Managing People - Compensation
Choosing Incentive Plans

Choosing Incentive Plans

Incentive Plans Pull Companies Together!
Years ago the only employees offered incentive pay were sales personnel, piece workers, and top executives. Today most large corporations, and many smaller firms, offer an incentive package to all of their employees.

Some kind of incentive pay is an important part of any compensation plan. Incentive pay shows appreciation and creates a sense of participation in the company's well-being that straight salary dollars, no matter how large, don't convey. A well-designed incentive-pay plan can also help pull people together, help point them in the direction you want them to go, and give that extra push that every company needs in today's competitive environment.

Profit-Sharing Plans Are Common
Profit-sharing plans are probably the most widespread incentive-pay programs at larger corporations. They are generally company-wide and made available at least to all full-time employees. Usually the company will contribute a small percentage of its pre-tax profitability to a pool, which is then divided among eligible employees. Division is typically prorated according to the base salary of each participant. Profit sharing is generally done on an annual basis. At some firms profit sharing may be directly contributed as pre-tax dollars into a retirement program, such as a 401K program.

Profit plans work best at more established firms with relatively steady earnings. The criteria for the profit plan must be carefully defined in advance.

Profit Plans Don't Always Work
The advantages of a profit-sharing plan include: It pulls people together since everyone is on the same plan; it gets people to focus on profitability; and its cost to the company goes up and down in sync with pre-tax earnings.

The disadvantages include: It echoes the base salary; it does not take into consideration performance during the year; it is focused on a single objective.

For smaller companies with erratic earnings, profit-sharing plans can frustrate and irritate employees by creating expectations that are not fulfilled each year. I switched away from a profit-based incentive plan because I found that a small payout level, following a year of weak profitability, made a low morale situation even worse.

Incentive Programs Award Achievers
Last year we switched to an individual bonus incentive program, where the annual payout is determined by a subjective evaluation of each person's performance.

The advantages are: Unlike a profit-sharing plan, we can dramatically differentiate the payout given to a star performer versus a weaker one; we can differentiate between an individual's performance and the company's performance; and there is complete flexibility for a significant one-time payout if an employee has an extraordinary accomplishment that may not be repeated in future years.

The disadvantages include: The payout is subjective, and employees may feel that they deserve a higher pay-out; it can be divisive when, all too often, a top performer tells other people what a big bonus they got; employees may focus more on "looking good" than on working to increase corporate profits.

Many Other Incentive Options
In addition to profit sharing and bonuses, here are some other incentive options:

• In salary-at-risk plans, which I don't recommend, employees receive their full base pay only if performance meets minimum goals, but a larger payout is possible.
• Gain sharing, popular at some manufacturing firms, provides for a portion of increases in efficiency to be shared with employees.
• Stock or options are available at many public companies, but are less practical at private ones.

Some plans have multiple goals with a percentage of the payout determined by how well a person performs on each objective. While I highly recommend incentive-pay plans, design and implement yours carefully! All too often incentive programs backfire when they fail to meet employee expectations.