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Incentive Programs: Paying for Performance

& Management.

A regular incentive program (or bonus) can be an excellent mechanism to redistribute the wealth a company retains in the good years and remain solvent in less successful ones. Ad hoc incentives can also be used to reward above-and-beyond performance.

Unfortunately, too often the enthusiasm around the first surprise reward quickly morphs into entitlement on the second or third incentive period. Instead of appreciation (what a lovely recognition!) people can react with resentment (why did she earn more than me)? Instead of something extra when the company is particularly prosperous, the “bonus” becomes expected. Reducing the downside risk of what is intended as an upside bonus involves clarifying the purpose of the incentive, ensuring its allocation is grounded in fairness, and explicitly defining the criteria for earning it.

Purpose

Some believe that pay-for-performance and/or variable compensation will automagically attract the strongest performers while organically weeding out the weak. If they don’t perform, I don’t have to pay – everyone wins! But even in 100% commission environments, the lowest performers are still warming a seat that could be filled by someone more capable, not to mention the damage they could wreak on a company’s brand. On the other end of the spectrum is decades of research that people are motivated by autonomy, mastery, and purpose – just pay them fairly and focus on the total rewards of the organization. But that sounds like a lot of work. Can’t we just throw money at this problem?

Incentives can accomplish some goals but not all. What organizational values is the company looking to reinforce? Do you want a Jack Welch-like culture where the bottom 10% are cut every year or a more community-based culture where the rewards from performance are shared across the team? There is no right answer to this question, but the philosophy put forward will then guide the strategy and tactics for incentive programs. With the philosophy in place, the rest of the questions are simpler to answer. Knowing the purpose the incentive is meant to fulfill may help identify alternative solutions. If incentives are the answer, they need to be fair.

Fairness

It’s disheartening to pay out tens of thousands of dollars to the team only to receive complaints and criticisms for the method of distribution. McKinsey & Company has found three practices that influence the feeling of fairness: effective coaching by managers, goals linked to business priorities, and differentiated compensation.

Employing the principles of “fairness” vaccinates against the negative potential outcomes of incentives. Regular coaching should ensure people know how well they are performing compared to expectation and clear up any confusion around incentive distribution. Goals linked to business priorities clarify how individual performance impacts the economic drivers that allow an organization to fund an incentive program. Differentiated compensation makes explicit the value that each position (or band of positions) brings to the organization.

Explicit

People need to understand which of their actions earn a bonus to unlock its motivational power. In a piece-work environment this is simple to achieve but, these days, most organizations carry out their work with cross-functional teams completing complex functions that might take years to drive measurable results. In this case, weighting the incentive more toward overall team or organizational performance and less toward individual performance may make sense. Some organizations get into complex calculations assigning points for years of service, objective performance criteria, and even subjective evaluation by the manager or leader of the organization. While this degree of complexity may make sense in some environments, it can lead to a demotivating situation where people don’t really understand how they are being paid. At minimum, ensuring employees understand the range of incentives available (e.g. a percentage of their salary) helps keep their expectations realistic.

There are so many ways to structure incentive programs and we’re always happy to discuss the specific potential solutions for your company and its unique circumstances. In general, keep the method as simple as is reasonable, as objective as possible, and base it on what the organization can afford. Funding the pool of incentive money on EBITDA is a good start for small business. Basing the pool on revenue could be a recipe for cash crunches down the road.

For incentives to be remembered and drive behaviour, a quarterly bonus is the right frequency for most organizations, but whatever frequency you choose it should happen on a regular schedule. Humans are strongly addicted to their food and shelter – we don’t want to keep them guessing about whether they’ll have enough.

It’s okay to break with the routine as well. For a job very well done or above-and-beyond performance go ahead and reward them outside of the usual schedule (individuals, teams, or the organization as a whole). Just be sure the reward is based on obvious criteria. When a person is performing well above expectation, a bonus is a nice thank-you. If the same person keeps getting these random “above-and-beyond” incentives, consider raising their base salary and resetting the bar for excellence.  

The best tip for implementing an incentive program is to be transparent about the purpose, the criteria, and how and when the money will be distributed. With this in place, we can change the conversation from, “How much am I going to get?” to “How am I best able to contribute?”

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