Getting the best out of the gig economy

As the gig economy grows, companies need to adapt to a changed incentives landscape.

22 May 2023

As the gig economy grows, companies need to adapt to a changed incentives landscape

The gig economy is growing at a fast rate. In 2022[i], 36 percent of working Americans—or about 58 million people—identified themselves as independent workers, up from an estimated 27 percent in 2016. In China in 2022[i], the number of gig workers was about a quarter of the workforce, or 200 million people. That number is predicted to double by 2036.

Gig workers are an important source of flexible labour for companies and the sheer size of the gig economy represents a major upheaval for companies’ work and hiring practices. Hiring workers to perform a task as a gig raises different challenges for employers than assigning the task to a permanent employee. To thrive in this new setting, companies need to understand how to motivate gig workers. In addition, employers need to understand their own changed role in this landscape and reassess their incentives and pay structures.

Changes in the workplace

The rapid increase in the number of gig workers—also called freelancers or independent workers—is due to a combination of the pandemic and its impact on the economy, changing work preferences and advances in technology.

The growth of the gig economy has upended the traditional manager-worker relationship. Where once the worker was directly supervised and monitored by a manager, now the gig worker typically works away from the company’s workplace, from home or from a shared workplace, for example.

Getting the best out of absent workers is a challenge for employers. One concern is slacking off—the belief that workers might shirk their work if they are not physically present and supervised in the workplace. The COVID pandemic highlighted this challenge when large numbers of workers were forced to work from home for extended periods. While many reported higher efficiency when working from home, their employers were not always convinced. Many believed their employees were not working as productively as they would if they were back in a supervised work environment. As the pandemic declined, employers were keen to get their workers back to the office.

It has not proved easy—many employees had found that working from home improved their work-life balance, for example, by doing away with the need to commute to and from the office each day. Many also found they enjoyed the autonomy of working at their own pace—a key attraction of the gig economy, and likely part of the reason for the rising numbers of workers who have chosen to join it. So when the time came to return to the office, some chose instead to leave their jobs and switched to freelancing. At the same time, the slowing economy coupled with the increased cost of living since the pandemic pushed some employees to take on gig jobs in addition to their full-time jobs to supplement their incomes, further boosting the competition.

For companies too, COVID highlighted the advantages of a gig economy. The global economy slowed during the pandemic, forcing many companies to let go of employees. To save costs, some began to hire independent workers to take their place on an ad-hoc basis. Often, gig workers are hired to work on specific projects, especially creative projects such as graphic design, content writing or marketing.

The growth of the gig economy has been heavily underpinned by technology. Global platforms such as Uber and Upwork have enabled large numbers of workers and hirers to find each other quickly and makes price comparisons easy. That ease of access to the marketplace has spurred increased sign-up and growing competition among gig workers competing for the same jobs. While workers can choose from a selection of posted jobs, employers can scan a large number of workers to find those with the best credentials for the task.

That type of increased competition has long been believed to spur workers’ output and innovation, but is that true of the new gig economy where the effect needs to be assessed on the individual level? New research conducted by Yanhui Wu and Feng Zhu, “Competition, Contracts and Creativity: Evidence from Novel Writing in a Platform Market”, looks at how high levels of competition affect the motivation and productivity of gig workers. The answers they found will help companies deepen their understanding of how to get the best out of gig workers.

Online novel writing

The researchers examined how the gig economy works in the setting of Chinese novel-writing platforms. Online novel writing is big business in China. It evolved in the last two decades to become a multi-billion dollar business by 2017, with more than 300 million users and about one million writers. The business operates on platforms that match authors with readers. The biggest platforms are backed by major Chinese tech companies, including Alibaba, TenCent and Baidu.

