Join our community of smart investors
OPINION

The incentive is all

The incentive is all
September 6, 2017
The incentive is all

Actually, the problem was not just that the Provvy hired 2,500 folk and gave them a silly job title. Simultaneously, the bosses of the Bradford-based lender decided that the business model its home-credit operation had used since the late 19th century needed a radical shake-up. So about 10,000 self-employed agents – mostly former customers working for pin money – were told “thanks, but you won’t be needed much longer because you’re being replaced by customer experience managers”. Then – and here’s the really stupid bit – the Provvy’s bosses imagined that during the transition those agents would continue working normally, doing their weekly rounds, knocking on doors, collecting the loan instalments.

For Provident, the reality was as grimey as many of the streets on which it does business. Agents gave up on the job and weekly collections, which normally run at about 90 per cent of the money due, dropped to 57 per cent in the summer. As a result, Provident dished out a brutal profit warning. For 2017, the consumer credit division, which made £115m pre-tax profit in 2016, will dive into losses of maybe £120m, with £20m of one-off costs in addition. For good measure, the dividend for 2017, the interim part of which was announced in August, has been axed.

Provvy’s bosses would surely have done better if they had paid attention to Charlie Munger, Warren Buffett’s nonogenarian sidekick at the enormous US conglomerate, Berkshire Hathaway (US:BRK.B). Mr Munger is convinced that what matters most in business, if not in all human affairs, is incentives.

But incentives work both ways – give people good incentives and they will work well, but give them perverse incentives, and they will behave perversely. The challenge is often knowing how to frame the incentive.

Mr Munger is fond of quoting the example of FedEx (US:FDX), the Memphis-based global courier famed for its overnight shipping service. At the heart of FedEx’s promise of next-day delivery is the ability to load up planes quickly so that they will meet their slot. The problem was that, no matter what FedEx’s bosses did, the night shift would always overrun. Eventually, after going through the gamut of bonuses, pleas, threats, you name it – all of which failed – FedEx chanced on the happy solution. Rather than pay employees by the hour, which created the perverse incentive to eke out a task, it paid them by the shift and, when the plane was loaded and the work done, they could go home. Instantly, problem solved.

Still in the courier business, but this time closer both to home and to Provident Financial’s problem, there was an infamous episode of perverse incentives created at courier firm City Link while it was owned by Rentokil Initial (RTO). City Link had been built up as a franchise operation in which a national network of agents linked up a disjointed parcel service run by British Rail. In 2005, Rentokil decided it wanted to buy in the franchises prior to expanding the operation. In effect, that gave franchisees the incentive both to be bolshy and to do sweet f.a. for the following 18 months. City Link was never the same again and was eventually sold to a private equity firm that oh-so-kindly put it into administration late on Christmas Eve 2014.

Which is not to imply that a similar fate awaits the Provvy’s consumer credit division. But it’s not as though Provident Financial’s misery ends there. It also faces regulatory threats at Vanquis Bank, its fastest growing part, which provides credit cards for borrowers with poor credit scores. The Financial Conduct Authority is investigating Vanquis’s ‘repayment option plan’, which is effectively insurance against late payment and the worry must be that the product came with predatory pricing. Most likely, incentives were at work there, too.

Whether Provident Financial’s sorry state provides an incentive to buy its shares is also a thought. It’s easy to come up with that notion. After all, we know of the stock market’s instinct to overreact and here are shares that, at 858p, are 74 per cent below their 12-month high. And the company’s equity is now valued at barely seven times average net profits for the past six years.

That suggests Provident’s bosses won’t have to get too much right for the stock to be cheap in the long run. The key factor may be the incentives that tie customers to the Provvy. In personal finance, the bore of switching is often an incentive to stay with a provider, yet many of the Provvy’s typical customers don’t even have the luxury of choice. That might add up to a powerful business franchise but, first, those customer experience managers may have to patch up some goodwill. Let’s hope they have the right incentives despite that risible job title.