Supply Chain KPIs: When Incentives and Bonuses Are Toxic
Tracking KPIs is essential to manage supply chains, but incentivizing individuals based on metrics can backfire. This article provides historical examples and supply chain cases where incentives created issues such as diminished motivation, unethical behaviors, or even exacerbated the very problems they aimed to solve. We advise balancing intrinsic and extrinsic motivators, carefully implementing rewards, and avoiding penalties. Follow best practices to optimize performance, not metrics.
This article pursues the discussion that started with our previous article, How to Select Supply Chain KPIs. As we argued, using KPIs is critical to managing supply chains. But if poorly selected, they come with pitfalls. Overly specific KPIs risk narrow focus, reduced collaboration, and misalignment with business objectives. Conversely, holistic KPIs (such as global revenues or costs) dilute accountability and responsibility while being poor pointers to lead day-to-day individual decisions. We concluded the article by advising to accommodate the risks of using specific KPIs by allocating a couple to each team.
This article moves on from how to select KPIs to how to manage teams with KPIs by exploring the unintended consequences of overemphasizing targets and rewards — and how to avoid these. From the streets of colonial India to the boardrooms of modern corporations, we’ll expose the risks of ill-conceived reward systems and the lessons they hold for supply chain managers. Section 1 sheds light on how incentives impact motivation and creativity. Section 2 showcases how, sometimes, incentives can ironically exacerbate the very issues they sought to address. We will illustrate this with multiple firsthand accounts of team members manipulating data and metrics to collect bonuses. As we round off in Section 3, we’ll arm you with best practices for using targets and incentives to oversee your supply chain and lead your teams effectively.
Acknowledgments
Bernard Mirasson, Alberto Nuin, Mariusz Lesiewicz, Laurent Staub
The Over justification Effect: A Tale of Children, Drawings, and Rewards
Extrinsic and Intrinsic Motivations
When trying to motivate teams, managers often turn to incentives and rewards — extrinsic motivators. But humans also have intrinsic motivations that come from within. Understanding the difference is critical to boosting performance:
- Intrinsic motivations tap into passions, interests, and values. They include the joy of learning new things, the drive to master skills, or a sense of purpose. With intrinsic motivations, the activity itself is rewarding.
- Extrinsic motivations come from outside factors like money, prizes, or avoiding punishment. They can provide external pressure to complete tasks that we might not find inherently enjoyable or interesting.
Both intrinsic and extrinsic motivators have their place, but overemphasizing extrinsic rewards can undermine intrinsic enjoyment. In the late 1970s, researchers Mark Lepper, David Greene, and Richard Nisbett conducted a study on this phenomenon in children.
Rewarding Children to Draw
The researchers observed children during their free play periods and identified those who naturally spent a lot of time drawing, indicating they were intrinsically motivated to do so — they simply enjoyed drawing.
The three researchers divided the children into three groups:
- Expected Reward Group: These children were shown a “Good Player” certificate, adorned with a gold seal and ribbon, and told they would receive one if they chose to draw. After drawing, they were given the promised certificate.
- Unexpected Reward Group: These children were not promised any reward for drawing. However, after they finished drawing, they were given the “Good Player” certificate as a surprise.
- No Reward Group: These children were neither promised nor given any reward for drawing.
Weeks later, the researchers watched the children during free play.
Findings #1 — Rewards and Long-Term Motivation
Children in the No Reward and Unexpected Reward groups continued to draw as much as they had before the experiment, indicating that their intrinsic motivation remained unchanged.
However, children in the Expected Reward group showed a significant decrease in their interest in drawing during free play. They spent 50% less time drawing than they used to before the study. Having been promised a reward for drawing previously, their intrinsic motivation to draw for the sheer joy of it had been undermined.
Findings #2 — Rewards and Creativity
In another related study, children’s art teachers were asked to rate the creativity, quality, and interest value of the paintings done during the experiments. They found that children who were expecting rewards drew more pictures but of lower average quality. Children tended to draw simple drawings just good enough to collect the rewards.
Multiple follow-up experiments prove that when you reward individuals for an activity they inherently enjoy, their internal drive and creativity weaken. It’s as if the external reward overshadows their personal joy and satisfaction. This phenomenon, known as the overjustification effect, suggests that external rewards can sometimes backfire, mainly when applied to tasks people already find rewarding.
