Strategies to Scale — John List on Final Dollars and Culture Scaling

Strategies for Scale — John List on Final Dollars, Bureaucracy, and Culture

Strategies that scale

In The Voltage Effect, behavioral economist John List writes that there are five signatures that inhibit a start-up or policy from scaling up. As we’ve discussed previously, they include: (1) false positives; (2) audience neglect; (3) unscalable ingredients; (4) cost traps; and (5) negative spillovers. The prospects for scaling are diminished if one or more of these factors are unmet.

While these are intuitive ideas, is there anything we can do to improve our chances when it comes to scaling? In his experience and research, List says there are four strategies to consider together: (1) designing effective incentives; (2) thinking at the margins; (3) knowing when you should quit; and (4) nurturing a scalable culture. While these aren’t revolutionary strategies by any means, very few start-ups, companies and governments will master the art of scale.

Show me the incentive

For one, most of us continue to suffer from a correspondence bias, writes List. “We overestimate the influence of personal characteristics and underestimate the influence of situational factors.” Our limited brains crave simplicity. So we’re happy to boil politics and enterprise down to the successes or failings of a charismatic individual.

List reminds us, however, that organizations work only when everyone is motivated in the correct way. No matter how talented they are, individuals cannot scale. But incentives do. The companies and institutions that function at scale are the entities that get their incentives right. As Charlie Munger says, “show me the incentive and I will show you the outcome.”

“Humans don’t scale well, from a quality or cost perspective… While we should always strive to hire well,… every once in a while a rotten apple gets hired… [But] even those apples can behave with integrity and work hard with the right incentives… Motivating people in the service of a common goal hinges on one thing only: you have to get the incentives right… This essential ingredient has more to do with how people work than with who works.”
John List. (2022). The Voltage Effect.

Self monitoring and self image

Incentives, however, are not just about monetary rewards. They can also target our social drivers. Consider, for example, our tendency to “self-monitor”, which refers to our implicit habit to “monitor our social standing in the eyes of others.” Self-image preservation is a powerful motivator. Many parents, managers, and salespersons understand this implicitly and use it to great effect with their respective children, employees, and customers.

List recalls, for example, working with the Dominican Republic government in 2018 to reduce corporate and individual tax evasion. Their strategy was simple: a “messaging campaign… to incentivize people to avoid perceived damage to their social standing.” They sent text messages to remind taxpayers of “a new law that made any punishments levied for tax evasion a part of the public record.” The results that followed were not all that surprising. By targeting their perceived social standings, the “tiny” pilot program “increased tax revenue by more than $100 million.” This was “income that the government would not have received without [their] nudges.” Now, this is not to suggest that we should be designing incentives that target our self-image in every way imaginable. The point is to highlight the manner in which behavioral nudges can move us.

Endowment and clawback effects

Another finding is the endowment effect. As possessive creatures, we “hate losing something we already [own] more than we like acquiring something we don’t”, List explains. It is another manifestation of loss aversion. People feel more strongly about losses than they do about gains. This asymmetry creates a strong motivator among children, communities, and nations. We want to keep what we believe is already ours.

Let’s say, for example, that Harvard University has accepted you into their economics program, and offers you one of two funding options. The first awards you the prestigious John List Scholarship upfront, which pays $20,000 at the end of the year. But it is yours to lose if you fail to maintain a credit average. The second option is the same scholarship, but it is yours to win at the end of the year if you maintain a credit average. Which option do you prefer?

While both options are identical in expected monetary value, most students, I suspect, will prefer the first option (this is aided in part by upfront recognition). The fear of losing a scholarship already won may also motivate them to study harder. This is an example of what List calls a “clawback approach”. The incentive taps into loss aversion and the endowment effect.

Again, this is not to say that every incentive we design should be a clawback. For one, it is very easy to abuse people with unrealistic conditions. Imagine, for example, that you work in sales and your manager tells you that the bonus is yours to keep unless you’re unable to triple sales this year. By locking into your loss aversiveness with certainty, the manager may generate discontent and resentment. Sometimes, bad nudges are worse than no nudges at all.

