Explore Rice

7/15/2005 12:07:00 AM

To make group bonuses go far, business must throw free riders from the gravy train

A majority of America's largest companies use group cash incentives as a way of motivating productive teamwork. Few companies, however, can report that cash bonuses alone always produce the desired effects. What companies need, according to a Rice report, are monetary rewards in combination with routine performance reports and formal rules for monitoring worker behavior to encourage team cooperation and penalize "free-riders."

-----------------------

Over half of major companies in the U.S. use some type of group or team-based cash incentive to motivate their workers, but experts aren't certain these compensation plans are effective. Most plans, especially those that only involve cash bonuses, inadvertently reward uncooperative workers and encourage quantity over quality. What they should include, according to a new Rice study, are combinations of monetary rewards and formal rules and procedures to encourage cooperation and penalize 'free riders.'

In a report titled "Effects of a Team-Based Incentive Plan on Productivity, Product Quality and Firm Performance," Francisco Roman, an assistant management professor in Rice's Jesse H. Jones Graduate School of Management, compares a factory's productivity under a piece-rate incentive plan versus its output following adoption of monetary incentives, routine performance reports and formal rules for monitoring worker behavior.

"After the second plan was implemented, the company saw significant improvements in productivity and product quality," Roman says.

"Labor productivity increased from 60 percent to over 90 percent, product defects were reduced on average by 95 percent and both turnover and absenteeism decreased."

Some of these dramatic results were based on the way in which monetary incentives were distributed. In the factory's earlier compensation plan, a significant portion of workers' earnings was based on individual merit. Workers received base pay and individual attendance bonuses, representing 70 percent to 80 percent of their total earnings.  

In contrast, the new incentive scheme ties a larger percentage of a worker's total earnings to the team's performance. All teams must coordinate efforts to achieve at least one of three quarterly plant-wide performance goals – both in productivity and quality. The amount of bonus depends on which of the three goals are reached in that time period, and workers are only eligible for this particular incentive if they have near perfect attendance during that quarter.

In the earlier arrangement, workers were eligible for a piece-rate bonus based on the number of units produced daily by the team. According to Roman, the factory found that the piece-rates were only partially effective in motivating teams to raise output and often caused workers to ignore quality over quantity. The result, according to company reports, was that an average of 12,000 defects occurred in the months before it introduced the new plan.

In lieu of group piece-rates, the company introduced both team-level and plant-level incentives. One provides each worker with a daily fixed cash bonus when the respective team reaches a fixed number of units and a minimum number of defects. Teams can also earn extra bonuses when exceeding the daily quota. If the team fails to meet both goals, they are not eligible to earn the bonus, and instead, only receive their daily wages.

"Essentially, this type of compensation plan will put more pressure on workers individually and as a team to produce more with a limited number of defects," Roman says.

At the same time company managers provide teams with daily and weekly performance reports. Workers, for example, are told how many units and defects each team is producing throughout the day. Managers also generate reports showing each team's productivity, defects, material waste, absenteeism, turnover and the number of orders completed on time.

To address the problem of individual team members shirking their responsibilities, teams can now suggest they be dismissed after repeated written warnings.

"Shirking had not been disciplined in the firm before," Roman says, "but following this initiative, production workers confirmed that it raised the effectiveness of peer pressure across teams."

Based on his interviews with both management and workers, Roman found the new management controls have helped to reduce enforcement costs and allowed workers to enforce productive behavior among themselves. As the company's data shows, workers are now more motivated to work harder, to cooperate to raise their performance and to learn new ways to improve productivity and quality.

Roman's analysis was based on archival data from three production units in a maquiladora manufacturing facility in northern Mexico. Maquiladora factories are primarily U.S.-owned facilities in Mexican border towns that import materials and equipment on a duty- and tariff-free basis for assembly and, later, exportation.   A division of a U.S. Fortune 500 company, this particular plant has achieved the greatest amount of productivity among all the firm's factories worldwide within its division.

"This study not only confirms theoretical predictions about when and how team-based incentives are more effective, they provide some very practical guides for firms seeking to implement these types of incentive schemes," Roman concludes.

In addition to his work on incentive schemes and managerial control and cost systems, Roman has done research on the impact of innovation and managerial practices on firm productivity and the effects of incorporating non-financial performance measures on firm performance.  

Formerly a financial analyst for Motorola de Mexico and a senior cost analyst for the Mexican operations of Becton Dickinson Medical Systems, Roman has extensive experience in the operations and strategic functioning of maquiladoras.

A member of the Jones faculty since 2003, he earned his doctorate in accounting at the University of Arizona.

For more information on this research, please contact Roman at froman@rice.edu or Debra Thomas in the Jones School at dthomas@rice.edu.