Stop the $600 Annual Incentive!

Stickman-$600 incentive-20211216As regular readers know, I am someone who does a ton of incentive compensation work. I believe in incentives and their ability to align people with the culture, strategy, and goals of a company. I know incentives work when properly designed and communicated. I also believe that managing people is more important than incentivizing them.

This is a quick article about well-meaning but misguided short-term incentive plan design. When business leaders are asked 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. This can be summarized as: “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 your incentive on what matters, but it 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 that covers 30-50% of the total incentive target and 4 or five smaller goals that break down the remainder of the incentive target. These may be great when target values are large, 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. There are six metrics that drive the target value. The main metric covers 50% of the total, the other five metrics are evenly split 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 perfectly clear. 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 the achievement of this goal. Clarifying this metric as a management goal for the leader and ensuring that they follow through on communicating and updating 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”, “The Decision Makers Guide to Equity Compensation”“Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.