Jul 12, 2016
Many organizations strive to have a “pay-for-performance” culture in which employees’ actions and results have a direct causal relationship with their pay. Typically, an employee’s job performance, measured against their individual job responsibilities, is rewarded by increasing their base salary through a merit increase program. An employee’s contributions toward organization or department objectives are normally rewarded through one or more bonus or incentive plans.
Bonus Plans vs. Incentive Plans
Bonus plans are “after the fact” and reward employees for their overall performance and contributions without setting individual objectives or committing to specific payment levels based on results. Bonus plans do a great job of rewarding performance and have a broad motivational value if they are consistently given after good performance, but they are not as effective for incenting specific actions/behaviors, or supporting a “pay-for-performance” culture.
Incentive plans are “before the fact” and incent employees to take specific actions to meet individual and/or organizational goals. Incentive plan objectives are communicated prior to the plan period along with an explanation of how results will translate into individual award payments. If the incentive plan is communicated and documented well, a plan participant will know what he/she needs to do in order to receive an award and approximately what that award will be for different levels of performance. The employee’s pay is directly linked to performance.
Remember that just because a plan communicates a specific objective prior to the plan period does not necessarily make it an incentive plan. In order for employees to understand how actions and/or behaviors will impact their incentive award, they need to have a “line of sight” to the objective. In other words, employees need to understand what they specifically can do to impact the results of the objective. If the only objective in your plan is “company revenue of $X,” many employees may not believe they can impact the objective and will simply wait to see if they are rewarded after the fact. However, if you are able to also include individual or departmental incentive objectives that support the overall revenue goal, it will incent specific actions and behaviors. In addition, if you communicate objectives but do not specify how the award will be calculated based on results, participants will not have a clear understanding of how their actions and/or behaviors will impact their pay.
If you are unsure of whether you have a bonus plan or an incentive plan, ask yourself, “do the participants in this plan know in advance what they need to do in order to receive an award, and approximately what amount the award will be if they are successful?”
Effective Incentive Plan Components
If you decide incentives are right for your organization, here are a few tips on designing an effective plan. The most effective incentive plans have four things in common:
- The plan is specific. Employees know, in advance and in writing, what they need to do in order to receive an award and what that award will be for different levels of performance.
- The plan design is simple and easy to understand. Employees need to easily understand how their day-to-day actions and behavior can potentially impact their incentive award.
- The incentive opportunity is meaningful for the employee. Incentive targets need to be a substantial portion of the employee’s total compensation in order for the employee to change behavior to attain it. In our experience, incentive targets should be at least 10% in order to be considered meaningful to participants.
- Good communication at all stages is critical. The plan is communicated in advance and in writing to all participants. Senior management provides clear and regular communication on the progress of the incentive plan goals and/or targets along with encouragement and direction on how to improve results.
Incentive plans require significant effort and focus but a well-designed plan is critical to creating and supporting a true “pay-for-performance” culture at your organization.