Procurement and contract incentives and the law of unintended consequences

The older (more experienced) I get, the more I feel we all underestimate the impact that incentives have on pretty much everything in life; from contracts to social and economic behaviour. And those incentives very often drive unexpected and unintended consequences; behaviour that is rational (based on the incentives) but is not at all what was intended.

In terms of contracts, pretty much every major contract I've ever seen had some unintended outcome drive by the incentives that were (probably accidentally) baked into the terms and conditions.

They may not even have been intended as incentives; but they acted in that way, whether it was PFI contracts being re-financed or outsourced service providers choosing to pay service credits rather than fix a problem (because there was an economic incentive to do that).

A friend of mine pointed out another great example; an IT outsource where the provider was paid (partially) based on the number of calls to the help desk. But of course that was a dis-incentive to actually fix problems; or even to install decent kit and software initially! They made their money on the huge number of help desk calls.  And in a real-life case a provider was prosecuted for making calls themselves to their help desk - and answering them very promptly - in order to make sure their response times met the monthly  target ("95% of calls answered withing 5 rings" sort of thing).

So how can we avoid this - as far as possible anyway? One option is to make sure every procurement team has one or two cynical b*****ds who can review key contractual terms; payment mechanisms, commercial incentives and similar. Their job is to look at contracts and service level agreements and think about what an unscrupulous supplier could do to 'game' the process. Don't rule anything out; if a course of action increases revenue and profit, however strange or dysfunctional it may appear, you should assume a supplier will at least be tempted to do it.

I've been thinking about this in a couple of wider contexts where commercial considerations play a large role; it applies there just as it does in the procurement world. So we'll come back to this hypothesis shortly, but I'd love to feature here any other funny / tragic / educational examples of perverse contract incentives that you've seen.

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Voices (3)

  1. Christine Morton:

    Can I relay a good unintended consequence? It is my favourite.

    A long time ago in a galaxy far far away, when I worked in the private sector in the US…

    I was the project manager for the new Warehouse Management System that was being installed at my workplace (the largest bulk candy distributor in the US). We had moved from a paper-based pick-ticket system, where orders were printed and then picked manually, to one where orders were transmitted via small satellite towers in the ceiling to wrist-mounted barcode scanners. Walk throughs were designed so that the most efficient way to walk through the warehouse was determined and people weren’t tracing and retracing their steps.

    We hadn’t realised the full power of the system until I wrote a Crystal Report that showed how quickly and accurately the workers were picking —- AND put it live on screen in the warehouse. Now, the pickers were being shown live data as to how well they were performing against their peers. Before, evidence of picking efficiency was anecdotal and now we had proof.

    The pickers, being shown their productivity levels, started to compete against each other to be the most productive.

    And the overtime budget dropped like a stone. 🙂

  2. bitter and twisted:

    The most important part of any contract is the exit.

    Its futile to try to enforce good performance through contract terms and incentives and legalese.

    The Seller needs to be getting enough for them to want to keep doing the job; the Buyer needs to be able to walk away and try someone else.

  3. Dan:

    Possibly just a myth but back in the Soviet Union, a factory made screws, and had to meet a quota (rather than just rely on supply and demand. This was the USSR after all).

    At first the quota was based on numbers of screws produced. So to save time, they produced screws that were so small they were useless.

    The next year, the powers that be had wised up, so the quota was based on a certain weight to be produced instead. So the factory made a few screws that were massive. Which, again, were useless.

    In this case, profits weren’t an issue. Its just human nature to take the line of least resistance, and if targets aren’t aligned with objectives, the objectives simply aren’t a priority.

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