Incentivizing Change – Providing the Spark

The environmental movement has learned an important lesson in the last 6 months. One can host concerts, win Oscars and run ‘Public Service Announcements’ ad nausea, but until an activity hits people in the pocketbook, they are slow to change behavior. The price of gas has doubled in recent years, causing a dramatic shift in how folks buy cars. In June, sales of SUVs at Ford dropped 54% from a year ago, a result that Mr. Gore cannot lay claim to. It is simply because the cost of operation (gas) outstripped the benefits of driving an SUV. The rational consumer always votes with their wallet.

‘Organic’ societal change takes generations. Views and values take time to evolve and work their way through accepted wisdom. Over history, great periods of change have come about from some kind of catalyst. Technology in the industrial and internet revolutions drove change. Political change in the ‘New World’ was brought about by excessive taxation. The French Revolution and the fall of the Czars in Russia were caused by rational consumers wanting to better themselves. These catalysts can all draw roots back to incentives, whether self-interested or dovetailing with some perceived social agenda.

Organizations, made up of human animals, can be viewed as a subset of society. These firms turn, dip and rise on the actions of individuals and how those individuals are aligned with the whole. There is a large body of research on the alignment of managers and employees to organization. One theory goes that if compensation is directly linked to the overt goals of an organization, employees and managers will perform better simply because what is good for organization is good for the employee. This theory has proven time and time again to be spot on.

Alignment has been accomplished in organizations to date largely through financial incentives tied to profitability and share price. Profit sharing has because the norm from the machine shop floor to the board room by compensating employees and officers with share ownership. Over the last 20 years, pay in the form of equity ownership has become the method to drive all players in the same direction.

Share based alignment makes sense at the macro level, but how does a firm drive tactical change? Individual businesses that need a rework or at a nascent stage are not usually linked to the performance of the whole yet can be critical to the future of a firm. A plant, a new technology or the next game-changing service must be treated as an investment, typically back loaded with returns. Bonuses, directly tied to measurable benchmarks are commonly implemented in these situations to keep eyes on the prize.

One of the questions posed when speaking of diversity, of which disability is the largest subset, is the question from line managers, “Why am I doing this? I need to meet my business goals and this is a distraction.” This question is an indication of senior management’s failure to align staff with corporate goals. Simply put, employees do what managers pay them to do. If diversity is important to a firm, they will build it into their compensation structure, top to bottom. If a firm says diversity is important to them, and they do not pay for diversity performance, they should be deemed as either delusional or somewhat less than forthright.

Put your money where your mouth is. A rather large company in Seattle, the one that does not sell coffee, is doing just that. The American Bar Association reports that Microsoft will pay its preferred outside counsel a 2 percent bonus if they meet diversity goals. This says to Softy’s lawyers that if their firms reflect Microsoft’s diverse Customer base, they get paid more. Simple, no? It is this author’s bet that this will work, and work well. Microsoft deserves kudos for aligning their suppliers with tactical goals through compensation. The question now becomes, does the maker of Windows include Disability in their definition of diversity? This is not clear.

The need for alignment around diversity within an organization is only needed if diversity is critical to business success. Let’s be clear, for most firms it is. Demographics say so. If you sell coal to steel plants, and all the Customer wants is coal, diversity is not critical for you. Any other consumer or public facing entity needs to make diversity goals central to its compensation system. How central depends on how diverse your source of revenue is, from either the production side or the Customer side. As a rule of thumb, if your employee base is above 10,000 and/or your customer base is above 100,000 your firm needs to incent diversity to drive growth and shareholder value.

Organizational change happens when managers cause it. They cause change by altering their team’s behavior to bring about a different result. This change eats up time and resources that could be allocated to other activities. It is in the manager’s best interest to allocate the most resources to the area where her compensation gets maximized. Therefore, if an organization desires change resulting in a more diverse employee and customer base, managers must be incented to move resources to that end. It is up to senior management to decide how important that shift is to the firm and the team will react to those signals.

Oil at $60 means more carbon in the air, regardless of the outcry. If society deems oil consumption negative to the environment, it must tax it to keep prices high enough to encourage switching. Activist ‘hot air’ does nothing in the short- to medium-term but add to CO2 emissions. The same is true of diversity within an organization. Until incentives are aligned, change will be a slow generational grind. The rational manager always follows her wallet.