November 15 by Sarah Van Caster
2017 Nobel Prize for Economics and Thaler’s Work
This month, the Nobel Prize in Economic Sciences was award to Richard H. Thaler, an American economist and professor of behavioral science and economics at the University of Chicago Booth School of Business. Thaler’s work in behavioral economics, which is the study of economics from a psychological perspective, has persuaded many economists to pay more attention to human behavior and to acknowledge the pertinency of his behavioral findings to multiple economic theories. His work has had a far-reaching impact in the business world as well as reshaping public policy. His theories help explain why incentives are critical to driving human behavior in the workplace, and why getting them right should be a top priority for any organization.
“In order to do good economics, you have to keep in mind that people are human,”
For centuries, traditional economic theory followed the assumption that humans make logical, self-interested decisions. Craig Lambert of Harvard Magazine explained that, “the classical Economic Man makes logical, rational, self-interested decisions that weigh costs against benefits and maximize value and profit to himself. Economic Man is an intelligent, analytic, selfish creature who has perfect self-regulation in pursuit of his future goals and is unswayed by bodily states and feelings.”
Prior to Thaler’s work, mainstream economists followed this presupposition that people consistently behave rationally. Economists recognized that this was not always true, but it was generally accepted as a close enough assumption for modeling purposes. Thaler took on the charge of pushing economists away from that assumption. He did not simply argue that humans are irrational. That is fairly easy to prove – think of our own irrational behaviors at home and in the workplace. Instead, the reason his work became so valuable was he was able to demonstrate that people are in fact, predictably irrational, and therefore, human behavior can still be anticipated and economically modeled. And if we can predict irrationality, we can find ways to motivate people, even when they behave in irrational ways.
Click here to learn the 7 common pitfals that can derail incentive programs.
The most famous business application of Thaler’s findings is from his paper with Shlomo Benartzi, Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving. This breakthrough revolutionized the way people save for retirement. At the time, many organizations had 401k plans, but enrollment rates were alarmingly low. People were not choosing to sign up for savings plans, even though it was in their best interest. Through his research, Thaler found that with the proper nudge, or incentive, people could be motivated to make better decisions. With 401k plans, he found that if companies automatically enrolled employees into the savings programs, while still giving them the freedom to make their own choices on investment selections, paycheck percentage, and even have the option to opt out, savings rates skyrocketed. Subsequently, Thaler’s proven theory of automatically “opting in” has been applied not just to employee savings, but across a wide variety of social issues from organ donation to health care selection.
What Thaler’s Award Says about Effective Sales Incentive Strategy
This concept of nudging behavior is also being applied successfully to sales incentives. Not only do we bring our irrational human behavior into the workplace every day, we also live in a fast-past, instant-gratification, highly commoditized world and our personal motivators have changed. Beyond a steady paycheck, sales professionals now seek things like flexibility, autonomy and purpose in the jobs they do. The work we do has also become more complex, and for all of these reasons, the incentives we use must evolve as well.
The traditional carrot and stick approach to sales incentives (and disincentives) dates back centuries. Research on scientific management in the late 1800s found that pay for performance was the best way to motivate worker performance. To get more out of employees, you gave them extra pay for higher production. It was that simple. Additionally, the ultimate stick in the workforce has always been the threat of termination. But the work of Thaler and behavioral economists has debunked these insights in the modern workplace. They have found that merely paying people more does not ensure increased performance.
Successful Characteristics of Effective Sales Incentive Management
In fact, according to several studies conducted by the Harvard Business Review, behavioral economists found that, when not designed properly, “rewards can actually undermine the same processes they are designed to enhance”. And the constant looming threat of termination may momentarily increase performance, but it ultimately leads to unsatisfied workers and high turnover. So knowing all of this, how can we adapt our sales compensation programs to more effectively motivate behavior? Many successful sales incentives now take these behavioral concepts into consideration. Regardless of industry or region, successful sales compensation programs share the following characteristics:
1. Simplicity – When sales incentives are too complex, sales people get frustrated and demotivated because it is not clear to them what it takes to succeed. To avoid this trap, keep your sales incentives straightforward and give your salespeople the tools and communication they need to understand their plans and regularly monitor their performance/progress.
2. Connection to Performance – Payments/rewards need to be communicated and distributed in a timely fashion. All too often, commission payments are delayed months, if not quarters, after a sale has closed. This essentially defeats the purpose of a behavior-driven reward. Minimize leg time between activity and incentive payment so salespeople can connect the dots between their performance and subsequent reward and stay motivated.
3. Ownership – Give salespeople the opportunity to feel a sense of ownership in their compensation plans. Constantly solicit feedback about what they do and do not like about the plans, give them options like selecting from a pre-defined list of incentives or rewards so they feel they have a say. Change plans regularly to avoid fatigue with certain programs/rewards. All of this can go a long way in motivating behavior.
People – salespeople, employees, customers and partners are still the single most important asset of every business. And thanks to the groundbreaking behavioral economic work of Thaler and others, we now have a better understanding of how to successfully motivate human behavior.