Thursday, December 12, 2013

HR Pros Ignore Economics at Their Own Peril

While the students in my personnel economics course were taking their exam recently, I was browsing my twitter timeline. In close succession, two tweets jumped out because of their direct relevance to this course. The subject of each tweet was a failed HR policy, but after only a half-semester of personnel economics, every student in my course should have been able to easily predict the risks of these HR policies based on a basic understanding of the economics behind human behavior. These are two more examples, then, of the importance of equipping HR professionals with an understanding of economics principles.

Here is first tweet:







This story from Salon (Ayn Rand-loving CEO destroys his empire), describes how the CEO of Sears, former fund manager Eddie Lampert, ruined this venerable retailer:

Lampert took the myth that humans perform best when acting selfishly as gospel, pitting Sears company managers against each other in a kind of Lord of the Flies death match. This, he believed, would cause them to act rationally and boost performance.

My students should instantly recognize this as a form of an economic tournament. Tournament theory in personnel economics reveals that the drive to win an economic contest can motivate higher levels of productive effort, but also provides an incentive to engage in influence behaviors (that is, unproductive activities that enhance one's own chance of winning at the expense of organizational goals). So the result was predictable:

Instead of enhancing Sears' bottom line, the heads of various divisions began to undermine each other and fight tooth and claw for the profits of their individual fiefdoms at the expense of the overall brand.

And then the second tweet:








This story from the Daily Mail (Desperate delivery men ditch your Christmas gifts in the BIN) begins with

Couriers paid per parcel they deliver are desperately dumping Christmas gifts in wheelie bins [a wheeled trash can in America], under doormats and in plain sight of the street....These workers, thousands of whom are temporarily employed at this time of year, are given as little as five minutes to drive to an address and drop off a parcel before starting the next order. They are expected to deliver 100 packages in a day -- and will get between 80p to £1 for each one successfully left (though drivers in rural areas will get slightly more). Many are self-employed and have to use their own car or van, and must then deduct all their costs, including fuel, from their pay. They are paid nothing if they leave a 'Sorry you're not in' card. If they have to return the following morning, this trip is usually made in addition to the parcels they need to deliver that day.

This is an example of a simple piece-rate performance-based compensation plan. Basic theorizing in personnel economics indicates that such incentives can be a good motivator. But a basic understanding of economics principles also teaches us to be cautious because poorly-designed incentives can lead to adverse outcomes by self-interested workers as they respond powerfully, perhaps over-powerfully, to these incentives--for example, by pursuing quantity at the expense of quality.

Again, the results of this case are predictable to anyone with an understanding of the economics of human behavior:

As a result, delivery men feel under pressure to find any means possible to empty their vehicles. In some cases, parcels are being abandoned in dustbins -- only for them to be emptied by the bin men. They have been thrown over fences and locked gates, chucked out of moving vans, left in the rain, put in plain sight by a front door, wedged underneath cars parked in driveways and badly hidden under bushes and between shrubs. It means that parcels frequently disappear or arrive damaged.

As both of these unfortunate cases illustrate, it is important that HR professionals develop an understanding of basic economics principles and how they apply to HR issues. This is the domain of personnel economics. As in much of economics, the models used in personnel economics research can seem quite stylized to students and HR practitioners. There are only one or two types of workers, there are only one or two types of tasks. Effort directly yields saleable output either with or without a random error term. And then graphs (or worse, equations!) are used to find optimal outcomes where marginal cost equals marginal benefit. And so forth.

It can be difficult to grasp these stylized models if one tries to understand them by searching for direct examples from real-world applications. My advice is to instead try to understand these models at face value. They are meant to be stylized portrayals of key issues, not literal reflections of real-world complexities. In this way, the key results are clearer, rather than clouded by confounding complexities.

