Effective incentive compensation practices help you attract, retain and motivate your talent — better enabling them to support your organization’s mission, strategy and values to help achieve your business goals and objectives. Incentive compensation empowers your organization to focus attention on those areas that are critical to your organization’s success.
Whether you have an existing plan in place or are looking to develop an incentive plan, there are three things you should keep in mind about incentive compensation when reviewing or creating a plan:
1. Manage your risk
Employee incentive programs come with different types of risk. It’s important to assess those risks and weigh the cost benefit to your organization.
First, you want to make sure you’re incentivizing the right behavior in your employees. Misaligned incentive plans encourage risk-taking or undesirable behavior. They can reward short-term gains at the expense of long-term success and jeopardize the safety and soundness of your business.
One extreme example is the Wells Fargo scandal where employees opened new bank and credit card accounts in customer names without informing those customers or gaining their consent. The employees did so to hit their sales targets. Over 3.5 million fake accounts were opened, and over 5,300 employees were fired for unethical behavior. Many people are goal driven, and if you attach monetary rewards, you may find you have some very motivated, creative employees striving to achieve those goals.
So it’s critical to not only achieve the right results but also encourage the right behavior. Be careful of what you incent, because you might just get it. Manage your business’s risk by starting out with the right incentives.
Second, ensure your program is sustainable. If everyone achieves their goals, how much would it cost?
Before putting a program in place or revising your current program, engage in stress testing to project payouts in various scenarios. It’s best to know in advance how performance will impact incentive payouts and your budget. We recommend clients include a base level of performance on an organization-wide level before incentives are paid.
For example, if your net income (or other key metric) requirement isn’t achieved, no incentives are paid. This helps manage your risk as well as ensure the sustainability of your overall compensation and benefits program.
Third, put practices and resources in place to help you reevaluate risk on a regular basis.
It’s helpful to form a compensation committee composed of outside directors, whose job is to approve all decisions impacting compensation risk and provide appropriate governance and oversight. In the absence of skilled professionals on staff who are familiar with incentive compensation, work with external specialists to ensure you’re not taking undue risk. Create a sunset clause on your incentive plans to encourage proactive, intentional review of plans at the conclusion of each plan period.
2. Set the right goals
It can be easy to set goals that are too broad, too vague, unmeasurable or even insignificant.
Your employees want and need to understand how their efforts will lead to actual change and improvement in your organization, as well as their own success. It’s important that incentive goals outline and articulate the WIIFM (what’s in it for me) for employees by clearly indicating that if the organization/department/individual achieves X, then the reward earned is Y.
When employees have too many goals they’re striving to reach or when their incentive calculations are too complicated to understand, it can be disincentivizing and cause employees to become disengaged.
Setting a few focused goals, keeping them simple and clearly communicating them to employees is critical to motivating employees towards goal achievement.
Another important thing to keep in mind when setting goals is to tie them to your organization’s overall strategy. If you can get your employees to focus their time and talent on the goals that will move your organization towards your strategic vision, you will achieve those big-picture goals much more quickly.
3. Understand that it can be a journey
Many organizations engage Wipfli to transition from a discretion-based incentive plan to a pay-for-performance incentive plan.
It is not uncommon for organizations to earmark a pool of money for bonuses and use their discretion to determine how those bonuses are allocated. However, when employees are unclear how their performance and actions impact their incentive compensation, discretionary plans often fall short of truly motivating employees. Without the direct link between action, results and reward, employees may not have a clear line of sight as to what they need to do to earn the incentive.
It can be daunting for an organization to move from discretionary to metric-based, as there is a perceived loss of control over distribution of incentive awards. It can be a gradual transition, incorporating metrics alongside the discretionary decisions. It is important to ensure understanding of the new metric-based approach by those impacted and to verify desired results are being achieved.
In some instances, you may wish to run a newly designed plan side-by-side with an existing discretionary plan. This will allow the organization to see the plan in action and to make adjustments as needed before bringing it forward to employees.
Creating effective employee incentive programs
If you have any questions about incentive compensation or are looking to start or revamp your program, contact us. Or read more about compensation in our article Building an effective base compensation plan.