Incentives are an excellent way to foster loyalty and to get the extra effort sometimes required for a company to continue to grow and succeed. It is important to keep in mind that incentives can also have unintended negative consequences. For example, if an employee thinks they are deserving of an incentive bonus but don’t receive one or get one they feel is inadequate for their contribution, the incentive, meant as a motivational tool, can turn out to be a disincentive and create employee dissatisfaction when the opposite effect was intended. There is a saying, “tell me how you measure me and I will show you how I perform“, and its corollary, “if you measure me irrationally, do not be surprised by irrational behavior.”
Bonuses, not to be confused with incentives, are when companies “share” a portion of the profits with its employees. Generally, these come in the form of a “special day” or year-end bonus. These should be considered benevolent gifts from management, as there was no specific behavior of performance that drives the bonus. In most cases, bonuses are paid after the financial results are posted and only excess profits are used to fund the bonus. The philosophy being that it is better to share a portion of the company’s success with the employees rather than pay an equivalent amount in additional taxes. The structure of bonus programs is usually subjective and used as a means to reward the employees in general for the overall success of the company.
Incentives are quite different. Unlike bonuses, incentives are paid for specific, predictable behavior or results. The goal of an incentive program is to create one that has objective criteria for its basis. The criteria needs to be fair, obtainable and provides the type of positive motivation for which the incentive is intended. Incentives are not be benevolent gifts from Management but are earned for specific and measurable results. Unlike bonuses, incentives are paid before the financial results are posted as part of the recipients’ earnings, and are taxed accordingly.
When developing an objective incentive program for small business there are multiple things to consider to avoid pitfalls. Who should be eligible for such a program? How to determine what is “fair” and provides the impetus for the desired behavior or results. How are owner’s draws and dividends or other expenses that get assigned to the business treated? In some cases, these costs increase the indirect expense possibly creating an unfair burden on those with profit goals.
Another difficulty with incentives is the development of specific incentive programs: Based on the type of business, there might be several different populations of employees for which incentives make good sense. For example, in a contracting company you may have the following programs:
2) Project Managers
3) Service Personnel
4) Administrative Personnel
1) Foremen: One company wanted to address an erosion of the company’s profitability directly related to lower labor efficiencies on jobs. An incentive was developed to allow Foremen to be eligible to receive a calculated, proportioned amount based on achieving targeted savings in labor and material costs on jobs based on the job estimate. The incentive is tied directly to the specific goal of improving labor efficiency and to use quoted material rather than spot purchases. The result will be increased profitability for the company with a portion of the profits going to the ones who had the most direct impact on it.
2) Project Managers: Adding to the emphasis on improved labor productivity and materials costs, the Project Managers were also eligible to receive a bonus on a job’s Net Profit. The presumption being that labor and material are the only controllable costs, but also every project must cover some portion of the company’s overhead. Because they are so closely aligned the Foremen and Project Manager’s incentives should be paid on the same dates.
The primary goal of these two programs is to increase the awareness and emphasis on controllable costs of labor and material purchases. It will also serve to help the Project Managers become more fiscally aware of a project’s finances.
3) Service Personnel: The Service Manager and Service technicians will participate in a quarterly incentive program based on the overall profitability of the Service department as a whole. The Service manager will be eligible for a certain percentage of the overall performance of the department and each of the technicians will share an amount set aside based upon their tenure with the department.
4) Administrative employees: Once annually, the administrative staff (To include Project Managers) will be eligible for an incentive based on the overall company profits. The payout is based on two factors that include: The percentage of Net Profit to be put into an incentive pool and the percent an individual earns to the total administrative salaries. This bonus, if offered, is paid sometime after the fiscal year closes.
The company, in the example, will pay out approximately 4% of revenue in the four incentive programs and the year-end bonus program. This is a very small price to pay to keep good employees happy and motivated.
Other businesses will have completely different populations. The key is to establish the incentives using S.M.A.R.T. metrics for your incentive plan will help you track the performance of each individual. They should be obtainable, even if some goals are a stretch to achieve.
In summary incentive plans are a very economical way to provide motivation for employees who are in roles where specific and measurable outcomes can be achieved. Each program should focus on the goals management and owners want to accomplish.
When contemplating the development of an incentive program, be aware that not everyone who receives an incentive will be pleased. If the recipient feels their reward is not commensurate with their contribution, the incentive could turn into a disincentive, breeding ill will. This is the exact opposite of the intention of the program. For that reason, any incentive must be objectively based, fairly applied and easily understood by all the participants with goals that are attainable, even if they are a stretch for the participant.
There is no one perfect solution for an incentive program, but by using just a few critical metrics the right program can be developed for any sized company.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information: