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“Incentives are what drive human behaviour. Understanding incentives is the key to understanding people. Conversely, failing to recognize the importance of incentives often leads us to make major errors”.
Incentives rule the world yet we fail to grasp this simple principle. Incentives are the driving force in any behaviour we exhibit. Charlie Munger has been pretty vocal about the power of incentives and its role in shaping human behaviour.
In his speech “The psychology of human misjudgement”, he reflects on how the power of incentives never disappoints him:
“Well, I think I have been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I have underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther”.
Let’s take an example of a guy who wants to change his behaviour for the better but is unable to do that. Now one may wonder what isn’t allowing the person to change for the better; because there is an incentive to stick with the old pattern. Your social setting is the biggest incentive for you to keep on exhibiting that pattern which causes you misery. Now to promote change effectively one needs to understand the role of incentives in driving behaviour, you need to change your social setting wherein that behaviour gives you the reward, that way you link the incentive with the desired goal you have.
For example, you want to learn to program, but the current environment doesn’t allow you to go for it. Now to make that change a little easier to join those people who are actively pursuing programming that way you have changed your external setting and in turn, your incentive to change has become favourable.
Charlie Munger has given a brilliant example wherein simply altering incentives resulted in desired behavior:
“The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And federal express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally, somebody got the happy thought that they were paying the night shift by the hour and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked”.
If your external settings don’t change the behaviour pattern would remain sticky. For the change to happen effortlessly the external setting and in turn, incentive needs to change. Charlie Munger has given another fantastic example wherein the misaligned incentives hampered the sale of a superior product:
“Early in the history of Xerox, Joe Wilson, who was then in the government, had to go back to Xerox because he couldn’t understand how their better, new machine was selling so poorly in relation to their older and inferior machine. Of course, when he got there, he found out that the commission arrangement with the salesman gave a tremendous incentive to the inferior machine”.
Shane Parrish has also put it aptly:
“Ignoring incentives almost never works out well. Thinking about the incentives of others is necessary to create win-win relationships”.
Have you ever realized why results are so important to you? Because you were rewarded for your results rather than effort, Naturally, your mind was conditioned to focus on results. The conditioning referred to here is known as operant conditioning, which means that behaviour is driven by its consequences. If the consequences of a particular behaviour generate handsome rewards, like you, would keep on playing the lottery if you were rewarded for each and every play even though we know the nature of the lottery is quite risky.
Learning about incentives is of utmost importance. To gain more understanding of this topic one can refer to the document “Psychology of Human Misjudgement”.
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