Keep Incentive Plan Design Simple

Complexity can kill any value sharing arrangement. Some reading that sentence are nodding their heads knowingly right now. They've experienced that complexity and watched failure overcome what seemed in the beginning like just the right solution to plan design.

Companies run into the complexity problem most commonly when they try to manage behavior through the incentive plan. They construct metrics and measures that are intended to focus the employee on specific business drivers. By the time they construct those metrics for every category and tier in the company, they have a monster on their hands. It's usually about that time that our phone rings.

As you approach incentive plan design, keeping it simple has to be an overarching aim that guides the process. To accomplish this, think in terms of deciding between two basic plan types and three basic measurement categories. Then plan to "weight" the measurement categories by tier of employee to address the variance in impact at each level of the workforce. Here's what I mean.

Two Plan Types

When building a short-term incentive, a company will need to decide whether they want to use a profit-based allocation model or a targeted KPI approach. In simple terms, a profit-based approach will focus everyone in the workforce on the profitability of the company and a pool will be used to generate payouts once a certain threshhold of profitability is achieved. The KPI approach focuses the attention of an individual or team on defined performance indicators or intiatives which, if achieved, will drive greater profitability, revenue, EBITDA or whatever other key outcome you measure.

Each of these approaches are discussed more thoroughly in an article and/or webinar on our website. I will refer you there for greater detail.

Three Measurement Categories

Most plan types can be managed well by "weighting" how much of an incentive will be tied to company performance, how much to team or department performance and how much should be based on individual performance. The weighting each of these is given depends on the sphere of influence of the participating employee. For example, tier one employees (executive level) might have a weighting something like the following: 75% company, 0% team, 25% individual. A second tier (directors) might be allocated as follows: 25% company, 50% team, 25% individual. And so on through the tiers.

The three measurements approach allows you to have one plan while making room for adjustments to be made by category of employee based on its ability to impact company, department or individual outcomes.

Long-Term Incentives

Just a word about long-term value sharing. The approach described above can apply to LTIPs as well, but is most commonly used for short-term incentive plan design (payouts for performance in a period of 12 months or less). To effectively design a long-term value sharing arrangement, you will need an additional planning tool; a decision tree process that helps you ask the right questions and arrive at a suitable plan model. Ultimately, there are about nine different long-term value sharing approaches you could adopt. Questions such as "are you willing to share equity?" lead to one conclusion or another about which plan type will be most suitable for your organization. To learn more about the decision tree process access the VisionLink article entitled: "Long-Term Incentive Plans--Which is Right for your Company?"

Once a long-term plan design is determined, a "simple" approach should still be applied. The three measurement categories approach will help you do that.

In the world of compensation design, as in so many other things, "less" is often "more." Keep it simple.

 

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