David A. Boyle, C.M.C.
Partner
HR-on-Demand Inc.

Toronto, February 25, 2001

Incentive Trends and Ideas 2001

You are about to update the design of an incentive plan and are searching for the best ideas available to build a fair plan to stretch and challenge members of these teams based on some combination of team, individual and corporate performance.

HR-onDemand has undertaken a literature search which encompassed the internet, public domain records (e.g., SEC and OSC databases), academic articles and books together with the incentive expertise available through the American Compensation Association, the Canadian Compensation Association, the Conference Board and client experience.  The trends and best ideas are documented as follows:

KEEPING PLANS SIMPLE

The greatest strength, and the greatest weakness, in successful incentive plans relates to keeping things simple.  To be both simple and successful the literature suggests:

1. The incentive pool should be visible to the employee participants as it accumulates. The earlier and greater the level of anticipation the more motivating for the employee and the earlier any negative business trends will be corrected by these employees as they adapt.

2. The incentive pool should be accumulated based on goals and measures which best reflect employee influence on the continuation of corporate health over the long term and meet expectations of the shareholders.  Profit, margin, consistency in meeting plan month by month, on-time-delivery and client satisfaction are well documented as good measures everyone understands.

3. The incentive pool accumulation should be based on corporate performance.   Corporate performance is the “must have” component in determining pay out from a basic incentive plan.  Employees in the divisions must be conscious of their contribution to corporate performance and must be encouraged to work  as a team to jointly focus on achieving corporate performance targets.

4. Access to incentive pay out from the incentive pool should be based, at the very least, on meeting team performance targets.   Not meeting team targets limits or precludes payment from the incentive pool.

5. The best plans also include a personal performance improvement target for each employee,  such as: Employee X must improve personal skill in gathering and using  competitive intelligence to support a planned 5% gain in division market share.

6. The best plans are based on management leadership and team member mutual trust, supported by a flow of relevant management information in time for corrective action.

7. There should be an assumption in the plan that goals, measures and funding formula  will change and there should be a documented process for addressing change as the corporate plan unfolds, annually and forward.

8. Successful plans also have a component allowing corporate leaders to spontaneously issue special recognition of employees in cash,  at the time when an exceptional individual effort, team performance or corporate contribution is identified.  These awards are usually small, under $2500.00, and may be in the form of family trips or privileges.

9. A general rule exists:  “when salaries are kept low, incentives are paid easily and early”.  The higher the salary competitively, the higher the standards to become eligible for incentives. 

10. The second general rule: “the larger the salary the greater the incentive award necessary to overcome perceived taxation.”

Bottom Line:  Incentive plans are complex processes.  “Simple” refers to a measure of clarity in how well  the plans are documented and understood by the member employees.  Plain language is preferred, not legalese.  If the employee can easily anticipate the incentive, clarity will support plan success.

 

SHORT-TERM VS LONG-TERM INCENTIVES

To keep incentive plans simple many corporations develop separate plans for short-term (annual) incentives and long-term (three to five year) incentives.

Short-term incentive plans usually identify very specific profit, expense management, revenue, team achievement and market-share targets to be reached within the annual business plan.  Rewards are most often paid out when awarded.

Long-term incentive plans serve to reward year-to-year consistency  and a growth pattern in shareholder value.  Such rewards are often deferred through stock-option arrangements, pension top-up or other long-term pay out contract.

A “Phantom Stock Plan” is a long-term incentive plan and acts like a stock option arrangement in an organization where dilution of share value is a concern.   An accounting formula is developed to create value for a share.  Targets are developed which support the enhancement of the value of the company to the ultimate business stakeholders.

“Golden Hand-Cuff Plans”  are also long-term incentive plans designed to keep specific employees, with key talents, close to the corporation for the future.  These plans are made up of cash, ownership, incentives and tax and benefit perquisites.  These same plans can also play a role in developing a “poison pill” to resist unwanted attempts to merge with or sell ownership to a third-party corporation.

Bottom Line:  Short-Term Incentives tend to be straight-forward, Long-Term Incentives are more complex.

IMPORTANCE OF GOING BEYOND “THANK YOU”

Employees are the foot soldiers in the front-line of business, often pushed into action or accused when failure occurs.  An appreciative leader helps but tangible recognition is a requirement.  The literature arising from silicon valley, north and south, indicates that occasional “spot” awards, a recognition that says “You are Special” or earned privileges and working conditions are especially important.

These awards are of a one time nature, granted when an individual or team has done something noteworthy, such as:

• Doing something beyond the call of duty
• Staying really late to get something completed
• Meeting an impossible deadline
• Pitching in to help when employee doesn’t have to
• Spontaneous, unsolicited praise from a customer

Bottom Line:  Fifty dollar bills, trips, tickets, extra vacations, when associated with recognition, go beyond “thank you”.  The key is to publicize the event.

CELEBRATE  AS  #1 PREFERRED WORKING ENVIRONMENT

Publicizing achievement seems corny, and modest people shun the attention received but the literature confirms that deep down people want, need, grasp for recognition.  The least expensive incentive is recognition and the work environment which generates recognition is preferred hands down. 

