The Weekly: Edition #92 - April 9th, 2021
Goodhart's Law & Business
"When a measure becomes a target, it ceases to be a good measure." - Marilyn Strathern summarizing Goodhart's Law
Most business owners know their KPI's cold and know how to craft systems and processes that achieve successful growth in these KPI's. But every once in a while, the pressure placed on a single measure, whether through incentive programs or competitive emphasis, causes second-order effects that are purely detrimental - all in order to 'hit the target'. This is known as Goodhart's Law - the more a measure becomes a target, the more reasons people will find to game the system to achieve a satisfactory rating.
We have written about incentives before, and Goodhart's Law is a mental model for understanding why incentives cause second order effects that are not always apparent from the start. Applying Goodhart's Law helps explain why, for example, some teachers may cheat for their students when their bonuses are on the line or why hospitals may fudge patient data when their ratings are at stake.
Simply put, when a rating or measure becomes everything, human behavior tends to get funky.
Let us be clear - tracking KPI's for a business is incredibly important in order to understand what direction your business is heading. Simply tracking KPI's doesn't tend to lead to adverse outcomes. Rather, when extreme pressure is exerted on a particular measure through incentives, second order effects tend emerge in ways that are hard to foresee.
For example:
- The Federal Reserve publicly pushes for 2% inflation and maintains that CPI is in line currently. However, this emphasis on one single indicator leads to second-order effects that are deeply felt but not taken into account in the CPI. For example asset prices are running hot and supply chain constraints (and thus pricing pressures) are real, but this doesn't 'show up' in CPI.
- Wells Fargo employees were pressed hard for growth in absolute number of checking accounts - and growth is exactly what happened, but at what cost? The measure became so emphasized that employees began bending rules and compromising their integrity just to hit the mark.
- Academic citations are incredibly important for scholars. So important in fact, that one professor decided he would cite his own work to boost his credibility:
"For scholars, being frequently cited is a path to tenure and stardom, so the temptation to manipulate citations is huge. Sundarapandian Vaidyanathan, a computer scientist at the Vel Tech R&D Institute of Technology, won an award from the Indian government for being among the nation’s top researchers by productivity and citations. But in 2019 the journal Nature wrote that 94% of the citations of his work through 2017 came from himself or co-authors. He has defended himself, writing that “the next work cannot be carried on without referring to previous work.”'
In general, the more a measure or rating is emphasized, the more that behavior will change to achieve a certain level of that rating. Goodhart's Law tends to be at the heart of scandalous behavior when the measure of success becomes so important that the incentive to succeed overrides all ethical boundaries. Gaming the system is inevitable, so be careful in choosing what you incentivize as a business owner.
Here are four parting thoughts to consider when deciding how to track, measure, and incentivize better performance in your business with Goodhart's Law in mind:
1) Know your KPI's and what human input is required. This is the first place to start thinking about what could go wrong before it does.
2) Do not incentivize proxy KPI's because this encourages gaming the system without real results (e.g. growing the number of checking accounts vs. growing dollars in checking accounts).
3) Avoid creating a pressure-cooker effect where one single measure is emphasized above all else.
4) Create guardrails and policies (e.g. qualifications on incentives) to get ahead of any potential unethical behavior.
Goodhart’s law rules the modern world. Here are nine examples. (Bloomberg)
+ "What Goodhart said 46 years ago in Sydney was this, which he jokingly termed Goodhart’s Law: “Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” In other words, as the British anthropologist Marilyn Strathern later boiled it down: “When a measure becomes a target, it ceases to be a good measure.”"
What it cost to keep two restaurants open during the pandemic without outdoor dining or delivery (Eater)
+ "Sales for Big King and North totaled nearly $2 million in 2019, with 65,000 in-person guests served. In 2020, total sales were closer to $1 million. Of that, $457,000 came in before March 15; since then, Mark says, his monthly average has been only $40,000 to $50,000. Neither restaurant offered delivery before the pandemic — and they still don’t. Mark refuses to work with third-party delivery services like Grubhub or Uber Eats because he considers their business practices — such as regularly charging restaurants more than 30 percent of the cost of an order in delivery fees — “predatory.” Aside from that, he says, the cost of insurance and wages for drivers wouldn’t be worth the money made from added sales. That left takeout as the only option for the restaurants to survive."