Revolutions at the margin

Whether in business or public policy, decision-making involves some sort of cost benefit analysis. People weigh up the pros and cons of their options and act accordingly. So when it comes to decision-making at scale, you best be measuring costs and benefits in the right way.

Take healthcare for example. Is it better to measure benefits based on the number of lives saved or the number of years of lives saved? If you operate on the latter measure, health proposals that focus on the youth rather than the elderly may command a higher proportion of the health budget.

The last dollar spent

When it comes to expenditure or returns on investment, List says that we have to “look not at the positive impact per dollar spent on average but the positive impact of the last dollar spent.” In other words, we have to think about “scale from the margins.”

Consider, for instance, a $50 million investment to boost education resources for students. While the program may generate benefits as a whole, it may be the case that the first $30 million spent delivers substantially more benefits than the final $20 million spent. In that case, the government might prefer to allocate the final tranche of funds to other major initiatives instead. But if governments are measuring their return-on-investment as a whole, then nuances at the margins might get lost—inhibiting more effective allocations of resources.

“Economic theory teaches us that a firm is operating efficiently only when the marginal benefits of the last dollar spent on all inputs are equalized across the firm. This gives us a decision rule… We should allocate the investment to the input where the marginal benefit per additional dollar spent is the highest.”
Adam Smith Visits the Mandalorians in John List. (2022). The Voltage Effect.

Obvious, bureaucratic stuff

Marginal thinking is basic economics. So why do few organizations practice it? For starters, it is not easy to do well. Organizations have to dissect their data and analysis to compare alternatives on a like-for-like basis. You also have to experiment more to build data points and to see what does and does not scale.

Leadership must also cultivate a culture that allows people to make and admit mistakes. Nobody likes to admit with the benefit of hindsight that their proposal or policy did not scale as anticipated. And when the fear or failure is engrained, people will find ways to rationalize their position favourably.

Worst of all is the ever present stench of bureaucracy. Resource allocation, after all, requires hard work and consensus. You are effectively taking funds from one project or division and moving it to another. Have you tried asking bureaucrats and managers in the rat race to cede their power to someone else?

List sums it up perfectly:

“Bureaucracies aren’t just sluggish. They are irrational and insatiable. By its very nature, each agency is concerned only with its own survival, and that survival depends on the level of its funding. The result is a culture where efficiency… is secondary to political self-preservation. This isn’t to say that the bureaucrats [or managers] at the top of agencies… are rapacious thugs… Rather, they are simply players in the inescapable drama, wherein competing departments try to amass as many resources as possible, gobbling up money like the biblical whale that swallowed Jonah. Worse, funding for agencies is determined by how much they spent in the previous years, which actually disincentivizes those agencies from saving money… The problem… is that marginal gains are short-circuited by the slow-moving, highly politicized mechanisms of bureaucracy.”
John List. (2022). The Voltage Effect.

Knowing when to quit

American culture reveres the hero’s journey in sports and entrepreneurship. “But for every one of those feel-good stories”, List reminds, “there are likely a hundred thousand people… [who] never get to the finish line.” When the odds are overwhelmingly in your disfavor, it is okay to quit and try something new.

Sunk cost fallacy

We are, however, often unwitting victims of the sunk cost fallacy. We develop “an irrational commitment” to time and money that we’ve already exhausted. When a risky venture goes south, we double down recklessly in hopes to salvage things when the rational mind suggests we ought to stop.

This sounds silly, but it happens at grand scales. Just ask JP Morgan Chase trader Bruno Iksil—dubbed the London Whale—who accumulated more than $6 billion in trading losses after trying and failing repeatedly to claw himself out of a series of bad bets before the company and authorities found out.

Opportunity cost neglect

We tend to double down irrationally when we fail to properly consider our options. This is called opportunity cost neglect. How can you know when to stop or to change course if you are unaware of the alternatives that are available to you? Many leaders fail to grasp the concept of opportunity cost and path selection. Some meandre forward without any sense of their alternatives, while others try to to be all things to everyone in fear of getting things wrong.

To avoid these dangers, List reminds readers to “scale one idea while simultaneously considering other possibly worthy ideas… When you have lots of alternatives, quitting will be much less painful, both emotionally and practically.” For most of us, this isn’t so easy. We have to overcome another “cognitive bias that behavioral economists call ambiguity aversion”—a tendency to “cling to the status quo… [because] we fear the unknown.” I also believe that this is in part why management consultants are so popular. Executives want a respectable albeit expensive way to pass their uncertainty onto someone else.

