2 Steps to Reduce Profits: Targets and Incentives

Wednesday, June 10, 2009 by Tripp Babbitt
When I first was introduced to the theory of variation (by W. Edwards Deming) back in the 1980s.  I was taken aback by what this all meant.  The realization of the differences between common and special causes of variation are simple yet profound (please read: Service Metrics: What You Need to Understand).  This theory helps us understand that performance is 95% attributable to the system (work design, measures, management thinking, constraints, policies, regulations, etc.) and 5% is attributable to the individual.  Theory of variation also taught me that setting a target will not change the system, only a change in method (e.g., a change in the system itself) could facilitate improvement of performance.  A target or goal without a method is useless.

When an organization adds in incentives (financial rewards, pay for performance, etc.) it ignores the fundamental premise learned from the theory of variation that the individual is inextricably tied to the system in which they work.  In essence, this means all this attention to the individual is working on the small problem while ignoring the big problem (the system).  I am both thankful and cursed that Dr. Deming presented this thinking to me.

Some 5 years ago I was presented something that further explained the problem of targets.  John Seddon (my Vanguard partner) had studied failed organizational change management programs.  Taking Deming’s theory he expanded upon it.  He discovered when organizations set targets that this became the de facto purpose.  Instead of working to improve service or product we work to achieve a target set by (in some order) Wall Street (dividend), executives, managers, supervisors and front-line workers.  The problem with these financial and performance targets is that they do not create the value for the customer which drives the profit and not vice versa.  He further discovered that as command and control managers used these arbitrary measures with targets, method was constrained because the work winds up getting designed around reporting requirements and not the customer.

A better method is to define purpose from a customer perspective, derive measures related to this purpose which in turn liberates method and innovation. a simple but profound systemic relationship.  One that John Seddon references as systems thinking. 

We have seen too many times where an individual hits their targets, achieves their incentive and the company goes out of business (AIG comes to mind).  This is a failure to understand the theory of variation (Deming) and the relationship between purpose, measures and method (Seddon).  Until we begin to understand this theory and relationship we will continue to send our companies down the path to reduced profits.

Tripp Babbitt is a speaker, blogger and consultant to service industry (private and public).  His organization helps executives find a better way to make the work work.  Download free from www.newsystemsthinking.com "Understanding Your Organization as a System" and gain knowledge of systems thinking or contact us about our intervention services at [email protected].  Reach him on Twitter at www.twitter.com/TriBabbitt.

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