Intrinsic vs. Extrinsic Motivation in Supply Chains
Both intrinsic motivators (such as purpose, mastery, or autonomy) and extrinsic motivators (incentives or promotions) have a role depending on the context. Intrinsic motivation drives passion but might not give the necessary rush to deliver urgent tasks. Extrinsic incentives can drive action but may undermine creativity and long-term passion if overemphasized.
The key is to promote intrinsic motivators and use extrinsic motivators only if this is not enough. Lean too heavily on extrinsic rewards like bonuses, and you risk short-term thinking, unethical behavior, risk avoidance, and demotivation –- we will cover some of these in the following section. However, ignoring extrinsic motivators might leave you without incentives for unglamorous but essential work. We will discuss best practices to set incentives in the following sections.
Strive to tap into intrinsic motivations through job design that allows autonomy, control, and mastery. In other words, ensure skill development and ownership. Avoid toxic management practices (pressure to deliver specific numbers, blaming mentality), and promote discussions to lead (mentor) team members to reflect on their performance and progress further over time.
Perils of Perverse Incentives: India’s Snakes, Hanoi’s Rats, and Supply Chain Planners
Blame the game, not the players.
The Cobra Effect
In the heart of colonial India, British officials faced a growing menace: cobras. The slithering serpents were a deadly threat. In a bid to tackle the problem, the officials devised what seemed like a foolproof plan. They offered a bounty for every dead cobra, hoping this would incentivize the public to help eradicate the snakes.
Initially, the plan seemed to work. People turned in dead cobras in droves, collecting their rewards and leaving the officials pleased with their ingenious solution. But as time went on, something curious began to happen. Instead of the cobra population dwindling, it seemed to be on the rise.
Confused and concerned, the officials decided to investigate. What they discovered was both shocking and ironic. Enterprising individuals, seeing an opportunity to profit, had started breeding cobras. The more cobras they bred, the more they could kill and turn in for the bounty. In trying to decrease the cobra population, the British had inadvertently incentivized its increase.
Realizing their blunder, the officials promptly canceled the bounty program. But the cobra breeders, now left with worthless snakes, released them into the wild. The end result? An increased cobra population.
This tale, famously known as the cobra effect, serves as a stark reminder that reward schemes, no matter how well-intentioned, can sometimes exacerbate the very problems they aim to solve.
The cobra effect is not an isolated case. Something similar happened later in 1902. To combat a rodent infestation in Hanoi, Vietnam, the French colonial rulers offered bounties for dead rats. However, as the administrators didn’t want citizens to carry around dead rats to claim rewards, they only requested to bring dead rats’ tails as proof. Soon, the rulers started to notice tailless rats in the streets. Clever locals were cutting off rat tails to claim rewards, then releasing the rats to breed further.
In the modern corporate world, imagine rewarding IT teams based on lines of code produced. The likely outcome? Voluminous but inefficient code, compromising software quality. But they would get high yearly bonuses.
Incentives and Targets: Supply Chain Tales
Show me the incentives, and I will show you the outcome.
Charlie Munger
Over the years, I collected similar stories on how individuals or entire teams gamed metrics to collect rewards. Here are a few examples.
- Demand Planning. During a presentation, a world-known consultancy showcased its forecasting model’s impressive accuracy to our mutual client’s executive team (an international manufacturer). However, a small footnote caught my eye: they’d excluded the “5% lowest-performing SKUs” from their data. Digging deeper, I uncovered that their high accuracy was only consistent during the three specific months used for evaluation. The consultancy had signed a performance-based contract: their payment was tied to the reported accuracy. The pressure to deliver was so high that they came up with multiple hacks to show artificially high accuracy. (After six months of negotiation, they got away with it and charged a six-digit figure.)
- Inventory Management. Management gave a strict 98% in-stock target to their inventory planners. Those who didn’t meet the 98% in-stock target were confronted to provide an explanation for the low in-stock levels and detail their corrective actions. So, some planners found a workaround: the day before the in-stock report runs, they would flag most out-of-stock items as inactive.
