Compensation: Stop the $600 Annual Incentive!
As regular readers know, I do a ton of incentive compensation work. I believe in incentives and their ability to align people with the culture, strategy, and goals. I know incentives work when properly designed and communicated. I also believe that managing people is more important than incentivizing them.
This is a short article about well-meaning but misguided short-term incentive plan design. When we ask business leaders to identify critical metrics for success, we often get two types of answers. The first is a big-ticket item that aligns well with management. These metrics are important, but they may not always resonate with rank-and-file employees. The second answer is a laundry list of all the things that must be accomplished during the upcoming year. In between these answers is the real core of your incentive plan.
A few years ago, I wrote about the Incentive Plan Rule of Three. Let me summarize, “No more than three metrics (KPI), no more than three defined goal levels, no more than three incentive plans for any one individual.” This rule allows you to focus incentives on what matters, which also helps make those incentives meaningful.
Over the years, I have seen many companies with “multi-metric” incentive plans. These plans usually have one big goal covering 30-50% of the total incentive target and four or five smaller goals that break down the remainder of the incentive target. These may be great when target values are significant, but they are just plain crazy for your mid-level and lower-level professionals and support staff.
Let’s do some math!
Imagine Sally makes $60,000 a year. You have created an incentive budget targeted at 10% of her pay. Six metrics drive the target value that could aid in promoting employee retention which is included in effective compensation consulting services. The primary metric covers 50% of the total, evenly splitting the other five metrics at 10% each.
$60,000 * 10% = $6,000
50% of $6,000 = $3,000 (not terrible)
10% of the remaining 50% ($3,000) = $600 per “mini-metric”
This means that you are asking Sally to focus on something specific and work to attain a higher level of performance for about $2.75 per day, or $0.35 per hour. Sally must keep $0.35/hour. As related to a specific mini-metric top of mind for the next year and the hope that, after taxes, she has “won” the money to buy her kid a Lego set! To be clear, Sally isn’t going to do that.
This is where managing beats incentivizing. The leader who chose this metric was probably right in defining it as important. But the return from the incentive plan will have no impact on achieving this goal. Clarifying this metric as a management goal for the leader and ensuring that they communicate and update progress throughout the year will have far more impact. This is where compensation professionals have to educate. (Don’t “push back.” Teach.)
With a bit of math and discussion about best practices, you can usually get leaders to reevaluate and narrow down the focus of the incentive plan and help everyone have a more incentivizing year.
Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is a leading expert on incentive plans and equity compensation issues. He has written several industry resources, including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, , “Equity Alternatives,” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.
Posted by DanFutureSense on 12/16/2021 at 10:50 AM in Executive Compensation, Incentives/Bonuses, Pay for Performance, Performance Management, Small Company Compensation, Total Rewards | Permalink | Comments (0)
Tags: bonuses, dan walter, futuresense, incentives, managing, productivity
