Designing Effective Performance-linked Compensation Plans

Tuesday, 28 January 2014 10:36 Written by
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Performance based compensation is the variable portion of the total compensation and is paid when performance criteria are met or exceeded. Companies often tie variable compensation to individual, team or company targets. Such compensation allows companies to influence employee behavior so that they meet the specific company objectives. Creating effective performance based compensation plans can be very tricky. Here are a few things to keep in mind when you designing rules for your variable compensation. 


1. Make the targets achievable – While it is important to set high standards for your employees, it is equally important to make the targets not too difficult to achieve. Many leaders make the mistake of setting the bar too high. If your employees feel that they simply cannot achieve the goals set by you, they may completely lose interest in working towards the targets.

2. Make the goals clear and measurable – Everyday, I see a road sign on my way to work. It says – ‘Do not over speed’. That’s it. The sign does not say anything else and there is no other sign on that entire stretch. I am always confused. What is the speed limit? How much speed is too much? Here, even if I slow down, I do not know if I achieved the goal of not over speeding. ‘Do not over speed’ is not a clear goal and is definitely not measurable. It seems merely a suggestion. Your company incentives should be clearly defined and should be tied to measurable goals. In the case above, a more appropriate sign would say ‘Do not drive over 40 MPH’.

3. Use criteria that your employees can control – You should connect the right people to the appropriate targets. For example, you should not keep company profitability a target for a sales person who sells your products. It is not up to the sales person to ensure company profitability. If you want to encourage your sales people to sell more profitable products over less profitable products, you need to set individual product sales targets or change the product mix. In this situation, do keep in mind that if all your employees start selling the more profitable product then the sales of the less profitable product will plummet.

4. Do not change your Plans too often – It is OK to tweak the compensation rules and the plan structure in the early days of the performance period. However do not adjust them in the middle of the cycle. You run the risk of confusing your employees or making them think that the management does not want to pay their incentives.

5. Calculate the rewards accurately and pay immediately – At the end of the performance review, you should be able to calculate and pay the incentive quickly. Many companies finish their performance year in December and do not pay their variable compensation till April or even May. While it may work for some, your top performers may get demotivated and disengaged with such a long delay in getting paid. If your incentive rules require you to do a ton of spreadsheet work and is becoming taxing on your HR, you should look into getting a quality compensation management solution. A good tool will reduce your overall time to calculate variable compensation substantially and will provide you with greater accuracy over manual calculations.

Remember not all incentives offered by you need to be monetary. While additional cash is a good reward, there are other cost-saving awards that can motivate your employees just as much. Many service based companies give reserved parking spots each month to the highest performer of the month. For high performing working parents, companies have started to offer flexible hours and work-from-home benefits. Such incentives cost very little and go a long way in creating a motivated and energized workforce. Other rewards such as faster laptops, latest phones, catered lunches and additional training can create a win-win situation for the employers and the employees. As the employee enjoys these awards, the employer gets a more productive and skilled workforce.

By keeping the above in mind, you can create a very efficient, effective and extremely manageable performance based compensation systems that will not only motivate your employees but also help you achieve your company goals successfully.

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