Over the last 20 years, I have had the opportunity to review dozens of incentive compensation plans and suggest improvements. Unfortunately, most of the plans I have reviewed fall far short of what is required to create a real incentive. One of the biggest mistakes you can make in devising an Incentive Compensation plan is to reward the wrong behavior.
Many plans reward things like:
While all of these things are nice, incentive compensation is not the mechanism to reward them. Do I really care if someone works a lot of hours? No. They might be a particularly slow worker who needs the time to accomplish what others can in a normal work day. Why should they be rewarded through incentive compensation?
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One of the biggest mistakes in devising an incentive compensation plan is to reward the wrong behavior.
Should someone get more of an incentive payment just because they have been here forever? No. Think of the negative impact on someone who has been here a shorter amount of time, but contributes twice as much profit to the firm. Why should they care about profit when it isn't rewarded?
Should someone be rewarded by the perceived value of their contribution? No. Perception is in the eye of the perceiver. It will be viewed by the staff as too arbitrary and a moving target. When someone is put in the position of making this judgment, they tend to fall back to the politically correct decision. They reward things like how much they like this person, their seniority or how much they need the money.
This does not mean that people should not be rewarded for all of these things - just don't do it in your incentive compensation plan.
Successful plans are structured to:
Incentive compensative is design to reward those employees who exceed the minimum profit expectations. Employees, who only meet the minimum expectations, are already being compensated with a base salary. They do not get an incentive compensation payment. When they see others in the company getting incentive payments, they have an incentive to do better next time.
Non-economic contributions to the company are not rewarded in the incentive compensation plan. Examples of non-economic contributions are winning awards and organizing the library. Reward these outside of the incentive compensation plan.
Do not limit the reward. Why would anyone want to provide a disincentive? If the employees are making a great deal of money let them keep going. I am more than happy to share.
The optimum frequency of incentive payments is quarterly. There needs to be a immediate cause and effect to reinforce profitable behavior. If the payment is annual, employees won't worry about profit until sometime between Labor Day and Halloween.
I realize that this subject is a lot more complicated than this short article. Future issues will go into greater detail. The bottom line is that if someone makes a lot of money for the company, they deserve to be rewarded. The more money an employee makes for the company, the more they should be rewarded.
If you have an Incentive Compensation plan at your company and would like to
share your ideas, please send me an e-mail