Decisions, Incentives, and Prices Archives

Santa undoubtedly learned how to deliver billions of packages around the world, by aircraft, in a single night, by emulating FedEx. In 1971, Yale alumni Fred Smith founded FedEx with the goal of providing an end-to-end, air cargo delivery network for the U.S. To make the deliveries efficient, FedEx relied on a hub-and-spoke distribution system where all packages would be rapidly shifted among airplanes at one central airport each night. That meant the entire customer experience relied upon the FedEx night shift completing their job of shifting packages as quickly as possible. But for some time, they just couldn't manage to do it -- the night shift would rarely complete its mission on time. FedEx's management team tried changing the night shift's processes, how packages would be stacked and organized during the shift, how packages would be loaded, what type of equipment was used to help move the packages, how packages were labeled and tracked -- nothing worked. The management team appealed to the night shift's sense of mission, but that didn't work either. Finally, a FedEx manager got the bright idea that it was counterproductive to pay the night shift by the hour when the company wasn’t trying to maximize billable hours but rather accomplish a specific task (shifting the packages among all the planes) as quickly as possible. So FedEx started paying the night shift employees on a per shift basis rather than a per-hour basis, and employees were allowed to go home when all the planes were loaded. And, overnight, FedEx’s night shift became a paragon of efficiency, and FedEx’s problem was solved. "Incentives are superpowers... Never, ever, think about something else when you should be thinking about the power of incentives." Charlie Munger For fun, here is a modern day example of an equally terrible incentive mistake that many companies are still making: Many large tech companies compensate their engineering employees with stock options. Those stock options benefit underperforming employees the same as over-performing employees, which has several undesirable psychological consequences that impact the company's bottom line: Employees don't "feel" a direct connection between their performance and their compensation. The stock option is perceived as part salary and part casino winnings, rather than as compensation that depends on the employee's actual quality of work. The highest performing employees can feel that they are not being compensated fairly, since their compensation is tied to the same stock performance as the worst performing employees. Stock options are supposed to create loyalty from employees. However, in a bull market, they can have the opposite effect. Employees can get rich quickly even if they haven't provided significant value, and then retire early, leaving the company shareholder's worse off not only because the employee was compensated for more value than they provided but also because the company has lost an employee who must now be replaced. In a bear market, stock options can become worthless even for highly productive employees. That can disincentivize a company's most valuable employees and lead to some of them leaving to join other companies that offer stock options with lower strike prices for the current market. If you enjoyed this article, subscribe to the Axiom Alpha Letter to read more like it.