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Project incentive systems

‘Free riding’ has a bad name, but it may be a necessary burden if firms adopt proper incentive systems for cross-functional projects, says a study by Jeremy Hutchison-Krupat of Cambridge Judge Business School.

One team member relaxes and lets their colleagues do all the work.

The “free rider” concept has a long history in company incentive systems: this concept says that when compensation is based on team output rather than individual functions, some team members exert less effort and still receive the same remuneration. Examined through the lens of individual effort – which implicitly assumes that “more is better” – free riding has long had a negative implication.

Jeremy Hutchinson-Krupat
Dr Jeremy Hutchinson-Krupat

Yet free riding can result in a beneficial end-journey for companies. A recent study by Dr Jeremy Hutchison-Krupat of Cambridge Judge Business School takes a different approach to the free rider concept: the research focuses on the firm’s outcome – as opposed to effort – and concludes that “free-riding may become a necessary burden for the organisation to absorb, if it means they are better off in the end.”

The study finds that team-based rather than functional incentive systems may be preferable in certain situations – based on factors such as the degree to which value can be “decomposed” into specific functional contributions, the level of risk in each function’s contribution to the project, and the burden placed on each function.

“Team-based incentives allow an organisation to pursue a riskier set of projects by placing ‘smaller bets,’ i.e. lower effort at lower cost, on these projects,” the study says. “Such a result can have important implications for organisations that seek to expand their strategic new product portfolio.”

However, because various functions usually incur different costs to generate value to a team project, other companies can benefit more when project team members’ efforts are “decoupled” based on each function’s verifiable contribution.

The study – entitled “Incentive design for cross-functional teams: putting the pieces together” – was published earlier this year in the Journal of Enterprise Transformation.

Dr Jeremy Hutchison-Krupat, University Senior Lecturer in Operations & Technology Management at Cambridge Judge, discusses some of the study’s findings and implications:

By shifting the focus away from the individual level of effort to outcome by the firm, free riding doesn’t seem quite so negative. This different perspective on free riding offers some valuable insight to managers: scaling back of individual effort to meet an organisation’s broader needs may be very beneficial to the company, not least by better allowing new projects to be pursued with less cost and risk.

There is a tension between some of the study’s findings. While team-based incentive systems can advance company goals in some cases, the study’s examination of different costs to create value tends to favour a system based on functional contribution. So managers need to pay really close attention to the fundamental drivers of value in their firm in deciding on the proper incentive system.

There are both direct and indirect costs in each function’s performance. The direct or operational costs include the cost of materials to complete the project, which can reflect relative performance (lighter and stronger bicycle frames are more costly). Indirect costs reflect the fact that effort put into one activity means less scope for effort expenditure on alternative tasks or projects. Both costs impact value created for the firm, and should figure into managerial decisions on the proper incentive system.

Karma (good and bad) can also play a role. Verifying the effort that each function puts into a project can be tricky. A given function can work very hard and generate little value due to bad luck, while another function might glide along but hit a gold mine through good fortune.