will not guarantee his comeback. If you want to know if your clients are satisfied, you should learn to measure it, and you shouldn’t rely on revenue figures.
Chapter 3. Shoes and consumer loyalty
I have a client — the chain of shoe stores. Before the next strategy workshop I visit three stores of the chain, and I do a social experiment. I walk into the store, and sales girls immediately reach me with the question — «How can I help you?». I answer — «Thank you. I’m just looking». I make it very clear that I’m not going to buy anything, at least not today. The tide of enthusiasm quickly wanes, and they turn away with indifference.
I ask the HR-director of the company:
— Which incentive system is used for staff?
— Oh, we have a very effective one! The income of all employees is based on the volume of sales — he says with excitement — With the aid of this salary system, we have raised the profits by 20% in the last year alone!
Oh, the metrics… Of course, if we talk about the number of visitors, the average check, the rate of converting store visits into purchases, it is convenient to use such metrics. Applying the modern accounting software, you can get it with the flip of a switch. However, there are some interesting questions. Does this system work for long-term consumer loyalty (I am sure this result is expected by the top management of the company)? The sales girls lost their interest without immediate purchase from my side. Nevertheless, the good advice could persuade me to come back in a few days in order to make a big check purchase. And also, I would recommend the store to friends.
Why didn’t the store consultants want to tell me about the shoes? If I had bought them right away, they would have a bonus from this sale. And if I hadn’t, they would have spent ten minutes on me for nothing. I might have bought shoes on their day-off, in another store, or on a website, and my consultants would have nothing from this sale. The company would make a profit, and the particular employee would not.
Such «stimulation» does not encourage the store consultants to work for the consumer loyalty to the store chain. It forces the consultant to become a selfish person, interested only in personal income but indifferent to the success of the company.
Case «Real Estate Agency»
We develop a strategy for a real estate agency. Part of the project is a «sellers and buyers» research in general, as well as an analysis of the clients who used the services of this agency (let us call it «Agency») in particular. A specialized research company organizes a consumer focus group.
Agents in our «Agency» are not independent «hunters.» They are regular staff members, who are continuously trained on sales. «We start coaching sessions with the personal finances of the employee», the co-owner of the agency tells me with pride. «Which means that the coach asks everyone to set personal financial goals for the year and then to develop a road map to achieve set goals». In this way, the agency helps staff to «stay hungry» and to participate in deals more actively.
We watch the participants of the focus group through a one-way mirror. A moderator talks to people who bought or sold the apartment with the help of the «Agency» during the last 60 days. The moderator has already found that, in general, the participants are rather pleased with the work of the agency, although we do not see delight either. Then, the moderator starts to use leading questions in order to reveal negative impressions of the focus group members.
— They’re greedy, — the glum man in the jacket says.
— What do you mean? — The moderator asks.
— I came to buy an apartment. I was met, at first, with goodwill and enthusiasm, with coffee served, and so on. But when I mentioned that I had a small amount of money and needed a small one-room apartment, the employee lost interest in me. He didn’t even try to hide that he was wasting his time with me.
— Yeah, yeah, — a lady joined the conversation, — They got dollars spinning in their eyes. Like they are cartoon characters, remember?
The business co-owner staying next to me is clearly disappointed.
— You do realize they write about it on social media and tell other people, right? — I ask.
Of course, I do — he sighs — I didn’t expect that reaction.
The answer is wrong. He didn’t expect any reaction from clients because he didn’t think about them, blinded by the growing number of deals and commissions. He is not much concerned about the client, who is just the source of profit. You might say — a cash cow.
When employees who deal with clients have their earnings directly related to the sales, it doesn’t make them more «caring.» Do not harbor any illusions. On the contrary, the more they focus on self-profit, the faster they want to get rid of the client and to start with the next one. A client who doubts, a client with a small amount of money, a client who came just to check up — they are a waste of time and efforts. The employee can spend this time on money-making instead. Does it help the business to succeed in the long run?
Tony Hsieh, the founder of the company «Zappos», highlighted in his book «Delivering Happiness», that he didn’t limit the phone conversations between the call-center operators and clients. In this way, he avoided a decline in service quality. Once, the call-center operator even ordered pizza delivery for a client who asked for it. Would she have done that if her salary depended on the number of phone calls a day? No, she would not. She would have attempted to shorten every conversation. That would have reduced the number of operators and increased the profits of the company, but not the loyalty of consumers.
The more employees salary depends on company profits, the more we force them to treat the client as a «wallet on legs». For example, an agent from our «Agency» shows a future customer an apartment that has a defect invisible at first glance. The agent knows about it, but he realizes that it may scare the buyer away. Or the defect might lower the cost of the house, which means that commission will be lower as well. Do these terms encourage the agent to be honest?
Chapter 4. KPI and team spirit
I came to the office of a potential customer to attend a staff meeting. The shareholder intentionally left the meeting to let me look at managers «in the natural habitat.» I sit quietly in a dark corner, not participating in the conversation.
I hear a serious debate that splits participants into two camps. The first is led by the sales director and head of logistics. They offer to buy expensive TMS, Transport Management System, to increase the speed of goods delivery to customers. The HR-director and Chief Finance officer are on the other side. They think that TMS will ease sales and logistics departments’ work but won’t increase the volume of sales.
— Dear colleagues, — the sales director says with unconcealed impatience, — All crucial competitors make delivery to customers on the same day for a long time already. The delivery on the same day is made by them if the order is placed before 14:00, and we do it on the same day only for orders placed by 11:00. I have shown you the breakdown.
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