The ‘Cobra effect’ (unintended consequences)

AS an accountant, I keep myself well-informed and updated about financial developments, including the jargons. One term that caught my attention – maybe because of its relevance to current political and business situations in the Philippines – is the “cobra effect.”

The term was coined by Horst Siebert, a German economist and professor, based on an incident in India during the British colonial rule. This famous anecdote describes a scheme during the British Raj when Indian subjects were paid by the government if they brought in dead snakes. The scheme was aimed at addressing the problem of an increasing number of cobras in the city.

It worked for a while until people started to breed cobras, then subsequently killed them to redeem the cash. Outraged at the “cheating,” the government canceled the program. In the end, the number of cobras in India increased tremendously because people released the ones they bred since they no longer had use for them.
We read of many examples of the cobra effect where noble intentions and apparently good actions ended up doing more harm than good.

Our country is not far from experiencing examples of the cobra effect. When the Philippine government started its war on drugs, there were rumors that policemen received cash for every dead drug lord, pusher or user who resisted arrest. While there is a firm action against illegal drugs, the “reward system” might have led to deaths of innocent people due to acts of abusive policemen whose only objective is to get the reward instead of putting a stop to the illegal drug industry. The solution appears to have encouraged wanton violations of the law.

Business organizations, big or small, have also not been immune from the cobra effect. When there is a pressure for organizations to boost profits or peg the bonuses of top managers or employees to the increase in the number of customers, or to sales growth on a regular basis, there is a tendency for employees to create bogus accounts or sales transactions just to meet management expectations.

Wells Fargo is a perfect example. In the last quarter of 2016, Wells Fargo hogged business news headlines when it announced that it was paying US$185 million as fines to the City of Los Angeles and federal prosecutors. The penalty was a settlement for the illegal opening of deposit and credit card accounts of its customers. The report disclosed that from 2011 to mid-2016, Wells Fargo employees opened about 3.5 million deposit accounts and 560,000 credit card applications, which netted the company US$2.6 million in fees.

The investigation revealed that the scheme of top management to drive up revenues by selling more products to existing customers and the intense pressure to meet the demanding quotas led its employees to resort to these illegal acts.

In my work as an auditor, recovery rates (or the fees that I am able to bill for the time charges of the team doing the audit) become one of the key result areas in measuring efficiency, the profitability of an engagement and the managers’ bonuses. For a service business primarily selling skills measured by time, this is an excellent measure. However, the system can be “gamed” when the audit staff members are not allowed to charge overtime work to keep the recovery rate at an acceptable level. Without a good feedback and monitoring mechanism in place, this results in demoralization among staff members for the unpaid productive work performed, as well as in misleading information for management on the reported recovery rates.

Management leaders should be aware that business decisions, or policies, might create a cobra effect. The potential for unintended consequences is exacerbated by globalization and digitization. We live in a highly connected world where management actions could have unforeseen multiple outcomes. When the action is taken, the intended outcome might happen, but a number of unexpected outcomes might also surface. Only in rare circumstances are the unintended results beneficial.

How then do we reduce the impact of such fallouts to an acceptable level? On one hand, management should make strategic decisions for the company. It should not be paralyzed into not making these decisions in the end for fear of the unintended consequences. In fact, sometimes, management is encouraged to fail fast.

Having said this, the management should always consider not just the best potential or good outcomes but also the possible negative behavioral responses of its people or customers when certain policies, procedures or business decisions are implemented. It is worthwhile for management to monitor the implementation of the chosen course of action and see if it is effective and working as planned. If the negative unintended consequences (especially those that are severe) are looming, the management should be agile to counter, alter or modify its decision or scrap the initiative altogether.

Almost all decisions have good and bad effects and people (including customers) behave and react differently to decisions or policies that come their way. Thus, there is always a need to ponder on the cobra effect.
Ramil Nanola is a partner, Audit & Assurance of P&A Grant Thornton. P&A Grant Thornton is one of the leading audit, tax, advisory and outsourcing firms in the Philippines, with 21 partners and more than 850 staff members.

For your comments, please email ramil. nanola@ph.gt.com or PAGrantThornton. marketscomm@ph.gt.com.
For more information about P&A Grant Thornton, visit our website www.grantthornton. com.ph.

As published in The Manila Times, dated on 14 June 2017