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Moral Hazards of Metrics
| Guest post by: Steve Major |
Article Overview: Build on your awareness of moral hazards within business. Steve touches on seven moral hazards within business - quantitative versus qualitative; creativity, innovation and intuition can be put aside with metrics; no evolution, efficiency versus effectiveness; myopia; assumptions and biases; looking backwards not forwards. This article builds upon the work of Ron Baker of VeraSage Institute.
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Moral Hazards of Metrics
Since the global financial crisis, there has been much discussion about the concept of moral hazard. Moral hazard is originally a term from the insurance industry whereby where a particular risk is insured can lead to behaviour that the insurer is not comfortable with. For instance, because we know our house is insured for theft we get a little bit lazy about ensuring that all windows and doors are locked and adequately protected.
In the financial sphere since the GFC the discussion on moral hazard has been around because the government was willing to step in and support a lot of the investment banks. This has led to a risk taking behaviour that led to dire consequences financially in 2008 and 2009. The phrase "too big to fail" has become part of the lexicon along with "moral hazard".
There are also moral hazards associated with the use of metrics in business. Before I go on further I must give credit to Ron Baker of VeraSage Institute, and his initial work on the hazards of measurement. You will find this work in a chapter of his book ‘Measure What Matters'. This article continues to build upon Ron's work and take it further.
In this article I will briefly cover seven moral hazards:
1.Quantitative Versus Qualitative
When we measure things in a business the quantitative things are easier to measure and thus become the focus. The management accounts, the financial statements, all of the financial tool kits are focused on the quantitative aspects of measurement.
However the story is not complete without the necessary qualitative data. But qualitative data often means judgment calls. This can be very subjective and dependent on the questions being asked.
It is only with the qualitative data, that we can get the full insight into a part of the business that we need to focus on for the business to grow.
One of the hazards of measurement therefore is to only focus on quantitative data, rather than completing the picture and gaining the full insight and looking at the qualitative.
One of the hazards of measurement therefore is to only focus on quantitative data, rather than completing the picture and gaining the full insight and looking at the qualitative.
2. Creativity, Innovation and Intuition Can Be Put Aside with Metrics
Innovation, creativity and intuition are necessary to take the leap forward in business. But with a measurement system in place there is a tendency to rely on that measurement system to the exclusion of relying on creativity and innovative solutions.
The measurement system becomes the ends, rather than the means to determine where we should look at innovation. I believe that there is a place for innovation and measurement rather than an ‘or'.
Metrics can tell us what and where to look for innovation. If we only use metrics then creativity can be stifled. Those who push measurement only, of which there's some very deep works of Thomas Davenport competing on analytics etc, are relying on the fact that there is the necessity to have evidence in making decisions. I believe it can become a moral hazard when all that we do is rely solely on precise measurements, rather than looking at the intuition and creativity being applied to the insights developed from the measurement.
3. No Evolution
The numbers and the metrics we use today may be appropriate in 6, 12 months or 2 years time. Metrics need to evolve as the business grows and the customer needs change. The insights derived from today's metrics may not be relevant in 12 months.
The numbers and the metrics we use today may be appropriate in 6, 12 months or 2 years time. Metrics need to evolve as the business grows and the customer needs change. The insights derived from today's metrics may not be relevant in 12 months.
Unfortunately there is a tendency that once a measurement system has been established, for it to become very hard for it to be modified and changed. There is a tendency to believe that the metrics of the past are relevant into the future.
4. Efficiency versus Effectiveness
One of the areas that Ron Baker and I have had great discussion about is the tendency in business to measure efficiency rather than have measures around effectiveness.
One of the hazards of measurement is that it is easy to measure efficiency, and whilst there is a place to measure efficiency it cannot be the principal focus of the measurement system.
Professional service firms are renowned to measure productivity, but it is not measuring the effectiveness of the solution to the customer.
