In American business, an individual’s compensation package, particularly among managers and sales people, frequently includes an incentive component. An example might be a manager who is paid a base salary of $75,000, but is able to earn an additional $25,000 if he or she is able to achieve certain goals or outcomes. The proposition is, “If you do this, I’ll pay you that.” It’s a simple, straight-forward, and fair transaction, isn’t it? Well, yes on the face of it, yet the incentive portion of a compensation package can be fraught with all sorts of misunderstandings and unintended consequences. To learn where some of these potholes are and how to avoid them, please continue reading below.
“Compensation is an equity issue. People want to know that they are being compensated fairly compared to others doing similar work within the company, and to others doing similar work in other companies. After that, it’s a non-issue.” ~ Richard Teerlink, former CEO of Harley-Davidson
A good place to begin is with the realization that incentive-based pay is not appropriate for all people and all jobs. So before you start trying to design an incentive-based pay system, you need to understand what jobs respond well to such systems and what jobs do not. While we’re not going to get into that here, you can read a previously published blog on the subject here https://rocksolidbizdevelopment.com/ourblog/motivation-toss-the-carrot-and-stick/, or see an excellent TED talk on the subject by Dan Pink here https://www.ted.com/talks/dan_pink_on_motivation .
Next, make sure incentives are based on SMART goals . . . that is, goals that are Specific, Measurable, Achievable, Results-oriented, and Time-based. Loosely-defined goals without appropriate metrics and deadlines are in trouble before they start.
Goals can be inappropriate if the person being incentivized has little or no direct control over them. For instance, a company might offer its top managers an incentive if the company reaches a certain level of profitability. However, since each manager has direct control over only his or her own department, and since no one except the CEO has direct control over all the elements that go into overall profitability, that is not likely to be a successful incentive situation.
You need to guard against conflicting goals. For example, if you give your Director of Operations a goal to increase quality while giving your Chief Financial Officer a goal to reduce labor and material costs, you may have just set up both for failure.
Beware of setting goals that are too rigid. An employee who achieves 99.9% of a goal is not going to feel very happy about being rewarded with a warm handshake and a hearty, “Nice try!” When setting the ground rules for your incentive program, you should consider a threshold of some kind, below which nothing is paid, above which some portion of the incentive is paid. Where the threshold should be set, and what sort of incentive should be paid above the threshold, should be established at the outset, not when the problem rears its head. This is where your sense of fairness kicks in.
What about the opposite problem? Let’s say someone blows the doors off whatever goal was set. Again, your sense of fairness should rule, and how this situation will be handled should be worked out at the beginning.
Whatever incentive program you put in place, and whoever you expect to incentivize with it, you need to put a sunset provision in it . . . an expiration date, probably annually, but it could be any timeframe that makes sense to you. There may be unintended consequences to your program that you need to address. Or there may be changes in your marketplace or in your organization that require changes to your incentive plan. Either way, whoever is involved in your incentive program needs to understand that it is subject to periodic review and is not an entitlement program that goes on in perpetuity.
Never lose sight of the fact that when you introduce new incentive programs or amend old ones, you’re impacting peoples’ livelihoods. That’s serious business . . . scary business. People are naturally fearful when their earning power could be disrupted, so be patient, take the time to carefully explain the necessity for the program you propose as well as the benefits it will carry for them and for the company. If you have earned the trust and respect of the people included in your incentive program, they will accept that changes are necessary and give you credit for having pure motives. They may not like the changes, but they will do their best to understand and accept them.
This is not intended to be a comprehensive list of everything you need to consider when putting together an incentive program for appropriate individuals in your company. But it is intended to demonstrate that there’s a lot to think about. Incentive programs, when thoughtfully conceived, thoroughly explained, and smoothly launched, can be powerful motivators, and not incidentally, a fair way to share the wealth with the people who are helping you to build your business.