Once this understanding is achieved, then the critical step is to apply the insights in real-world settings. So the value of personnel economics for HR professionals is not in the literal application of stylized economic models; rather, the goal is to develop the ability to translate the insights of the models to real-world applications in ways that reflect a nuanced understanding of employee and employer behavior. The Sears example is not a literal application of a simple tournament theory model, but the insights generated by tournament theory provide important warnings about the behaviors that would be expected to result. The package delivery example also has complexities beyond a basic economics model--there are issues of training, monitoring, bonuses, temporary work--but again, the insights generated by a stylized model greatly help us understand what happened in this messier case.

With that said, it is important to appreciate not only the power of personnel economics, but also the limitations. There are other factors that also help us better understand what happened in these cases. For example, in the Sears case, managers were humilated and spied on. As insightfully noted by the Salon article,

Employees are not just competitive beings -- they benefit from cooperating with each other and perform better when they are respected, rather than beaten down and driven by fear.

So the goal of developing an understanding of economics principles for HR professionals should not be to provide the basis for a dogmatic application of stylized economic theories--the two cases here clearly demonstrate the pitfalls of that approach. But these cases also illustrate that HR professionals should only ignore economics principles at their own peril. Ultimately, workers are very complex beings driven by economic, psychological, social, and other concerns. So HR professionals must develop sophisticated ways of thinking in order to analyze real situations and design policies in a holistic way. This includes, but should not be limited to, thinking rooted in economics.

302 comments:

  1. wow, perfect article with perfect examples and explanations.

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    1. I have liked the with article and very interesting

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    2. Interesting article. I agreed with the paragraph that says "employees are not competitive beings, they benefit from cooperating with each other and perform better when respected, rather than beaten down and driven in fear". I employees will perform better if treated with honor

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  2. Two very interesting examples of how economic incentive drove workers toward their own self-interest rather than benefit to the organization.

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  3. Treat your employee right and they will take care of you.

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    1. Very true! i would add... that sounds that many are treating employees and machines rather than human beings and therefore the result is lack of respect for others...

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    2. So true! Investing in employees is a smart business

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  4. Pitching one against the other has rarely produced results that contribute towards an organisation's betterment holistically.

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  5. Employees of the month photos are often posted in high traffic areas in organizations. Such as worker cafeterias and reception entrances. Many employers honor such contest winners as incentives to other workers.

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  6. These are great examples of good ideas, in theory and how quickly they can go wrong, when human behavior isn't factored into the policy.

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  7. Very interesting article. Thanks

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  8. wow, perfect article with perfect examples and explanations.

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  9. A number of lessons to learn.Human nature is unpredictable!

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  10. Found articulation for a recent experience at work I had. When workers are self-motivated, would readily cooperate, designing tournaments and pitting them against each other really ruins it!

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  11. Like I always say, You need to give respect in order to be respected.

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  12. It is important to understand that each employee is unique and every company is unique even different branches/offices within the same company are unique. There are many variables and needs to accomplish goals therefore it is important for companies and managers to be open minded but maintain structure. Balance is needed be operate a trustworthy organization with trustworthy employees. I believe it is possible.

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    1. That's the word... Balance. Also tactics is required when dealing with employees, not forgetting to put into consideration economic, behavioural, psychological and social factors

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  13. Very Good. Employees need to be respected and motivated to do well.

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  14. Very good examples that show that incentives can have negative impact also. Well written.It is important to think carefully before any incentive is given as it can back fire also.

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  15. I truly appreciated, and can relate, to the many examples provided within the article. May very well serve as a wake-up call for some manangers; and how to properly treat, respect, and motivate employees.

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  16. I think it is intelligent to use the human's competitive nature to help motivate them and help them from being opportunistic, bored, and as well as taking advantage of the corporation

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  17. Great information in both cases.

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  18. Incentives as explained in your article are very true killers when used in the sales part of an organization. Sales only bothers for items that will add to their incentive or bonus and not to the quality for a customer. Sadly this way of (sales) business is very dominant within my company.

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    1. Yes, especially in sales. Like Mr.Budd said, you cannot measure all employee effort, especially when there isn't any tangible result. It doesn't mean they are not working as hard as those who produce results. And so giving incentives to those who produce results and not to those who don't because you feel they're not working as hard, can foster ill feelings in the office. This isn't good for business

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  19. Incentives as explained in your article are very true killers when used in the sales part of an organization. Sales only bothers for items that will add to their incentive or bonus and not to the quality for a customer. Sadly this way of (sales) business is very dominant within my company.

