Keep Incentive Pay Plans Simple but Challenging

Jun 29, 2015
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LAS VEGAS—The age of base pay as the most important compensation component is over, and the era of variable comp is at hand, said Stacey R. Carroll, SHRM-SCP, during her June 29, 2015, concurrent session, “Effective Incentive Plan Design,” at the Society for Human Resource Management 2015 Annual Conference & Exposition.

“Despite what some high-priced consultants will tell you, you can do this on your own if you have the right framework and ask the right questions,” said Carroll, president of Honolulu-based HR Experts On-Call. “More often than not, you can design your own program, and perhaps then have a consultant review it”—an option that is much less expensive than a consultant-created program.

As to why incentive pay plans are important, Carroll quoted Jack Welch, former CEO of GE, who said, “It goes without saying that no company, small or large, can win over the long run without energized employees who believe in the mission and understand how to achieve it.”

As Carroll said, “A 3 percent across-the-board pay hike may make your middling employees happy, but you’re likely to lose your top performers.” Likewise, she said, if top performer Sally gets a 3.4 percent raise, and Joe, who works next to her, gets 2.8 percent for doing the bare minimum, Sally isn’t going to feel appreciated. And it’s Sally you want to keep, not Joe.

“Compensation sends a message about what you value as an organization,” Carroll noted. She drew a distinction between two popular types of variable pay: incentive pay, which is metrics-driven and uses a clear-line-of-sight formula (“if you do this, then you will get this”), and bonus pay, which is more subjective. At the end of the year, bonus programs might reward “good performance” in the eyes of a manager, but they’re less effective at driving behavior.

Meaningful Goals

Goals tied to individual incentive payouts should challenge and stretch employees, or else “they become entitlements very fast,” Carroll said. “If they’re not challenging, the payouts are just base pay by another name.

“Your employees’ first response should be ‘no way can we achieve that!” And then you help them to see that it is possible, and they get excited.”

Goals should be tied back to what you are trying to do as an organization, she added, “or else they’re not worth doing.”

Goals should be measurable, of course, and focused on outcomes, not activity, which is a common mistake. “Employees figure out ways to achieve activity goals that are far afield of achieving desired outcomes.”

For example, a sales team that has a goal of increasing the number of calls per day to potential customers might dial the phone but hang up after the first ring.

Similarly, if the goal is to increase customer retention, measure that, not how well customer service is viewed. While it may seem that good customer service would lead to customer retention, that might not always be the case. Customers might find your call center reps friendly but still feel that the reps weren’t able to provide value.

“In almost all situations, a general profit-sharing plan is ineffective, due to the poor line of sight between behavior and goal,” Carroll noted. She advised scrapping them.

“Your rewards should be commensurate with the outcome that was achieved and is meaningful to the employee and sustainable by the organization. It should be a symbol of success,” she said.

For incentives to be meaningful, payouts to top performers should be equal to at least 7 percent of salary, Carroll advised. “Giving out $500 on a salary of $75,000 won’t drive behavior.”

She also recommended having no more than three metrics linked to incentive payouts, or employees will lose focus.

Having too many metrics also tends to reward the same thing twice, since target outcomes A and B are both intended to lead to target outcome C. “If you can’t count the metrics on one hand, you have too many,” she said.

“The closer to the action the award is, the better,” she explained. This may mean trickling incentive pay out over four quarters, so that a 10-percent-of-salary payout is delivered in installments of 2 percent in the first, second and third quarters with a larger, final payment of 4 percent in the fourth quarter.

And if annual goals are not met? “Make adjustments going forward, such as reduced raises,” she said, “rather than trying to claw back the payouts, absent indications of misconduct.”

Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow him on Twitter @SHRMsmiller.

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