Tuesday, January 22, 2013

Incentive Trickery

This post is going to begin with a bit of a primer for those of you who haven't taken microeconomics in the last twenty years.

Incentives are costs or benefits that motivate you in some manner.  A lower price is an incentive to buy a certain good. The threat of a higher marginal tax rate is an incentive to work less and relax more. A handgun is an incentive to give your wallet to a persuasive mugger. Pollution taxes are an incentive to avoid polluting. A pleasing feeling of helping your fellow man is an incentive to donate your time to charity. Anything that influences your decisions is likely an incentive of some sort.

Incentives can be internal, like the feeling of a job well done when completing a task, or external, like a paycheck. For the sake of this discussion we'll be discussing extrinsic incentives, or incentives which originate from outside yourself (like a paycheck).

Imagine I've asked you to perform some mundane task. For example, I would like you to sort skittles by color.  To motivate you I'm going to give you a small toy of your choice from a bucket of similar toys. You can pick any toy you want, but first you have to sort skittles for ten minutes. I'll also give you the option of working for an additional ten minutes for an additional toy.  Would you choose to work for ten or twenty minutes?

A recent experiment found that only about ten percent of people chose to work for twenty minutes (their task was transcribing text). It's not a terribly surprising result. Little toys aren't a very good incentive for adults, the task is tedious and becomes more irritating as participants hands begin to tire.  However, the study didn't end there.

Another group of participants were asked to do the same activity under the same conditions but with one important difference.  The rewards (our extrinsic incentive) were split into two groups. The rewards were the same as the first group chose from, but arbitrarily split into two groups.  If the participants worked for twenty minutes they still received two rewards but instead of picking two from one pile they selected one from each pile.

It's important to note that there is no case in which this reward is better than the first groups. To demonstrate this imagine instead of toys you were picking letters. You like letters closer to the start of the alphabet more than letters near the end. We've got all the letters from A to Z to choose from.  If you were in the first group (who could pick any two letters from one big pile) you'd of course pick letters A and B if you worked for twenty minutes (since you prefer letters close to the start of the alphabet). However, suppose you were in the second group and the letters A and B were in the same pile. Now you have to pick the letter A from the first pile and the letter C (the closest remaining letter to A) from the second pile leaving you worse off than if you'd been able to get your favorite letters, A and B.

So if the second group's reward options were at best the same as the first's and possibly worse than you'd expect less of group two to work for the twenty minute interval.  Yet over three times as many participants from group two worked for the longer time period.  Apparently the simple act of separating the rewards into arbitrary groupings greatly increased participants motivation to work.

So what causes this dramatic shift in motivation? There are a couple explanations.

Firstly, although the items in the different groups were fundamentally the same (little trinkets of little value) most people won't mentally categorize them that way.  Most individuals will feel that if they don't get something from both groups that they will have missed out on an opportunity.  The fact that what they're missing out on is a valueless trinket very similar to what they'll already have is irrelevant at the time. They only perceive that they won't have anything from the pile they're foregoing.

The second possible reason is similar but subtly different.  Generally speaking the first unit of a good is the most valuable to an individual.  For example, one steak dinner in an evening is great. Two steak dinners is still great, but most people would agree it's not twice as great as one steak dinner. In the case of this study the first group got their first trinket for working ten minutes which then immediately devalued the second trinket they would receive for working twenty minutes.  The second group however had an artificial divide between the first and second trinket. The trinket they received for the first ten minutes of work devalued all other trinkets of that pile, but the second pile's trinkets maintained full value.

It's a silly but potent distinction. It's unlikely it would persist for many more divisions (especially if trinkets were allocated every ten minutes instead of all at once at the end) but it's still an important tool for the creation of effective incentive systems.

Suppose you were an employer attempting to attract the finest talent at the cheapest cost.  Fundamentally, you can offer very limited rewards to your employees. Your rewards break down into three categories: a rewarding job, a pleasant environment, and money.  Only so much can be done to make a job rewarding, digging ditches is digging ditches no matter how you frame it.  The environment can be changed a great deal to suit your employees. However, money is where you can really influence decisions.  Clearly everyone expects to receive a paycheck.  But if you had to choose between an employer that paid $75,000 annually and one that paid $65,000 and offered more vacation, a company car, more comprehensive retirement planning and offered miscellaneous perks like take home dinners twice a week and health club compensation which would you choose? The fact is the $65,000 plus the perks may actually cost a company less than the $75,000 but it certainly sounds like a lot more.

Ultimately it's all money in different forms. However, the artificial divisions make it seem as if foregoing option two would be missing out on a lot more than just some additional cash.  It's cases like this that make comparing incentives in an equivalent currency (such as dollars) a particularly powerful tool in decision making.

This phenomenon is not limited to incentives others provide either.  Next time you're thinking about breaking your recent New Year's resolution to lose weight consider promising yourself a couple small treats instead of a half gallon of ice cream.  You may find it more effective per calorie consumed.

My apologies to anyone who missed the updates over the holidays. Hopefully you and yours had a Merry Christmas and Happy New Year.

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