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  20. I kept thinking back to the days of working in an Recruiting firm, how you had minimum metrics to keep your job, but everyone undercut each other because everything was a competition for the paid for trip and the quarterly bonuses.

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  21. Well said! Workers like the humans they are are psychological and emotional beings. Pitch them against each other and those who feel beaten down are demoralized and thus might not be able to perform to full capacity - then you don't get the best out of them. Thoroughly thought up and designed incentives are truly important indeed for better productivity aligned towards organizational goals. Thank you for this piece.

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  22. Wells Fargo Bank firing employees after being over incentivized is an example of a corporate backfire.

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  23. This comment has been removed by the author.

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  24. I think that employees are influenced very strongly by positive reinforcement and that these initiatives lead to higher productivity

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  25. Interesting article with real life examples that drives the message down quiet clearly. It seems to though ignoring personnel economics by HR managers is not "ignoring" in the real sense but making an alternative choice.

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  26. Professor Budd, I am really trying to understand that if I am applying any theory of Economics in my organization, should I make it completely transparent with the participants (how to achieve it?) I guess the proper implementation of the HR policy should be molded as per the culture of the company and then implemented.

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    1. Remember culture is brought by the way HR policies are made and obviously they are made so that its digestible by the people in the organisation.There are diverse group of people in the organisation hence you are making them follow under one hr policy manual of the organisation.
      And incentives need to be made transparent to the employees to increase their effectiveness not only in sales but also their own efficeiency and selling the product to the right customer in a right manner rather than just making nos. for the incetives.

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  28. Very interesting. Economics affects all aspects of living including corporate existence and intrigues.

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  29. Good read. Spelling mistake found, achieved is spelled wrongly as acheved. Thank you!

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  30. Very interesting and with practical examples

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  31. It is good example for using human resource polices thank you

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  32. Interesting article with great examples. Thank you for sharing it.

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  33. Great incentives examples of what can go wrong, need to strike a balance between economic insurance - Fixed Pay and incentive Variable pay. Too much incentives on say quarterly sales results in unethical sales impacting corporate reputation and undermining brand value. My Employers have recently put a cap on Sales Incentive at 35% of total remuneration and for GM level 25%. Other long term incentives help e.g. stock options.

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  34. Ayn Rand...amazing that even in my nonprofit, human services organization there are management devotees of her philosophies

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  35. This was a great article. Great examples on incentives on what can go wrong, etc.

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  36. it's amazing to see how much more we need to learn about people's behavior.

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  37. incentives are great if it is well managed and monitored.

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  38. True examples, employees exploitation also leading to poor customer service. Cheap or seasonal labor can be changed easily but since the service is impacted heavily, negatively, the whole process should be managed properly including employee's hard work appreciation.

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  39. People Behavior,,Incentive,,Managing,, Monitoring I think all these elements together can create a good employee and achieve organization goal

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  40. Accurately put. If employees are pitted against each other then it becomes purely about self interest and looking out for one's self. The fine line to walk entails lining up the self interested employee's goals to line up with the principal's goal in order to keep both parties happy.

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  41. This very thing is going on at our job and you just see the aspect of teamwork becoming nonexistent.

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  42. Great article with perfect examples and explanations like Kevin & Dawit says: "incentives are great if it is well managed and monitored" because "it's amazing to see how much more we need to learn about people's behavior"

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  43. These are great examples of the pitfalls of incentives without the understanding of economic principles.

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  44. That's significant article for HR person. Although economic principle is important, it should be based on people's behavior.

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  45. Measure what matters. Two great examples that HR professionals and managers can learn from. Some activities are not economically viable, but acting as if they were is a recipe for disaster. The burden/loss is shifted to the contractors in the delivery case.

