Elements of an Incentive Program

Share on LinkedIn Share on Facebook Share on Twitter Share on Google Plus Share this Page

Looking for a way to motivate or incentivize employees to meet a goal or objective? Whether it’s sales, productivity, service, quality, teamwork, or just a change in behavior, incentive programs can be an effective tool to meet your organization’s needs and objectives. Here are the most important elements of an incentive program.

 

Clarify the objective of the incentive program.

What is the purpose of providing the incentive? Will it be designed to improve the productivity of your production staff, increase sales, improve customer service, and enhance management? Usually, the objective of an incentive plan is tied to meeting some organizational or departmental goal or objective or motivating/changing a specific behavior. This may be general or specific to a certain work group or department.

Define the incentive.

Define the type of incentive you will provide and make sure that it aligns with the objective. Individual incentives should be tied to individual goals and performance, team incentives should be tied to team goals and performance, and so on. Also, will it be offered in addition to a salary increase or instead of one, and will it be considered part of the total compensation package? Below are three (3) types of incentives to consider.


Type of Incentive

Description

Individual incentives

  • Tied to the achievement of individual and/or organizational goals
  • Typically only distributed to specific individuals
  • Differentiates top, average, and bottom performers

Gain-sharing

  • Tied to the margin of profit or savings attained through a group or team’s performance
  • Typically only distributed to certain groups or teams
  • Rewards and encourages teamwork

Profit-sharing

  • Tied to the margin of profit attained by entire organization
  • Typically distributed to all employees or certain executives/managers
  • Provides employees with “line of sight” – how their contributions impact the organization’s success

 

Create a measure for the incentive.

Having a clear objective will make measurement easy. Measurement could be as simple as determining whether the goal was achieved or not achieved. You may also weight what percent of an objective was met (i.e. 75% of goal achieved or 110% of goal achieved). One key question your organization will need to consider is if you will payout for not reaching goals completely or if you will payout extra for exceeding goals.

Determine who is eligible to receive the incentive.

If the objective of the incentive plan is specific to a certain work group or department, eligibility should be constrained to only employees in those areas. If the objective is general, eligibility may be widespread, applicable to nearly all of the workforce. We find that incentive plans typically follow one of these two tracks.

Establish the size of the incentive.

This is, first and foremost, dependent on what your organization can afford to pay – which may vary from year to year and depend on cash flow, revenue, and profitability. The size of the reward may be a fixed dollar amount or a percentage of salary. On average, we find that variable pay costs account for 3% of revenue (variable compensation divided by total revenue) – compared to compensation costs which typically account for 25% of revenue. Below are average target percentages, maximum threshold percentages, and percentages of total cash pay that incentive/bonus pay represents.


Type of Employee

Average Target %

Max. Threshold %

% of Total Cash Pay

Production, Maintenance, Service

4.4%

6.6%

4.1%

Clerical, Technical

4.0%

7.7%

4.3%

Supervisory, Managerial, Professional

8.1%

12.1%

6.6%

Source: 2011 ERC Pay Adjustment & Incentive Practices Survey

Identify the form of payment.

Some incentive/bonus payments are paid out in lump sums annually, while others may be distributed across paychecks throughout the year. Annually is by far the most common frequency of payout, but quarterly is a close second. Monthly and semi-annual payments are extremely rare.

Incentive programs can be effective in promoting the behavior and results we want in our organizations, but in order to do that, they need to constructed effectively. This starts with clearly identifying the objective of the program and then aligning all of its pieces and parts (type, work groups eligible, size, form of payment, etc.) with that purpose.

Additional Resources

Pay Adjustment & Incentive Practices
Benchmark your organization’s pay adjustment and incentive plan practices with our ERC Wage & Salary Adjustment Survey. For more information about this survey (including pricing information), please click here.

Consulting & Project Support
For assistance in developing incentive/variable pay plans and compensation systems or benchmarking compensation practices, please contact consulting@yourerc.com.

10 Ways to Manage Pay & Performance

Share on LinkedIn Share on Facebook Share on Twitter Share on Google Plus Share this Page

10 Ways to Manage Pay & Performance

Most employees want the opportunity to earn more pay based on performance, but such initiatives can be difficult for employers to create and administer. Here are 10 things to consider when managing pay and performance.

1. Does your culture align with a pay for performance program?

To be effective, your organization’s culture should align with a pay for performance program. This means that your organization should be committed to rewarding, recognizing, and promoting top performance, and employees should be aware of this commitment. It’s also important that your culture conveys an atmosphere of fairness and objectivity. Otherwise, pay for performance programs will fall prey to perceptions of subjectivity and bias, limiting their effectiveness.

