Incentive plans that work

Written by Dr Mark Bussin, Chairman, 21st Century Pay Solutions Group • Online since 15.09.2015 • Filed under Industry news • From Issue 2 - September 2015 - February 2016 page(s) 33-34
Incentive plans that work

Employee incentive plans go by many different names – you’ve undoubtedly seen your share. But, with many economies struggling, how should you approach your employee incentive plans differently to reach your  organisations goals? Can an employee incentive plan actually create the results you need?

First let’s look at the bigger remuneration picture and where exactly incentives fit in. At the start we have the base salary component – the guaranteed income for the complexity of work performed. Next is the benefit package that takes care of the health, wealth and needs of the employees. Perquisites aid in our ability to perform best at the job and effectively. Shortterm incentives (bonuses, incentives and commission) rewards what happened last year, and long-term incentives are used for retention and shareholder alignment. For the purposes of this article, we focus mainly on bonuses and incentives. There is growing distinction between the definitions of bonuses versus incentives. Bonuses can be defined as reward after something good happens but was not promised in advance in most situations. An incentive is a payment that is promised in advance in a performance period and in return to a specific objectively performance measure.

Components of Total Remuneration

Bonuses grab the attention of employees but do not motivate them for a long-term period. In our view, bonuses have a place in the remuneration mix, but the company should not spend a great deal of money on bonuses because they do not motivate as incentives do – they are safe, but not influential. Individual incentive plans are designed to reward employees for their improved commitment and performance at an individual level. Typically, goals reflect participant’s specific responsibilities, and payouts are based on an evaluation of the individual’s performance relative to present goals. Because participants often perceive the goals as controllable, individual incentive plans provide a clear link between pay and performance and will have a high impact on employee behaviour. Based on the article Test Your Incentive Plans Against These Guidelines, Timothy O’Rourke and Matthews Young describe some very interesting guidelines that are worth repeating.

Guideline 1

The potential incentive must be big enough to get the employees’ attention. We know that well designed incentives make most employees focus. Good employees already work hard, but hard working employees who are not focused often work against the results the company seeks. Incentives create focus. However, you have to get employees’ attention first.

Guideline 2

The performance or results required to earn the incentive must be within the employees’ control or significant influence. This guideline has led to the failure or success of more incentive plans than any other guideline. One must be able to see or understand the cause and effect relationship between one’s effort – the results of that effort and the reward. The need to provide the proper ‘line of sight’ between output and rewards at all levels of the company may require a large number of different incentive plans to cover all employees under incentives. The administrative requirements then become burdensome and we have seen diminishing returns from an effort to cover an ever-increasing number of levels in the company. On the other hand, we have seen successful applications of different mixes of remuneration components for different levels of the company.

Guideline 3

The performance or results required to earn the incentive must be perceived as achievable with ‘stretch.’ If I told you that I would give you one million rand at the end of the next year, I would probably get your attention. And, your next question would be ‘what do I have to do to get it?’ Then, if I told you that you would need to get yourself to Mars and back, I would lose your attention. No matter how good the promised reward, the employee must believe that the desired performance is achievable. Of course, Guideline 2 has a great deal to do with the employee’s perception of the ability to achieve the desired outcome. We have also found that the objective  must be perceived to require a stretch. If I told you that you could earn that million-rand incentive if the paint on the walls of an empty storage room remained the same colour all year, you would probably focus on the objective for a while. However, after some time, you might begin to doubt that I would really pay you for such a meaningless objective. Then, you would get bored with the effort and realise that, if I was not lying to you, the objective was too easy to achieve and you would stop watching the walls. The incentivised performance needs to be perceived as a desirable, stretch goal to get and keep the employee’s attention.

Guideline 4

The payout must be worth the effort required to ‘stretch’. This guideline suggests that the plan should pay something for partial achievement of the desired outcome. Not only must the potential incentive be big enough to get employees’ attention, but it must also be perceived to be worth the effort. If the effort or focus required to get the full incentive opportunity requires stretch, in other words it’s seriously at risk, then the actual payout after the final measurement is made needs to justify the attempt that was made to achieve the full objective. Many plans fail because they have a ‘cliff’ where any level of achievement below the objective pays nothing. ‘Cliffs’ encourage employees to do anything to achieve the last few units of measurement. If they are close to achieving the stretch objectives, they might do something you do not want to happen to get over the cliff. One CEO with a cliff plan lamented that he was afraid the employees would sell the furniture at year-end to achieve a tough revenue objective.

Guideline 5

The payout should never be a surprise. This assumption often differentiates an incentive from a bonus as defined at the beginning of this article. If the payout cannot be forecast as the performance period proceeds, the plan will fail to keep the employees focus on the desired outcome. Furthermore, the first time that the desired outcome is achieved, and the employer fails to pay the incentive, the motivational power of the plan is lost forever.

Guideline 6

The sources of performance tracking must be readily and frequently available. For the plan to avoid surprises, it must pay for the achievement of objective measures of the desired outcomes. Too much subjectivity in the measurements will turn a plan into a surprise bonus. Furthermore, the participants in the plan need to know where they stand at all times. Therefore, the sources of the measurements should be available to every  participant on a regular basis.

Guideline 7

Calculations for determining payouts must be simple and clearly understood. The KISS guideline applies to incentive plans as much as in any endeavour, if not more so. The key question to ask is, ‘do my employees know where they stand at any point in time during the performance period?’ To keep the employees focused, they need to know where, precisely, they stand and how much they are leaving on the table. This guideline argues against formulas that create curvilinear payouts and plans that use more than a few measures of success.

Guideline 8

Finally, you will get what you pay for, so be sure it is what you really want. Incentive plans are powerful forms of remuneration. Well-designed plans focus employees much more than any other component of reward systems. Many a management team has driven their company in the wrong direction because they rewarded the wrong outcomes. Before you even consider incentives, make sure you know the company’s strategy and the critical measurements of success. These guidelines are basic enough to be applied to all types of incentives – short-term, long- term, cash and non-cash, current and deferred, management and staff. Applying them will aid in motivating employees and achieving desired results and most of all creating a fair, unbiased, and trust-focused culture. Please remember that incentive schemes are not a substitute for good management. Common sense needs to be applied and employees need to be led. There is no substitute for great leadership.

Dr Mark Bussin, Chairman of 21st Century, has remuneration experience across all industry sectors and is viewed as a thought leader in this arena. He serves on and advises numerous boards, audit and remuneration committees, and has consulted in many countries for multinational companies. 21st Century is a one of the largest full-spectrum specialist remuneration and reward consultancies in Africa, with a national and international capability serving Government, Parastatals and two thirds of the companies on the JSE. For more information, visit www.21century.co.za.

Issue 2 - September 2015 - February 2016

Issue 2 - September 2015 - February 2016

This article was featured on page 33-34 of SABI Magazine Issue 2 - September 2015 - February 2016 .

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