Designing an effective incentive plan requires a delicate mix of art and science (and yes, politics), and one that cannot be undertaken lightly. The art comes in at the psychological level, the science at the budget and measurement, and the political in working with senior leaders (with the common misnomer that they are on an incentive plan, so they know how to design an incentive plan). This balance, when managed correctly, will result in increased performance, increased employee satisfaction (at least for those performing), and a way to effectively identify poor performing employees and managing them “up or out”.

At the core of every effective incentive plan there are 11 essential fundamentals. While deviating from these fundamentals may still result in the desired result, the further one goes from these, the more likely there will be frustration and counter-productivity.

  1. Make it objective. Keep away from qualitative measures and stick with the factual ones. How many X units are produced in Y time. The more qualitative you make the measures, the more subjective it becomes (and the more questions that will be raised).
  2. Make it simple. Keep the measures to less than five (if at all possible). The more measures you implement, the more diluted the value of each measure becomes. Your employees will, by default, focus on those measures that are either easiest, or result in the most money. Be wary of “sub-measures”, where you might have 4 measures, but each measure has 5 sub-measures. The last thing an incentive plan should do is result in questions and confusion.
  3. Make it attainable. If the incentive is individual based, make sure the individual has full control over the different variables to attain the incentive. Tying an incentive to components that others have control over will, without a doubt, result in dissention and dissatisfaction.
  4. Make it meaningful. This is tricky, because there might be financial constraints, but you should design the reward to be significant enough to “catch someone’s eye”. The dollar amount is important, but the percent of base salary is more important ($1,000 bonus paid to someone who is earning $12.00/hour is significant, whereas the same bonus paid to someone making $200,000/year might be viewed with less exuberance).
  5. Make it timely. This is two-fold…(a) make sure the measurement period is long enough to allow the employee to complete the task/goal/objective, and (b) make sure the timing of the payout is as close as possible to the performance.
  6. Forecast the expense. Expect to spend the money! If someone achieves the goal you set out, you should pay them as per your commitment. Failing to do so will result in dissention that is difficult to overcome for many years.
  7. Make sure the core of the plan is designed correctly. Focus on “incentivizing” for performance that is greater than the level currently being performed…but is still attainable. A good incentive plan pays for itself in increased productivity.
  8. Conduct look-back analysis on a regular basis. Look-back analyses are often overlooked (and rarely discussed). These are regular evaluations of the plan, the performance, and the payout. If employees are getting paid incentives, but the organization is not benefiting from the effort, an adjustment needs to be made. Likewise, if employees are not receiving any incentive, an adjustment needs to be made. Semi-annual (or preferably quarterly) look-back analysis will reveal the true effectiveness of the incentive plan.
  9. Don’t be afraid to change it (just not too often). Tied to the look-back analysis, when you identify an issue with the incentive program, don’t be afraid to “tweek” it. Employees will see this as your vested interest in the program. Just make sure you don’t adjust it too frequently. Semi-annual adjustments are reasonable…monthly are confusing. If you are needing to make adjustments too frequently, pause the program and evaluate the foundation of the design!
  10. Make it open/visible. Too often, incentives are kept “top secret”. If everyone on a team is on the same incentive plan, share the metrics, and the individual’s performance. Employees are often driven by competition (each employee wants to be #1).
  11. Make sure it’s compliant (especially for hourly employees). Depending on the industry, there may be specific legal requirements that must be met (Loan Officers, as an example). That said, one legal requirement that is often misunderstood is when providing incentives to Nonexempt (hourly) employees. In those cases, if the incentive is based on performance (as opposed to subjectively provided, such as profit-sharing), the incentive needs to be recalculated back into the employee’s wages for the period earned, and a true-up for overtime may be in order. This is a complex subject, and one best left for experts to evaluate to ensure your compliance with the Fair Labor Standards Act. For more information on bonuses and overtime, click here.

An incentive program, if designed correctly, will result in a more productive, more satisfied, highly engaged employee. On the other hand, one that is poorly designed, that overlooks many of the fundamentals of an effective incentive plan, will lead to more disastrous results!

Disclaimer:        The materials contained in this paper are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem.

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