Elsewhere in this book we’ve talked about the importance of setting up performance measures and tying incentives to those measures.

Putting performance measures in place is like removing a blindfold. Suddenly you can see what is transpiring in the different areas of the business. You can figure out which products and locations are doing well and which are struggling. You can track down the reasons for this more easily and make better management decisions.

Once risk information becomes a part of those metrics, you can make even more informed decisions. You can better understand mitigation choices, identify origination points for the true value of different business aspects, and see the different products, services, and sectors of the business in a new light.

As with all of these situations, though, there can be a flip side. Sometimes you can become overzealous or implement measures too quickly. When this happens, you can miss some of the subtle aspects of measures, as well as human nature.

The GoGrow Company found itself in the doldrums. For many years, it had produced fertilizer and seed products for both retail and business uses.

But GoGrow needed to be revitalized—and senior management knew it. They decided to revamp the company through a number of new management techniques. Recently, they implemented a number of new risk management capabilities throughout their production areas. They streamlined processes and improved the quality and control of their manufacturing procedure. Things were going very well.

The next step: building in greater capabilities as part of their sales and customer management processes. Enthusiastic with their results, GoGrow moved on to performance measures and incentives for its sales force.

GoGrow was beginning to turn itself around; already, it had taken numerous correct steps. Choosing to add risk-adjusted performance measures and align those with their incentives and salary discussion was a good idea.

The company completed the process of building performance measures. Management decided on an approach in which they applied a variant of RAROC and made a number of accounting adjustments to the core equation. That way, they could benchmark the company’s performance against competitors. They were thrilled with the prospect of finally being able to get a clear, apples-to-apples comparison against the competition. The measure was so attractive that they decided to use it internally as well.

Before the first quarter had passed, GoGrow’s board had become so enthusiastic about the measure that they decided to start using it to remunerate performance. That way, they could align their sales force with internal company objectives. It made sense to use the same metrics!

They rolled out the plan with only the most cursory planning. There was no discussion or education of the sales force or direct management. After all, they were broadly familiar with the risk measures; what discussion was required? In the first quarter, the company ran into some general timing issues with completing the measurement, but management attributed that to first-time set-up issues.

As time went on, though, the sales managers became confused. They weren’t sure they understood the measures and how they were generated. Much of the information consisted of items they couldn’t track; numerous accounting adjustments further confused them. In addition, they found that the earlier timing problem didn’t end with the first quarter. It was too hard to prepare the numbers; they didn’t finish until many weeks after the reporting period ended. This interminable lag time without information further infuriated the sales managers.

Eventually, a few of the sales managers started to understand the basics by trial and error. They found that it wasn’t too difficult to hit their targets. They just needed to sell some of their mainstream products to easier repeat customers and the problems took care of themselves. They found that they didn’t need to sell many specialty products. The sales managers had always found those products a bit challenging anyway, since they were designed for specific customer needs, and the particular customer set who bought them was the most challenging. Additionally, the sales managers no longer felt the need to seek out new customers. The model seemed to be fairly insensitive to how much they sold. All that mattered was that they made good deals. The better the deal, the better their bonuses.

After a while, the sales teams focused on selling fewer and fewer items, cherry-picking deals on a risk-adjusted return basis and weeding out the less attractive prospects. There was no point in working hard on difficult deals when they didn’t get paid for it, and management didn’t fully understand how the numbers broke down, anyway. Besides, most of the sales force and their immediate management were too frustrated with the measures to care.

In time, the company faced a real shocker. Even though the quality of its deals increased, the volume decreased dramatically. Rather than growing, the company was shrinking. By the time management finally recognized this sharp downturn, GoGrow had severely damaged its market position. This, in turn, increased its unit costs, and the company fell into a downward spiral.

A review of risk management principles as they pertain to GoGrow’s situation reveals a series of missteps that coalesced into a major downturn.

Establish simple and transparent measures.GoGrow implemented hard-to-understand measures that were also hard to generate regularly. These measures frustrated the sales force by making it difficult to meaningfully track activities.

Align incentives properly.The measures only captured part of the company’s objectives and did not address the need to manage and improve sales volume and growth.

Validate the approach.GoGrow failed to fully plan out the process and its potential consequences. The company didn’t realize that its complex measure would be hard to generate and slow to provide feedback.

Communicate and socialize with stakeholders.The new approach was not properly communicated with the sales force. They rapidly lost interest and faith in the approach and opted for the easy route, even though they likely knew it would yield undesirable outcomes.

GoGrow eliminated the performance and incentives approach and moved back to the old modus operandi of rewarding sales volume. Market share slowly returned. However, it took a while before the company could bring back either the risk-adjusted performance measures or the incentives tied to them. The whole concept of complex performance metrics had so annoyed the workforce that no one wanted to hear any more about them.

Eventually, GoGrow relaunched the program. The company built a simpler measure of RAROC for routine reporting and performance tracking. Then GoGrow waited nearly two years to ensure that the front line would accept the approach again. Finally, management initiated a very clear RAROC program accompanied by growth incentives.

As part of rolling out the new incentives, GoGrow made sure to engage key salespeople and key management in both the process and design of the new metrics. The company ensured that everyone understood the measures and also delivered timely monthly reports that were easy to understand.