Striving for simplicity with incentive pay

Well-defined targets, measures and objectives key
By Michael Hiles
|Canadian HR Reporter|Last Updated: 05/06/2011

Incentives have become popular in recent years. No self-respecting owner or manager feels she is managing effectively unless some kind of incentive scheme is part of the arsenal.

However, many managers’ analytical basis for supporting incentives is based on a mixture of hearsay, wishful thinking and knowledge gaps.

The central idea behind incentive programs — rewarding employees for performance — has a long history, particularly in sales compensation. Commission schemes have elements to recommend them for other incentive pay programs:

Simplicity: Commission arrangements that work best feature clear objectives and don’t require overly sophisticated calculations. This makes it easier for people to stay focused and, at the same time, not game the system.

Profitability: Simple sales commission schemes can be easily designed to achieve the first duty of incentives — they should clearly pay for themselves.

Ease of use: Goals and rewards usually can be adjusted to refocus sales attention onto a company’s needs and strategies and it is often easy to design administrative rules and systems that satisfy everyone.

Many variable pay programs are not very well-designed, with targets or objectives that are ill-defined or misunderstood. Measures are often not made explicit and the criteria for a larger or smaller bonus — or none at all — is open to interpretation. The result? Payouts are determined in a less-than-rigorous or ad hoc fashion.

Some organizations realize the most effective use of variable pay is a year-end thank you to employees, when an organization has done well and there is extra money to spread around. Normally, better performers and more senior people receive more, based on their level of contribution to the overall results.

When this type of scheme is well done (thanks to good communications), everyone knows that if the company has a bad year, there will be no bonuses. This kind of arrangement is close to profit-sharing — although often this is not how the scheme is described.

There seems to be a positive relationship between the ratio of variable pay to total compensation and the maturity of the enterprise. Startup companies often promise employees significant variable rewards if the company does well — mainly because they cannot afford market rate pay in the beginning. Not only does this minimize contractual commitments for large fixed costs, it can attract candidates with a risk-oriented entrepreneurial profile.

As organizations mature and become more stable, entrepreneurial risk-takers need to be supplemented or replaced with more operationally oriented staff. A settled environment with some longer-term stability is often a prime motivator for this employee group, for whom money is important but not an active motivator. In a strong sense, these individuals want their compensation to be adequate (perhaps even generous) and fair, competitive and well-designed (with good benefits). But, once these elements are in place, compensation should be off the table as a focus and motivator. These people do not want much of their pay at short-term risk — they want to be sure they can make their mortgage payments.

The satisfaction generated by variable pay schemes relates to employees’ attitudes. Even when an incentive scheme is introduced with a goal of changing and focusing behaviours and incenting even more effort, many individuals see it as found money at bonus time. It can top up registered retirement savings plans or upgrade vacations. Workers do not plan their financial lives on a guaranteed bonus.

Additionally, many employees do not change their behaviours much in an environment of significant variable pay. They feel they are doing their best already and have neither the time nor resources to do much more. Often, work-life balance issues mean they will not sacrifice their family life for a chance at money that is not at all certain.

As a result, variable pay as a thank you for a successful year is more powerful than an attempt to incent individuals to act and perform in a way that may not be realistic or possible.

Look long and carefully at the incentive plans. There is no magic bullet, no quick fix and there can be speed bumps and potholes along the road. Business history is littered with disasters linked to badly designed variable compensation schemes.

Leveraging greed is risky. Take the time to carefully think through the plans — and be skeptical of the latest trends. These often tend to be short-term and trying to influence employees with a flavour-of-the-month incentive scheme can be counter-productive — there is no substitute for careful planning and good design in an incentive system.

Michael Hiles is a compensation associate at AlternaSolutions, a consulting firm providing services in HR strategy, process and policy development, compensation, performance and talent management, and learning and development. For more information, visit www.alternasolutions.com or call (514) 910-7594.

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