How to Create an Effective Incentive Compensation Plan

Maple Holistics, a natural personal products company, uses online time tracking software to measure the productivity and efficiency of remote and on-site employees. The data is especially useful as the company uses that information to award bonuses to the employees who are most productive each quarter.

“We like to reward hard, genuine effort whenever we possibly can," said Nate Masterson, the company's CEO. “The unexpected surprise of a bonus is a great boost for morale. There's nothing quite like getting extra money because we know you're working hard."

An employee bonus program, or incentive compensation plan, can be one of the best ways to reward employees for performing exceptionally. But structuring an effective plan requires careful thought and strategy.

 

7 Key Components of an Incentive-Based Compensation Plan

“With an incentive compensation plan, you're trying to influence employees' behavior, so you have to determine which behaviors you want to encourage and make sure your plan awards them fairly and ensures your customers still get the service they need," said Andy Coates, senior compensation consultant at City National Bank.

Consider these seven steps to creating an effective incentive compensation plan.

 

Start at the Top

The first step to designing — or revamping — an incentive-based compensation plan is to seek feedback from top leaders within your organization. “Talk about what kind of behavior you want to reward," Coates said. “Make sure you're rewarding behaviors that will help your business financially and that will be positive for your clients as well."

Leaders also need to discuss which employees will be eligible for incentive compensation. In many organizations, employees involved in the sales function earn bonuses or incentives based on their sales. But some companies also offer incentives to employees in customer service, marketing and other functions.

For instance, at Ridester, a ride-sharing blog with 650,000 monthly visitors, marketing staff earn a base salary along with bonuses for achieving key performance indicators (KPIs) such as backlinks and online mentions — public relations efforts that are considered important to the success of a digital publication.

“This results in getting the team to continue to improve, and do better each time, which results in improved results for the company while also directly impacting the employees' compensation in a positive manner," said Syed Irfan Ajmal, growth marketing manager at Ridester. “We feel this system is the primary reason for our rapid growth over the past year, from 253,000 visitors per month to 650,000 visitors per month."

 

Align Measurable Tasks With Company Goals

When you've decided which tasks or performance indicators you want to encourage, determine how you will measure employees' success.

Ideally, your incentive plan should motivate employees to focus their efforts on activities that are directed toward achieving specific company goals. An incentive is structured so that employees perform measurable tasks that lead directly to the accomplishment of company goals — increased sales or profitability, improved customer retention or acquisition, or the achievement of KPIs, for example.

At Ridester, the company uses a third-party software tool to calculate both the number and quality of links and mentions, and that data is used to pay out bonuses.

“Both of these KPIs have a massive impact on helping us attain our company goals of increasing our brand visibility online as well as our organic traffic which, in turn, increase our revenue," Ajmal said. “We have agreed upon a clear price formula with each employee in this regard."

Ajmal recommends paying monetary bonuses based on individual results rather than departmental or company-wide results, as that allows employees to have more control over their accomplishment. For broad company-wide goals, consider experiential incentives, such as parties or retreats.

 

Tie Incentives To Finite Goals

The performance indicators you're measuring shouldn't be open-ended, but should have a finite end date — usually the end of a quarter or year. Award employees on a regular basis, such as every month or quarter.

Ridester adds bonuses to employees' checks every month based on their achievement of KPIs. Maple Holistics provides incentive pay awards every quarter, based on employees' productivity.

Make sure the bonuses or incentive rewards are tied to achieving performance standards that are specific and measurable, and over which employees have some degree of influence.

 

Set “Stretch” Goals

Your company pays employees a salary for doing their basic jobs, so don't give them extra incentives for doing what they're supposed to do. Instead, an incentive-based compensation plan should stretch employees to go above and beyond average performance — and reward them for doing so.

However, the measurable goals you set for employees to earn incentives should not be so difficult that they aren't realistically achievable.

 

Make the Plan Adaptable

Your company's strategies and goals will change over time, so your incentive plan should be dynamic enough to change with them. However, it's important not to constantly shake up the plan because most employees will need some time to build up success in the incentivized tasks.

“If you change your incentive tasks every quarter, it's difficult to see whether the approach was successful," Coates said. “It takes time for a goal to take effect and to make sure you're incentivizing the correct behaviors. If you change it really fast or change it again and again, you'll have a hard time determining whether the plan is working."

 

Communicate the Plan

Most employees are interested in opportunities to make more money, so take time to explain your incentive plan to those who will be affected. An in-person meeting may be necessary to introduce the program and explain how it works. It's also important to provide each employee with a copy of the plan in writing so they can refer to it when needed.

Make sure each employee understands what he or she must do to realize the incentives. Establish yourself or another company leader as the point person to answer questions about the plan, and refer to the written plan document if there are any misunderstandings.

 

Establish Parameters To Protect the Integrity of the Incentive

While an incentive compensation plan can help boost performance on the indicators you've set, it's important to ensure that employees are not overly focused on the incentive to the detriment of other important aspects of their jobs. No company wants employees engaging in unwise actions in the pursuit of the incentive award.

To help avoid such a scenario, consider these strategies:

• Establish a cap or maximum on incentive payments (e.g., two times the target or no more than 100 percent of salary).
• Require that a portion of the incentive payment be deferred for one or two years, with future payout contingent upon continued employment or continued employment and performance.
• Reserve the right of executive management to make downward adjustments to payments based on such factors as financial and individual performance or other behaviors inconsistent with company expectations.
• Include a “claw back" provision whereby all or a portion of the payments must be repaid based on factors like inappropriate financials.
• Adopt strong corporate governance, including active and effective oversight by executive management and the board of directors.
• Ensure that your company's leadership and culture support and reinforce the appropriate and desired results and behaviors.

A well-structured incentive compensation plan can present a win-win scenario for your company and your employees.

At Ridester, the incentive compensation plan has resulted in employees spending more time and energy on meeting company goals, as well as increased employee engagement and retention, Ajmal said. “Employees can directly correlate their rewards with the growth the company experiences," he said.

Enabling employees to reap financial rewards based on their performance will motivate many of them to work harder and smarter and make better decisions that are not only in their best interest, but are also in the long-term best interests of your company.