WHY YOUR INCENTIVE PLAN DOESN’T WORK AND WHAT YOU HAVE TO DO ABOUT IT

An incentive is an action taken to change the short-term behavior to match a pre-determined objective.

In dealing with employees we are constantly dealing with the issue of “alignment.” Alignment is matching the best interests of the company with the individual best interests of the employee. The theory is that each person acts in their own best interests and therefore by rewarding certain activities with a reward that is desired by the employee; their actions will change to obtain that reward. In the development of an incentive program one has to determine what changes in the behavior of employees would benefit the company, the amount of benefit that it would generate, and how to deliver to the employee some percentage of that amount for the desired change in behavior. In other words, if an employee changes their behavior and now does “X” and that as a result of this new performance the company will benefit by “Y” dollars, what percentage of Y should we pay to the employee and in what manner.

Often overlooked in this analysis is the issue of what behavior we are already paying for in the base pay of the employee. If a sales person receives a base salary, then there is a certain minimum amount of sales that they must produce in order to cover that salary. Therefore if we are going to also pay a commission on the sales that they generate, those commissions should only start after that minimum production has been generated to cover their base salary.[1] This issue gives rise to the axiom that “you cannot create a rational incentive plan until you have first defined the results that you are already paying for in their base pay.” The violation of this rule dooms most employers in their attempts to develop an incentive plan without professional help. As a consultant all you have to do is look at a company’s job descriptions to see if they have identified results that are required for each position rather than tasks and if you only see tasks, you can be assured that any incentive program that they have is fundamentally flawed.

These are the basics of incentives. More recent analysis has brought criticism to the “stick” and “carrot” approach to behavior modification. In Coaching for Performance, by John Whitmore,[2] you will find an analysis of Maslow’s Hierarchy of Needs as applied to the workplace. He advances the theory that standard incentive programs treat people like “donkeys” rather than “humans.” He applies Maslow’s Hierarchy of Needs to show that incentives should instead be directed to moving people up this scale—from “Belonging” to “Esteem from others” to “Self-Esteem” to, finally, “Self-Actualization.” He also provides an excellent analysis of the stages of team building.

In my experience, no new theory is ever completely right, and no old theory is ever completely wrong. The truth is generally in the middle—which leads us to management development.

In Minding My Own Business,[3] I have divided employees into three categories—climbers, campers and quitters. A climber is any employee who is self-motivated and wants to perform. A camper is any employee who is merely there for a paycheck and receives their self-fulfillment from activities other than their work or career. A quitter is someone who is actually detrimental to the organization and probably will not change. All three types of employees can be found at all levels of the company—there are field level climbers and there are high management level campers and quitters. Often our comfort zone will actually create campers out of the climbers that we promote to high level management. The critical purpose of these classifications is this: although your climbers only account for about 20% of your workforce, they produce about 80% of your profit; your campers account for about 75% of your workforce and produce about 30% of your profit and your quitters actually cost you about 10% of your profit. So where do we want our turnover? In the campers and quitters of course. But to avoid having turnover of your climbers you have to give them a ladder—climbers want to climb and if we don’t provide the ladder, a competitor will.

In the past we have structured incentive programs to merely provide bigger carrots to the climbers, however the application of newer theory would be more effective. Climbers want more money, but also want the opportunity to progress up the Maslow Hierarchy. Campers are not necessarily seeking their fulfillment from their employment and therefore are not going to respond as well to these incentives as is a climber. Campers can be safely treated as “donkeys” and enough reinforced behavior will result to justify the incentive. Quitters on the other hand are another matter. They are not yet to “donkey” status and therefore must be identified and treated with parental directives—your performance is unacceptable, here is how it must change, if it does not change within a given period you will be terminated.

Left out of the analysis by Whitmore is the role of the “team” in the development incentives. Although he discusses team building at length, the tie is never made to the Maslow Hierarchy. In a workplace, it is only through the creation of a “team” that the progression from belonging, to esteem from others, to self-esteem to self-actualization makes sense. Therefore after an organization has created an effective and rational incentive program next the “climbers” should be identified and “teams” should be created to implement a second level of motivational incentives. This has numerous ancillary benefits. First it provides a “ladder” for those climbers to climb which reduces their turnover and increases their bond to the company. Second it allows the owner to tap into their most important resource and delegate to this team (or teams) responsibility for management issues that is currently taking up their time and energy. This frees the owner to be better at doing his or her job of running the company.[4] In the development of this “management team”[5] the owner is actually building a company—a company with value that exceeds their own input. This is critical if the owner ever intends to leave the company (sell). For a company to have any real value the cash flow must be produced by systems, procedures and controls rather than by the individual efforts of the owner; otherwise when the owner leaves, there is no company.

To summarize, the owner must:

  1. Identify what results the company is currently paying for in each position’s base pay.
  2. Identify the climbers, campers and quitters.
  3. Assume that the quitters are leaving and recruit for these positions so that no quitter can hold the company hostage. Turnover should occur on your time table, not theirs.
  4. Identify the changes in behavior that the company desires.
  5. Determine the benefit that would be derived to the company from this change in behavior.
  6. Develop and implement an incentive program to align the new behavior of employees with the desired result.
  7. Determine the size and structure of a “management team” to be comprised of climbers.
  8. Perform team building activities within this group.
  9. Assign to this team management issues and tasks that will free the owner to do a better job of “running the company.”
  10. Continually reinforce the decisions of the “management team” and create opportunities for “new climbers” to join.

[1] Note that taking this into account by providing a reduced commission rate is actually counter-productive as it penalizes your high producers who greatly exceed the amount required to cover their base. Any compensation plan that over-compensates the lower performers and under-compensates the higher performers is fundamentally flawed.

[2] Coaching for Performance, Third Edition 2002, John Whitmore, Nicholas Brealey Publishing, London.

[3] Minding My Own Business, Dirk Dieters, Author House 2005.

[4]Ibid. See MMOB for an analysis of the six responsibilities of the business owner.

[5] Note that the “management team” consists of all climbers, not just those climbers who are in management. Field workers and staff level employees may also be climbers and those people need to be included in this “management team.” The Fremont Group has developed a formula for the rating of employees upon this scale and for the identification of persons in non-management positions who are equally critical to the long-term success of the company and whom must be included in this program.