Edisonian failures

As inventor Thomas Edison once said, “I haven’t failed 10,000 times. I have successfully found 10,000 ways that will not work.” This is not only a testament of perseverance but of knowing when to move on. “Had [Edison] toiled away on unscalable ideas forever, he might never have produced some of history’s greatest inventions”, List writes. Scaling may involve false starts. Sometimes it is better to restart than to double down. Indeed, as Eric Ries observes in The Lean Startup, a fledgling company’s runway depends not only on its cash burn rate but on the number of pivots it can make until the game is over.

Scaling culture correctly

We arrive finally at perhaps the hardest challenge of all: scaling culture. Think about it for a moment. As a company or a nation grows in size, the social norms and institutions that gave rise to its original success begins to take a life of its own. Much of human history, it seems, is a reflection of our ability and inability to organize cohesively at scale. Many systems collapse under their own weight.

Uber syndrome

List recalls, in particular, his time with Uber as their chief economist. Uber co-founder Travis Kalanick “believed in meritocracy in its purest form.” Their meetings “were jousting matches”—“fast, fierce, and gladiatorial”. And for a time, it seemed to work. Uber’s business model was disrupting the world.

But runaway growth and success can disguise a lot of things. You risk conflating the wrong with the right. And in List’s assessment, “Uber’s culture didn’t scale.” By early 2017, many scandals in the ride hailing company began to unravel. For starters, there was Google’s self-driving car company Waymo, who “filed a suit against Uber that alleged the stealing of trade secrets.” Not long after, the New York Times uncovered Uber’s Greyball software that supposedly helped the company to “evade law enforcement and government regulators.” Then there was former employee Susan Fowler, who blew the whistle on “Uber’s toxic workplace culture, in which sexism and sexual harassment were tolerated”, List writes. But that’s not all. Later came the “news of the woman in India who was raped by her Uber driver, only to have the company acquire her medical report in the hope of discrediting her account.” Clearly, Uber had taken a wrong turn somewhere.

Meritocratic in name only

Meritocracies, unfortunately, rarely live up to their ideals in practice. “Plenty of smart and hardworking people get passed over for promotion”, List laments. “Privilege and other factors, like who talks the loudest or plays internal politics most skillfully, end up perverting [the system].” Left unresolved, culture and standards deteriorate. You end up with a culture not unlike Uber.

As List reflects:

“The best people and ideas, sadly, didn’t always win out. This was because the culture at Uber made it acceptable to run people over if it was framed in the service of ideas, efficiency, and profit… Where did Uber’s culture leave those who were deep thinkers but slow talkers? Introverts who prioritized listening over grandstanding?… They got run over… Eventually, it even led to the loss of potential employees…”
John List. (2022). The Voltage Effect.

The solution then is obvious. Just don’t do the bad things that Uber did. And in this way, we’ve come full circle because culture and incentives are intertwined. If your company seeks only to promote dog-eat-dog individualism, that’s what you’re going to get along with all the baggage it brings.

Better instead to nurture “coopetition”, List suggests. That is to promote a culture with incentives that rewards not only the individual, but the elements of diversity and cooperation too. This may range from knowledge transfer and skillful implementation to displays of integrity and collaboration. (As an aside, is it not embarrassing that we are still writing about the basics of human decency in the twenty-first century?)

Autocatalytic effects

Indeed, scaling is a difficult game. From incentives design to culture building, you have to get each and every element correct. But there’s a sort of autocatalytic effect at work. If a company or institution gets the foundations right, then success begets success. Scale comes about as a self-reinforcing by-product. But when the foundations are wrong, the system soon finds itself up against the limit. Without tweaks or pivots or restarts, the enterprise may collapse under itself. To succeed, the decision-maker must distinguish between far-reaching, scalable levers from the ones that are not.

Sources and further reading

List, John. (2022). The Voltage Effect.
Brandenburger, Adam., & Nalebuff, Barry. (1996). Co-opetition.
Ries, Eric. (2011). The Lean Startup.