How to Design Incentive Programs that Work

To use incentives or not to use incentives, that is the question often being asked by managers in today’s competitive marketplace. Combating high turnover and looking for ways to increase productivity to reduce the cost of processing are the driving forces behind the increasing interest in incentive programs

Experience suggests that the primary reason most incentive programs fail to deliver the desired results is that they are put together and implemented too quickly without adequate thought. To be effective, an incentive program must be tailored specifically to your organization, its people, its jobs, and the company’s culture. A cookie-cutter approach, simply trying to use a program that has worked for someone else, is likely to fail.

The good news is that a well-constructed incentive plan can improve morale, reduce turnover, increase productivity, and have a positive impact on the bottom line.  

Pitfalls of a Poorly Designed Incentive Program

Most operations are organized as conventional hierarchical systems with a senior manager, middle managers, supervisors, and staff/operators making up the “org” chart. 

Following the appropriate lines of communication and the outlined chain of command are essential in this type of organizational structure. Job descriptions are well-defined. Traditional compensation systems are in place, which includes the appropriated grade levels and associated pay scales. Can incentives work in this environment?

The answer to that question is “Yes.” But before we go any further, let’s take a look at the potential consequences of poorly planned incentive systems.

• The same people get rewarded all the time, so the “also-rans” quit trying.
• With too much emphasis on individual performance, unhealthy competition develops meaning that people are more concerned about their interests than what is good for the company. There is no incentive for the good performers to help those who are struggling.
• It takes so long for people to see the benefit of the program that they give up on it. Weekly incentive programs are based on meeting quality and/or productivity goals every day.

• If a goal is missed early in the week, employees see no benefit in struggling to meet the goals the rest of the week.
• Unrealistic goals can cause employees to feel defeated before the program gets off the ground.
• Complicated formulas for rewarding incentives can give employees the impression the company is cheating them.
• Many incentive programs are viewed by employees as simply another management ploy to get them to work harder.
• Some managers communicate the workings of their incentive program in such a way that employees see an implied threat of negative consequences if they fail to achieve incentive goals regularly.

Here is an example of how a well-intentioned incentive plan can go awry. On a recent engagement, the manager proudly explained that their incentive program places importance on both productivity and quality and that quality was given the heaviest weight. The manager went on to say that individual employees could receive an additional two dollars per hour for their week’s work if they met the quality and productivity goals set by the company. However, since quality is too important, employees receive no incentive pay if their quality performance is subpar for any one day they worked during the week. So, what is the problem with the program?

After talking with the staff, it became clear that employees have two major issues with this program. 

First, if they miss quality goals before their last day of work for the week, a key motivational element is gone. 

The focus on quality and productivity fades slightly until the beginning of the following week. The second issue revolves around the method in which the quality of each individual’s work is determined. Some employees feel the quality sampling techniques are questionable, that sample sizes are too small to adequately determine the quality of their work.

How to Design a Successful Incentive Program

How do we avoid the pitfalls that seem to accompany most incentive programs? There are ten keys to developing and implementing a successful incentive program.

1. A successful incentive program must have as its foundation a solid metrics system that provides reliable quality and productivity data.
2. Base the incentive on achieving specific cost goals. (Meeting cost goals is, in turn, dependent on meeting quality and productivity goals.)
3. Find a way to reward both the superstars and those that are showing improvement.
4. Use a combination of individual and workgroup incentives.
5. Distribute incentives frequently enough to maintain employee interest.
6. Don’t keep “raising the bar” to make it more difficult for employees to receive an incentive. If change is required out of economic necessity, explain this to employees before changing performance requirements.
7. Make the performance requirements clear.
8. Clearly and simply explain the formula for determining who gets what incentive.
9. The “reward’ must be meaningful to your employees. Seek employee input regarding your plan before implementation.
10. Communicate the plan to employees well before the implementation date and answer any questions they may have.

Assume you are spending $56,000 per month on labor expenses. How can we structure an incentive program for this operation?

Designing Group and Individual Incentives

One of the major complaint’s employees have with most incentive and recognition programs is that they focus only on the “superstars” and the tendency is for the same people to win over and over again leaving little or no incentive for others to work on improvement. This approach helps to avoid that issue.

The goal of any company is to make money. Operations contribute to that goal by managing costs effectively. In this case, we have decided to set a goal of reducing our labor expense to $48,000. First, we need to create a pool of money to use as an incentive for reaching the goal. We set aside one-third of the monthly savings, in this case, $2,667, if the goal is achieved with 80% to be allocated for group incentives and 20% for individual incentives.

Using historical data, we can calculate the productivity rate and quality percentage that will yield labor savings. If the group achieves these goals for the month, $2,346 (80% of the $2,667) will be divided among the employees. The percentage of the pool, each individual receives is based upon a simple formula: The number of hours worked by the employee divided by the total paid hours for the month. For example, assume an employee works 120 hours for the month and the total paid hours are 1900. This employee’s share of the incentive pool would be 120/1900 times $2,346 or $148.

To combat the concern that if employees can cut the hours required for the task/project they will be cutting their pay, management must ensure enough work/additional projects are available to keep staff fully employed. If staff is not allowed to work their full 120 hours per month, their support for the incentive program will quickly wane. The goal of the incentive program is to encourage the staff to complete projects with fewer labor costs while meeting productivity and quality goals.

The heavier emphasis on group performance encourages experienced people and top performers to help bring new employees and poorer performers up the curve more rapidly. The sooner they are contributing at an acceptable level, the sooner the lion’s share of the incentive pool becomes available.

Individual incentives are best structured with two components: top performers – those who exceed performance expectations for the month – should be rewarded and incentives for those showing the most improvement over past performance. Adding the “most improved” component gives virtually everyone a chance at the individual incentive pool, too. 

To continue with our example, twenty percent of the total incentive pool – $522 – is available for distribution to individuals. One way to allocate this pool is to provide 60% of it to the “top performers” with the remaining 40% going to the “most improved” staff. To performers can best be defined by calculating quality or “error-free” productivity rates for all operators and identifying those whose error-free rate is above the calculated standard.

Error-free or low-rework productivity gives us a simple way to use both quality and productivity performance in calculating incentive eligibility and gives both factors equal weight. If three staff members demonstrate the same error-free performance, 60% of the $533 – $320 is evenly split between them.

To determine who shares in the “most improved” pool, a minimum acceptable level of improvement in error-free performance must be specified. Ten percent for example. The remaining $213 in the incentive pool is divided among those who have shown improvement of ten percent or more.

Momentum, Metrics, and Money  

If monthly incentive rewards are received often enough and are large enough to maintain interest and focus; the program will continue to reap benefits for all. However, this approach will fail if a good system is not in place for tracking quality, productivity, and work hours. The incentive program should be reviewed annually for possible changes and tweaks.  

The accurate metrics that a good incentive program can deliver reinforces the importance of these types of programs. Improved performance and quality metrics will then enhance the bid and proposal process with more accurate costing. Greater costing accuracy aids the bidding process with more accurate margin determination. Collectively, the combination of all the elements ensures job profitability. Therefore, a well-designed and implemented incentive program that shares operational cost savings with employees is a win-win situation for the company and for the employees. 

A solid incentive program that maintains its momentum is a strong contributing component in the execution of the profit program cycle. It provides rewards for staff for delivering productivity and quality, while incentivizing them to continually deliver results while at the same time promoting an increased net profit.