Beware of the

By Team Invester India Alliance

22 Feb 2022

If you are part of the startup ecosystem that deals with semiconductors or hardware; you must have heard of Moore’s law. If you are part of sales teams, you may be familiar with the Pareto principle (also known as the 80-20 rule) which often says that 80% of sales come from 20% customers. In fact, you may have unknowingly applied to your studies when you completed 80% of the work in the last 20% of the semester! If you are a strategy enthusiast, you may have heard of Porter’s five forces framework. These are just a few frameworks, rule of thumb or guiding principles that business leaders have relied on for the last few decades.

However, one such fascinating principle that affects almost everything around has often not received adequate attention. We are referring to Goodhart's law, which is named after British economist, Charles Goodhart. In technical terms, it states the following – 

“Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes” 

In plain English, this law is expressed as follows – 

“When a measure becomes a target, it ceases to be a good measure”

Read the Wikipedia article explaining this in more detail here. 

https://en.wikipedia.org/wiki/Goodhart%27s_law

Today, data analytics and data driven decision making are the buzzwords. Any strategic decision – whether it is a business decision or a public policy decision is more likely to succeed if it is based on hard data. That’s very logical, but as we do that, we must be mindful of the Goodhart Law if you are ever going to rely on metrics for decision making. Not remembering or appreciating this may be a root cause of quite a few failed businesses (Start-ups & established companies) around us. Often, the cause of failure may have been attributed to something else (failed strategies, inability to read market transitions, inability to move fast enough, wrong product market fit and so on). 

The Goodhart Law & public policy

Our lives have been literally turned upside down for the last couple of years as we fight what seems to be a never ending pandemic. The metric that is continuously thrown at us is “Number of new cases per day”. All of us may remember reading headlines that went something like this – “In state XYZ, corona pandemic rages uncontrollably – it reported a number of new cases yesterday”. Thus, the metric (Number of cases) implicitly became a target. The states would naturally want to keep that count low to manage public perception. It is quite likely that some people would be tempted to keep the cases down by means such as discouraging testing.  

Let’s look at another example – 

We have often read that lodging an FIR at a police station is a difficult thing. The Goodhart principle may be behind this. Local police stations may be judged by the number of cases filed or the number of cases successfully solved by them. These are of course very reasonable metrics to track when you want to measure effectiveness of a police station. 

Could this be the actual reason why the citizens are discouraged from filing an FIR?

Thus, not paying attention to the Goodhart Law will often result in unintended consequences. In the worst case scenario, it may actually give you a false sense of security till one fine day it all blows up in your face. 

How does this apply to start-ups?

Many start-ups rely on digital engagement to track growth. One of the most commonly used metrics is of course “Monthly Active Users”. Nothing wrong with tracking this as a metric, but the moment you make this as someone’s target, the team responsible for it may feel the pressure to inflate it. As a result, you may spend more than you should on digital marketing, rely on bots to follow your twitter handle and so on. And coupled with a culture of ‘results at any cost’, this problem could be exacerbated multi-fold. 

World-over the sales teams are run on targets and you may not be an exception. Let’s say the account team lands a bumper deal this year. But next year, YoY growth for their account most likely won’t be the same. If the organisation uses YoY growth as a metric to measure account team’s performance – they would be more inclined to avoid such bumper deals that may sting them in future. 

These are just a few examples to give you an idea of how the principle plays out around you. 

In summary, data driven decision making is the right way and using metrics for performance tracking is unavoidable. But adequate care must be taken to ensure you don’t fall in the trap that the Goodhart Law warns us about