On these platforms, authors commit to writing a novel chapter by chapter. Readers buy each chapter at a set price fixed by the platform. Authors are paid in one of two ways: either a revenue-sharing agreement, typically split 50:50 with the platform, or on a fixed rate-per-word basis. In the revenue-sharing arrangement, the author’s income depends on how many readers choose to buy the chapter. In the fixed-rate arrangement, authors are paid a set rate for their work regardless of how many readers buy the chapters. For companies, it can be helpful to consider the revenue authors as gig workers, whose income depends on a fluctuating market, and the fixed authors as salaried employees who get paid the same amount regardless of market conditions.

The authors’ work was tracked on two levels: their monthly output, measured both by word count and frequency of book updates, and the creativity of their content, measured by comments made in reader reviews.

The researchers wanted to see how a surge in competition—similar to the current surge in the numbers of gig workers—affected authors’ output in both quantity, (measured by word count), and quality, (measure by the creativity of the content). They focused on a particular period in 2014 when several Chinese novel-writing platforms in the romance-related area were simultaneously closed down. The closures resulted in many of those authors moving to a new platform, creating a surge in the number of romance authors. The research focused on these romance authors.

The impact of competition

Readers pay per thousand words and one way that authors can attract more readers is by offering bonus content—writing more than one thousand words, but not charging for it. Authors can also write chapters more often, boosting their popularity with readers who want more frequent content updates.

The researchers found that when the competition increased, output also increased—and by a lot. The number of characters (Chinese characters, which can be considered as similar to words) that authors wrote per month almost doubled. The number of chapters they submitted increased by 29 percent, and the amount of bonus content that they offered their readers grew by 88 percent.

While competition boosted output, it had an insignificant effect on the creative efforts of authors. Authors’ creative efforts can take the form of creative twists, unexpected plot lines, cliffhangers and links to popular culture, such as TV shows.

The impact of pay structures

A key point was whether these authors were contracted on the revenue-sharing or the fixed-price model. The results showed that revenue-sharing authors improved both the quantity and quality of their output in the face of increased competition, but the same was not true for fixed-price authors, whose output on both counts barely changed.

“This sharp contrast confirms the argument that the fixed-price contract mutes an author’s response to intensified competition […], whereas the revenue-sharing contract spurs an author’s reaction to changing market conditions…” note the researchers.

For companies operating in the gig economy, the results show that increased competition spurs the productivity and creativity of workers who are paid on a performance basis, such as revenue sharing, far more than it spurs workers whose pay is not related to performance. Gig workers, then, are more willing to respond to market conditions that directly affect their pay. If a company offers more pay in a competitive environment, the result will likely be higher productivity.

But not all workers are motivated by higher pay rates. For some, the avoidance of risk is a bigger attraction than the possibility of more pay. For these workers, a fixed-rate of pay is preferable even if the rate of pay is lower, and an incentive to earn more is unlikely to result in higher output.

Getting the timing right

Companies often hire gig workers to beef up their teams when they are planning to launch a new product or service. New products and services are risky for companies—changes, even when they will improve the product or service, involve increased costs and an often unsettling period of adjustment for teams and customers. Major changes are usually less risky and costly at the outset of a product’s life cycle than later on.

The same proved true with regard to creative efforts. In the novel-writing tests, changes to the novel’s plot and design—the creative elements—were much more likely to take place early in the book’s life. Once the book was well underway, these creative changes did not appear.

It makes sense that major changes to the plot or direction of a novel are easier to build into the earlier stages of a novel’s life rather than when the action is already well underway, but there are other factors at play here too. For creative workers, such as novelists, pressure to innovate in a competitive environment does not often end well. Several psychological studies show that creative workers do not perform well under pressure, note the researchers. This is because the pressure to compete raises worries about failure and ends up reducing the likelihood of innovation.

Takeaways for companies

The research offers important points for companies to consider when hiring gig workers. In the gig economy, workers are no longer directly managed and supervised as they were in the traditional management system. In its place is the self-managed gig worker or freelancer who works unsupervised. In this changed landscape, companies need to reassess their pay structures to get the best out of these workers. Companies that can adapt to the changes and effectively manage and motivate gig workers will have an advantage when they need additional labour or help with particular projects.

