May 2006

How Many Measures and Goals for Incentives?

by Pat Zingheim & Jay Schuster

The majority of organizations use variable pay or incentives for some or all of their non-management and non-selling workforces. This means variable pay and incentives have become an important element of the total pay component of total rewards. Many organizations include variable pay as a powerful part of their total rewards initiative because experience and research suggests that organizations that link variable pay to goal performance are more likely to achieve these goals than are those that do not clearly tie pay to performance.

Many workforce incentive plans are designed by a team of employees and managers to match the direction and guidance provided to them by the business case for a total rewards strategy translated into variable pay. Although strategy may be developed higher in the organization, tactics are commonly practiced closer to where the plan is implemented. The reasons are many; but acceptance, communications, and continuous improvement of the incentive plan by the workforce are some of the reasons.

Measures and Goals

Incentives are powerful communicators of directions and values. They are not a fixed cost of doing business, and goals and all other incentive design elements may be changed from performance period to performance period. The way the most effective high-performance organizations create stakeholdership and engagement is by extending the workforce’s line of sight to measures and goals that are important to organizational success. This means selecting goals employees influence but do not necessarily directly control. For example, few employees actually directly impact company earnings, but they do influence aspects of organizational performance that influence financial results. For instance, customers are impacted by many employees, and how customers feel about an organization and the service they receive strongly impacts financial performance.

Incentive measures and goals are commonly selected from the strategic business plan and cascaded throughout the organization. This involves translation and communications, and the management and supervisory team is critical in creating understanding and workforce engagement. So the tactical solution is to make incentive plans as straightforward as possible. We often discuss communications in terms of an “elevator speech”—meaning if you get into the elevator on the first floor of a 20-story building, you should be able to communicate what the reward plan is about by the time you reach the top. 

Experience suggests that two to four incentive measures work best. Not everything that is important needs to be measured for incentive purposes. If you use four key goals related to customers, quality, productivity/cost/financial, the future of the organization, etc., the organization will get the results it needs by emphasizing the most important ways the workforce creates value. Each goal can be weighted ¼ of the total incentive value and counts enough so employees don’t focus only on one or two. And the more money you can put in the incentive plan, the better so the award is meaningful and worth working for. Base pay will always be larger than variable pay (except for some sales and executive jobs), but organizations typically don’t vary base pay up or down from year to year—with variable pay they can vary pay and send clear messages to the workforce.

Agility is Critical

One of the advantages of tying incentives to key measures and goals is that the incentive plan will encourage improvement in performance defined by these measures. If customer service is measured, it will improve. If delivery time to customers is measured and rewarded through incentives, it will improve. If financial measures are subject to incentives, the performance they measure will improve. Incentives work in both the short and longer term. So they are without doubt the best high-performance organizational reward change any organization can make. 

However, the fact that they work makes it essential to revisit the measures, goals, and general design of the incentive plan periodically. At some time, improvement in performance on a measure is slowed. Also, as organizational priorities change, communications with employees about what to emphasize and what performance standards are required often require incentive plans to change. Agility is essential, and course corrections may need to be made in order that rewards are focused on what is most important. Typically incentive plans are reviewed and modified on an annual basis, but plans with a performance period shorter than annually may be reviewed and modified more often.

The Tactics of Incentives

The strategy is a business case for continued high performance. The tactics are choosing measures and goals that fit the business plan. A few key goals are better than many goals that diffuse the emphasis on desired results. And flexibility is at the core of the message. As things change, so must the elements of incentive design to remain current and relevant to business plan goal achievement. 

Incentives and variable pay are the most powerful tool organizations have to focus on performance. The more variable pay replaces merit base pay adjustments, the better will be the performance of organizations and people. Also, it is essential to change incentives periodically and to make incentive changes a part of the natural incentive process to re-focus employees on the key goals driving organizational success. 

Copyright 2006 Schuster-Zingheim and Associates, Inc.