Obstacles to the
Effective Execution of an
Incentive Pay System

William Abernathy, Ph.D.

The use of incentive pay as a management and compensation tool is rapidly expanding both in the United States and abroad. The results organizations achieve, however, vary widely. These differences are due to three common problems; poor measurement, communications, and management.

Measurement problems

1. Subjective measures. Subjective measures are based upon supervisor or peer perceptions rather than objective data. It is well documented that perceptions of how well an employee performs are distorted by personal bias. Further, this type of measure fails to provide the employee specific objectives or feedback that are required to improve performance.
2. Multiple measures. Many incentive plan designers try to measure every aspect of an employee's job responsibilities. Too many measures reduce the focus of the incentive plan causing poor results. Two to seven measures are recommended with fewer being better.
3. Group measures. Our research finds a direct negative relationship between the number of employees assigned to the same measure data and employee performance improvement. This is one of the reasons traditional profit sharing has failed to produce significant performance gains. Measures related to an individual's performance produce the best results. However, it is often more desirable to measure team performance. We find that team measures where the team has fewer than 15 employees are effective.
4. Process measures. A common problem in incentive plan design is to confuse outcomes with processes or behaviors. For example, in a sales incentive plan we could measure actual sales dollars, number of prospects seen, number of closes, the cross-sell ratio, or the up-sell ratio. The outcome is clearly sales dollars. The process is calling on prospects, closing the sale, selling additional products, and selling high value products. Process measures are valuable management tools, but should never serve as formal incentive measures. Sales people could easily increase performance on a process measure with no bottom-line impact on the outcome - sales dollars.
5. Uncontrollable measures. On the other hand, only outcomes the employee can actually influence should be included in an incentive plan. It is all too common to determine incentive payments on financial or other high level results the employee cannot control. Return to stockholders, ROA, ROE and so on are useful management measures, but usually have no place in an incentive plan for employees. This common mistake is likely due to confusing the company's results with those of a specific individual or team. Ownership may be willing to share financial success with employees, but should not confuse this practice with incentive pay or performance improvement.

Communications problems

1. Employees don't understand the system. Designing well thought-out measures is a good start, but not sufficient to ensure the success of an incentive system. If employees do not understand the system, they logically will not respond to it. We find a good communications technique is to present employees practice sets of data from which they can compute the incentive payment. This approach helps explain the system and provides a tool for determining if employees understand it.
2. Delayed feedback. Over fifty years of behavioral research tells us that frequent performance feedback is critical for improving and sustaining performances. Our research finds a direct correlation between the frequency of feedback (knowledge of results) and performance. A comparison of companies offering quarterly feedback, vs. companies offering monthly feedback, found no improvement in the quarterly plans - even though the incentive pay opportunities were equivalent.
3. Recognition for goal achievement only. A too-common practice is to award incentive pay only when the goal is attained. No recognition is provided for incremental improvement. If the goals are a stretch, the employee may simply give up, rather than make the effort to gradually improve.
4. Measures and goals are changed frequently. In the start-up of an incentive system, it is often necessary to change measures and goals. However, once a system is refined, measure and goal changes, if needed, should be made on an annual basis. Our research finds a direct relationship between the consistency of measures and goals, and the level of employee performance improvement.
5. Closed book management. Many organizations, especially closely held ones, will not share information with employees. This practice creates two problems for the incentive system. First, employees are suspicious of incentive plans in which the payments are computed on 'mystery' data. Second, the employee improvement effort is hampered by a lack of information. Employees cannot improve an outcome without the information needed to assess the problems root causes.
6. Employees don't know how to improve. Many incentive system developers assume that the incentive system alone will improve performance. This is the case for straightforward results the employee can directly control. However, many performance deficiencies are due to more complex issues such as work process or work flow problems. Providing employees training or outside assistance with these kinds of problems will ensure improvement occurs.

Management problems

1. Managers don't manage to measures. An incentive pay system does not operate in a vacuum. Managers have a history of managing to something before the plan is introduced. Ensuring managers make the transition from past management methods to managing through measurement and incentive pay is critical to the success of an incentive plan.
2. Managers don't coach employees. Conventional wage and salary compensation promotes a style of management know as 'management by exception'. The manager simply reacts to employee mistakes. Employees work to avoid criticism rather than to earn their pay. With the introduction of objective performance measurement, the manager can be more proactive and identify improvement opportunities before they become serious problems.
3. Managers don't support the system. Many companies underestimate the effort required of managers to make the transition from traditional management to an incentive pay environment. Incentive pay will, in some ways, devalue the manager's importance. In an incentive system, the employee can directly increase his or her pay, and sense of accomplishment, without regard to the manager's opinion of their performance. As a result, some managers may not support the system unless their new role is well communicated and reinforced.
4. Managers negotiate measures and goals. There are two ways employees can increase their incentive payments. They can negotiate easier measures and goals, or they can improve their performance relative to existing measures and goals. The first approach is often easier and quicker. To prevent wholesale negotiation, the organization should implement a formal measure or goal change process and specific criteria for when to change.
5. Managers don't help design performance improvement plans. Many managers view incentive pay as an exercise in Darwinian 'survival of the fittest'. If employees fail to improve, they are simply 'unfit'. This is a very costly view of the incentive pay process. Managers must take an active role in assisting employees in developing solutions where measures fail to show improvement.
6. Senior Management doesn't integrate the incentive system with Human Resources. The incentive system measures should be integrated with the organization's recruiting, selection, training, evaluation, promotion, compensation, and job assignment practices. Otherwise, there will be conflicts between the two systems that can negatively affect both.