Do Incentive Plans Really Work?
An Interesting Debate
Business leaders that are trying to drive sustained performance inevitably come
face to face with this question: "Will incentive plans help?" The issue becomes
one of ROI. "If we allocate these financial resources to incentives, will
we build enough additional shareholder value to merit that investment? Will
performance improve?" Over the years, much has been written on both sides
of this argument. Given what's at stake, every CEO has to make a determination
about how he or she will address performance factors for which incentives are often
seen as a solution.
This subject has received some recent buzz due to the publication of the book Drive
(Publisher: Riverhead Hardcover), by author Daniel Pink. In his treatment
of the subject, Pink indicates that studies show the following:
- Rewards narrow our focus, concentrate the mind, and restrict our possibilities
When a task requires creative thinking, offering a reward extends the time it takes
to solve the problem
- Extrinsic rewards should not be applied to tasks that require
In reality, Pink's conclusions are not new, nor are they "wrong." Studies
have been researching this conclusion for 30 years. Indeed, rewards can distract
from results by focusing people on such issues as "how do I get this quarter's bonus?"
Similarly, incentive awards can buy temporary compliance but do not change intrinsic
motivation. They can likewise discourage innovation.
Instead of using incentives, Drive suggests that the focus should be on intrinsic
rewards. Give people autonomy so they feel more in control of the direction
of their lives. Provide opportunities for mastery so individuals feel they
are improving and getting better. Establish purpose in their work so employees
feel they are in the service of something larger than themselves.
For VisionLink, there is no real argument here. Given we are a compensation
firm that designs a lot of incentive plans, that may seem surprising to some.
But it's true; incentive plans can backfire. However......
We're not sure we agree with the foundational premise about compensation upon which
Pink bases most of his arguments: "Pay people adequately and fairly, get the issue
of money off the table, them give them lots of autonomy."
Our observation and experience is that this is not so easy in real life. In
response to that statement, consider how you would answer the following questions
if you were to adopt the "Drive" philosophy:
Do you set salaries at the same level that formerly reflected total pay?
How do you handle pay strategies for people of clearly different skill levels?
How do you budget for total compensation without anticipating self-financing elements?
How do you tell people, "don't worry about pay; just enjoy the 'intrinsic awards'?"
If you lead a business, you know these are real issues that have to be confronted.
So, the obvious question is: can a business develop a culture that supports intrinsic
motivation while still offering extrinsic rewards?
Perhaps it will not surprise you that our answer to that question is yes.
How? It begins with a foundational understanding of what it means to address
"total rewards" needs within an organization. At the core, every company must
effectively address and align four key elements if they want to attract premier
talent, keep them and have them perform well.
Compelling Future - do employees find the mission and vision of
the company compelling and do they see themselves as an integral part of its fulfillment?
Positive Work Environment - do employees like the nature of their
work, the team of people with whom they work, and do they have access to leadership
to solve problems and communicate about important issues?
Opportunities for Personal & Professional Growth Opportunities
- do employees see a career path, and that their unique abilities will not only
be utilized but maximized within the organization.
Financial Rewards - will employee cash and security needs be met,
and will they have an opportunity to participate in the value they help create (wealth
When you look at the issues that Drive and other studies have raised, it
becomes apparent that there is an incomplete picture of the rewards picture being
evaluated. They are addressing just two of the four elements: Compelling Future
(Purpose) and Opportunities (Autonomy and Mastery). What is needed is a total
rewards philosophy that addresses all four components in a way that also creates
a unified financial vision for growing the business.
Reinforce, Don't Force
When a company approaches strategic compensation plan design, it must start with
a correct understanding of the purpose of incentives. To bring this concept
into focus, let's start with the traditional view of these kinds of rewards.
Most companies are disappointed in the results they get from their incentive plans
because they use them in one or more of the following ways:
- "Carrot and Stick" approach to motivation
- Means of changing behavior
Getting people to do things they don't want to do
- Motivating people to "do the
Conversely, a healthy view of incentives would have a company view their purpose
This latter approach to incentives is one of reinforcement, validation, alignment
and unity. It conveys to employees that ownership sees them as key partners
and that the desire is to build a unified financial vision for growing the business.
It is in such an environment that confidence is conveyed, engagement is increased
and, as a result, productivity improves.
See the chart and illustration below that shows the contrast between the "force"
and "reinforce" approaches to incentive design, and the outcomes each produces.
Bad profits are those that come at the expense of the customer or client and erode
shareholder value over time. Conversely, good profits build long-term value
for the market, for shareholders and for employees.
Effective incentive plan design is fundamentally about fulfilling a commitment to
reward people fairly (even generously) for helping fulfill the mission of the organization.
When quality people understand and believe in this commitment, you reinforce
their intrinsic desire to deliver on your business plan.
Sustained growth in a business comes about primarily because key employees are focused
on performance factors they can impact - and they feel motivated to do so.
That focus leads to execution. When sustained, such a productivity pattern
brings about the results and success the business plan is seeking.