Incentives must respond to the very human need for achievement, recognition, power and control in their work and personal lives, building a sense of security and stability.  Incentives must also be used to educate your employees with respect to corporate progress in meeting strategic objectives and demonstrating to each employee how they can add to profits, complete projects, bring issues to closure, and experience what it is like to think like an owner.  Information transfer is best when based on celebration.

Companies are encouraged to invest in documenting and celebrating:

• Evidence of peer recognition and trust
• Breaking beyond personal, team, corporate or industry obstacles
• Innovation and idea generation, starting with the smallest and most understated
• Evidence of learning from experience and coaching peers and sharing

Bottom line:  Recognition systems are key to keeping people motivated over rough business cycles.  They are one incentive investment that needs continuance beyond the profit dip.  Everyone needs to celebrate.

HEALTHY TENSION:   TEAM VS INDIVIDUAL

The incentive literature confirms that there should always be a healthy tension between the demands of a team and the spirit of the individual.  This tension, and how it plays out in productivity, represents the core message a corporation must telegraph to its employees.

Best practice indicates that effective incentives should be based on evidence of:

• Team meeting target achievements
• Team meeting and exceeding customer (internal and external) expectations
• The individual employee improves the team
• The team enhances the individual contribution
• The team and the individual demand a lot of themselves

When individual target measures are set they should be written in the form of their contribution to the team achievement.  Individuals give the team an edge

through development of teaming, leadership and communication skills.  The edge is enhanced, for example, when the individual shares their passion for productivity, insight, respect for peers, what they learn from experience, explanation with clarity,  and analysis can be trusted.

Bottom line:  Respect the healthy tension but focus individual development on enhancing team performance.

WHAT KIND OF TEAM?

The literature identifies several types of teams variously named:  Parallel, Process. Project, Hybrid, and Virtual.  At any given time an individual could be a member of more than one team with different objectives, time lines and complexity of task.  So which team should be the focus of  an incentive plan?

Generally best practice will focus on incentives based on the base, permanent or home team for the individual.  Transitory teams are just that, transitory, contribution often will be recognized or receive special monitory awards separate from the base incentive plan.  Contribution to a transitory team can also be part of the individual measurement criteria within the base or home plan.

Bottom line:  The plan member should be rewarded based on the following:

Pay is based on skills, knowledge and value of the role to the company
Pay increases based on how the job is done
Recognition is received for effort, activity and multi-tasking
Incentive is awarded for base-team results

TAKING THE NEGATIVES OUT OF INCENTIVES

The basic philosophy behind incentives is to pay out to plan members.  However, every plan is also designed to cancel a pay out when the measures or standards are not achieved. 

Employees are creatures of habit.  When they receive bonuses year after year they become an “expected” part of compensation and even worse, personal and family budgets come to include this expectation.  Employees and their financial planners need to be reminded that incentive bonuses are not a reality until they are in the person’s bank account.

Incentive pay outs also attract taxation.  This taxation makes large incentives seem small and  increases the demand on the corporation to provide “flexible-compensation” to allow methods of tax deferral or opportunities for sheltering.

Incentive plans take a lot of criticism but successful plans frequently add the following features:

A. Allow plan pay out to be in the form of stock options (or Phantom shares) to delay the taxation day and provide further opportunity to tax shelter.  It is important in such cases that no cash reach the employee’s bank account during the transfer and that a contingency clause be in the plan contract to avoid “deemed receipt” rulings by the tax authorities.

B. Goals and measures established are reality checked by asking each employee to describe,  in his/her own words, their personal understanding of the goal or measure and when pay out will be awarded.

C. Pay out on a rolling average basis is often used to level size of bonus pay outs to offset an occasional bad cycle.  Hold-back concepts are also useful but the name of the concept alone introduces possible negativity.

D. Alternative forms of pay out need to be identified as a part of a flexible compensation strategy.  Examples of recommendations include use of pay outs to fund voluntary contributions to a pension plan, to top up insurance plans,  to establish family trusts and/or to fund future education or retirement allowances.     

E. In situations where corporate ownership dilution is an issue, plans are designed on the “gain-sharing” principle.  Measures are selected to reflect improvement in value to the ownership of the company.  Phantom Stock Plans are an example.  A measure can be structured to pay out on the incremental savings or value created when implementing a specific organization, product development or business process change.

Bottom Line:  Trying to protect the employee from cyclical earnings is often self defeating.  Best practice supports the use of realistic and achievable objectives. Your target should be achievable based on measures with management information provided in time to make corrective decisions.

PROFIT AS A MEASURE OR GOAL

A lot of the incentive literature focuses on how to select measures to support calculation of incentive pay out.  Profit is certainly the lead measure but it is clear that ‘profit” alone is too simple a measure and prone to build rewards based on short term results at the expense of long term corporate health.