Air travel is already back to normal in some places. Here’s where. (New York Times)
+ "In Florida, Key West International Airport is busier than normal, while Miami International has half as many passengers as it did before the pandemic. In the West, big-city airports — in San Francisco, Portland, Seattle — are serving a fraction of their typical traveler volume, between 24 percent and 46 percent. But smaller regional airports, near Jackson Hole, Wyo., and Colorado ski country, have passenger volume as much as 12 percent higher than this time last year. This pattern is typical across the country, detailed new data shows. Large hub airports have just a fraction of the travelers they did at this time last year, even as Americans are returning to flying, particularly to vacation destinations."
Craft Distillers Were Particularly Hurt by COVID (Inside Hook)
+ "As reported by The Spirits Business, the ADI January survey — which included 269 distilleries across 42 states and the District of Columbia — saw a 55% decline in revenue for U.S. craft distilleries in 2020, while 61% of the participating distilleries experienced a drop in revenue from online sales. The latter statistic might be surprising, given that several states loosened direct-to-consumer laws for distilleries."
10% of all restaurants have closed during pandemic (Restaurant Dive)
+ "Over 10% of U.S. restaurants have closed permanently since the start of the pandemic in March 2020, according to Datassential research. This equates to 79,438 shuttered restaurants out of the 778,807 in operation since the onset of COVID-19. The data does not include restaurants that have opened during the pandemic. The food truck segment has been the hardest hit of any foodservice segment, with 22.5% of mobile eateries closing. The quick-service segment has had the fewest closures, losing only 9.8% of fast food joints. Chain restaurants with less than 501 locations have closed at a higher rate than independent restaurants, with the largest permanent closure rate —16.2% — among chains with 51 to 100 units."
U.S. farmers vie for land as a grain rally sparks shopping spree (Wall Street Journal)
+ "The battle for farmland is playing out in small town community centers, online portals and parking lots, where bids in Covid-19-era auctions are placed with a wave from the window of a pickup truck or a quick flashing of headlights. There, auctioneers are peddling parcels of land to farmers eager to cash in on the best commodity prices in nearly a decade. They are also presiding over intense jockeying for fields that can test the fabric of rural communities as a shrinking set of growers compete for control of the nation’s prime soil."
The pandemic is changing employee benefits (Harvard Business Review)
+ "But one of the most dire consequences we face is the alarming amount of working mothers who face an untenable choice: their children or their paycheck. And as any parent will tell you, that’s not really a choice. This problem has surged over the last year: nearly 3 million women — especially Black and Latina women — have been pushed out of the U.S. labor force. A year-long pandemic has erased decades of progress, underscoring just how fragile and inept our old care system was. Our post-pandemic economy won’t fully recover — or reach its full potential — unless and until women get the caregiving support they and their families need."
Archegos poses hard questions for Wall Street (Financial Times)
+ "Historically, family offices have not had to register with the Securities and Exchange Commission because of an exemption for firms with 15 clients or fewer. The Dodd-Frank Act that tightened regulations in the wake of the 2008 financial crisis removed this exemption to shed more light on the hedge fund industry. However, the SEC has let family offices decide for themselves whether they should be registered and file regular reports. A search for Archegos on the SEC’s “Edgar” reporting system yields pretty much nothing — itself eye-catching. Its use of financial derivatives known as swaps to build positions might have allowed it to circumvent reporting requirements on big stakes. Finally, but most importantly: Can the Archegos blow-up trigger a wider financial conflagration, as LTCM did two decades ago? "
MLB’S 2021 Agenda: find fans, avoid covid, and labor strife (Sportico)
+ "Coming off a season abbreviated to 60 games by the coronavirus, MLB is trying to return to a full 162-game slate with three immediate missions: Keep control of COVID spread among each of the individual teams, as players and on-field staff become vaccinated; reopen stadiums to a modicum of fans facing modified restrictions dictated by health and safety protocols; and begin the process of collectively bargaining the current Basic Agreement, which expires Dec. 1 and could lead to a lockout."
Why ships keep crashing (The Atlantic)
+ "The Ever Given’s predicament is both highly unusual and typical: Seldom does a ship get stuck in the Suez (though it does happen every few years), and seldom does a maritime disaster attract such attention. But even though the world is incredibly dependent on ships like Ever Given—a reality that pandemic-related disruptions have suddenly made visible—major maritime incidents are surprisingly common. According to the insurer Allianz, 41 large ships were lost in 2019, and 46 in 2018. Over the past decade, about 100 big vessels have been lost annually. Why does this keep happening?"
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