Month: September 2015

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. 

The Idea

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.

All throughout the land, scientists laboured to find a way to detect when it had rained. If it rained only sometimes, it was useful: crops would grow, dams would fill with drinking water and house roofs would be clean. But, if it rained too often: floods would come, crops would rot and houses would grow mouldy and mildewy. It would be very useful to everyone to know how often it rained. But sometimes it rained at night! How were the scientists to know if it rained when everyone was asleep?

On one rainy day, Sally, one of the land’s great scientists, noticed something exciting: Every time it rained, the driveways became wet! In fact they stayed wet for hours afterward, particularly at night! A wet driveway might be a great way to tell if it had rained. Tests had to be done!

Sally applied for funding and over a period of a year research assistants stayed up all night in random geographic locations watching for rain and recording the wetness of a random selection of driveways. Pebble, concrete, bitumen, flat, steep, curved, straight…it didn’t matter. It really worked! 100% of the time that it rained, the driveway became wet. 100%! This was sensational. Even the proportion of patients with heart conditions having high cholesterol was not 100% and yet cholesterol tests were a trusted test across the globe. Driveways were available all over the world…the Wet Driveway test was marvelous!

Sally became an international sensation. She was interviewed about her great idea, invited to lecture at universities and at business functions. Soon she was being asked her opinion about all sorts of things with little relationship to either driveways or rain because polls show that she was one of the world’s most trusted “smart people”.

After a while, other scientists were able to publish useful guidelines above which various conditions occurred. On average driveways were wet about twice a week. However, if the driveway was wet more than 5 times in a week then flooding risk was increased by over 250%. Less than 0.5 times a week indicated an 80% increase in the likelihood of drought. Similar thresholds were calculated for plant rot and mildew house. Soon everyone was using the wet driveway test, and the new thresholds. Television stations started to include the wet driveway averages in their newscasts. Even governments and corporations started to use the new statistic in their budget deliberations.

Sally was very pleased that her idea was being developed in such a useful fashion. Some of the applications being developed were ones she had never considered herself. Being a trained scientist she used her frequent television appearances to educate the general public about the proper ways to use the wet driveway test:

“2 wet driveways a week is only an average of course, and a global average at that. Some driveways are located in places where rainfall averages higher or lower than the global average.”
And
“You shouldn’t get too worried if your driveway doesn’t get wet for an entire week, it doesn’t mean you’re in drought straight away. It’s when the average over the year gets below 0.5 that you can say you’re in drought …and don’t forget to adjust for your local averages”.

Despite Sally’s sterling efforts, untrained amateurs continued to use the test based on the simple guidelines only. Still, on balance, Sally felt that using the test simplistically was still an improvement over not using it at all. But the people and even other trained scientists continued to use both the tests and thresholds in an uninformed and simplistic fashion. One week of no wet driveway and people started to install water tanks and buy water. On the 6th day of rain, some people began packing up their houses ready for a flood. “Well it is 100% accurate isn’t it?” Sally tried to explain that the thresholds were based on averages and that “above 5” only indicated an “increased risk” of flood. The 100% referred to the indication of rain and then only in the direction of rain producing wet driveways, not wet driveways producing rain. The 100% did not refer to the flood risk at all. Despite her efforts, some companies started to sell flood preparation kits: “For that dreaded 6th day”.

Other companies began to sense a market opportunity. Market Research showed that people not only wanted to predict the future of floods and droughts using the Wet Driveway test, they wanted to be able to influence it. The companies set their scientists to work to:

“Find a way to keep the wet driveway average between the safe levels of 0.5 and 5 days a week,” said the CEO of one company.

Soon, a famous hairdryer company, managed to develop a “driveway dryer”. “As soon as you get to 4 Wet Driveways, you turn on the Renington Driveway Dryer and you’ll stay below 5, guaranteed!”, claimed the internationally televised advertisement. Renington sold millions of the their patented Driveway Dryers. Renington was also reportedly working on a driveway wetting device which could push the average above 0.5 and, presumably, thereby avoid a drought. Householders started using their garden hose to wet their driveways in an effort to “Ward off the drought.”

Sally immediately saw the problem. People thought that drying or wetting their driveway would influence the weather and therefore their risk of flood or drought. In fact she’d even heard some other trained scientists (possibly working for Renington) saying scientific sounding things like: “evaporation from aqueous covered non-porous surfaces contributes positively to the local humidity, which in turn increases the probability of rain.”

Sally knew she had to educate the puiblic and immediately used her guest television spot on Ellen:
“The Driveway test only tells you if rain has occurred, much like a cholesterol test just tells you how much cholesterol is in your blood. There is no evidence that wetting or drying your driveway will change your risk of flood, plant rot, drought, or whatever,” Sally explained.
Ellen asked her, “So are you saying you were wrong about your test?”. A little shocked by the question, Sally stammered a feeble “No-o, but…”. Ellen interrupted her to announce a commercial break.

Later that day the CEO of Renington offered Sally a highly paid position as Executive Vice-President of Research and a generous research budget guaranteed for the next twenty years. The Driveway Dryer is still a hot seller.

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When I catch myself making this typically human correlation-causation error, I find it useful to “Remember the Wet Driveway Test”. Also it helps me identify when people generally or even entire industries are making the same common error. As we know much competitive advantage is found through not making the same mistakes as everyone else. Have you got any classic examples of this common error?