Circular Logic – Compensation Plans That Make Your Head Spin
Circular logic is a term used in business to explain the difficult process of finding the best middle ground between what you ask for and what you get. Often, this pursuit can lead to some incredibly convoluted or "crazy" business practices with no clear pattern, but if you're looking for viable solutions, there are ways to find them. The following guide will help you understand a little more about how these schemes work so you can identify them during your next interview.
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How it works
The basic idea behind this type of scheme is for each party to get what it wants by making concessions. In practice, however, the concessions can often create more problems than they solve -- or even be detrimental in the long run. For this reason, company managers have devised an effective way to mask the system so that employees don't realize that they're being shafted. It sounds a bit complicated, but if you take a look at the particulars you'll see that it's really not as difficult as it looks. They do this by setting up a circular chain of reasoning that leads to the illusion of mutual gain without actually delivering any value whatsoever. Here's an example of how it works:
Company 1 wants Company 2 to produce a product. Company 1 needs to get the product for cheap so that it can be more competitive with Company 3, which is also looking for cheap products. So, because we're trying to make the most of a limited budget, we agree to pay less money for the product than what is usual. The effect is that Company 2 needs to find some way of making up the money lost from our initial offer and this starts the circular logic.
Company 1 agrees to pay Company 2 $500. Work is done on the product. As expected, it costs more than $500, which means that Company 1 has to pay Company 2 extra money so that the product is profitable. This adds up to a whole lot of extra work for Company 1 and its crew without delivering any value for Company 2. In this way, even the money required for the initial work is not very good value because it will only come at a direct expense of valuable human capital within Company 1. The next step is a new round of circular logic.
Company 1 agrees to pay Company 2 $500. The work is now done and it costs much less than $500, which means that Company 1 has to pay Company 2 a little extra, which means that the new product is not profitable. Therefore, the circular logic says: "Now we'll just get the product for free," and it goes around in circles.
Company 1 agrees to pay Company 2 $500. As it turns out, the product costs more than $500, so Company 1 has to pay more money for the existing product than was initially required. This goes on indefinitely and so the company gradually starts to lose money, while taking on more and more work.
By the end of the process, Company 1 is left with a shoddy product anyway (or none at all), while Company 2 has plenty of money and no customers. Even worse, in the long run Company 1 will be at a distinct disadvantage relative to its competition, because it didn't really manage to save on costs even though it was able to temporarily pull off an impressive deception. Only an external audit will reveal that things did not go as they were intended -- which is why many companies that use this scheme never achieve any significant success at all.
The real point of this example is to help people understand that circular logic is something that only appears right in a flawed system, because it's actually the result of an implicit assumption present within the whole scheme. Because we (in this case Company 1) consider Company 2 to be an asset, we have made an assumption (that makes logical sense) that the "cost" of the product can be subtracted from its initial offer. We think that Factory A's contribution to our business will always be at least half what its real value is, because managing it is easier than managing alone. Our argument seems to make sense, but in practice this is where we get into trouble.
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How to deal with circular logic
The problem that occurs here is that this system creates a cycle of mutual destruction. Company 1 needs Company 2 to keep its costs down and so it has to find ways of doing so. This is actually a valid business objective and it makes sense if you consider that Company 2 can be used as a critical component in achieving the goals of Company 1. Until now, however, Company 1 hasn't uncovered what is happening behind the scenes and so it hasn't realized that its short-term objective has resulted in a long-term loss. The only way to solve the riddle is to make explicit one important assumption:
Company 2's contribution to Company 1 will end up being exactly what it is worth.
If this was the case, then there would be no problems at all. But, this assumption is not correct. It's as if you're leaving out an important fact in a math problem and then you can't work out the solution. Just like the teacher would tell you to check that your problem makes sense, it's up to us to make sure that the assumptions we've made seem believable. Since we took on Company 2 because it would save us on costs, we have to remember what those costs are. Instead of looking at short-term results and assuming that they'll be profitable in the long term, we should accept that they might not be and then ask ourselves why we're doing it anyway.
Conclusion
Circular logic is the result of an implicit assumption that we make with regard to things. It's a useful concept to understand when it comes to evaluating systems and the results they produce, but it's also important to remember that not all assumptions are valid and we shouldn't assume them just because they seem reasonable on the surface. We can also tell other people about our assumptions, so long as we make sure that what we're saying makes sense in terms of their knowledge and experience.
Circular logic is an important concept in conceptual analysis, but it's less obvious when applied within management.