Increased competition in the market allows employers to choose from among a vast range of gig workers, but the extent of market competition alone is no guarantee of better performance. The type of contract offered to gig workers has a marked effect on outcomes. Contracts with strong incentives, such as revenue sharing, encourage increased output in markets where there is strong competition. But one-size does not fit all: some gig workers prefer a fixed rate of pay that allows them to avoid risk. For these workers, the incentive of higher pay is no guarantee of greater output.

The authors note that their results apply mainly to individual workers in the areas of entertainment and arts and culture, and possibly also to app development and online product design. The findings may not apply as much to complex innovation, such as corporate research and development and other areas that involve long-term investments, high fixed costs and coordination among many workers.

About this Research

Yanhui Wu and Feng Zhu (2022) Competition, Contracts, and Creativity: Evidence from Novel Writing in a Platform Market. Management Science 68(12):8613-8634.

Read the original article

References

[i] https://www.mckinsey.com/featured-insights/sustainable-inclusive-growth/future-of-america/freelance-side-hustles-and-gigs-many-more-americans-have-become-independent-workers. August 2022.

[ii] https://doi.org/10.1108/OXAN-DB271315

Translation

Long held assumptions about the mutually incremental relationship between quantities and discounts have been upended by new research. The rule of thumb that the bigger the purchase quantity, the higher the discount is shown not to hold true for medium-sized customers buying products such as semiconductors, with implications for other products and industries.

Pile them high and sell them cheap. Buy more, save more. These slogans, and the thinking that lies behind them, have been accepted principles of product sales and marketing for generation.

The logic seems indisputable from the points of view of both the seller and manufacturer and that of the buyers. If a seller or manufacturer makes a large number of identical items and a single customer wants to buy a large part of this total production, then that buyer will receive the goods at a cheaper price than a buyer who wishes to buy a much smaller amount of the same product. The accepted theory has been that the seller is eager to dispose of his stock as quickly and as easily as possible, and so a big customer will get a better deal. By the same logic, it follows that customers who buy progressively smaller amounts of the same product will receive progressively smaller discounts.

However, the underlying premise behind these assumptions – that the bigger the purchase, the bigger the discount – has now been shown to be valid for only part of the story. In a new study by Wei ZHANG, Sriram DASU and Reza AHMADI entitled “Higher Prices for Larger Quantities? Nonmonotonic Price-Quantity Relations in B2B Markets,” published in 2017 by the Institute for Operational Research and the Management Sciences in Maryland, USA, the first part of the established belief holds true: the biggest customers do receive the biggest discounts. These customers remain the most valuable to a seller or manufacturer as they account for the bulk of sales. They are therefore typically able to use their size and bandwidth to exert pressure successfully on the seller to get a large discount.

The research focused on investigating the impact of a buyer’s purchase quantity on the discount offered. In this case, the seller was a microprocessor company selling semi-conductors, which are a short-life cycle product. The company negotiates with each of its buyers to set a price for the product. The buyers are mainly large electronic consumer goods manufacturers. In line with established beliefs, the research showed that the discounts received by smaller customers increased in line with the quantities they purchased, and the smaller the quantity they purchased, the smaller the discount they received.

What is unexpected is the experience of medium sized buyers. According to established logic, these customers would be expected to receive bigger discounts on their purchase price than smaller buyers. But this is not the case. In fact, the researchers found that as the quantities bought increase, the discount decreases, and then increases again for the biggest quantities.

“Contrary to our intuition, larger quantities can actually lead to higher prices,” say ZHANG, DASU and AHMADI.Thus, while previous beliefs of a bigger purchase quantity meaning a bigger discount would have resulted in a curve heading steadily north-eastwards, the results of ZHANG, DASU and AHMADI’s studies is an N-shaped curve. This unexpected result is rooted in the importance of capacity to the seller and its impact on the price negotiation process, explain ZHANG, DASU and AHMADI.

