Managers prefer flat fee contracts — and that may hurt profits

Do you pay independent contractors using a flat fee per project? New research from the School of Management shows you may be losing money.

The study found that when managers hire freelancers, particularly for projects with longer deadlines, they tend to prefer flat fees over metered (i.e., per-hour) rates, resulting in lost profits for the organization.

“In many businesses, effectively hiring workers under temporary contracts is crucial to the bottom line,” says Indranil Goswami, assistant professor of marketing. “If managers under- or overestimate the scope of work, they could delay the project or overpay contractors, sacrificing profits.”

Goswami led the study, which was published in Organizational Behavior and Human Decision Processes, with Oleg Urminsky, professor of marketing in the University of Chicago Booth School of Business. Their research is the first to identify how external deadlines affect the hiring of independent contractors.

The pair conducted 15 experiments with both novice and experienced managers across different tasks with externally set deadlines of varying lengths. The study design ensured these deadlines did not provide managers any information about the task or affect the workers’ behavior. Even then, when deadlines were longer, managers typically chose flat rates over metered fees, which resulted in significantly lower profits.

By controlling for different factors in their experiments, the researchers discovered two dynamics that motivated the managers’ selection: First, they misinterpreted the scope of work, assuming projects with longer time limits would take longer to complete.

“Many of us have learned to associate long-term deadlines with multistep projects and a large scope of work, and it can be difficult to alter that perception,” Goswami says. “When external deadlines are far off, even experienced managers may overestimate a task’s complexity and reject compensation agreements based on time.”

Second, managers were concerned that with metered contracts, workers would slack off to prolong the project and earn more money. Their worries persisted even when the workers’ pay would not increase with longer hours (as in the case of a firm that pays staff on salary, regardless of how it contracts with clients).

“Although ‘strategic slacking’ does happen, our evidence suggests managers tend to misjudge how often this occurs and may unnecessarily avoid metered rates, leaving money on the table,” he says.

Goswami cautions that the study focused exclusively on one-shot interactions between managers and independent workers; future research could examine how repeated engagements influence compensation decisions.