The Right Incentives for Teams

e+i Dec 2011


What incentives create the best environment for innovation? Large financial rewards for success and low penalties for failure might motivate the lone genius to pursue a potential breakthrough, but those incentives won’t necessarily work for teams, say Darden assistant professors Jeremy Hutchison-Krupat and Raul Chao.

In most large organizations today, innovation projects are not solo endeavors; they are collaborative efforts involving multiple people from multiple functions. As Hutchison-Krupat and Chao have found in recent research, the team-based nature of innovation must inform how managers use the levers of reward and punishment. The key is to find the right balance.

“A lot of the managers we talk to say that they have trouble finding the right mix of incentives for the teams they oversee,” Chao says. “And that’s not surprising. Teams are complicated.” Experimental studies conducted by economists and psychologists on incentives and decision making don’t offer much guidance to those managers, because the decision scenarios are often pure gambles. For example, study participants might be asked how much money they would place on a roulette wheel knowing that the probability of success is approximately 50%. Innovation projects, Hutchison-Krupat notes, are certainly risky, but they are not gambles. “In successful innovation projects, there’s an endogenous creation of value,” he says. “The contribution of the team determines, in large part, the success or failure of the project.”

To explore how reward and punishment reinforce or offset each other in a team environment and how best to use those levers in tandem, Hutchison-Krupat and Chao conducted a controlled laboratory experiment with 152 participants from the Amazon Mechanical Turk site. The subjects, who represented a broad range of ages and experience, were given a series of eight product development projects. Some subjects were told that they were working alone, others that they were part of a team. Each subject had to decide how much to invest in the project. If a project was successful, the subjects were told, they would earn a percentage of the profits. If a project failed, they would be penalized a percentage of the amount the company had invested. The researchers varied the amount of the reward and of the penalty across the eight scenarios. Actual money was used in the experiments to make the incentives tangible. In fact, successful teams took home as much as $200.

For the individuals told they were working solo, the findings were not surprising: The higher the potential reward, the higher the amount the subjects invested (when the penalty was held constant). And the higher the penalty for failure, the lower their investment (when the reward was held constant). This fits well with the notion, popularized in the management literature, of the importance of creating a culture in which experimentation and risk taking are valued and rewarded rather than feared and punished.

More interesting was what happened with the individuals told they were part of a team. Those subjects did not respond as enthusiastically to the possibility of a large financial incentive, nor did they reduce their investment as much when faced with a higher penalty. The team effect seemed to mute the power of both rewards and penalties. As Chao comments, “Working with other people introduces an element of uncertainty into any project. You don’t quite know what they will do and what you’ll end up with.” The team certainly contributes to the outcome of the project, but the individuals on it realize on some level, perhaps, that the relationship between incentives and effort is not necessarily a direct one.

This is good and bad news for managers of teams. Incentives can help promote a culture of innovation, but managers need to be careful in their use of rewards and penalties. In particular, establishing a blanket incentive policy may backfire. Instead, managers should, for each innovation project, consider the specific nature of the team responsible for it.

As a next phase in this research, Hutchison-Krupat and Chao plan to conduct experiments in which two subjects work through innovation scenarios together in real time and conduct joint decision making about their investment in response to different levels of reward and penalty. Through this further exploration of the use of incentives for teams, the researchers could take some important steps toward articulating what we mean when we talk about a “culture of innovation.”

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