Linking CEO pay to customer happiness: Benefits and risks for Indian firms

Irdai's recommendation on linking CEO remuneration to customer grievances offers a larger lesson on rewards, governance and what companies choose to optimise

The Insurance Regulatory and Development Authority's (Irdai's) recommendation last week to link CEO remuneration to the reduction and speedy addressal of customer grievances has sparked considerable interest in the corporate sector. It should. While the immediate context is insurance, the principle is much larger. It goes to the heart of how businesses are led, what senior management is rewarded for, and therefore what organisations actually optimise.

 

As a watchdog of the insurance sector, with a role to ensure its healthy growth by avoiding mis-selling, improving customer service and encouraging greater efficiency, the Irdai’s recommendations make sense. The aim is to build trust in a category "where the customer understands the product the least when buying it, and needs it the most when claiming it".

 

 

While these recommendations focus on insurance, considered more broadly, this logic applies to almost every business. Anyone in corporate sector leadership positions knows that once rewards are strongly linked to short-term profit outcomes and share price growth, leaders of these companies tend to maximise them, often at the cost of other important outcomes.

 

A simple example is to look at the skew of sales in a month or a quarter towards the final days. In business after business, this writer found that even when there was no consumer or customer reason for a month- or quarter-ending peak, sales were always heavily skewed towards that period. The skew was even more severe when market conditions were tougher.

Why do short-term targets distort management behaviour?

The reason is simple: the figures have to look their best at the end of the month, quarter or year. The entire senior management team, starting with the CEO, is rewarded for that result; hence, the behaviour is encouraged. The consequences often include overloading trade channels with inventory, higher distribution costs due to increased demand for transport on a few days, and higher sales promotion costs to incentivise or “grease” the system. Besides this, there is the extreme management effort from factory to supply chain to sales teams that goes into making this happen.

 

Similarly, several other management “malpractices” abound when incentives and rewards are purely short-term profit-focused. Learning and development and systems improvement budgets are slashed, market development efforts such as advertising are “suspended”, preventive maintenance schedules are “postponed”, etc.

 

This is management reality, not just in the Indian corporate sector, but globally.

How does the Balanced Scorecard help?

A simple management framework created several decades ago to balance both short-term and long-term priorities was the “Balanced Scorecard”. By clearly articulating objectives and goals across four parameters — financial, customer, process improvement, and learning and development — and assigning appropriate weightages to each of them, the framework can give boards and leadership a way to ensure that management focus addresses all stakeholders. The framework could be adapted as required, for example to include sustainability or governance or other goals that have become increasingly relevant recently.

 

A case where this was done and showed very positive results was in the Gillette Company in the early 2000s. The company was floundering and a new CEO, Jim Kilts, inherited a bad system where company leaders and management did “whatever it takes” to meet quarterly financial goals and Wall Street expectations.

 

As a result, customers were overloaded with inventory, quarterly and month-ending sales peaks rocked the supply chain system, and managers unwittingly de-prioritised relationship-building and muscle-building goals.

 

Kilts started by refusing to give stock analysts quarterly growth guidance. With brutal honesty, he said he didn’t even know accurately what the company would sell next week! He then set up and rigorously implemented the Balanced Scorecard way of incentives, along with the usual stock options that reward long-term stock price performance. Leaders and managers had to show performance on a number of parameters, including customer, internal processes, and learning and growth.

 

Management behaviour changed almost magically! The result was a company turned around in terms of fundamental financial performance. It also resulted in greater satisfaction for customers, employees and shareholders.

What should companies watch out for?

While the Balanced Scorecard has proven to be a powerful tool, like any management tool, it is only as effective as the intent and integrity of the leader who uses it. Customer grievance scores, and indeed almost all scores, can be manipulated or “managed”. They can be “weaponised” and cause unnecessary stress in an organisation.

 

This is where the Irdai and other organisations or boards that mandate such rules need to be sensitive and handle these with extreme maturity. These scores need to foster wholesome accountability. But what is needed, at the root of accountability, is a joint belief in the purpose and values of the organisation. Scores, customer or financial or others, need to be used not as a pure “carrot and stick” for management, but as a guide to desired actions that lead to that purpose and to live those values.

 

“What gets rewarded gets done” is a popular adage. Wise business leaders know that while that is correct, it is not that simple! 

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The author is Managing Partner at RedVent Strategy & Design Ltd  Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper