A number of companies are currently considering new or reviewing existing incentive structures and assessing whether they are fit for purpose for the year ahead.
In this article, we share the 4 most common issues regarding incentive plans and our suggestions to address them.
Ad-hoc or no incentive plan at all
We are often surprised at the number of companies who do not have a structured incentive plan as part of their employee reward offering. These companies rely on paying a salary which may be increased from time to time and perhaps a ‘Christmas bonus’ with a tenuous link to performance. There are a few limitations with this approach:
- Motivating employee discretionary effort – without a formal incentive structure the business may not be able to effective communicate key imperatives, reinforce and encourage employee behaviours and efforts beyond what is expected for the role, to drive business growth.
- Managing an increasing salary budget – the lack of a variable pay component means companies will be limited to increases in fixed remuneration to recognise and reward staff. These increases in fixed remuneration may be unsustainable for the business in the future.
- Attracting and retaining the right people – variable remuneration linked to ‘stretch’ performance recognised through an incentive plan can be key to attracting and retaining the types of individuals required to drive business success. In today’s competitive marketplace for talent, formal incentive plans are often a prerequisite for candidates seeking a new career destination.
Our Suggestion: Whether public or private, businesses should consider the introduction of a purposeful, well structured and clear incentive plan that aligns the interests of employees to the interests of the business. The key is to design a scheme that encourages and rewards ‘what’ is achieved and, equally important, ‘how’ employee behaviour aligns with the company’s desired culture.
Performance measures that don’t stack up
When it comes to performance measures used in incentive plans, often there is a tenuous link between an employee’s objectives and how these contribute to the overall business success. This potential disconnect can result in suboptimal workforce productivity where employee’s efforts are not aligned with business imperatives and dysfunctional behaviours (e.g., siloed workplace culture).
From our experience misalignment between personal outcomes and company performance can occur when companies have adopted a “set and forget” approach to incentives. For example reward strategies that work well in times of high performance may not be as applicable to times of low overall company performance.
To understand effectiveness of performance measures and alignment with organisational performance, in 2017 The Reward Practice analysed a sample of executive payouts shortly after the WA mining industry boom began to taper off. Specifically, we looked at short term incentive (STI) payouts for ASX CEOs and the returns to shareholders over the same year. The chart in Fig. 1 illustrates a lack of congruence in Metals & Mining companies between TSR (Total Shareholder Return) and executive STI payments.
We acknowledge this analysis provides a reasonably simplistic assessment of pay alignment with performance (e.g., 1-year TSR is a lag indicator and not necessarily representative of long term business success). Nevertheless, the analysis does raise the question of whether appropriate performance measures have been adopted which are in the interests of the business and its shareholders.
Our Suggestion: Companies should take a holistic view of both organisational and staff performance. Company value creation and incentive payouts should have a reasonable measure of congruence. When designing incentive schemes and defining performance metrics, it is also advisable to scenario test them to identify any potential payout anomalies.
Payout timing not consistent with performance outcome
For many companies, an annual performance assessment and annual incentive payment is the norm. This one size fits all approach to incentives may not be effective for reinforcing performance and reward messages to employees at varying levels of the organisation. For example, a production workers effort can be realised on a monthly or quarterly basis, whereas for an executive it may take 12 months or longer to see the fruits of their labour!
Misaligned performance outcomes and when the payment occurs also creates the potential for overpayment and/or underpayment. The result being that an employee may receive a payment inconsistent with the outcome and the business can be exposed for providing a reward when performance doesn’t warrant it (one of the reasons why ASX companies adopt deferral on STI payments providing more time to verify outcomes).
Our Suggestion: To be effective, an incentive scheme should recognise and reward employees as close as possible once the outcome is realised. Companies should think about incentives based on business operating cycles rather than short-term incentives and long-term incentives which are often aligned to predefined performance periods (1 year or 3 years). Also look at designing incentives for workforce segments (e.g., staff, management, executive) to help identify key performance horizons and align timing of rewards.
The purpose of the incentive is not clear
We see many incentive plans that are well designed. They are fair to employees, competitive in the market, align with business value drivers, promote a constructive culture and reward high performance. However, if the purpose of the plan is not effectively defined and understood by all stakeholders, it can be all for nothing!
The purpose of an incentive program can vary greatly depending on what outcomes and behaviours the organisation wishes to reward. For example a start-up focussed on proving the commercialisation of a product, service or resource may use an incentive plan to focus on a key milestone (e.g., FDA approval, JORC) with the payment provided as shares in the business. The purpose of the scheme is clear – achieve the key milestone and become a shareholder!
In many cases however we see the purpose is not clear (whether due to the documentation or how it is perceived). This can mean participants will make their own determination including a view the incentive represents an ‘entitlement’ regardless of performance (personal and/or business). Clarifying the purpose and managing employee expectations around incentive payouts is therefore important. If the purpose is to reward individuals based on the company growing, the incentive payout must reflect this.
Our Suggestion: Employees are critical to translating business strategy into success, making incentive plans a key tool to reinforce the desired goals and behaviours. An effective incentive plan must start with a purpose which communicates to employees the linkage between business goals and personal outcomes (e.g., if the company increases profitability this can lead to an incentive payment).
Incentive plans that encourage employees discretionary efforts towards key business imperatives can be highly beneficial for all stakeholders. We specialise in designing effective, ‘fit for purpose’ remuneration strategies for organisations and then help you implement them across your business.
Find out how your business can benefit from a new or revised incentive plan today. Contact us