Moral Hazard

At some stage everyone gets acquainted with the dilemma of how to respond to bad behaviour.  Faced with whether to rescue such fallings can cause sleepless nights when you feel that you might inadvertently be rewarding them and thereby encourage future failings of a similar nature, rather than stem their re-appearance.

A classic ‘moral hazard’ in sales often concerns how to treat a salesperson that’s way off quota.  If you pass on leads, add territory/opportunity, or keep them in post, then rather than raise their and the collective performance, you can instead let the rest deduce that they can get away with below par figures and the overall number drops.  Thus Sales Managers can be inclined to let someone swing in the hope that it avoids an under-performance disease spreading.

Yet there’s another selling moral hazard thrown up by the credit crunch-ed recession.

What do you do when a customer ‘suggests’ you understand an imminent huge reduction in previously guaranteed supply, an interminably long delay to your latest project or the necessity to swallow a massive discount?  Especially when the hammer blow is supposedly softened by reference to the current economic climes…

Does acceptance leave you open to suffer yet more damage at a later date?  Is your policy of appeasement doomed to leave you making ever more devastating concessions?  How do you avoid the traps of such moral hazard?

The successful solutions I’ve seen are based on what happened in the UK a couple of years after the dotcom bubble burst and raw material metal prices soared, when construction activity was thought to be dropping by around ten percent.

The winners I knew defended margin and tried to lock-in supply.

In the case of maintaining a profit, the approach was to reduce provision commensurate with overall project caps, so that a fall in revenue did not lead to disappearing margin.  In other words, you can help with the topline being less, so long as the delivery is also less in line with it.

With trying to cement a supply arrangement, short-term special pricing was granted so long as an increase was enshrined in the contract for the subsequent year.  I was surprised at how the clients accepted a price rise next time round, but it did make for a simple conversation at that subsequent renewal time.