A measurement system can drive people to focus more and more on efficiency and never look at whether what they are doing is effective. Is the product or service that they are providing to their customer still the effective product?
Continental airlines and Gordon Bethune are a case in point. The focus had been cost per passenger airline mile; which had led to a set of behaviours that fitted, but had nothing to do with an effective solution for their client. Gordon changed this by putting the focus on on-time arrivals, which led to an entire change to the focus on the business.
5. Myopia
A measurement system can lull us into a constant focus on the short term.
Because of some of the other hazards explained often businesses are measuring precise data on the efficiency of the business in the last 3 months and projecting forward to the next 3 months.
This myopia means that we can miss the bigger insights as to where the market is moving and where the customer is moving. This myopia could lead us to miss the innovation leap that a competitor is making to which our customers are attracted towards.
6. Assumptions and Biases
A measurement system by its very definition makes some assumptions about our customers, our team and how they behave. There are some inherent biases within the design of metrics. A hazard that can develop is that we stop looking at what these biases and assumptions are.
Within economics there is a study called behavioural economics. Dan Ariely is one of my favourite behavioural economists, where they study the assumptions and biases and what that means to our behaviour.
Dan is at pains to point out that business and government ignore this information to their own detriment. I believe that one of the reasons that they ignore it is because they have got a set of data and metrics, which has been designed some time ago, and nobody stops to look at how this has been compiled. It is easy to just accept the data and work with it rather than try to determine the assumption and biases that may be within it.
The biases and assumptions need to be part of the review process of any metrics employed in a business.
7. Looking backwards
The measurement systems and financial analytic tools that are most commonly used within a business look at the past. The metrics look backwards and tell us what has gone on.
It is only with insights into what might be happening into the future that we can look at developing and leading the business.
A lot of the ‘off the shelf' financial ratios and metrics focus only on history; it's like driving the car with a rear-vision mirror only. We need to look out the front to be able to guide the car to our destination.
We need to have financial measures and metrics and data that are focusing on the future decisions of the customer and staff, rather than just the past decisions. To avoid this we need to have lead metrics designed. These provide insights into the future.
Summary
In summary, moral hazard is something that the legislators are grappling with, to determine how to manage the financial institutions in the future. They are grappling with how to save the economic downturn hitting on the small business and individual, but not leading to risky behaviour by the big financial institutions.
We have this same battle within a business. Metrics can lead to behaviours that lead to poor decisions. Moral hazard is always a danger. We can minimise the impact by firstly being aware and secondly have a detailed process of reviewing the metrics used. Metrics can give us great insights if used properly.
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Article Tags: assumptions, biases, business, efficiency, intuition, metrics, moral hazards, ron baker
Referred by: http://www.dglong.com
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About the Author: Steve Major RSS for Steve's articles - Visit Steve's website Click here to visit Steve's website   MIND TRAP Ignoring the Evidence MIND TRAP Heuristic Thinking Moral Hazards of Metrics MIND TRAP Following Fads and Fashion How the Right Information Can Mean Increased Profits |
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- Why do I include this in a list of books aimed at female entrepreneurs? Well...in the expectation that there are as many female history buffs as male ones, and in the belief that anyone interested in history will find this book fascinating, while those interested in project management will learn a thing or two.
I think this was the first "gimmick" book - an author using a historical figure (usually a male, military figure, it must be admitted) to talk about modern day business management. I refuse to read any of the kind that advocates - even obliquely - the techniques of the Sopranos or the Mossad - but these military ones are pretty fun.
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Only in the understanding of history, Napoleon might say, do we gain an understanding of strategy in the present. In the same spirit, Napoleon on Project Management offers the recipe for successfully managing your commitments using the strategies, tactics and priorities that propelled Napoleon himself to victory. [The book doesn't gloss over how Napolean eventually fell in defeat, of course, and there's lessons to be learned there as well.
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Foreword by Douglas James Allan (Napoleanic Society of America)
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