If there is one topic in business literature that has been covered exhaustively, it is Key Performance Indicators (KPIs). But if you’re not careful, the indicators you set might inadvertently encourage behaviours that can be dramatically damaging…
“In 19th-century India, the city of Delhi had a snake problem. A rather large population of cobras slithered the streets with impunity. The British government decided to get rid of the snakes through crowdsourcing. Officials offered a bounty for every dead snake that locals brought in.
But something unexpected happened.
Soon after the British started to pay for every dead cobra, they realized that local entrepreneurs had begun to breed snakes in order to get paid.
The government canceled the program. So, the cobra farmers released their worthless snakes into the streets.
It turned out the British didn’t want dead snakes; they wanted fewer live snakes. By incentivizing the wrong thing, they inadvertently doubled their problem.”
If there is one topic in business literature that has been covered exhaustively, it is Key Performance Indicators (KPIs). In procurement it’s no different; just do a Google search on “Procurement KPIs.”
KPIs have become an integral part of business, but they should still be approached with caution. Because business is human by nature, there are many pitfalls to consider when defining KPIs. If you’re not careful, the indicators you set might inadvertently encourage behaviors that can be dramatically damaging, and lead to a very different outcome than the one you expected.
KPIs can have negative side effects
The story at the beginning of this post is the origin of the term “Cobra Effect” and illustrates the potentially negative impact that poorly designed KPIs and incentives can have.
In the world of Procurement, some KPIs may create similarly problematic situations. For example, the following two KPIs are used or mentioned quite often:
- Number of suppliers per £/$/€ million third-party spend
- Number of Procurement FTE per £/$/€ million third-party spend
First of all, both KPIs are useless without context and, what’s more, they can also foster dangerous behaviors and outcomes. For example, spend consolidation or supplier reduction programs are quite common in Procurement, and they can lead to over-dependencies by creating situations of quasi-monopoly. Therefore, such a leading indicator (supply base concentration serves an objective, it is a means, not an end) should be considered in a broader context and need to be counterbalanced with other corresponding leading indicators, such as, for example, the impact on savings and on risk exposure (dependence, single-sourcing, etc.).
Another classic example is related to payment terms. Whenever organisations try to improve their cash management/flow, they also question whether or not to extend payment terms with suppliers, even though it has been proven time and time again that the impact of extending payment terms is minimal. Despite bringing some short term benefits, choosing to extend payment terms could create long-term issues, as suppliers will not consider such procurement organisations as a “customer of choice.” In that specific scenario, it would be much more beneficial and valuable to improve Source -To-Pay processing times. This would improve the management of liabilities and cash by, for example, using supply-chain finance, which is a more effective way to improve cash management and, at the same time, relationships.
Purpose is the most effective way to influence behavior
The science of motivation is a complex topic and there are numerous studies in the field of behavioral economics that demonstrate how people are biased and often unconsciously make irrational decisions. Therefore, organisations must use caution when designing KPIs to avoid the folly of rewarding A, while hoping for B.
Luckily, there is a well-known and proven safeguard against pitfalls like these: create a sense of purpose and give actions meaning.
Rather than just focusing on a target, this approach focuses on outcomes (‘why’), which will facilitate adoption and alignment across the organization. Then, people will be able to define the ‘how’, and engage in the appropriate activities (‘what’) based on the context they are in. This form of “commander’s intent” also gives collaborators and suppliers more autonomy (the topic of KPIs and their impact also applies to contracts as a measure of the deliverable or outcome). They need this autonomy to adapt their actions in a dynamic and volatile environment.
“When a measure becomes a target, it ceases to be a good measure.” –Marilyn Strathern, British anthropologist