Saturday, September 4, 2010

8 Questions to Ask if Your Incentive Comp Plan Isn't Working

Some business owners believe incentive compensation plans don't work. Many don't, and the reasons vary.  In some cases, employees are just not money-motivated. In most cases, however, an incentive plan that isn't working is a poorly-designed incentive plan.  In a recent meeting of Chief Executive Boards International, one member said his "discretionary bonus" had become a Christmas season entitlement. Several members contributed good ideas on how to construct an incentive plan that works, whether for sales, operations, shipping/receiving, etc.

If you want to redesign or install an incentive plan for your business, it's important to get it right -- the first time, if possible. To help you with that, here are 8 key questions to ask about your plan design:
  • Is it Meaningful? -- If the employees do what you want them to do, is the reward at stake enough to get their attention? This is a failing of many incentive programs. Employers put microscopic incentives on top of comfortable base salaries. Employees quickly conclude, "So, if I show up I get paid well. If I knock myself out I get paid scarcely more." If you want more variable pay, you may have to reduce base pay.  Here's an article on one way to fix that "not meaningful" problem...
  • Is it Achievable? -- If Superman couldn't ring the bell, your employees won't try to, either. The moment they figure out the goal is unachievable (at least by ordinary humans), the incentive value is lost. Design in some flexibility, such as reward thresholds that are set annually, in response to market conditions. Then you can move the carrot within reach.
  • Is it in sight? -- Business owners love annual payouts -- they're simpler, happen only once, and smooth out ups and downs over the year. Few employees can keep their eye on a reward a year away. Most are living paycheck-to-paycheck, and the idea of an annual payout is simply beyond their attention span -- perhaps beyond what they visualize as their future with your company. The carrot is so far away, it's beyond the horizon. Think quarterly, even monthly or project-by-project in your plan design.
  • Is it clear what you want? -- Can they connect the dots between the result you want (the measure/metric of performance) and specifically what you want them to do? The connections between their actions and cost reduction, waste reduction and productivity improvement are clear to you. Don't expect those connections to be clear to them.  You might test this by asking exactly what they're doing to get to the goal.
  • Is it within their control? -- More importantly, do they see exactly how their own behavior, effort and accomplishment directly connects to the incentive? I contend that incentive comp plans tied to "overall results" or "company profitability" or even "department performance", if the department is big, hardly ever work. The average employee just can't connect the dots between what they do and the overall result -- it's just a big squishy idea that they can't get a hold of.
    Instead, tie incentive pay to something they can relate to -- units produced, cycle time, inventory reduction (turns), Accounts Receivable (DSO), etc. depending on what's within the workgroup's direct control & visibility.
  • Is it fair? -- Can the good things I do be undermined by poor performance on the part of others? Sales compensation, for example, that ignores market conditions causes sales people to get rich when things are booming and starve to death when demand slows. A commission structure with annually-adjusted quotas is a lot more flexible than something cast in stone. Here's a way to incorporate that idea...
  • Does it pass the Martini Rule? -- Can the employee explain it to their spouse over only 1 martini?
  • Is the reward something they want? -- Perhaps money isn't their objective (believe it or not). For many people, time off is a lot bigger motivator than money. Here's an article on that topic...
Once you design the best incentive comp plan of all time, lay it out on the desk, and move to the chair on the other side. Then, put on your employee hat and figure out how you would game the system to get the maximum reward with the least amount of effort. That done, rework the plan with caveats, adjustments, etc. to head those games off at the pass. Rinse, lather, repeat.

If you have some views on incentive compensation, please click "Comments" below and share those with others. 

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

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