Incentive Plans & Performance Measures
Most organizations use some kind of pay for performance program for their employees. There are cash incentive plans and non-cash incentive plans. The non-cash incentives include trips and recognition programs.
Whenever you implement or change your incentive plan, you should use the best performance measures possible. A “performance measure” is the metric by which you are gauging an employee’s results, such as revenue, profit dollars, profit percentage, net income, EBITDA, number of new customers, number of customer calls, number of invoices processed, etc.
Test #1 - Is it Relevant?
When considering a measure, ask yourself “is this relevant to the health of my business?” If someone does this really well, will my top or bottom line show a direct impact in a relatively short time? If they do it poorly, can I be hurt seriously?
Most of the performance measures listed above pass this test for most companies…but some do not. One questionable one from the list which is sometimes used for inside sales reps is “number of customer calls.” It doesn’t take much thought to realize that if you pay an incentive for making lots of calls, you will get…lots of calls. Be sure you are paying for results that matter to your business.
Test #2 - Is it Controllable?
Can the employee influence the outcome? If the answer to this question is “no” then you are not developing an incentive plan—you are developing a profit sharing plan. For an incentive plan to be motivational, the employee must be able to positively or negatively impact the results.
Many CFOs and CEOs believe all employees should be paid based on EBITDA, or net income, or some other bottom line number. But only a few employees in the company can actually influence that number directly. One of the real tricks to successful incentive design is figuring out what matters to the business (relevancy) and then mapping out how each person’s role in the organization impacts that result (controllability). That is where you should start looking for good performance measures.
Test #3 - Is it Measurable?
If you can’t measure it, you can’t track it and you better not try to pay for it. Many of the performance measures that pass the first two tests fail this one.
Always consider the balance—what will you gain by using the performance measure in an incentive plan versus what will it cost for you to measure, track and report on the results.
Test #4 - Is it Objective?
This last one is really a quality of measurability and it can make or break the perceived fairness of an incentive plan. Managers of small business or teams, or groups that do many alternating functions, often want to revert to a subjective evaluation based on manager observation of performance. Subjective measurement tied to incentive pay is dangerous territory and can become cause for a discrimination suit.
There are times and circumstances where small doses of subjective evaluation can be delivered as part of a well-rounded incentive plan, though we recommend the impact of subjectivity typically be kept to about 10% of the overall total target incentive.
When used in the proper way, incentive plans can be powerfully motivational and can drive employees to higher levels of performance—helping management balance risk, costs of compensation and improve employee morale and sense of purpose. However, if the four rules above are violated in the plan, you will no longer have an incentive plan—you will have a disincentive plan.