"Whatever
you subsidize, you get more of."
Referring
to government incentive and assistance programs, that quote was
attributed to Milton Friedman, the Nobel Prize-winning economist
from the University of Chicago.
The business
version of that statement is:
"Whatever
you incent, you get more of."
All too
often, however, functioning incentives — both official and unofficial
— of different parts of companies are not aligned so as to mutually
reinforce what is best for the parent firm. Sometimes such incentives
actually may work against each other.
My first
encounter with such problems occurred when I was with Shell in the
1960s, in trying to coordinate exploration data needs with the goals
of our drilling department. We needed rock data — cores or sidewall
samples — to calibrate our borehole logs, seismic and cuttings
records.
From the
viewpoint of the drilling engineer, however, our request represented
increased costs, time and hole-integrity risks.
We were
being rewarded for making a successful new play, which required
us to locate the correct reservoir facies, whereas he was being
rewarded for drilling a trouble-free well as cheaply as possible.
Our respective
reward systems were not aligned.
Here's
a second example:
During
the 1980s and early 1990s, several companies reported drilling an
embarrassing number of obligatory dry holes in international contract
areas. Many of these dry holes, at the time of drilling, were recognized
as having no chance of finding oil or gas, but the contracts which
had been signed several years earlier before additional data had
been acquired required them to be drilled anyway.
How did
this happen?
The business
folks who obtained international concessions were being rewarded
by how much acreage could be acquired in certain nations or regions,
and sometimes they were not in effective liaison with the regional
explorationists and play-makers, who were mapping future potential
trends based on geotechnical criteria.
The result?
The company was acquiring a lot of land — some under very attractive
terms — but much of it was not very prospective.
Naturally,
low historical success rates by the company's exploration department
did not encourage the management to award incentive bonuses to geoscientists!
Once again, key incentives were not aligned.
As E&P
companies of all sizes seek to become more efficient (and thus optimize
their economic performance), they inevitably come to grips with
the necessity of central coordination of their portfolios. The reason
is straightforward: Individual business units simply cannot have
the perspective to select those projects that are best for the parent
organization, to maximize the likelihood of meeting its goals for
cash flows and growth.
Sometimes
this sets up tensions between the operating business units and headquarters.
Understandably, business units want to maximize their autonomy,
whereas headquarters wants to be sure project selection optimizes
portfolio performance.
Commonly,
the problem is that whereas the incentives for the headquarters
staff are aligned with corporate performance, incentives for business
units are focused more on local performance metrics than on corporate
goals.
A third
example: At the local business unit level, the goal might be "to
get three exploratory wells drilled this year."
Such a
goal focuses on activity rather than adding value. All too often,
this sets up a "dash for cash" that results in business unit A's
good projects not getting drilled because available budget went
to business unit B's prospects, which were rushed through, overestimated
and oversold.
Result:
the corporate portfolio underperformed, even though business unit
B may have achieved its own goals of getting more of the drilling
budget.
Solution?
Take a hard look at your stated incentives (as well as the unstated
ones!). Are you really rewarding the behavior you want? Are you
just rewarding activity, or actual creation of corporate value?
The goal
of everyone should be, "What's good for the portfolio is what's
good for the company — and my business unit is just one cog in
that wheel."
Whenever
I'm asked to help client companies correct chronic under-delivery
of promised E&P reserves, I ask, "What are your geoprofessionals
being rewarded for — creating value, or getting wells drilled?"
In all
our discussions with senior managements, one of our key counsels
is: "Take a hard look at your incentive systems, both stated and
unstated — be sure you're really rewarding behaviors that are aligned
with your corporate goals."
Remember:
"What you incent, you get more of!"
Recommended
Reading: The Clash of Civilizations and the Remaking of World Order,
Samuel P. Huntington (Simon & Schuster, 1996).
In one
of the most important books of the last decade, Huntington provides
the thesis and documentation that a globalized, integrated world
economy along the Western model will not eventuate in the 21st century,
because the other seven dominant world cultures will be able to
hinder and suppress free-market functions. Very strong stuff.
Read
it, you'll like it!