This is a common question, especially for smaller companies, whose resources are limited. It’s certainly understandable for a manager to want to develop an incentive plan that only pays out of the company profits (if there are any). The first problem with this approach is it neglects to consider that for employees who are instrumental in generating revenue and margin for the company, individual performance-based incentive compensation should be an essential part of their compensation package (often as much as 50%) and not just a “nice add-on” to payout only when the company can afford it. You would not opt to skip their base salary payments if the company is below its goal, likewise you cannot “skip” their incentive payments. The second reason serves management’s self-interest. When employees believe that it’s possible to earn incentives for their individual performance, they will be motivated (assuming your plan has been well-designed) to work to earn those incentives and then earn even more. If you make it a requirement that the overall company must hit its goal before any individual incentives are earned, then you’ve created a hurdle that may feel unattainable and certainly will feel uncontrollable to the individual employee. When this happens, the employees are more likely to “just give up”, making attainment of the company goal even more difficult, and the short-fall even worse. It’s perfectly appropriate, however, to include a secondary or tertiary plan component based on company goal attainment, but even then the payout should begin at a level of performance that is somewhat below goal as this encourages more growth towards goal.
Question and answer format
We have one sales rep who was brought in to sell into a different market with a base pay level that is much higher than that of the rest of the team. We have changed our emphasis and he is now selling the same products and in the same role as his 9 peers, but at a higher base. How do we correct his base pay?
This one is tricky as you know, and fraught with opportunities to totally undermine the motivation of Mr. Overpaid. Aligning compensation is the fair thing to do (at least internally). However, a transition of some kind might be a nice compromise so here’s an idea:
Reduce the base, but fund a guarantee for six months equal to the amount of the base that has been reduced. Then require that the sales person “earn through” the guarantee before additional variable pay is delivered.
Let’s do an example:
> Current too-high base = $80k
> Appropriate base = $60k
> New target incentive (once base is $60k) = $40k
So you’ll need to take $20k out of the base, which is $5k/quarter. The sales person then is guaranteed $20k for the quarter = new base ($15k) + guaranteed variable ($5k). If the person earns less than $5k on the normal variable pay plan, then no additional pay is delivered (beyond the $20k). If they earn $7k (for example), then an addition $2k would be paid.
Continue this for a very few quarters as a transition, then they would be on the regular plan like that of their peers.
Clearly, if Mr. Overpaid is not satisfied with the lower base, he will have a look around during those six months, and may move on to a job that meets his needs for less risk if he can find one. Meanwhile, he has a chance to see what his earnings would be on the new plan and re-commit to the job with the new compensation arrangement at the end of six months if it works for him. And the company has established a clear endpoint by which the too-high-base will end.
Question and answer format
This high-end residential remodeler wants to reward project managers who bring projects in on time and within budget. Given that they have a great deal of control over on-time, on-budget project completion, it was a great idea to provide them with incentives to make that happen.
In order for incentives to really drive behavior, they need to include both an element of risk (they would earn less than their full market value if they didn’t earn the incentive) and potential for upside (they have an opportunity to earn more than their full market value if they beat their goals).
In addition, the incentive opportunity at target (for at-goal performance) should comprise at least 15%, and probably more like 20-25% of their total compensation. Moving to this sort of pay mix isn’t something to be done all at once — gradually over time is probably best — a value closer to 10% of base as an incentive opportunity in the first year would be a good place to start. Then in future years, base increases could be withheld to fund a more meaningful incentive opportunity.
Identify the measures and mechanics of the plan. If the incentive at target is $10k per year, and if a typical Production Lead is responsible for 5 projects per year, then the “plan” could be a simple as $2000 for each project completed on-time and on-budget, payable following customer sign-off. Consider adding some upside in the form of additional payments for savings vs. budget (e.g., $1000 for each $10,000 in savings) — but be careful about what behaviors are rewarded when choosing this path — you don’t want to jeopardize quality. Also consider paying a portion of the target incentive for almost-there performance (from our example above, you could reduce the payout by $500 for every day late, for example).
The possibilities are endless, but the principles are few.