By Claudine Kapel
Annual incentive plans are generally hailed as strong vehicles for driving desired performance and results. But a new Towers Watson survey suggests organizational pay practices may be undermining the links between pay and performance and eroding the value of such plans.
The survey found 24 per cent of North American respondents pay out some level of bonus to employees who “fail to meet performance expectations.” And 18 per cent give employees the same payout relative to target, regardless of individual performance.
The survey featured responses from 121 organizations in Canada and the United States.
“While the vast majority of employers have some type of annual incentive plan, the way some incentive plans are designed and viewed by employees raises the question of whether employers are getting a good return on their investment in these programs,” says Towers Watson.
It suggests “many organizations are paying for the status quo” and treating their annual incentive plan like “a de facto profit-sharing plan.”
Other Towers Watson research suggests employees don’t perceive annual incentive plans to be effective. This research indicates less than half of employees agree there is a clear link between their job performance and their pay or that high-performing employees are rewarded for their performance.
Further, Towers Watson’s research indicates annual incentive plans fall low on the list of reasons people join an organization, ranking 22 out of 27. They don’t fare much better as a retention tool, ranking 15 out of 27 as a reason to stay.
Towers Watson suggests disappointing funding levels may be one of the reasons annual incentive plans are failing to inspire. Survey participants reported their average projected bonus funding for current-year performance is 87 per cent of target. In fact, Towers Watson notes incentive plan funding has been below target for six of the last seven years in Canada and seven of the last nine years in the United States.
Given the significant dollars many organizations spend on incentive awards, it’s important for such programs to be more than just elaborate profit-sharing plans.
The irony is that many organizations have introduced annual incentive plans in a bid to slow the growth of fixed costs associated with salaries and salary increases. Incentive plans, by their very nature, are meant to represent variable pay opportunities – which means awards should correlate to performance and results. This is the key to ensuring a plan delivers an appropriate return.
But without a link between pay and performance, two unfortunate consequences may arise:
- Incentive awards will be seen as an entitlement, eroding the cost-containment element that should be inherent in variable pay.
- Incentive plans will have limited motivational value for high performers who won’t see much return on their superior contributions.
Here are some questions to consider if you want to ensure your incentive plan has more motivational staying power than the annual Christmas turkey.
- How strong is the line of sight in the plan? Are employees clear about what they need to do to earn an incentive award? Can employees influence the achievement of their incentive objectives?
- What types of measures are included in the plan? Does the plan include unit and/or individual measures?
- To what extent does the plan deliver pay for performance? What level of differentiation is there in terms of award payouts for superior performers relative to average or poor performers?
- To what extent are performance ratings from the performance management process considered when determining incentive awards?
There are many considerations that shape whether an incentive plan delivers optimal value. But if organizations don’t forge a strong connection between pay and performance they may find themselves driving up their compensation costs without generating incremental gains in performance and results.
Claudine Kapel is principal of Kapel and Associates Inc., a Toronto-based human resources and communications consulting firm specializing in the design and implementation of compensation and total rewards programs. For more information, visit www.kapelandassociates.com.