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  46. I'd also like to point out the recent pitfall of Wells Fargo Bank and customers being sold banking products they didn't need and worse, didn't know were opened in their name. Bankers were quick to sell any product available because it was in their best interest due to having to meet an excessively high sales quota to maintain their jobs. Even though there was monetary incentive to sell more, the primary incentive was to keep their employment, which is a terrible way for any organization to run their business! This not only impacted bad employee behavior, but also sorely impacted trusting customers.

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    1. And ultimately cost the organization in fines and reputation

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  47. People are your most important resource, and they are complex. Find out what works and what doesn't. So insightful!

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  48. This is very interesting. Well said!

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  49. This Is a very interesting article. Organizations and managers can easily be tempted to ignore economic principles and just want immediate result.This can affect their HR policies and in the long run have fatal negative effect on the organization.

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  50. I still can't believe these companies implemented this just for bonuses or to meet their bottom line.

    I understand we need money to survive and splurge and have nice things but something really wrong with the directors of these companies when they see money over anything

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  51. Great article with clear examples. Concepts are clearly understood.

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  52. I think the most important in this concept is how experienced we are and it is not only by reading and pass the lesson. this needs to be worked on it and also requires studying humane behaviors and learning more about them.

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  53. Great article with clear examples, thanks

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  54. relevant examples you made. thanks

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  55. Very insightful and clearly explained. Thanks Prof. Budd

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  56. It is full of very valuable information

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  57. I do not think money is everything, there's the exciting value we get in business.
    Money is very important to secure people's needs but not everything

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  58. very interesting approaches in dealing with motivation, I personally think that respect is the factor to success

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  59. Treat your employees well by giving them value, motivate them by monetary aspects and also by non-monetary aspects, they will definitely work for the organizational success.
    If they don't work after providing all these benefits, then the organisation have to fire the hiring manager who hired that employee.

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  60. So true, I can relate with the Tournament style, this happens a lot in real life and one of the reasons why I left my job of 10 years, when the boss stops thinking for the benefit of the Company and of all the employees but started being obviously biased and listens only to very few some who butters him and do some personal chores, very discouraging and sad.

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  61. Very interesting, I personally think workers are highly motivated through financial incentives. The tournament approach is the best.
    Thanks very much Prof Budd

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  62. This was a very interesting read. It helps to see how an economics understanding is truly beneficial to HR professionals...although at the onset of hearing that, one may think that this sounds crazy.

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  63. clear explanation and examples

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  64. Isaac Olatunde Olubowale do affirm that: This is indeed classic.
    I am better equipped in my leadership role vis-a vis my expectation (positive result) from the Workers I lead and guide.
    The following from the article are note worthy:
    - "Workers are very complex beings driven by economic, psychological, social, and other concerns.
    - Employees are not just competitive beings - they benefit from co-operating with each other and perform better when they are respected, rather than beaten down and driven by fear"
    - The HR Professional's goal is to develop the ability to translate the insights of the economic models to real - world applications in ways that reflect a nuance understanding of Employee and Employer's behavior.

    Thank you.

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  65. Example was very good it related to this topic .

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  66. Wow, great! So loving! I learned a lot.

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  67. HR professionals need to understand the economics of human behaviour so they can bettter create and manage their HR policies and people. Thank you.

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  68. For sure, efforts yield good output by the workers. And ao, HR managers should manage their employees and policies well.

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  69. The topic is explained excellently with great examples. It was interesting and insightful. Thank you.

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  70. Topic was explained very well . It was intresting and insightful. Thank you

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  71. Very Good. Employees need to be respected and motivated to do well.

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  72. Topic well thought-out. It makes reference to how employees need tends to override that of the employers.

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  73. Great article and very insightful. competition amongst workers or colleagues is disastrous in any Organisation.

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  74. Very insightful... I can clearly see how this affected the teams/organizations I have been part of in the past, and how differently this can be dealt with in the future

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  75. Great article! thanks for sharing

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  76. True. Good reflection on the pros and cons of different approaches

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  77. It's inspiring to see how we involve economic principals in HR Related policies and can actually tell whether the policies are the good ones or not.

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  78. great article and very inspiring.Thanks

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  79. The two examples are so true, however very exciting

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  80. Yes, the "domain of personnel economics."

