The cobra effect

“Show me the incentive and I will show you the outcome.” — Charlie Munger

Well-designed incentives have the power to create great outcomes; poorly-designed incentives have the power to…well…create terrible outcomes.

Goodhart’s Law says that when a measure becomes a target, it ceases to be a good measure. Simply put, if a measure of performance becomes a stated goal, humans tend to optimize for it, regardless of any associated consequences. The measure often loses its value as a measure.

One of the most prominent examples of this in action comes from the story of the British colonists’ cobra eradication efforts in India.

There were too many cobras in India. The British colonists—worried about the dangers of these venomous creatures—devised a plan to reduce the cobra population.

They started offering bounties for cobra heads.

Some savvy locals developed a business model:

• Breed cobras
• Chop of their heads
• Turn in cobra heads and collect bounties

The British realized what was happening and ended the policy. Many of the breeders simply released their remaining cobras onto the streets, thereby increasing the population of cobras.

The British viewed cobra heads as a simple measure cobra elimination, so attached an incentive to deliver cobra heads. The result? An incentive designed to reduce the cobra population actually increased it.

Once you internalize this framework, you see it all around you:

• Wells Fargo Account Opening Scandal: Senior leadership of the bank viewed new account openings as an easy way to track business growth, so it gave its junior employees target account opening goals. The result? Employees opened millions of fake accounts to hit their targets and Wells Fargo was fined billions for the fraud.
• Amazon’s “Hire to Fire” Issue: Amazon believed employee turnover was healthy and had created a culture where the bottom 10% should be scrubbed annually in order to continue to upgrade the talent level of the organization.To incentivize healthy employee turnover rates, it gave its managers a target rate for annual turnover. The result? Media articles about a “hire-to-fire” practice emerged. Managers had allegedly hired employees they planned to fire in order to meet their turnover targets.

Credit to Sahil Bloom from The Curiosity Chronicle.