Arguably the most common and effective approach to variable pay is an executive incentive scheme that defines performance goals and what potential earnings are on offer should the goals be met. The performance goals can be individual objectives, team company-wide. The period over which performance is measured is typically annual however can be shorter such as monthly, quarterly.
The following are typical considerations when designing a short term incentive plan.
The table above provides an outline of some of the key points to note when designing an incentive structure. There are other factors to consider, many of which will need to be assessed against internal business and market considerations.
Recent Market Practices
There has been a recent shift by some organisations to remove or replace short term incentives for certain employee groups, such as administrative staff or wage employees. The administrative and cost burden of a structured incentive program for these broad based roles vs the financial ROI may create little value for the organisation. Alternative approaches such as reward and recognition schemes are being used, providing less formal, more frequent interactions encouraging good behaviours.
It is important to set clear objectives and rationale for why the incentive plan exists. Like any other investment, appropriate measures are required to identify the value the incentive plan is bringing the organisation and to evaluate success. Determining the return on equity of a plan will be easier when using data driven measures which can be readily identified, such as increased sales or production rather than soft targets such as cultural change. Admittedly, there are other ways to measure the value of an incentive plan besides financial return on equity. Customer satisfaction and employee attitude surveys can also present useful insight to a plan’s effectiveness.
There have also been examples of organisations spreading incentive payments equally across all individuals as an easy fix, intended to create positive morale. However, these schemes are actually more likely to be perceived as inequitable by employees, as they do not take into account individual performance. Empirical evidence also suggests that this can lead to lower performance by employees.
The most effective way to differentiate incentives across individual employees is to use clear and understandable objectives / measures, and provide tools to track progress towards achieving them. Importantly, achieving meaningful incentive difference between high and low performers cannot be achieved without capable managers who effectively manage employee expectations and maintain ongoing dialogue about performance.
Individual Performance Structure – this incentive mechanism aims to enhance the performance of the individual by creating a direct link between their outputs and the rewards they may receive e.g., sales commissions based on personal sales. Note when collaboration and co-operation are important to an organisations goals, individual incentives may discourage a combined effort and have a detrimental effect.
Team Based Structure – commonly used to promote a collaborative environment where team members are encouraged to help one another to achieve a group objective. This method works well to create a sense of trust and increased communication between individuals, to work towards the collective goals of the group.
Organisational Performance Structure – utilised to reward individuals based on the success of the organisation over a specific time period. This approach creates a sense of ownership and belongingness by the individual to the company and other employees. A potential approach is to tie the organisation’s performance to the grant of equity instruments for employees.
In many cases, incentive plans will require a level of customisation such as combining organisational wide performance with individual objectives linked with an incentive program. Ultimiately an optimal structure is key, supporting both business needs and engaging participants discretionary efforts.
Actions to take:
- Ensure there’s a clear purpose for incentives (e.g., focus on key corporate objectives, recognition).
- Communicating what is expected of employees in exchange for their reward helps foster the success of the program.
- Undertake a ROI analysis to ensure a cost-benefit decision between various reward offerings and assessing the value they create for the employer and employee.
- Consider a customised approach such as a combination of individual, team and organisation wide performance based incentives for more effective outcomes.
- Establish a sunset clause to ensure a review of the incentive plan is undertaken to keep it relevant and effective.
If you would like to discuss any of these matters, please feel free to reach out to us.
Warren Land 0412 774 206 firstname.lastname@example.org
Bryan Cooke 0408 916 405 email@example.com