Incentive Plans: Often Misunderstood & Therefore Misused

Defining the role of an incentive plan in a compensation structure is critical and often misunderstood by those responsible for designing pay plans. As a result, many companies either misuse incentives or abandon them altogether thinking they have no real impact on performance.

Much of the literature on the subject in recent years simplifies the issue and suggests incentive plans don’t really “work.” If the argument is that incentives can’t really change behavior, then I agree. However, that isn’t the role of an incentive and it misses the point. Companies need be able to define what it means to create value in the business and then institute a philosophy for sharing it with those responsible for its creation. When incentives become “value sharing plans,” they take on a different meaning and have a different impact.

Compensation in general—and incentives specifically—are a way of framing the financial partnership a company has with its employees. If you do away with value sharing, you fundamentally alter the nature of the relationship between key producers and the organization. The best talent wants to know that if it helps create value, there’s a mechanism for participating in it. In that context, the test of an incentive plan’s effectiveness is whether it creates alignment between the way people are paid and the growth objectives of the business those individuals are responsible for achieving.

Some organizations write off incentive plans because they've tried paying an annual bonus in the past and found the impact of it lacking. This may have occurred because it was a poorly designed plan or wasn’t the kind of value sharing that was needed at the time. A company must be able to determine which type of incentive is most needed and therefore should be given the highest priority. Sales incentives, for example, help define individual roles on a business development team and how each part of the sales process should be rewarded. Sometimes this needs to be the focus “right now.” If so, an organization needs to look carefully at whether the strategy it is using properly supports the outcomes being sought.

Performance incentives, on the other hand, are typically more broad-based and should create focus on the revenue engine of the company. They are intended to emphasize what needs to happen “this year” to ensure the business model is succeeding. Alternatively, growth incentives share value that is created over an extended period of time—typically three years or more.

Ultimately, most companies will need all three kinds of incentives to build a value proposition that will attract and retain the best talent. Each is a strategic tool to help communicate ‘what’s important’ and the outcomes the company, department or individual should be focused on achieving. All play a critical role in creating a unified financial vision for growing the business, which is the ultimate role of compensation in an organization.

I discussed these concepts in detail in a webinar entitled, “Do Incentive Plans Really Work?” You can view a recording of this event by clicking here. This presentation helped organizations understand the proper role of incentives and how they can become a more effective compensation strategy for a business.

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