The way you design your incentive pay program can make a big difference to multiple pieces of your business, so it shouldn’t be an afterthought. Organizations are using incentive pay programs to help them compete for talent, to combat turnover, and motivate all employees to higher levels of performance. But when you get it wrong, you might be wasting your compensation dollars and driving your employees towards undesirable behavior that hurts the long-term success of your organization.
Often, when building out a new plan, it’s tempting to follow the best practices, the next practices, the “bleeding-edge” practices that other organizations are doing. One of the best things about incentive pay plans is that their costs are variable. So how do you know how to build the right bonus plan?
Consider the needs of your organization, your organizational culture, your business goals and objectives, and the makeup of your workforce. As we go through each of these five tips, think about how your organization’s unique circumstances can point to the right way of designing the plan you need.
1. Align Pay to Organizational Results
We’ve done a fair amount of work with organizations on their compensation strategy. One of the first questions we ask is, “what are your organizational goals?” Typically our project partners respond with their talent goals: retention, recruitment, development. Those are definitely good goals, but they’re not business goals.
Let’s say the business goal is to double revenue in the next five years. A business strategy might be to develop and release a new product every six months. In order to make that strategy work, the talent strategy might be to recruit, retain and develop innovative product developers. The compensation strategy should clarify organizational priorities and feed into the talent strategy, business strategy and ultimately the business goals.
How? In this example, you might choose to have competitive base pay for your software engineers, research and development, product managers, etc. But beyond that, it’s not a bad idea to find some way to incentivize innovation – the actual ideation of the products to be created.
2. Set Meaningful Goals
In order to create alignment, to create line of sight for employees, you have to set meaningful goals. There are lots of schools of thought on the best way to create clear goals and objectives for employees, including: MBO, SMART, KPIs, OKRs, Cascading goals, etc. If you want to dive deeper into which types of goals make more sense for your organization, take a look at this guide from Betterworks.
Behind all of them is the intention of making clear goals to help employees better understand the expectations of their roles, and how their efforts and performance level translate into rewards. Most emphasize the need for goals that are in some way measurable and time-bound. Obviously the goals should help connect the dots between individual and organizational performance. And the goals should be concise – simple. As employees are going about their day-to-day work, it should be clear to them what and how they are working towards accomplishing their goals.
We can’t understate the importance of setting good goals. It all hinges here. We bring up the cautionary tale of the Atlanta school district who, in 2009, had the right objective in mind, but through poor planning and poor goal-setting, rewarded the wrong behaviors. Specifically, the district wanted to improve student learning. The measure they picked for that objective was increased scores on standardized tests. Because principals and teachers were incentivized to raise student test scores (not to improve student learning), the wrong behaviors evolved: the teachers cheated on the tests on behalf of the students.
Know the behaviors you seek to see and consider what unintended consequences you may find based on the design of the incentive plan.
3. Consider your workforce: what’s in it for them?
When it comes to designing an effective incentive plan, start by thinking about what motivates your workforce. Ask yourself, what will enable them to feel like they’re getting a good deal? Part of your design challenge is to figure out who finds value in incentive pay, and how will you generate value from their efforts.
To design an effective incentive plan, start by thinking about what motivates your workforce. Ask yourself, what will enable them to feel like they’re getting a good deal?
It’s not about catering to the needs and preferences of your workforce; it’s about understanding your workforce enough to know what types of pay are most motivating. What is the value your organization has to offer to current and prospective employees? What is the value you expect in return? Does it seem like a good deal to you? To them? Keep in mind that the value your employees find in working for your organization typically goes far beyond pay. Consider your total rewards package, developmental opportunities, the ability to do meaningful work, or whatever your specific workforce finds most motivating.
For more tips on how to compensate, motivate and reward a multi-generational workforce, check out PayScale’s whitepaper Compensation Challenges for a Multi-Generational Workforce.
4. Think About Differences Across Your Workforce
Your workforce is probably not monolithic. There are ways to consider various different personas within your workforce in order to identify the types of things that are likely to motivate your workforce.
