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« Price gouging on John Stossel | Main | Innovation - Movie Theatre style »

16 May 2006

Comments

John Cooke

This article brings to mind the 'flat rate' pricing involved when having your car serviced. What you might see on your invoice only tells half the story. When you are quoted a price to replace say, a head gasket, that price includes both parts & labor. While the parts is generally a fixed cost, the labor is actually estimated based upon what the employer is willing to pay the mechanic to perform that job. If the employer has decided that a head gasket replacement for your vehicle should only take one hour, then that is the labor cost he puts into the estimate you get. If the mechanic is skilled and has invested in the right kind of tools, maybe he can peform the job in 45 minutes. If so, he gets paid for the full hour of labor that the job is billed out at. Although this may not be the case everywhere, sometimes the 15 minutes of added labor value is split between the employer or employee, the basic economic principle is still applied. If another mechanic took two hours to perform the same job, they would only be paid for one hour of labor. This type of flat rate pricing is becoming more commonplace in the service industry, while the old model of paying for hours worked is slowing going away. Watch for the next time you need an HVAC technican, electrician or plumber at your house.

Ben Pratt

Thanks John - your comments get to the heart of the principle-agent problem with its asymmetries in knowledge (adverse selection) and action (moral hazard).

George Orwell

>>Here's a quick way to destroy your company: make sure there's no connection between what employees are paid and the value they create.

Want an even faster way? Make sure there is no connection between the value an employee creates and the employees you eliminate after an acquisition. It's a sure-fire way to demoralize large groups of people in a very short time.

Ben

George:

First, I want to be clear that the MBM Blog is my personal venture paid for by my own funds - it does not represent Koch Industries or any of its companies... therefore, comments requesting responses on Georgia-Pacific pricing policies (for example) cannot be addressed here - since I don't represent GP in this forum. Please see the "About" link for the disclaimer.

Your comments / challenges regarding this post on linking value creation to incentives, on the other hand, are welcome. I agree that if a company decides it must eliminate positions and it just willy-nilly lets people go at random, based on seniority, or some other equally goofy criteria other than real value creation and competitive position in the industry, then they aren't behaving smartly. Valuable employees will take note of this and start planning alternatives accordingly.

Sometimes a company is legally or contractually required to do such goofy things (as is the case occaissionally with organized labor). In such cases they don't get to pick and choose which laws they will or will not follow, or whether they will honor a contract's terms... they have do it - even if it is against their principles.

Are we in violent agreement on this or am I missing your point?

Ben

George Orwell

Sorry, Ben - I did know that this is your own venture and I should not have asked for a response to a company-specific policy. I did, however, rephrase the question on the post so that it applies to many companies, espcially those whose main business is commodities.

And, yes, we definitely agree that applying across-the-board incentive/hire/fire policies is generally bad business practice. In fact, we discussed it several months ago in class. However, I have seen, firsthand, MBM used in exactly that way - by people who were following directions from people who understand MBM far better than I. That's the break between theory and practice, and I think that "valuable employees" are taking note and leaving (or certainly looking).

Ben

Any guiding principle applied as a bureaucratic, detailed rule will eventually fail. I can imagine times when it might be required to cut across the board without respect to performance. I am sure you can too. I cannot imagine it being anyone's preference, but what is and what should be are often at odds.

It must always be recognized that there are no answers in this life - only tradeoffs. MBM provides guiding principles and a general framework that organizes a core set of mental models against which you can take any prescriptive action and compare for consistency. It's not always the case the two reasonable people would agree on whether something is consistent with MBM - that's why we say it takes a lot of humility and intellectual honesty, and a healthy challenge process. Even after that it doesn't mean everyone is going to agree. The ultimate test will be whether value was created.

Assuming we hold people accountable for results (maximizing long term profitability of the company by creating real value for society while faithfully conducting all affairs lawfully and with integrity) then over time we will tend to become a stronger, more profitable company.

This is the evolutionary argument from the 10,000 foot level - it's not a helpful argument to those who don't fare well at the hands of a crummy manager... but then, there were crummy managers before "MBM" got there and there will be crummy managers afterwards... the difference is that an MBM company tends to find them and grind them out over time.

Those are my thoughts at least - I am willing to be wrong.

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