Understanding Incentives

In the book Freakonomics by Steven Levitt, an experiment is described involving a manager overseeing several daycare centers who faced a persistent issue: despite a clear policy that children should be picked up by 4:00 PM latest, some parents were consistently late. This resulted in at least one teacher having to wait for the parents to arrive.

A few economists heard of this problem suggested that the daycare centers impose fines on parents who were late. They decided to test this solution by conducting a study across 10 daycare centers over a 20-week period.

The fine was not introduced immediately. For the first four weeks, the economists simply tracked the number of late pickups. The result was an average of eight late pickups per week per daycare center.

In the fifth week, the fine was introduced in six of the daycare centers. It was announced that any parent arriving more than 10 minutes late would be charged $3 per child for each incident. This fine would be added to the parents' monthly bill, which was $400 per month at the time.

After the fine was implemented, the number of late pickups dramatically increased in the six daycare centers. No change occurred in the other four daycare centers where the fine was not introduced.

Why did this happen?

Previously, being late meant that parents were relying on the generosity of a teacher who had to stay late. Parents had to face this teacher and apologize for the inconvenience, and as a result the guilt of causing this inconvenience to the teacher was a strong deterrent.

However, once parents had the option to pay a small fine and avoid the guilt, they chose that option instead. The situation shifted from being a moral or social issue, to being a financial transaction.

It is important to remember that there are three basic types of incentives: economic, social, and moral. Economic incentives involve financial rewards, such as bonuses or salary increases. Social incentives relate to recognition and status, such as acknowledging an employee as ‘Employee of the Month’ or ‘Top Performer for the Quarter’. Moral incentives are based on ethical values and a sense of duty. This may include encouraging employees to participate in a company-sponsored charity event.

To effectively retain employees, we must use a combination of different types of incentives. If someone chooses to leave an organization for social or moral reasons, an economic incentive alone will not suffice. We must recognize that people are motivated by more than just money and appeal to what truly matters to them. Only then will we be able to retain them.