Aligning Incentives

moneyIf you have not read the book, Freakonomics, it would be well worth your while. Steven Levitt looks under the surface of people’s behaviors and reinforces the idea that human beings act according to incentives. What may appear to be an alignment of incentives can actually be a misperception.

I liked Levitt’s example of the sale of a $300K home. With an offer of $290K from a buyer, real estate agents sell their sellers to take such an offer. It really has to do with the math. Waiting a week might net an extra $10K, but the vague math and large numbers distort what the agent is tuned into. That extra $10K only translates into an additional 1.5% commission of $150. The seller has a benefit of $10K to wait. The agent has a much smaller incentive to deal with the hassle for another week. In this scenario, which plays out often, the agent is working against the seller’s interest. In fact, agents sell their houses closer to their asking price than everyone else to prove the point.

Put Yourself In Your Partner or Customer’s Shoes

We spend so much time thinking about ourselves, that it is hard to think about what other people want or are motivated by. When it comes to deal making, it is critical to get your eyes off of your own rewards and think about who you are doing business with. Do your customers or business partners benefit handsomely? Is there enough incentive on the table for them? It is not just a reward, but the amount of the reward that will create incentives.

The mere fact that so many real estate deals happen as Levitt describes, or the numerous other scenarios he exposes in his book, reveals we use emotion over logic too often. We are blinded by our own greed or desire that we cannot see what someone else is motivated by or how much, for that matter.

If you are going to make good deals, then make sure there is proportional risk and reward for all parties. Ask the simple question, “What does everyone get out of this?” It will help you see how to align incentives if there is not a good setup in place.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s