Perverse incentives, the cobra effect and balancing OKRs
Goals and incentives matter – setting goals and creating incentive systems work. That is why organizations use them, they get people to behave in certain ways.
But you have to be very careful when creating goals to avoid creating perverse incentives. A perverse incentive is an incentive that produces unintended and undesirable results, which are contrary to the interests of the incentive makers.
Perverse incentives hurt. They are the incentive system version of shooting oneself on the foot.
Perverse incentives are also called “Cobra Effects”, due to an anecdote set in colonial India. The anecdote is not historically true, but it helps understand this key concept:
During British colonial rule, there were a lot of venomous cobras in Delhi and the government decided to create a program to incentivize the population to kill the cobras.
The program was simple: bring a dead cobra and collect a bounty. Week after week, the government paid increasingly large sums of money as more and more dead cobras were delivered.
All went well until one day a British officer went to the countryside and discovered that the population started breeding cobras since it was a more profitable activity than breeding anything else.
What would you do if you were the British governor after discovering the cobra breeders?
When I ask this question in my OKR workshops, most attendees say that they would cancel the program and stop paying the bounty.
And that is exactly what the British government did.
What did the population do? They released all the cobras. The government ended up with a much larger population of snakes after spending large amounts of money.
Perverse incentives and cobra effects are all around us:
- Sales teams with aggressive quarterly goals give large discounts in the end of the quarter in order to reach the quota. Clients know this and so wait until the end of the quarter to get a bargain;
- Managers that try to spend all their budget surplus by the end of the year – even with non-priority projects – to avoid having next year’s budget reduced;
- Doctors and hospitals that order several diagnostic tests due to high reimbursement rates.
It is very important to understand that perverse incentives are not simply a matter of people acting in bad faith. Your team may be simply trying to reach the established goals, without a complete understanding of the organizational objectives.
Making sure all OKRs are clear and sustainable, avoiding perverse incentives, is a direct responsibility of the team leading the OKR initiative.
How do you avoid perverse incentives?
Intel’s Andy Grove has a great recommendation for dealing with them:
“For every metric, there should be a paired metric that addresses adverse consequences of the first metric.”
So each key result should be “paired” (or balanced) with other key results to avoid perverse incentives.
When studying OKR components, some may ask why do we need the nested structure with several key results. Why can’t we just list the key results in the first place?
We need several key results in order to balance them. Having several key results allows us to avoid perverse incentives by creating an OKR that is healthy and sustainable.
As an example of balancing key results, let’s recall our OKR example from the previous section:
Objective: Delight our customers.
- Increase average weekly visits to 3.3 per active user.
- Increase non paid (organic) traffic to 80%.
- Reach a NPS (Net Promoter Score) of 52%.
- Reduce revenue churn to 1%.
- Increase engagement (users that complete a full profile) to 75%.
Let’s evaluate how those key results balance each other:
- The first key result alone (increasing visits) could be achieved by spending lots of money in marketing. But that is balanced by the second key result (increasing non paid traffic);
- Increasing visits could reduce engagement, making customers that simply bounce of the site. The last key result avoids this;
- Finally, increasing NPS and reducing churn assure that we are focusing on happy, loyal customers.
As a general rule, you should balance efficiency metrics (i.e. delivering on time) with quality metrics (i.e. fewer product bugs).
For example, a sales OKR could be balanced by including revenue, margin, customer satisfaction, reducing default and increasing upselling.
Remember that you can balance key results inside the same OKR or among different OKRs. Two different OKRs, each with one objective and a set of key results, can balance one another.