Don't Let Metrics Undermine Your Business - Notes

Don't Let Metrics Undermine Your Business

Idea in Brief

• Companies that work hard on their strategies and carefully monitor their progress often run into spectacular trouble.
• Tying performance metrics to strategy has become an accepted best practice over the past few decades.
• People have a behavioral tendency—known as surrogation—to confuse what’s being measured with the metric being used.

How to Fix It

• To reduce the risk of surrogation, make sure that the people executing your strategy had a role in formulating it.
• Don’t link incentives too tightly to strategy metrics.
• Use multiple metrics to assess performance.

The Problem

• Strategy is abstract, but metrics give strategy form, allowing our minds to grasp it more readily.
• Metrics translate strategies into tangible terms.
  • Ford's "Quality is job one" became Six Sigma standards.
  • Apple's "Think different" and Samsung's "Create the future" linked to sales from new products.
• Metrics can cause companies to lose sight of their strategy and focus solely on the metrics.

Wells Fargo Example

• Wells Fargo employees opened 3.5 million unauthorized accounts due to their cross-selling strategy.
• Costs of the debacle:
  • Initial fines: 185 million
  • Reimbursements to customers: 6.1 million
  • Class-action lawsuit settlement: 142 million (covering damages back to 2002)
• First-quarter credit card applications decreased by 42\% year-over-year.
• New checking-account openings decreased by 35\%.
• Additional revelations about unauthorized mortgage modifications and fees and improper auto loan practices surfaced.
• The bank set aside a 3.25 billion accrual for future litigation expenses in the fourth quarter.
• The Federal Reserve prohibited Wells Fargo from growing its assets until it strengthened its governance and risk management.
• The Consumer Financial Protection Bureau (CFPB) and the Office of the Comptroller of the Currency (OCC) jointly fined Wells Fargo 1 billion.
• CEO Timothy Sloan resigned in March 2019.
• Wells Fargo did not have a cross-selling strategy but a cross-selling metric.
• The focus on the metric unraveled the bank’s long-term relationships.
• The tendency to mentally replace strategy with metrics is called surrogation.

The Surrogation Snare

• Metrics are inherently imperfect and are flawed proxies for underlying goals.
• Common scenario: A company selects "delighting the customer" as a strategic objective and tracks it using customer survey scores.
• Employees start thinking the strategy is to maximize survey scores instead of delivering a great customer experience.
• Tactics like pop-up windows, follow-up emails, and robocalls can lower customer satisfaction but may be used to boost survey scores.
• Surrogation is especially harmful when the metric and strategy are poorly aligned.
• Example: A production manager's success at achieving the strategic objective "make high-quality products" should be measured by precise quality standards (such as "ball bearings must be 10 millimeters in diameter, plus or minus 0.0001 millimeters").
• If success is measured by the number of customer returns, the production manager might find creative ways to avoid returns.

What Happened at Wells Fargo

• The widely accepted theory blames the company’s incentive system.
• Richard Cordray, the former CFPB director, said Wells Fargo built an incentive-compensation program that allowed employees to pursue underhanded sales practices.
• Challenging sales quotas and relentless pressure to meet them were also causes for misconduct.
• A permissive sales culture existed, where managers espoused the philosophy that “it was acceptable to sell 10 low-quality accounts to realize one good one.”
• The investigation found that managers referred to products that the customer did not need (or want) as “slippage” and that a certain amount of slippage was deemed “the cost of doing business in any retail environment.”
• Incentives, pressure to meet quotas, and sales culture were all tied to the performance measurement system.
• Ex-CEO John Stumpf’s mantra, “Eight is great” (the goal was to have eight Wells Fargo products per customer), was based on this common denominator.
• When the bank decided to actively track daily cross-sales numbers, employees rationally responded by working to maximize them.
• Metrics provide defined direction where strategy may seem too amorphous to have an impact.

Guarding Against Surrogation

• Two recent studies suggest that surrogation is a common subconscious bias: Whenever metrics are present, people tend to surrogate.
• Nobel prize winner Daniel Kahneman and Yale professor Shane Frederick postulate that three conditions are necessary to produce the type of substitution we see with surrogation:
  • The objective or strategy is fairly abstract.
  • The metric of the strategy is concrete and conspicuous.
  • The employee accepts, at least subconsciously, the substitution of the metric for the strategy.
• Surrogation can be suppressed by cutting off one or more of its key ingredients.

Get the people responsible for implementing strategy to help formulate it

• This helps reduce surrogation because those involved in executing the strategy will then be better able to grasp it, despite its abstract nature—and to avoid replacing it with metrics.
• Research suggests that simply talking about strategy with people is not sufficient; you need to involve people in its development.
• Intermountain Healthcare's goal is to provide high-quality, low-cost care.
• A key battleground is the treatment of lower back pain.
• The strategy aimed at reducing unnecessary interventions.
• To measure performance, Intermountain began tracking whether doctors waited at least four weeks after meeting with a patient with lower back pain to recommend an X-ray, MRI, or another, more invasive diagnosis or treatment method.
• Nick Bassett, executive director of population health at Intermountain, says that “without question, when physicians are involved in designing objectives, they better understand those objectives, and when they understand the objectives, they have proven time and time again their ability to determine the right course of action, often in spite of a particular metric.”

Loosen the link between metrics and incentives

• Tying compensation to a metric-based target tends to increase surrogation.
• Management didn't tie compensation to the metric, because they recognized that most doctors are already intrinsically motivated to provide high-value care.
• They set the target for the percentage of patients who waited four weeks before medical intervention at 80\%. This served as a reminder to doctors that high-quality, low-cost care for most patients meant waiting for lower back pain to resolve itself.

Use multiple metrics

• People surrogate less when they’re compensated for meeting targets on multiple metrics of a strategy rather than just one.
• At Intermountain, physician performance is assessed with patient satisfaction, condition-specific quality metrics (such as average A1C levels of diabetes patients), health outcomes (such as hospital readmittance), preventive efforts (such as appropriately timed mammograms), and total cost of care.

Wells Fargo Revisited

• The new management’s emphasis on rebuilding trust with customers after the scandal has made the long-term relationship strategy much more clear and prominent.
• The bank has stopped paying employees to cross-sell and has eliminated all sales goals.
• Wells Fargo now gauges strategic success using at least a dozen metrics related to its customer focus.
• Preventing the disease is far preferable to treating its symptoms.

The Biggest Surrogation of All

• Earnings were conceived as a proxy for something bigger and more abstract: Hicksian income.
• John Hicks described this fairly abstract metric as the amount of money that can be distributed to shareholders while still leaving the company’s value unchanged.
• Earnings were a clearly defined proxy for that value and were intended to make an abstract concept more concrete.
• Generating accounting earnings isn’t necessarily the same thing as creating value.
• Investors who surrogate may support financial decisions that do not create value, such as cost cuts that undermine customer service and long-term financial performance.
• The outsize market reactions we see when a company misses an earnings target by a penny suggest that many are falling into the trap.