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The Truth about Financial Incentives

Over the last year or so, I’ve seen a rising belief that says financial incentives don’t work. There are even studies that reinforce this belief. One shows that when financial incentives are given for simple tasks, productivity can rise. But when the task is complicated, results can actually get worse.

BIG Finanial Incentive!

The findings make sense in the short term. Simple, repetitive tasks don’t fully engage a person’s brain. When you add in an incentive, it generates a spark to put in a bit extra.

But for complicated tasks, people are generally more focused on what they are doing. When you add the pressure of an incentive, performance can suffer. Very few people actually can hit that clutch jump shot at the end of the game. For the majority of the population, when you add stressors past a certain degree, you get diminished results.

But the problem with short term studies such as this one is that they neglect some aspects of the real world. People are financially motivated, and will go to great lengths to reap a financial reward. Consider these examples:

  • People go to college to improve their earning power.
  • Salespeople go to seminars to learn how to sell more. They invest in computerized tools to make them more effective, and devote themselves to learning how to use the new systems.
  • Food servers modify their behaviors to match what customers tip for.
  • People bucking for a promotion will take on extra projects and work long hours.
  • NFL players (anecdotally) work the hardest in the last year of their contract.
  • People get jobs to earn a paycheck.

The last one is somewhat tongue-in-cheek, but I want to stress an important point. Take away this financial incentive and see how many people show up every day. I am betting attendance would be rather low. Financial incentives are in place for every single employee of every single company. There may not be additional incentives on top of that one, but the underlying premise is undisputable. People will adjust their behaviors for a financial reward. Now, many of the examples above also have other underlying motivators, but that doesn’t exclude money as one of them.

The main point I am trying to make is that financial rewards are complicated. They seem to work in the short term when there is actually something the person can do differently (i.e. set the alarm to get to work on time, or refill a customer’s coffee more frequently). But they don’t work in the short term when better results need more skill.

In those cases, the incentive needs to take a longer term view. It needs to inspire the person to add to their toolbox so they actually can improve their performance. In many cases, skills take time to develop, so the incentive needs to take that into account. You can’t just pay a person to do better today. But you can give them an incentive to improve their skills so they can do better next year.

So, what’s the link to Lean? Simple. In a Lean company, every job becomes more complicated. People are asked to do more than their counterparts at less improvement-oriented companies. So the structure of financial incentives needs some careful consideration to make them effective.

What do you think? Do financial incentives have a place, or are they an ineffective method of improving employee performance?

 

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4 Comments

  • Jeff,

    These studies are certainly very interesting. I believe that I read about the same study which you are referencing. It reminded me of all the surveys we’ve seen over the years where people rank money behind several other factors which they say are important to them. I’m skeptical of those surveys (maybe people don’t want to admit how important money is to them) but this more recent study makes me wonder.

    My experience has been that money motivates people. I’ve seen many people take on jobs that are more difficult or stressful for the pay increase. I’ve seen people jump through hoops to get their bonus. I’ve also been in a couple different plants that rolled out a bonus program for the hourly workforce. It was clear that the bonus motivated at least a large segment of those plants.

    I cannot however say definitively that this motivation turned into improved results. There are many other variables involved besides the team’s motivation. To use your analogy of the basketball game, the team is more motivated to hit the jump shot at the buzzer. The question is will your team react like Butler (who got worse in the 2nd half) or UConn (who got better in the 2nd half).

    I think it’s clear that there is a motivating factor which makes it worth trying. I don’t think that Lean pressures match that of a championship game and you get more than one try. My bigger concern is that money can demotivate just as easily as it can motivate. Make sure any incentives are well thought and administered well.

    There was something we did at Unilever that probably was more effective than the employee bonuses even though it was much less money. We gave $100 or $250 to any employee that did something noteworthy. What made it special was that a manager had to write a personal note about why they deserved the recognition. While the bonuses could put a few thousand into their pockets, the recipients of the individual recognition liked it better because they knew they earned it.

    Interesting post! Thanks for sharing.

    Chris

    • Jeff Hajek says:

      Chris,

      I was stunned at the poor shooting of Butler. I don’t think UCOnn’s defense accounted for all of that. But I digress….

      The key takeaway about the shooting is that an incentive won’t work for tomorrow’s game. But it will work for games next year–if the person has time to spend on the court practicing, getting a good coach, doing conditioning, etc. Financial incentives work when properly structured. They fail miserably when done incorrectly, and as you said, can even be a major demotivator.

      By the way–Chris was our featured Lean thinker recently.

  • Mark Stover says:

    Many years ago, Alfie Kohn published a book called Punished by Rewards. Financial incentives, performance reviews, gold stars, and all the rest actually create counter-productive outcomes. But, we are conditioned to believe in them. Why else does the bonus package continue to be a key part of executives’ compensation structure?

    Because the financial incentive is actually counter-productive, it is, by definition, a waste. I think most lean practitioners would want to avoid a waste of cash like that tied to incentives. And, instead, work on ways to make the work people do more rewarding in itself by providing people with more control and autonomy in the decisions made about their daily work.

    • Jeff Hajek says:

      Mark,

      I think there are many examples of poor financial incentives, (as well as examples of poor performance reviews) but that doesn’t mean that all financial incentives are bad. It simply means that it an easy tool to use incorrectly.

      So, I’ll ask you this question. Would you go to work every day if it was a great job, but you didn’t get paid? I’d bet the answer is no. So, fundamentally, financial incentives do work. (Granted, people do volunteer work, but it is generally only done after financial needs are met elsewhere.)

      The biggest problems with financial incentives are (1) that it is often difficult to identify the impact an individual had on a set of results, (2) they don’t drive the right behaviors, and (3) they are not linked to something that a person can actually control.

      As for your last paragraph, I can’t argue with the benefit of making a job more rewarding. In fact, I even agree that there are better ways to raise job satisfaction than bonuses. For example, in one study, a group of economists determined that having a boss you trust had the same impact on satisfaction as a 30% raise. But not being the best method of something doesn’t mean it is not an effective method. You can have autonomy in a job AND effective financial incentives. And I would say a Lean practitioner should use facts and data to see if the financial incentives were effective as designed, and if not, find root causes for problems and continuously improve the system.

      Finally, I disupte the premise that financual incentives are counterproductive. That would mean that with no other changes, any company with a commission-based pay system for its sales staff would see a rise in sales just by switching to a salaried pay structure. And that would mean that no entrepreneur would ever start a business and work longer hours with the hope of striking it rich. I don’t believe either of those to be true.

      Thanks for commenting, Mark. I knew that there would be some strong opinions on this topic.

      Jeff

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