So they question is, what performance factors should become the focus of employees
- especially key employees? It would make sense, at least in general terms,
that they be the same factors to which the CEO and shareholders devote their attention.
There needs to be alignment between what the business needs to achieve next, how
employee roles and expectations are defined, and what rewards will flow to those
who fulfill and/or exceed those expectations.
In our work with clients, we suggest the performance factor discussion begin with
what might be referred to as the "CEO Worry List." That list is broken into
certain categories as listed in the graphic below.
As the CEO of a company looks at such issues, what crosses his or her mind?
Likely, it's something like the following.
- We are not hitting our sales targets
- Sales are not growing at the right
pace - or at all
- Our sales cost is too high
- Our gross profit per employee is too low
- Our gross profit is not improving
Our headcount is too high
- Our market share is not improving
- Our return on equity is unsatisfactory
We are not growing our market value
- Our employees lack a sense of urgency
- Our innovation cycle is too long
We are falling short of critical KPIs
- We are not yet considered an "employer of choice"
- Our turnover is too high
Our talent level is below the desired standard
When a company creates incentives for employees in the organization, no award should
be paid unless improvements are made in one or more of these strategic areas.
As a result, the company needs a way to measure each of these components.
If a business can address these issues properly, the following results should emerge:
- New value is created
- Competitive advantage is enhanced
of choice status is attained
- A culture of execution and confidence emerges
The source of superior value being generated through these results allow the paying
of incentives to be a "self-financed." Value (incentives) is paid out of additional
value that has been created. If that value isn't created then rewards aren't
released - or at least they are diminished.
Such an approach communicates the sense of partnership alluded to earlier.
Until and unless this financial component is introduced in an incentive context,
a business is really not positioning employees to have an ownership mentality.
How could they?
Connecting the Dots
Something called "line of sight" is created in an organization when a connection
is made between vision and strategy, roles and expectations and rewards. In
such a context, incentives become the thread of continuity that connects those interdependent
elements creating a unified effect. The following two graphics illustrate
the outcomes and mindsets that should emerge from such an approach.
As illustrated in the graphics above, incentives become the lens through which an
employee is better able to see and understand what responsibility he or she has
for the (hopefully clearly) defined outcomes the business is trying to achieve.
This is what it means to achieve "line of sight." If the reward is tied to
factors the employee can impact, and it provides a meaningful benefit, that incentive
is much more likely to impact execution and results.
Don't Follow the Trend
One of the reasons many companies start questioning the value of incentive plans
is because they get stuck in an unproductive mindset. They typically get stuck
in annual bonus mode and their whole incentive focus is myopic. The trend
they follow goes something like this:
Develop and redevelop the short-term incentive plan - sometime using a profit-based
approach, other times making it target-based
"Some day" we need to develop a long-term incentive plans for senior executives
If companies are going to develop world-class compensation strategies and incentives
that play a meaningful and strategic role in their overall business, then they must
become trend breakers. Or better yet, they start a new trend. What is
needed is a balanced approach to incentives that addresses the need for generating
short-term results that drive long-term value. How does a company do that?
Here is an example of how such a trend breaking process might be approached.
Create a short-term productivity incentive that accomplishes the following:
Create a long-term incentive plan tied to growth and value creation goals that accomplishes
The graphics below illustrate the impact of these two approaches.
Again, as ownership looks to build the future company, it must create the right
balance in the mind of employees between the need to generate results (this year)
and build long-term value. Incentives, when engineered properly, allow employees
to have more of an ownership view of the "tension" between those two elements and
the personal financial impact of the company achieving or surpassing its targets.
Why would a company adopt such an approach to compensation? Because the following
results emerge, all of which promote business growth:
Employees are treated like true partners, therefore there is a unified financial
vision for growing the business
Values that employees participate in mature and grow, creating both a retention
and performance outcome
- An ownership mentality emerges
- Recruiting and retention of premier talent
Incentive become self-financing, not entitlements or unattainable payouts
All of this must grow out of a fundamental philosophy that an organization develops
to define what it pays for and the kind of performance it seeks to reward.
If a company adopts the measures outlined in this article, it might formulate a
compensation philosophy that has, at its core, a statement that goes something like
We pay fair salaries (at approximately the 50th percentile of market pay) with great
upside earning potential for short and long-term growth and profitability.
We share the economic value our employees create.
Do incentive plans work? What conclusions can we draw from the things just
- No, if "work" means you can positively improve results by tying incentives to targeted
- Yes, if "work" means you can forge a stronger relationship with employees
and engage them in a unified financial vision for growing the business
expect a traditional incentive plan to improve productivity (if anything it might
make it worse)
- Employee perception of the plan is more important than the plan
itself ("Is this a game or is this for real?")
- The lack of an incentive plan
can make it difficult to:
- Provide competitive pay structures without straining the budget
the commitment to support long-term wealth accumulation opportunities for top performers
- Consider developing an approach to short-term incentives that shares profits above
a productivity threshold
- Utilize a long-term plan that shares an appropriate
part of the created wealth with those that help create it
- Build on a philosophy
that treats employees as partners and your most important asset