Key steps for designing (or redesigning) your pay-for-performance plan
Companies are spending more than ever on pay-for-performance plans. Naturally, business leaders wonder whether they are getting the expected value from them. To make sure your pay-for-performance plan is effective, there are a few key points you’ve got to get right.
One of the first things to do when introducing an incentive plan is to consider its purpose. After that, identify how performance will be measured, and who participates in the plan. Finally, work with your finance department to understand how much (and how little) you could potentially pay out, and then roll out a robust communications plan.
[Pay-for-performance plans include both incentive plans for the sales force, as well as corporate bonus plans for staff groups (such as finance, marketing and human resources). The guidelines here apply to both types.]
1. Purpose: Whether you’re designing a new plan, or redesigning an old one, first carefully consider the plan’s purpose. What are you trying to motivate people to do? I was once asked to redesign a plan for client relationship managers at a major credit card company. The plan rewarded RM’s for driving growth and bringing in new revenue. The problem was that the product was well-established and there were few opportunities for growth. Not very rewarding! We changed the design of the plan to encourage RM’s to maintain and strengthen current relationships, and refer clients to innovative products in growing areas. The entire purpose had changed, impacting its design.
You may wish to drive different behaviors. You might need people to go out and build new relationships. You may want them to share in the company’s successes and failures. Assessing this overall purpose will be a key task early on.
2. Measuring performance: After identifying the purpose, the next step is to determine how you will measure performance. In the credit card example, performance had originally been measured using new clients and revenue growth. Under the new design, performance was measured using client retention. Also, because the company wanted more teamwork among the RM’s, their bonus became partly based on the performance of the business unit as a whole.
It’s essential to consider your level of confidence in your performance measures as well. If your measure is manager performance ratings, how much differentiation is there across participants? Do managers take a peanut-butter approach, where everyone is a winner? Confidence in your measures is essential for incentives to work.
3. Who gets to participate? With sales incentive plans, include the front-line sales people. You may also include people in business development roles or sales assistants. In these cases, be sure you can identify how they contribute to each sale, and how many dollars of incentive you are paying for each dollar of revenue! In corporate bonus plans, start with the highest-level people in the company, and then work your way down, considering how much impact each role has on company results. Many companies do not include employees who are in non-exempt, non-sales roles. In this case, consider the financial cost of including these employees, compared to the engagement cost of excluding them.
4. Model payouts: Partner with your finance team to model out the potential range of payouts, under high- and low-performance scenarios. This will tell you how much, or how little, you will pay out in incentives. Also, create a plan for how you will measure the plan’s effectiveness on an ongoing basis. For the previous credit card plan, we set up annual reviews with HR, Finance, and the Business unit leader, to review each RM’s payout.
5. Communications: Roll out a very clear communications plan. Make sure all leaders understand how the plan works before introducing it to the participants. In the credit card example, we held global town halls to give people the opportunity to ask questions and provide feedback. The plan is only motivating if people understand how their behaviors lead to incentives.
In sum, a pay-for-performance plan is a communications tool. It should simply tell people what behaviors to increase and which ones to decrease. Carefully thinking through these five components will help make sure it motives people toward your goals.
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