Everyone is probably familiar with what an incentive is - it’s a thing that motivates or encourages someone to do something.
Here are two great examples that illustrate the importance of incentives very memorably.
First here’s Charlie Munger’s favorite example:
One of my favorite cases about the power of incentives is the Federal Express case. The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked.
Here’s my favorite example:
There was a problem with mice on campus. The solution for exterminating the mice was to pay students $1 for every dead mouse they delivered. It worked! Until the students began breeding mice in order to make more money…