Compensation Challenges for Cross-Functional Product Development Teams

New product development (NPD) projects present distinct organizational challenges in terms of their execution: they require specialized competencies, which prompt cross-functional collaboration. Collaboration implies significant interdependencies between the functions, including both, organizational factors (i.e. cross-functional coordination), and those arising from the problem structure (i.e. underlying relationships between the market and technology). Such collaboration takes place in an uncertain NPD setting, where the effort put forth by each specialist is non-verifiable. Within such a setting, senior management must ensure that functional specialists contribute towards management’s objective (maximize profit). This study evaluates operational implications of incentives that compensate specialists based on either, their functional contribution, or team output (project profit). Specifically, we look at how, project uncertainty, functional interdependencies, and team heterogeneity, affect management’s optimal choice of compensation. We uncover key sources of tension associated with management’s decisions regarding compensation: management benefits by employing team incentives for projects with high uncertainty; however, when there exists substantial diversity regarding the specialists’ capabilities (cost of effort), functional incentives are preferred. Interestingly, we show that management benefits by offering specialists that exhibit coordination synergies, compensation that is based on functional contributions.