Human Resources: Basic Incentive Design: Simple Works Every Time

Although the business press says that about 60% of all businesses use incentives or bonuses to some extent, many organizations still do not use any form of variable pay at all.

What´s variable pay? It´s a cash payment that does not fold into base pay. It is a gift that doesn´t keep on giving if the performance reason for which the award was granted disappears. Variable pay ensures that performance continues from performance period to performance period. Awards don´t become annuities that continue if performance wanes. It is an award that is often granted for exceeding performance requirements and goal performance that is beyond what base pay is for.

At one time only executives, managers, and direct sales received incentives or variable pay. Now, these tools of rewards have migrated to everywhere in the organization, including the factory floor. The goal of incentive use most often to reward performance or recognize something employees do to add value to the organization. That can be a wide range of things that are either directly controlled by the employee or in some way influenced by the employee. Variable pay can be for individuals for their own performance or for collective performance as in team incentives. Most organizations say that incentives make it more likely goals assigned to employees will be achieved than when variable pay or incentives are not provided.

Great First Time Variable Pay
So your boss told you, "Put a variable pay plan into our XYZ organization, I think it will help their performance." Good challenge for you, but what do you do? Here are perhaps some ideas about how to start. Remember the goal of variable pay is to influence employee behavior and results. While you can´t get people to do what they don´t want to do through incentives, you can certainly give them a strong communications message about what is required to be an employee of your organization.

Here are some suggestions to keep in mind as you journey toward designing, implementing, and communicating a variable pay plan for your organization:

What Outcomes/Behaviors should be Rewarded: You get what you pay for, so, unless you don´t want people to do it, don´t pay for it. At the start of the design process the question is what do you want and can the employees you want to place on incentives deliver it? Consider outcomes such as cost containment, financial goals, completion of projects, meeting timelines, and quality improvement or effective work in a team environment. The issue is whether the goals are relevant to the business. Also, the challenge is to see whether the goal can be influenced by the performance of the employee or as a member of a team.

What Measures/Goals should be Used: How many balls can a great juggler keep in the air at once? If the juggler tries to keep too many in motion, no matter how good they are some may fall to the ground. It´s that way with measures and goals to be used for determining variable pay awards. Experience suggests that no more then 3 to 5 measures or goals work best. More than that and employees pick and choose those they can do best on. Also, the fewer really important goals the employees have to achieve, the more likely they will be the most important once-making meeting goals more probable.

Who Should Participate in Variable Pay: Once you pick the goals to be achieved, it´s important to choose the employees who can help the company achieve them. Are the goals and measures to be used achievable by an individual working alone or whether teams or groups of two or more employees can better influence the metrics. The goal should be one of inclusion-use the incentives and goals to encourage as many people as practical to help achieve the goal. Many incentive plans include support personnel in order that they will help keep the goals in reach.

What should be the Award Size: Most incentive plans for non-supervisory personnel are in the 4%-5% of base salary range. For supervisory and management, 7%-10% is in the ballpark. But there are no hard and fast rules. Our experience is that unless the opportunity to make a reasonable award in the 4%-5% of base pay level is realistically possible, it is hard to get the attention of employees. Especially if the goals require a performance stretch to achieve. Most organizations do some cost/benefit analysis regarding the incentive opportunity. This means determining what the value-added to the business is if the company shares alternative incentive awards for goals achieved.

And as the development and communications process unfolds, here are some suggestions about what it takes to get your basic variable pay solution into action:

Fewest Possible Measures/Goals: Now we have led you to pick no more then 3 to 5 measures or goals for your incentive plan. Ask yourself; can you get the results you want with no more than 3 goals or measures? Assume the potential award for success is $1.00. If you have 4 goals, each is worth only 25 cents. The fewer goals you have, the more each one is worth. And if people are focused on earning the incentive, the more valuable goals will more likely get employee attention.

Best Line-of-Sight for Measures: The ´line-of-sight´ is how close the measures are to the influence of the employee. For example the profit of the company are a very long line-of-sight because most employees can only very indirectly influence profits. On the other hand a goal of personally assembling a specific number of parts is a short line-of-sight goal because an employee may absolutely control this performance. The objective is usually to set goals that stretch the line-of-sight of the employees so they do not sub-optimize performance. For example between the number of parts goal and the company profit goal may be some other goals at the individual or department level. Overall parts quality from the line, cost management in the work center, and individual sales for a sales professional may be the way to go.

Period of Performance Measurement: Performance for incentive purposes can range from daily measures and payments to multiple year measurements and payment. It is always best to pick the shortest possible measurement period consistent with a measure adding value to the business. The more frequently performance is measured and rewarded, the more often the chance for course corrections. Also, the larger the portion of total cash compensation that is made up of incentives (cash compensation is base pay + incentives), the more frequently the award should be available. This is especially true of hourly workers who are most likely to understand shorter line-of-sight measures and goals. The longer the period over which performance is to be measured, the more likely we are talking about very senior people in the organization that can influence its long-term performance.

Straightforward Communications: Incentives or variable pay are communications tools most of all. And this starts with building a business case for implementing incentives or variable pay. Why are you adding a variable pay plan? What´s in it for the company and the employees? What are the measures and why are they important? And what do the employees need to do to earn an award? And the communications process should continue for the life of the incentive plan.

So these are some things to keep in mind as you build your incentive plan. There certainly are more but these should whet your appetite for more information. Reading books and articles on incentive design should start where our discussion leaves off.

Conclusions
Incentives or variable pay are part of the total compensation picture. Considerable information exists on variable pay and incentives and our goal here is to encourage further digging for information that will help you design incentives properly. Keeping the solution simple and emphasizing measures and goals that are important to the company and within the influence of the employees in the incentive plan are important ´tips´ to consider.

Incentive usage is growing annually. More and more plans are being placed in operation every year. So your interest in the use of incentives is not only not surprising, it is one of the capabilities any company that is interested in encouraging sharing results with employees must have in their ´knapsack´.