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Build a profitable business- the baby steps part 29

Similar incentives. Whenever you put a group of people together and try to organize them in some way, you will notice the extremely different personality types of that group. And since each personality type have their own special way to communicate, thonk, feel, act and get motivated it can be quite difficult at times to get them all running in the same direction, not to mention running at the same pace. But having a gorup of different personality types is not a problem, at least not in most cases. In fact, it can be beneficial to the group since each personality type brings with them their own unique skill set and ability. There is however one aspect that you need to have covered. It is the one aspect that makes or breaks most group efforts and if you fail to solve this issue your chances of success in the long run are slim or close to zero. We are referring to the incentives of each individual and of the group a a whole. We have learned the importance that incentives plays over a long period of time. It has reached the point where we will at times walk away from a deal if we feel that the incentives between us and our potential partner is to misaligned. It´s just cheaper. Rather than putting time and resources into something that is doomed from the onset, we simply let it go if we can´t find a solution.

You see it is our experience that if anything starts out in a problemtic way, you might just as well cut your losses right then and there. If it starts out bad, it usually gets a lot worse donw the line. And there is no start that can be worse than if you start something out with different incentives. You see it is incentives that drive people to action. It is incentives that guides the “invisible hand” that Adam Smith referred to. We like to think that there are a number of other things that make people tick. But in reality, people respond to incentives first and foremost. Their incentives. After all it makes perfect sense. In any given situation people will try to take the course of action that has the most positive implications for themselves. Some people call this selfishness. We call it an irresistable law of nature. After all, life is like a competition in many ways. We all want to accomplish things, to achieve dreams and to make our goals come true. That´s life. We will find ourselves competing with others on most occassions that we try to reach out to our goals. We will be competing for work, for affection, for money, for power or for attention. But we will be competing. And that´s just what nature intended for us. To compete and to move our species forward while we are at it. And when we are competing there is always a line that society says should not be crossed. It is the line of decency and fair play. It is a line of rules and regulations. It is a line of truth and solidarity with the next fellow. And yet, time and time again we cross that line. Most of us have done it sometime during our life. It most likely happened at a time when we really wanted something really bad. Something we felt very strongly about. When our incentives were strong enough we crossed that line. Perhaps we only crossed it briefly and not by a great margin, but we were on the wrong side of it for sure. And that´s ok. That´s just part of being human. We are all reaching for our goals and dreams and in doing so we are approaching that line all the time. We are balancing on it in our efforts to be faster, better, smarter and more successful. And deep down we know that if we didn´t approach that line from time to time, we wouldn´t be a winner. Winners compete. And to compete means to approach that line and keep as close to it as possible at all times. Because the truth is that unless you are actively seeking that line at all times, you are not really competing had enough. And if you are not competing hard enough, somebody else gets to walk away with the first prize.

Whenever we are about to make a deal with another party we always look to align our incentives. The most straightforward way of doing this is to split the profits. But even this can at times produce lackluster results. What if you do a deal with a sales organisation and they sell your product, and in return they get 50% of the profit. This is a common practice in many businesses. Is that straightforward enough? It could be. It all depends on the rest of the circumstances. If that sales organization is selling a trillion other products your deal with them can very easily be lost, and you arrangement will be worth nothing. That´s because they do not have the same incentives as you do. They want to sell, but it doesn´t neccessarily ned to be your product. They don´t care which product they sell, they make money anyway. Let´s give you another example. Let´s say you buy a company and within that company the founder is a working CEO. Let´s say the deal states that he gets payed in relation to what the company gross sales are for the next five years. You later find out that this CEO made a lot of volume deals where there was very little or no profit, but those deals were perfectly aligned with his incentive which was to get paid premium price for his shares. Let us give you another example. One of your employees has a small enterprise on the sideline. You make some inquiries about it and finally accept his explanation. His business, it turns out, is sort of a hobby and he spends very little time on it. In fact he figures it might make him better at his job. Later you find out that your employee has spent the better part of each day working on their own business, while simultaneously colleting pay from you. Why would this come as a surprise to you? You had very different incentives. Let´s do a final example. An employee gets a bonus that is correlated to how much business he brings in each year. The only problem is that the bonus is paid no matter how high the costs of the operations are. This is a detail which is not lost on the employee. The owners of the company later find out that they have had one of the best years ever in that particular department in terms of gross sales. Unfortunately the expense account of that department has shoot through the roof and is up even more than the sales figures. As they go over the expenses there are items there that are so ridiculous they can´t believe their eyes.

All the examples we have provided you with in this section are true stories that did take place. We just mentioned a few of them off the top of our heads but we could have gone on all day long. When the incentives of two potential partners is not as closely aligned as possible, in general that partnership will not end well. In fact, there is a significant risk that the partnership in question will end in bad blood. For society as a whole this mechanism is favourable. By looking out for their best interest individuals most often end up doing that which is best for society as a whole, the theory goes. Thus these individuals help society out, but they do so unintentionally. They are really only looking out for number one. Everything else is simply a byproduct of their real intentions. For those caught on the wrong side of a misaligned incentive it´s not as great. Hopefully they will learn from their mistakes and try to set things up in a better way next time. Individuals will always look out for their best interest. In our opinion, this is particularly true for high achievers and A-type personalities.

At the onset of any partnership each and every partner will ask themselves that age-old question. “Whats´s in it for me”? If you can all arrive at virtually the same answer, you will all work as one group towards that goal. If on the other hand you are best served individually by choosing different paths, that is liekly to happen and there will be no team and no common objective. The interests and incentives of potential partners must always be as aligned as possible or that partnership will most probably end. Next time you do a deal always try to make the incentives of everybody as similar as possible. That way you can all win. If the incentives are misaligned, one specific player tends to win, but only for a short period of time. Sooner or later such a partnership will crash and burn. Such are the forces of the invisible hand. Since Adam Smith did explain it in such an extraordinary fashion there is little left for us than to mirror the words of the master himself. Here is the passage from the classic “Wealth of Nations” that best describes the invisible hand in action:

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.


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