Optimizing Systems
Most people believe that when every element of a system performs at its local best, the system performs at its global best. This is not so. In order to optimize the performance of a complex system (do the best for the whole) it is necessary to sub-optimize the performance of its sub-systems (not do the best for the parts).
The fundamental problem of human organizations is that people are evaluated according to the performance of the sub-systems they manage. Thus, the incentives lead people to optimize the performance of their business units, which inevitably leads to sub-optimize the performance of the company as a whole.
On the other hand, global incentives such as a profit sharing plan independent of individual performance create free-rider problems where the law of averages proportionally rewards non-performers and punishes those who excel.
We believe cultural alignment can transcend financial rewards. Having a shared purpose that ennobles those who seek it, and a sense of community that bonds those who belong to it, are essential aspects of a strategy to build an extraordinary organization.
SUB-SYSTEM VS SYSTEM INCENTIVES
Think of a soccer game. Each team wants to win by scoring more goals than the other. To do this, they organize in two sub-teams each with a sub-objective: the offense seeks to score goals and the defense to prevent the opponent from scoring.
If the offense were to receive payment in direct proportion to the goals they score, and the defense in inverse proportion to the goals they allow, the team would end up defeating itself. The offense would rather lose a game 5 to 4 than to win 1 to 0. The defense would rather lose 1 to 0 than to win 5 to 4. While each sub-team tries to optimize its sub-objective, it sub-optimizes the team’s objective.
Substitute "production" for "defense", "cost minimization" for "prevent goals", "sales" for "offense" and "revenue maximization" for "score goals" and you’ll see that this doesn’t just happen in soccer.