One of the simplest ways to differentiate your workforce is by generation. It may or may not be the best way to segment your workforce, as generational stereotypes are often just that, stereotypes. That said, they do provide a great example for how groups of people may feel differently about variable pay. For example:
- Baby boomers tend to be more private about pay, so public displays or discussion of pay may not feel motivating to this group: think goal charts and contests. This group tends to be focused on retirement and benefits, has longer tenures, and is less likely to be motivated by variable pay such as individual incentives.
- Generation X is the sandwiched generation. Smaller than both Boomer and Millennial generations, this somewhat pessimistic generation saw the end of pensions. Gen X is semi-private about pay, focused on cash and benefits, and fairly distrustful of organizations, having gone through more than one economic bust. For them, incentive pay is “pay at risk.”
- Millennials are a different group. They are notoriously public about pay. A highly mobile workforce, Millennials are focused on cash and variable pay. They see incentive pay as potential pay: it’s mine if I work for it.
- We don’t yet know much about Generation Z, although they’ve already begun to enter the workforce. So far, they seem to be a bit of a pendulum swing back from the Millennial mindset in some ways. They are realistic and very eyes open. They’re not as public in communication as we can see from their online social media preferences for temporary apps like Snapchat vs. Facebook.
Job Function and Job Level
Segmenting your workforce into generations is one way, but perhaps not the best way, to divide your workforce to gain a better understanding of what motivates them.
- Your accounting and finance group wants you to use variable costs, but not for their own personal pay.
- Sales is a high-risk / high-reward job, and they want those rewards in cash.
- Jobs at entry levels or closer to minimum wage tend to be more focused on base pay. There are very real costs involved in paying rent and buying groceries, and it’s tough when those are paid out on a variable basis.
Consider the various different personas in your workforce, their characteristics, and what types of compensation might motivate them. If you don’t know, ask.
Speed of Business & Org Lifestage
One consideration that guides many decisions, if subtly, is the speed of your business. This will depend on both your industry and the lifestage of your organization.
- Inception – aka startup: at this stage, cash is light and few organizational structures and systems are in place.
- Mix of pay: Typically in this stage, there is high equity, low base pay, medium variable pay, and high individualized rewards and recognition. Inception is typically a high risk high reward environment for employees.
- Payout cycle: employees will need to feel progress, so build incentives based on milestones and pay out when you reach them; don’t wait until the end of the year.
- Growth phase: at this stage, cash is tied up in growth; often the infrastructure becomes critical during this stage.
- Mix of pay: Organizations in this stage start pulling back on equity. They remain low base but high in variable and individualized rewards. Growth is still fairly high risk/high reward, but there is more potential for cash.
- Payout cycle: the organization is usually fast-moving during the growth stage. Waiting to pay incentives annually is too long. This is a good time to consider paying at the speed of your business, whether it’s agile, quarterly-based, or on another cycle altogether.
- Maturity phase: usually mature organizations have cash and organizational systems well in place.
- Mix of pay: Mature organizations are most likely to have and pay in cold hard cash. THey are low in equity, high in base, moderate in variable, and moderate in individualized rewards. Mature organizations are usually the safest bet for employees.
- Payout cycle: both now and future: quarterly & annual goals
- Decline (or hopefully renewal): at this point, pretty much everything is a question mark.
- Mix of pay: Organizations in decline don’t have a lot to offer in terms of long-term security. As a result, they aim for low to no equity. They usually offer medium base, but low variable that may not be motivating without confidence in the employer. These organizations have moderate individualized rewards and use culture or even “tradition” to bridge the gap.
- Payout cycle: Because confidence is low, if they do variable pay at all, shorter payout cycles might yield more effort.
Some considerations on the length of your payout cycle: make sure your incentive pay plan fits within your budget. Think about the timing of your pay out with respect to cash flow. And finally, done right, an incentive pay plan should reward the types of things that benefit the organization; they should be self-funding.
For more tips on how you can design an incentive pay plan that works for your organization, check out PayScale’s new whitepaper Variable Pay Playbook.