Finding and Aligning Incentives

I see this type of post a lot on Facebook:

I look at this post, and think “What a cool offer, let’s see what this service is.” Then I decide to check out the product, and I realize that the person who posted the status gets an incentive when you sign up using their code/link. It happens a lot, but there’s something much more profound to incentives than free Uber credits and access to betas.

What are they

Incentives are things that motivate people. You can categorize most incentives as financial, moral, or natural incentives. Financial incentives fuel our desire for wealth; moral incentives appeal to our principles; natural incentives act on our emotions. An example of an incentive is a bonus or commission on a sale.

Many of our day-to-day decisions revolve around incentives. You may be more productive at work because a raise incentivizes you. Or you may go to your religious institution because you are incentivized to be morally aligned (or are perhaps socially). Incentives help make up who we are, so it’s important to have an understanding of how they work. And an awareness of incentives can help you understand why people do certain things.

Recognizing Incentives

By knowing your own internal and external incentives, you will be more self-aware. And if you know the internal and external motivations of the people around you, you will know why people do certain things.

Recognizing your incentives is relatively straightforward for financial and moral incentives. Just make a list of how you spend your time and money and work back from there to infer your incentives. It’s a little bit harder for natural incentives because it requires some understanding of your own psychology, but good indicators are your emotions (e.g. curiosity, anger).

Once you can recognize your incentives, you can start identifying other people’s incentives. It’s relatively easy to notice most other people’s incentives because they are probably similar to yours. [1] Knowing how to identify an incentive structure is much different than actively recognizing incentive structures in your life, though. It’s the difference between knowing how a bike works and how to ride a bike. If you want to actively recognize incentive structures, you have to practice it repeatedly. Some strategies for actively identifying incentive structures are asking “Why did ____ make that decision?” or “What is the goal of ___ in this deal?” After a few what’s and why’s, the incentives of a person/group are elucidated. But the real art is differentiating what the actual incentives are in a system from the seemingly true incentives.

Seemingly True Incentives

These sorts of incentive structures exist all around us, but they are sometimes hard to recognize because we assume incentive structures operate efficiently. An example of determining a true incentive structure is Medicare’s drug reimbursement policy for medication given in the office. In this system, it seems like a doctor’s motive is your health. But your doctor may be incentivized to prescribe you a higher costing drug than a generic drug (a drug with similar effects) because they make more money from the higher costing drug.

Online news (and a lot of news in general) is another example of a perverse/convoluted incentive structure. It seems as though the incentive of the news is to provide the best reporting. But in fact, it usually isn’t. Because clicks-throughs financially reward online content, many writers optimize for click bait. And most things that are optimized for clicks are not optimized for reporting the truth. Rather, it’s about fighting and capitalizing on our limited attention span. When you realize that the news sources you trust make money off clicks, you will have a better sense of what may be true and what may not be. [2]

Aligning Incentives

Although perverse incentive structures may make you distrusting of people, particular incentive structures can be quite productive.

Some of the best incentive structures to exist are in high-performing companies. For a company to be truly successful, many different incentives have to be aligned from the company’s inception to both fuel success and to reduce issues down the road.

Say you have four potential employees that all have different incentives. Employee #1 wants a lot of money. Employee #2 wishes to work on things that have high utility. Employee #3 intends to work with the best people. And Employee #4 desires to work on hard problems. In a company, you can align all these different incentives pretty easily. You can appeal to Employee #1’s desire for money by offering equity. You can appeal to Employee #2’s desire for utility by choosing the right problem for your company to work on. You can appeal to Employee #3’s incentive to work with the best people by offering recruiting bonuses to those in the company that source and recruit the best people. And you can appeal to Employee #4’s incentive to work on bold work by having a moonshots program and 20% projects. [3] All these seemingly different incentives can be aligned very well. And the more aligned the different incentives of a company, the more likely that company is to be successful.

On the other hand, a company can be an example of a structure with many misaligned incentives. For example, you may want to work on a hard, long-term problem, but your co-founder isn’t incentivized to work long term. A classic case of this is Ronald Wayne, a lesser-known co-founder of Apple, who left the company after two weeks. [4] Another example of misalignment is if your employees want to exit quickly, but as a founder, you want your business to go public. Many of Facebook’s first employees had incentives that didn’t align with Mark’s. When Mark decided not to sell Facebook in the early days, many of those initial employees decided to leave the company. [5] Just one misaligned incentive can put a company in gridlock, or even worse, cause these stressful situations to bubble up later on in the future.

If you’re trying to be an exceptional founder, a skill you may want to work on is identifying and aligning incentives. Just one misalignment can cause a potentially huge headache for your team down the road. But if you take some time initially to figure out what everyone is motivated by, you can build your incentive structure to avoid potential impasses and to foster your company’s growth.

Thanks to Josh Browder, Richard Chen, Aneesh Pappu, Yonatan Oren, and Chris Barber for reading drafts of this.

[1] In some situations, it can be difficult to know incentives that are intended to be discreet. Many would point to politicians as having more discreet incentive structures.

[2] Trust Me I’m Lying, from what I’ve heard, is an excellent book on how the media can operate perversely.

[3] Google X is an example of an initiative for moonshots. Many companies also implement 20% projects.