Aligning Incentives is Everything

For those that follow along closely in the last few months I have been I have helping out a neoBank as they get ready to launch their offering and as part of that process I have been talking to a number of Social Media strategists and managers. This process has been an epic disappointment and I have spent the last few posts counting the ways these service providers are missing the boat, you can read the previous post on this saga here. In this post I am going to talk about the criticality of aligning incentives and how you need to keep that front of mind in any partnership negotiation process.

One of my favorite business quotes comes from Charlie Munger who for those that do not know is the brains behind Warren Buffet. Charlie just turned 99 years old last month and among the myriad of brilliant business quotes attributed to him once said “Show me the incentive, I'll show you the outcome". That is if you understand how people and organizations are incentivized you can pretty easily figure out how the process is going to play out and what the final result will be. As a leader building your career there are few skills more important then developing an intuitive sense of how incentive structures work and how they are going to develop over time. With this understanding you can insure that things are structured to turn out the way you want them to but more importantly you can quickly grasp when incentives are not aligned and steer clear of that relationship.  

To see what I mean let's take a look at a conversation I had with a social media marketing company a few weeks ago. Without getting deep into competitive intelligence we can say that each acquired customer has a lifetime value of X. In very simple terms I can take the average lifespan of a customer use a standard discount rate and figure out exactly how much I can spend to acquire a new customer today and be profitable long-term by taking into account the cost to acquire and service a customer. Yes a startup in growth mode might be happy to spend more than a customer is worth just to show growth but we are not currently in that environment so the math is pretty simple right now.

The incentive alignment issue pops up when you have a conversation with a marketing service provider. In these conversations they will make all sorts of wild claims including providing you with an estimated cost of acquisition of between 1/20th and 1/5th of my target max. You would think I would jump to hire them and just churn the acquisition machine but I'm not naïve enough to fall for the claims in a pitch. Instead I always try to lock them into a contract with aligned incentives. The fantastic thing about online marketing is I can absolutely identify exactly where a lead comes from and offer to pay the social media marketed a fixed rate for each acquired customer. To make the offer super attractive to the social media manager I offer to pay them up to 2x what they claim in the pitch on a pay for performance basis. The impact of this offer on the conversation is quite often a proverbial record scratch as they scramble to come up with a plausible reason why they are unwilling to accept twice the amount of money for the job than what they just asked for. The reality of course as I and they know is that their promises are absolute bunk and they cannot deliver even a fraction of the results they have claimed so taking a pay for performance deal will not net them anywhere near as much as a fixed price contract. This simple trick save hours of time and frustration of dealing with companies that cannot deliver and it should become your go to approach. On the other hand on rare occasion you will come across a service provider that will absolutely jump at this offer, those are the people you want to be working with.

All that said pay for performance in marketing is obvious but there are areas where pay for performance is not a suitable compensation scheme. In instances where you lack the ability to clearly track performance then you are going to be forced into a less ideal salary or hourly model but you should always view these situations as less than ideal and try to move to a pay for performance model if at all possible. This means really getting into the weeds on what a given service is worth and putting in the effort to track your results in a measurable way. If you can manage to accomplish this you are well on your way to building a business and even if it turns out to be nonviable you are going to see the problem coming from a long way off which is potentially even more valuable.