Best practice seems to focus not on profit itself but on “how profit has been produced”.  Examples of profit-linked measures are:

• Achievement of results within planned  profit budget
• Generation of margin through improved team productivity
• Exceeding business plan through higher sales per employee
• Reduction in cash flow requirement to meet plan
• Faster realization of returns from productivity investments 

The literature uses the concept of a “profit gate” or threshold to determine the size of the pay out to a member employee.  A “profit gate” simply says the company has to be profitable in order for bonuses to be paid.  Once the profit

threshold has been reached then the team has to meet selected targets and the individual’s performance must be at least satisfactory in order to be paid.

Profit is also subject to adjustments for accounting,  taxation and ownership interests.  Good plans use a profit measure which reflects corporate performance before adjustments take place.

Bottom-Line:  A profit measure should be chosen which reflects company philosophy,  supportive of achieving current year business targets in the context of the long-term health of the organization.

LINK PAY TO PERFORMANCE

Best practice indicates that incentive plans should be self-funding.  Dollars become available upon meeting a performance threshold.  No incentive dollars should be available if the threshold is not reached but the employee members need to be part of the information loop, they need to know the thresholds before the program begins and be made aware of progress towards threshold and how they might impact upon this progress.

Stakeholder interest dictates that incentive pool generation needs to be aligned to corporate performance in the context of how the competition is doing.  A 30% profit growth is of limited value if the key competitor is generating 50% profit growth.

The frontline plan members need to have their incentive focus linked the quest for higher stakeholder value.  It is noted that the lower the salary for an individual the less stock options support corporate performance.  To get the attention of the individual you need to reward performance close by in his/her unit or team.  Best practice seems to indicate it is smart to recognize a team or unit as a mini-business within the corporation and link team portions of incentive to performance changes at the team or unit levels.  Typical changes that need to be tracked are:

• Changes to operating cash flow for the unit or team
• Changes in time to market
• Changes in employee turnover
• Changes in customer retention

Bottom line:  The clarity of the monitored changes will be the basis of effective team incentives. 

 

OTHERS MEASURES

Other measures are common in the incentive literature but usually are applied as  supplemental.  Examples include: quality, meeting deadlines, customer satisfaction, employee satisfaction, client acquisition, cost reductions through outsourcing or process productivity improvements.

There are two reasons for using additional measures beyond “profit”, namely to:

• Provide a buffer to allow some reward when established targets are not met
• Provide an indirect “cap” to limit windfall pay outs

Bottom-Line:  Use other measures sparingly, if at all.  Using them requires administration cost and  increases the fog-index as to why a bonus was earned and paid in the first place.

 

RULES ARE NECESSARY

Incentive plans need documentation to establish a process but should not be used to throttle the leadership decision making ability.  Even in simple plans there are a few issues that need to be addressed to avoid conflict and hard feeling, for example:

• Bonus calculation when an employee is transferred from division to division
• Bonus pay out for exceptional effort when corporate and division profits are zero
• Establish the principle of pro-rata adjustments for months in plan
• Establish pay out policy to cover death, sickness or disability of a plan member
• Establish principle of “credit forward” to reinstate bonus if next cycle is very positive

Bottom-Line:  A few rules are necessary.  However, don’t be excessively restrictive.  Err in the direction of pay out when in doubt.

 

REINFORCE MESSAGES TO EMPLOYEES   

Recognize that employees receive “messages” from how they are paid.  It is important that such messages are in support of organization growth and the planned path of change.  Keep a link between the way corporate and team or division decisions get made with the way employee performance is evaluated

and rewarded.  Examples include: When owners are rewarded employees get rewarded.  Measurable productivity gains lead directly to rewards.  Realized gains from within the business create  real rewards.  Stock market or appraisal values are not usually controllable by the employee.

Bottom-Line: “What gets rewarded gets done”.  Can the employees see the impact of their achievements on generation of  the incentive award?

 

SIZE OF AWARDS

Size of the award varies widely in the literature.  Incentives in the 5% to 50% of salary form the common practice range, 25-35% being most typical in the wage range of companies employing technical professionals.  Awards specified above 50% usually are expressed in the form of achieving a “super-measure” or passing a “critical strategic hurdle” within the plan.  There are many plans which allow a windfall, even to a multiple of salary, but it is clear that best practice suggests a cap.  Awards above a defined cap should be managed on an exception basis.  A typical cap is 50% of salary but 100% of salary is not an unusual occurrence.

Bottom-Line:  A simple pay out table/grid should be developed to reflect the size of the incentive pool as “profit” grows and the “profit gate” for pay out based on actual corporate, team and individual performance achievement.

 

GETTING THERE FROM HERE

We need to be reminded that incentive plans require systematic administration and employee plan member communication on a regular basis to support plan effectiveness.  To get to a plan from here a number of steps are required, including but not limited to:

1. Confirm HRIS system capacity to track plan membership on the team and individual levels

2. Establish the stakeholder interests and align thresholds for generation of corporate incentive pool

3. Develop a communication plan to keep all plan members informed

4. Establish team and individual interests and set thresholds for distribution of the corporate incentive pool

5. Establish plan rules, caps, timing, eligibility. pro-rate

6. Customizing goals to teams and individuals

7. Develop models, examples for communication

8. Establish award review committee and its mandate

9. Automate link to pay roll after award authorized

10. Prepare fall-back strategy and communication if award not forthcoming

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