Help Guide: Aligning Financial Rewards in Business Transformation
Business transformation is not just about altering processes or technologies—it’s about redefining an organisation’s DNA. One crucial aspect often overlooked is aligning financial rewards with these transformative objectives. The consequences of this oversight can be profound, stemming from deep-rooted psychological predispositions.
Our Psychological Disposition Towards Rewards
We are inherently motivated by rewards, but we’re not always predictable in our reactions to them. Research has shown that people are affected twice as much by the fear of losing something as they are by the prospect of gaining something of equal value—a phenomenon known as loss aversion. Daniel Kahneman, a Nobel Prize-winning psychologist, posits that this is why we might spend hours hunting for a lost £10 note but will be far less likely to make the same effort to find a £10 discount.
Loss Aversion and Value Distortion in Everyday Decision Making
Daniel Kahneman’s exploration of behavioural economics, especially in collaboration with Amos Tversky, exposed the depth of our irrational decision-making tendencies. Not only do we exhibit loss aversion, feeling the pain of losses more intensely than the joy of equivalent gains, but we also often misjudge the actual value or likelihood of these gains and losses.
Everyday Examples of Loss Aversion and Value Distortion
Sales and Discounts: Beyond the fear of missing out on a deal, our perceived value of a product can get inflated during a sale. We might overestimate the utility or quality of an item just because it’s discounted, thinking we’re making a better decision than we actually are.
Endowment Effect: This isn’t just about valuing something because we own it. We might exaggerate the worth of our possessions, thinking that, for example, our used car or old phone is worth far more than the market price or that others would surely see its value as we do.
Sticking with the Status Quo: Our reluctance to change isn’t just about fearing loss. We often overestimate the benefits of our current situation while underestimating the potential benefits of change, keeping us stuck in sub-optimal situations.
Sports and Games: Poker players might not only chase their losses but also overestimate their skill and chances of winning the next hand. This distorted perception can lead to greater losses in the long run.
Gym Memberships: Keeping a rarely-used gym membership isn’t only about sunk cost. We might overvalue our future commitment, thinking, “I’ll surely start going regularly next month,” even if past behaviour suggests otherwise.
Over-insuring: Beyond the fear of a potential event, we might overestimate the likelihood of that event. For example, after watching news of a natural disaster, we’re more likely to upgrade our insurance, thinking such an event is imminent for us, even if statistically unlikely.
Lotteries: People tend to overestimate their chances of winning lotteries, believing they have a unique edge or “feeling lucky,” even when the odds are overwhelmingly against them.
Recognising both loss aversion and our tendency to distort value is essential. By understanding these cognitive biases, we’re better equipped to navigate decisions more rationally and beneficially in our everyday lives and when helping those around us.
The Cost of Misaligned Rewards
In the professional world, when financial rewards are not aligned with the goals of business transformation, the outcome can be detrimental.
Nokia, once a dominant player in the mobile phone market, faced challenges in adapting to the rise of smartphones. Internal competition for resources, combined with a reward system based on meeting short-term goals, hindered the company’s ability to focus on long-term innovation. This misalignment contributed significantly to Nokia’s decline in the smartphone market.
Harnessing Rewards for Successful Transformation
Conversely, when companies align their reward structures correctly, they can motivate teams to achieve even the most challenging objectives.
When Ford Motor Company was facing financial difficulties in the late 2000s, Alan Mulally, the CEO, introduced a performance-based bonus system. This system rewarded team achievements over individual successes, fostering collaboration and aligning personal incentives with the company’s overall transformation goals. This change was instrumental in Ford’s turnaround.
Personal Life vs. Professional Rewards
In our personal lives, we often set rewards for ourselves or our children as motivation. For instance, a parent might offer a treat if their child finishes their homework. The treat is aligned with the desired behaviour. Similarly, in businesses, aligning financial incentives ensures that employees are motivated to work towards the transformational goal, not against it. A particular case to watch out for is where people perceive that they will be in some way financially worse off as a result of the proposed changes, this will most likely put the brakes on their level of engagement, even if only at an unconscious level.
One example is the use of energy in our homes. We have a global imperative to go green and yet the green option remains more expensive for most people. That means they are left with a sense of internal conflict, between doing the right thing and balancing their personal budgets.
Recommendations for Organisations
Reassess Regularly: Ensure that reward systems are evaluated frequently to stay aligned with ever-changing business objectives.
Encourage Collaboration: Reward teamwork and collaborative endeavours over isolated individual achievements.
Communicate: Ensure all stakeholders understand the link between their incentives and the organisation’s goals.
Aligning financial rewards with transformational goals is not just a nice-to-have; it’s a strategic necessity. The psychological pull of incentives, especially when aligned with aversion to loss, can be the key to driving transformational success.