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  81. Very Interesting article. That's Great

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  82. I really enjoyed this articulation and examples.
    As a manager, I've never been a fan of contests. When you train associates, you stress process. You teach them the process and ensure them that following those principles and practices set by the business, will yield the product we all strive for. Implementing contests encourages the product over the process. Then why are we surprised when we find out that the process was compromised.
    Also, what will the behaviour be when the contest is over? Or are we going to do what, unfortunately, what so many retailers do, which is follow-up one contest with another and another... Which leads to so many other Principal-Agent Problems.

    Thank you

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  83. Great read! While I am not a fan of contests with only one winner I am a fan of quarterly bonuses that can be obtained by as many employees who reach the desired standard/goals. This in my experience has been an effective tool for team building.

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    1. True. Because this is not about winning the race but growing together. Team incentives is also one such idea which woould drive the employees as a team towards fulfilling the desired goals.

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  84. Awesome article sir, very interesting.

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  85. I believe working together is better than pitting one against one another.

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  86. awesome article sir! this is very useful

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  87. The article is very valuable, especially since the interest in the human aspect is above all aspirations and goals, and this must be taken into account in all circumstances.

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  88. perfect examples. well explained

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  89. I have the unbelievable opportunity in my current position to promote team building and enhancing the importance and benefit of working as a team. Many of our new employees have stated they feel like they have become a part of a bigger family. It is a wonderful atmosphere to be a part of and many of our staff have said they no longer dread Mondays but actually look forward to them. In contrast I came from a company where the HM created divisions and opportunities of competition within the HR Department. If the HR Department is not a uniformed functioning body the rest of the company will be disjoined and mistrusting as a whole.

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  90. Very good writing and example!

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  91. Woow very eductative, thank you.

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  92. Very insightful. Thank you.

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  93. very informative thanks for sharing this .

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  94. Employees of the month photos are often posted in high traffic areas in organizations. Such as worker cafeterias and reception entrances. Many employers honor such contest winners as incentives to other workers.

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  95. very useful knowledge about the types of pay-for- performance plan and types of Incentives

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  96. true that ! very well explained

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  97. Great article. Very resourceful and educative

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  98. This is very educative in deed.

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  99. Examples are exemplary sir

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  100. Very short and precise article but having significant knowledge and examples that mentioned.
    Thanks for sharing..

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  101. Wow! Very insightful with apt examples.

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  102. money is one of the key factors that keep workers to be self motivated

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  103. Nice article with perfect examples

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  104. Well said and the examples are superb

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  105. Very useful, thanks for sharing!

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  106. This is a very insightful article with clear examples.

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  107. This is really good with the real examples

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  108. This is really very helpful.. Very nicely explained..

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  109. Great explanation,as a HR,you shouldn't be partial.

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  110. Very nice explained it will help me in future in the organisation.

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  111. so true i like the statement "Employees are not just competitive beings -- they benefit from cooperating with each other and perform better when they are respected, rather than beaten down and driven by fear."

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  112. Very helpful and useful .. thanks for sharing . As we can say managers and HR should understand employees and figure out their own people

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  113. I really agree with this interested article because tend to work hard and perform well in team work.

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  114. An increasing demand for flexible working for employees sees the rise in the gig economy. Ignore them and you may just miss out on their talent.
    Most HR leaders still don’t expect the gig economy to significantly impact them over the next few years but flexible and approachable work is increasingly part of the worker motivation, particularly with the younger generations.

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  115. The Sears case emphasizes the importance of knowing your organization, knowing your employees, influencing a positive work culture and providing a supportive work environment. In the second case, it seems management lost sight of their customers--the reason for their existence.

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  116. Very interesting says alot with examples

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  117. I've learnt from this article especially the examples

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  118. This Sears case emphasizes on the importance of HR strategic planning. I learnt a very important lesson, that a poorly managed organization can collapse if they don't work as a team to plan and build it together. fear should not be an option, instead team building is the most essential and accurate way to manage employees.

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  119. i understand what i read and i have learn alot from this article

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