- Inventory Management. To evaluate forecasting accuracy, the management team of a company would freeze forecasts at a specific point in time to track and review accuracy. The accuracy achieved by planners was used to determine yearly bonuses. The overall achieved service level was also considered to award bonuses, but, unfortunately, inventory management was poorly done: days-of-stock were determined based on last year’s average. To ensure stock availability, the senior Demand Planner of a local branch was hacking forecasts by routinely increasing them by a significant 20%. But only after the day the forecast freezes for evaluation. This maneuver was a clever way to ensure he met his accuracy targets while getting more supply despite fixed stock targets. At the end of the year, he would reap bonuses for service level and forecasting accuracy.
From the streets of colonial India and Hanoi to modern corporate boardrooms, the dangers of (ill-conceived) reward systems are evident. Whether it’s breeding more cobras or manipulating data, the underlying lesson is clear: Incentives can lead to unintended and often detrimental outcomes. With these lessons in mind, let’s explore how we can use targets to manage teams while avoiding incentivizing users to hack the system.
How to Manage Incentives and Bonuses
Caution in Setting Targets
When a measure becomes a target, it ceases to be a good measure.
Goodhart’s Law
KPIs and metrics are invaluable tools, but like any tool, they can be overused: well-intentioned efforts to boost performance via rewards or incentives can backfire. Especially when these KPIs are too specific or inadequate.
When these numbers transform from mere indicators to the criteria for rewards or penalties, problems arise: employees may game the system (Cobra effect), lose motivation and creativity (lower intrinsic motivation), engage in myopic local optimizations, or make questionable trade-offs to hit targets.
Keep in mind that,
- Rewarding team members to achieve specific targets incentivizes them to be myopic about it.
- Penalizing team members for missing targets acts as a stronger — but more toxic — incentive due to loss aversion, a common cognitive bias (humans tend to avoid losses rather than seek equivalent gains).
- Toxic management (pushing employees to achieve targets by intimidation, bullying, or humiliation) imposes pressure on staff comparable to strict penalties. Toxic management will likely result in even more team members hacking metrics, corrupting data, or pursuing extremely narrow focus (among other negative consequences).
In short, incentives are to targets what financial leverage is to investing. (Leverage refers to using debt or borrowed capital to increase returns from an investment.) Leverage comes with greater rewards and risks: You don’t want to take leverage on a financial asset if you aren’t sure of its quality and expected growth. Similarly, incentives can give a push to the business value your teams deliver but at the strict condition that the metrics have been carefully selected. If the metrics aren’t adequate (for example, because they are too specific), you will face pitfalls: myopic behavior at best, lack of business value, or, worse, the cobra effect.
You should only use incentives or bonuses once you have identified a robust and healthy set of KPIs — a process that could take years. Incentivizing individuals based on metrics prematurely can amplify problematic behaviors, like narrow focus or unethical practices. This risk resembles taking on too much financial leverage without enough asset stability. However, once a set of robust, reliable KPIs aligned with organizational values is in place, bonuses based on these metrics can motivate teams. Still, exercise caution even with mature KPIs. Pushing teams toward specific targets could backfire if the metrics become too myopic over time. If you want to learn more about selecting the right KPIs, we discussed best practices in our article How to Select Supply Chain KPIs.
Are Rewards Fair?
Many objectives are achieved or missed due to external factors independent of the quality of the team’s work. Here are a couple of examples:
- Your inventory planning team could deliver a 97% fill rate this month thanks to exceptionally good forecasting accuracy.
- Your demand planning could fail to deliver a 60% forecast accuracy because of COVID.
Rewarding teams for being lucky (or for the work of others) or not giving a bonus to a team due to external events would be considered unfair. And humans are extremely sensitive to the perception of (un)fairness.
Conclusion
In conclusion, while KPIs and metrics are vital to managing supply chains, they must be used judiciously. This should be done in two main steps.
- First, select adequate KPIs to monitor a process’s efficacy and efficiency. We discussed this in the previous article, How to Select Supply Chain KPIs.
- Metrics should primarily be used to discuss, track, think, and improve.
- Using KPIs to reward or incentivize teams should be avoided or used with great care. Only do it once the metrics have been confirmed as healthy.
- Targets and KPIs shouldn’t be used to penalize team members.