2. What are the goals of the pay for performance program?

A pay for performance program can have many types of goals such as to improve productivity; increase customer satisfaction; enhance product quality; generate more innovation; boost revenues and profits; or reward top performers. Most goals for a pay for performance program focus on improving individual, team, and/or organizational performance. Be sure that the goals of this program are relevant to the business’s goals and needs.

3. What types of performance criteria will be rewarded?

The goals you define for the pay for performance program help determine what types of performance criteria will be rewarded. For example, if your goal is to increase customer satisfaction, the performance criteria may be customer satisfaction scores, number of customer complaints, or general customer feedback. If your goal is to improve productivity, the performance criteria might be quantity of products created, number of processes streamlined, or behaviors that enhance efficiencies. You may also consider making the performance criteria number of goals achieved or the impact of goals reached.

4. How will performance criteria be measured?

Often employers rely solely on performance reviews to measure criteria for a pay for performance program (i.e. a rating of “5” gets the highest incentive). While performance reviews can be a helpful measure, more objective measures of performance that aren’t as susceptible to rating error, supervisory perceptions and biases, or an ineffective form, should also be considered and used to measure performance criteria. Examples of such measures include goal setting, observable behaviors, and actual results (financial, quantity, or quality measurements).

5. Who will measure the performance and make pay decisions?

Sometimes performance can be measured without an individual, but other times, especially in the case of goal setting, observation, and performance reviews, an individual will need to measure performance , typically a supervisor, manager, or leader. Because these measurements are subject to human error, it’s critical that individuals are trained appropriately. Additionally, your organization will need to determine who will make pay decisions. Will you leave this discretion to your managers, providing them a fund to distribute these rewards?  Will HR or senior leaders be involved in the process, and to what degree? Most organizations involve all three groups at some level.

6. What type of pay for performance will you offer for meeting this performance criteria?

Not surprisingly, the most common types of pay for performance are merit pay, individual incentives, and bonuses. These programs tend to be easiest to administer and focus on individual performance. Increasingly, however, we are seeing some employers offer profit sharing, gain sharing, and employee stock ownership programs. While more complicated to administer, these programs have tremendous value, providing greater transparency and line of sight into organizational performance, reinforcing teamwork and collaboration, and offering employees a greater stake in the organization – giving them a true sense of autonomy and ownership. We find that organizations are offering multiple types of pay for performance for different segments of their workforce. This is ideal when different behaviors or results are desired that don’t necessarily fit one reward approach.

7. How much pay will be based on performance?

The trick to determining how much pay will be based on performance is determining what percent or portion of pay will have an impact on employee motivation or specific results you are seeking. Generally, studies find that when only 2-3% of pay is tied to performance, this is not enough to motivate desired behaviors or results. We have seen organizations reserve 2-4% for salary increases (i.e. cost of living, across-the-board, or merit) and 5-15% for incentive/bonus payout (with 15% typically targeted for executives). For example, NorthCoast 99 winners, provide an average of 10.3% incentive/bonus payout to top performers, 5.6% to average performers, and 7.3% overall.

8. What is the timing of payout for the rewards?

Most employers pay out rewards annually, but depending on the type of program a monthly, quarterly, or biannual payout may be more beneficial. Annual payouts may help your organization better manage costs and ensure that you have the funds to pay incentives to employees; however, there are advantages to paying out more frequently. When rewards are distributed closer to the time they were achieved, employees are more likely to view them as objective and relevant to their performance. In addition, paying out more often reinforces an on-going performance culture in which performance matters all year – not just at year-end – and makes supervisors manage performance on an on-going basis.

9. How will the program be funded and what are you willing to pay (the budget)?

Most pay for performance programs are funded using organizational profits or revenues. In this way, organizations frequently make pay for performance dependent on at least two factors: individual or team performance and organizational performance. Each year, you may budget for a percentage of revenues or profits that will be used to pay for performance. Organizational performance would dictate whether payout can occur.

10. How will the program reinforce other HR programs?

Pay for performance, at its best, reinforces and complements other HR programs and total rewards initiatives. What you reward in a pay for performance program should be similar to what you reward in a recognition program and how you promote people. Be sure to send your employees consistent messages about the results and behaviors you’re looking for, otherwise, your message will be lost.

Variable Pay Plans and Incentive Programs

Variable Pay Plans and Incentive Programs

Variable pay plans can be used as a motivation and retention tool for top performing employees.

Learn More to Get Started