Cheat sheet: How to build financial incentives that boost performance

Do people like being given money?

Yes.

Does giving them money encourage them to do what you want them to?

That’s a trickier question.

Do financial incentives work?

The subject of incentives blew up when Federal Opposition Leader Anthony Albanese floated the idea of a $300 cash reward for all Australians who become vaccinated against COVID-19 by December 2021.

It’s clever politics in many ways, but most particularly because it’s hard to argue against people wanting “free” cash.

If you dare argue the point, you look like an out-of-touch miser. “$300 might not seem much to you,” etc., etc. (Which may be valid, by the way).

But the real question, beneath the politics and hyperbole, is whether financial incentives like this work.

How should you think about financial incentives in your business, and does paying people to change their behaviour actually make them do so?

Money is less motivating than we assume it is

Let’s start by addressing the flawed assumption that money is the best solution. That if we give people money, they’ll be motivated to do what we ask.

Sometimes this is true, but not always. Indeed, we tend to overestimate how much we ourselves will be motivated by money.

In a study by the University of Chicago, for example, people said they preferred cash, but task performance increased more when given non-monetary rewards like vouchers for a massage. 

That’s the conundrum for any of us trying to get people to change behaviour — people think money will motivate them more than it really does.

That means when a political party or business commissions market research based on hypothetical future behaviour, like “would you get the vaccine if we gave you $300” or “would you switch banks if we gave you a $500 reward”, it’s best to take the results with a massive grain of salt.

Problems with financial incentives

On paper, financial incentives hold significant appeal. It means we can say, “Look, we did everything we could. We even paid them to get vaccinated/switch banks/work harder!” No wonder financial incentives are a popular go-to in policy and business circles. 

But a big problem with financial incentives is they shift the task from being intrinsically to extrinsically rewarded. Rather than feeling good that I am doing something because it’s the “right” thing, I am doing something because I am being paid to. 

According to the London School of Economics, “We find that financial incentives may indeed reduce intrinsic motivation and diminish ethical or other reasons for complying with workplace social norms such as fairness. As a consequence, the provision of incentives can result in a negative impact on overall performance”.

Throwing money into the mix also shifts what may have been a social contract to a commercial one. Rather than staying back late to finish that project because I want the team to succeed, I will only stay back late if I am paid. This is what a childcare centre discovered when they imposed a small fee for late-collection — more parents were late because it absolved them of guilt.

In addition: 

• Performance has been shown to decline in high-incentive, cognitive tasks. In other words, the more people are required to think to complete a task, the more their performance can be impaired by incentives. Conversely, when the task is straight-forward, financial incentives can help; and
• Just being reminded of money can make people more selfish, choosing to work alone and help others less. If you emphasise individual bonuses, don’t expect your team to collaborate.

Three steps to getting financial incentives right

1. Time the reward

   As a general rule, the closer the reward to the desired behaviour, the better. 

   For that reason, annual bonuses are pointless if you are serious about driving real performance. The reward bears no relationship to the actions your staff take throughout the year. In fact, all you end up rewarding is desperate last gasps and financial fiddlings.

2. Small and often beats large and rare

   Rewarding your team with smaller amounts more regularly will keep them more enthused than the same amount paid as a once-off. 

   Your team might get excited by an annual bonus when it’s announced, for example, but will forget about it for the bulk of the year. Instead, if they get smaller rewards along the way, they’ll enjoy more positive reinforcement.

   The objective here is to build on people’s inherent desire for progress. A study of 2000 workers found job satisfaction was strongly correlated not with their level of pay — as we might expect — but rather how their pay had changed. Getting smaller pay increases more often, it turned out, made these employees happier.

3. FOMO works

   When people see others getting rewarded for something they can also do, the “fear of missing out” (FOMO) can drive them to act. This is why a reward for being vaccinated by a certain deadline could work for some of those lagging behind. 

   It’s not about being motivated by getting the payment, it’s being motivated by fear of missing out on the payment. Fear of missing out on an entitlement is much more painful, and therefore motivating, than simply being rewarded.

   To use FOMO in your business, be very clear about what they need to do to qualify for the reward. You risk significantly dinting workplace commitment if people hold you responsible for them not attaining the reward, rather than seeing it as their own fault.

The bottom-line

The takeaway here is that money changes the nature of a relationship, sometimes in unexpected ways. Rather than seeing financial incentives as a straight-forward “do this, get that” transactional decision, think of them as something that can alter the fabric of your workplace culture in ways that are not always positive.

In short, financial incentives are an expensive way to influence action. Yes, cash can be compelling, but don’t rush to money as the ultimate reward.