Finding the right mix of incentives necessary to maximize employee performance can be a challenge. However, as employers continue to rely more heavily on variable pay to supplement flat salary-increase budgets, relevant, actionable and easily understandable performance metrics become an even more important element of effective incentive programs.
“As the economy has gotten stronger, the real focus is on trying to reward the best performers,” said Peter Gundy, managing director with Towers Watson in Stamford, Conn. To ensure that employers are indeed rewarding those employees, they must make sure that they are measuring the right types of performance. “Metrics are critically important not only to an effective incentive plan but also to moving the business forward,” said Gundy.
Performance metrics are a key way for employers to communicate what’s important to their employees. “With an incentive plan, you get what you pay for,” said Ken Abosch, compensation practice leader for Aon Hewitt in Lincolnshire, Ill. “If you are measuring the wrong things, people will focus on those things. They do what you ask them to do.”
‘With an incentive plan, you get what you pay for.’
Finding the Right Metrics
Performance metrics can vary widely by industry, company, position and other factors. Finding the right set is a complex exercise. Here are some do’s and don’ts to help guide the process.
• Identify business strategy and goals.
The most effective employee performance metrics are based on an organization’s broader business strategy and goals. Measures that align with the business strategy reflect and help to drive the right outcomes and behaviors for the organization.
Just what those outcomes are, however, can change over time. “Over the last several years, a lot of employers placed a significant amount of emphasis on profitability and cost control,” said Gundy. “Now as the economy has recovered and gotten stronger, there has been a push for more top-line, profitable growth with goals balanced between sales, revenue growth and profitability.”
Translating those goals into effective employee performance metrics is crucial. “Clear measures are probably the most important determiner of success for an incentive plan,” said Abosch. He urged organizations to select incentive plan performance measures based on what really drives their businesses. From there, they can focus on forging a strategic link between those drivers and the performance metrics in the incentive plan.
For example, an organization whose success is based on operational excellence must develop metrics so that every employee is focused on what drives operational excellence for that organization, such as timeliness, building efficiencies and streamlining operations.
• Don’t leave it in managers’ hands.
Effective metrics need to be relevant to individual employees. “One of the big mistakes employers make is to create an incentive plan with a bonus pool that is based on profitability and growth measures and then stopping there,” said Gundy. The thinking in these situations is that the organization makes the funds available for the bonus pool, then leaves it up to individual managers to figure out how to allocate that money. “That is a horrible mistake,” he said.
According to Towers Watson’s 2014 Global Talent Management and Rewards Study, only 45 percent of employees surveyed think managers are effective at making sure pay decisions reflect employee performance. Just over half (52 percent) say their companies do a good job of explaining pay programs, and less than half see a clear link between their pay and their performance.
Gundy notes that the lion’s share of issues occur when employees don’t understand the incentive plan or its metrics and when managers are not communicating or using the plan effectively.
• Make sure employees can control their outcomes.
Employees not only have to understand their performance metrics for an incentive plan to succeed, they also must understand how their actions and results impact those metrics. “The best plans translate the main bonus funding measures into something that is tangible, actionable and realistic to employees,” said Gundy. “Employees must be able to look at those metrics and see how they influence those things.”
For example, the speed at which an accounting staff member can collect on accounts receivable has a significant impact on the company’s available cash. That level of clarity must also exist when it comes to developing metrics tied to other goals, like sales growth and earnings per share.
• Don’t overwhelm employees.
It is important to strike the right balance between having too few and too many metrics. The “just right” combination of metrics can guide performance without overwhelming employees or diluting their efforts and focus on too many priorities. “Some organizations only care about company measures, and they do not cascade anything below that,” said Abosch. “In those cases, the total focus might be on, for example, the number of packages delivered with everyone measured based on that goal.”
Even when employers break down high-level goals to the individual level, they must take care not to overdo it. Abosch recalls one company that had well over 100 metrics for its incentives. “Such a plan is worthless in terms of creating focus,” he said. “You want to make sure you are not diluting the impact or losing focus by using too many metrics.”
Three to five metrics seems to be the sweet spot for many organizations. “You don’t want to have a plan that has 12 different measures,” said Gundy. “Such a plan loses its effectiveness.” Employers can guide employee performance even more by weighting each metric according to its importance.
• Revisit metrics regularly.
Organizations and their goals and priorities change over time, and so should performance metrics. “Employers should at least validate the measures every year,” said Abosch. “The business environment is moving quickly. Employers need to assess whether they are still using the right metrics.”
Some employers revisit metrics on an annual basis as part of the annual business planning cycle, while others do so at some other interval. However, any major shift in strategy, organizational structure or markets may require an off-cycle look at metrics. The key is to validate those metrics to ensure that they, and the incentive plan, are still driving the right outcomes and behaviors.
Ultimately, any incentive plan needs to drive better outcomes in order to pay for itself via performance improvements. Having the right metrics is just part of that equation. Everything from identifying the right goals to implementing and communicating the plan will impact an incentive plan’s success. It is important for employers to get them right.
Joanne Sammer is a New Jersey-based freelance writer.
Related SHRM Articles:
Variable Pay Spending Spikes to Record High, SHRM Online Compensation, September 2014
Annual Incentive Metrics: Hit the Target, SHRM Online Compensation, May 2014
Improving Performance Evaluations Using Calibration, SHRM Online Compensation, May 2014
Propel Performance with Pay: HR Leaders’ Insights, SHRM Online Compensation, May 2014
SHRM Online Compensation Topics & Strategy