To understand the importance of capacity in price setting requires a switch in focus from the buyer’s mind-set to that of the seller. The seller or manufacturer is not concerned solely with getting the best possible price for the product, they also place a value on capacity.

‘’Large buyers accelerate the selling process and small buyers are helpful in consuming the residual capacity,” write ZHANG and his team. “However, satisfying midsized buyers may be costly because supplying these buyers can make it difficult to utilise the remaining capacity, which may be too much for small buyers but not enough for large buyers. Therefore, midsized buyers are charged a “premium.”

To get the best price for all his products, the seller needs to avoid transactions of a medium size and instead plan his sales based on a rationing decision. The rationing decision depends on the remaining capacity level, purchase quantity, demand distribution and the buyer’s profit margin before subtracting the cost of this product. The calculation can be done by following a dynamic capacity rationing formula devised by the researchers. The formula is based on the need for the seller to find a balance between controlling the capacity allocated to each buyer while still offering a capacity range that is acceptable to the buyer.

Ultimately, ZHANG & Co, say, “The seller should reserve capacity for buyers who are willing to pay more.”

The pertinence of the research is clearly of most use to firms manufacturing or selling semi-conductors. This is a highly competitive industry with several unique features and is characterised in particular by fast changing technological developments. In the semi-conductor industry, manufacturing costs are high and lead times are long and these factors lead to inflexible capacities. It is common practice in the industry for sellers to allocate capacity to different product lines based on demand forecasts and to start work on the related production several months ahead of the planned delivery date. Customers arrive sequentially and differ mainly in the quantities of product they order. Although products have a set price, the actual price paid is typically agreed after a process of negotiation, with big buyers usually driving a hard bargain. Because of the nature of the business, negotiation on prices is inevitable, explain the researchers.

“Buyers know that the marginal production cost of microprocessors is low and that sellers are eager to discount prices to fully utilise their capacities. Moreover, buyers can allocate their business among competing sellers.”

But while buyers may have an advantage when it comes to price, sellers often have an advantage when it comes to selling and controlling capacity. Buyers are free to meet their needs by buying from different semiconductor suppliers, but they tend to decide on suppliers early on in the purchasing process. This is because the technical features offered by different suppliers vary, and once selected, these features will impact the design of the buyers’ products and will be difficult and costly to change. That means that buyers tend to keep to their chosen supplier.

The lessons that can be drawn from the study may also be useful to some degree to other businesses and products. Inflexible capacities are also a feature of many businesses in the tourism industry, for example, although the researchers note there are different characteristics and constraints involved – for example, hotel rooms do not go out of date in the same way that semiconductor products become obsolete. Hotel rooms, airline and coach seats are all fixed number items that the seller or owner needs to sell in quantities to his best advantage. The main customers in these industries include bulk buyers such as travel agencies and resellers who want to buy in large quantities but who also want to negotiate the best prices. As in the semi conductor business, the individually agreed deals are closely interconnected, with the price and quantity agreed for one buyer impacting the price and quantity to be agreed for the remaining buyers. The researchers recommend that sellers develop a price-quantity analysis model that can help them optimise their prices. As with semi-conductors, the key point for the seller is the need to control the quantity being sold to each buyer before negotiating the price.

“Basically, given that each transaction has an impact on subsequent transaction, a good model of the price-quantity relation is necessary for the optimisation of the trade-off between the profit from the current buyers and that of future buyers,” they explain.

Contributing Reporter: Liana Cafolla

Source: Wei Zhang, Sriram Dasu, Reza Ahmadi (2017). Higher Prices for Larger Quantities? Nonmonotonic Price–Quantity Relations in B2B Markets. Management Science 63(7): 2108-2126.

https://pubsonline.informs.org/doi/10.1287/mnsc.2016.2454

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