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Incentive Plans: Definition, Types & Elements

WHAT IS AN INCENTIVE PLAN?

An incentive plan is a form of additional compensation, which can be monetary or non-monetary, that boosts employee motivation and helps workers reach their organizational goals. These incentives are supplemental to an employee’s regular paycheck.

Offering incentives is a practice that has seen increased popularity over the past decade. In PayScale’s 2021 Compensation Best Practices Report, over 50 percent of organizations surveyed said they give individual incentives, and around 17 percent reported giving team incentives..

But what makes a good incentive plan? Like all things in compensation, it’s more complex than you’d initially think. But per usual, we’re here to help. Below, the five elements of a good incentive plan. Work through each of these as you design your incentive program, and you’ll ensure you’ve crafted strong, effective incentives.

But wait — before we move on …

Are Incentives the Same Thing as Bonuses?

In short: Nope. Both bonuses and incentives fall under the umbrella of “variable pay,” but they’re not the same. The big difference is in orientation: While bonuses tend to reward past actions, incentives aim to encourage future results. So in a very simplistic sense, you give a bonus for a job well done, but you offer an incentive for doing a job well. Because of this, bonuses aren’t always tied to a specific plan or goal, but incentives always are. Got it? Okay! Let’s get into it.

TYPES OF INCENTIVE PLANS

Incentive plans come in many forms depending on the company, employee, department. When developing an incentive plan, consider which goals you want to incentivize, strategies to do so, and which rewards employees desire the most.

Before creating an incentive plan for your company, it’s important to understand the most common ones. Each of these plans provides a different purpose for different company needs.

PROFIT-SHARING PLAN

Typically done on an annual basis, this plan occurs when a company awards its employees with a portion of their profits. Some companies determine the profit percentage based on position within the company or time spent with the company.

SPOT AWARDS

Usually given for short-term projects, spot awards are used to recognize an employee’s contributions as they occur. 

RETENTION BONUS

Retention bonuses are given to employees as a reward for staying with the company during pivotal times in the business cycle. 

PROJECT BONUS

Given to an individual or group, project bonuses are a form of additional compensation paid for completing a project within a particular deadline

GAINS-SHARING PLAN

A gains-sharing is an incentive plan where employees are monetarily compensated for increasing productivity levels within a group. 

STOCK OPTION

Stock options are an incentive that allows employees to purchase shares of the company for a set price and period of time.

5 Elements of a Good Incentive Plan

1. It Aligns With Goals and Results

As mentioned, incentives are intended to encourage specific results, so a good incentive plan should be tied to larger business goals. The first thing to figure out is what kind of business goal you’re trying to incentivize. Is it a revenue goal? Are you trying to grow your customer base? Do you need to increase production? Once you’ve identified the goal, decide how you’ll measure results. Whether you use MBOs, S.M.A.R.T. goals, KPIs, OKRs or something else, be sure you have a standardized method of measurement.

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2. It Considers Compensation Mix

“Incentive” does not necessarily equal “cash.” Rewards come in many forms, and what’s motivating to one team or individual isn’t necessarily what would entice another. A big part of getting your incentive plan right is knowing what form of compensation will be most effective.

Take a look at these data from the CBPR:

How Organizations Reward/Recognize High-Performing Employees

As the report says, “Responses within the ‘other’ category ranged from verbal expressions of gratitude, to vacations and trips, to preference for plumb project assignments. Learning and development also featured prominently in the ‘other’ category.

“Top-performing companies are more likely to reward high-performing employees with monetary rewards. They exceeded typical companies in all monetary rewards, especially goal-based bonuses (35 percent vs. 28 percent) and bigger base pay increases (58 percent vs. 54 percent).”

Think about what makes sense for your organization before jumping straight to “give them money.”

3. It Accounts for Your Individual Workforce

Similarly, you’ll need to customize your plan for your unique workforce. Are you designing this plan for individual contributors? Managers? A mix? And what is the nature of their work — is it service-based? Production? Knowledge?

These characteristics and more will influence what is and isn’t effective in an incentive plan. Be sure to think through and account for them.

Additionally, think about staggering implementation of a new incentive plan by job family or department. If you’re planning a brand new incentive plan for the entire organization, think about where it’s going to have the biggest impact and start there.

4. It Matches the Speed of Your Business

An incentive plan that matches the speed of your business should consider both your business lifecycle and the age of your organization.

Business lifecycle will be a big driver in deciding the cadence in which you plan, measure and pay out a given incentive plan. A business that incentivizes revenue-based activities should have incentive plans that follow the cadence of those revenue activities — for example, if sales goals are measured quarterly, the results for anyone who’s personal or team incentive is oriented to sales revenue should also be measured quarterly.

Organizational maturity should also be a strong consideration — is your organization growing quickly? Is it at its peak maturity? This is most important as it relates to cashflow and budget for incentive programs. If your organization is growing quickly and wants to incentivize growth-based activities, this is a great alignment plan, but you’ll want to make sure you can fund it and measure a pay out on those incentives regularly to keep moving the needle.

5. It’s simple enough to communicate

When you start getting crazy with convoluted calculations to determine incentive eligibility, you start losing employees’ attention — and motivation. Keep the numbers — mix of pay incentive as % of base salary and goal ratio of individual to organization — as simple as possible. Here’s an example:

Ahh, nice and clear.

Incentives can be powerful motivators — if you get them right. Include these five elements and you’ll have a great incentive plan for your organization.

Tell Us What You Think

Does your organization have an incentive plan? We want to hear from you. Talk to us about your goals in the comments.

Image: Audiencestack.com via Flickr

Rita Patterson
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Anna Sneha Mathew
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Anna Sneha Mathew

A good read.

Frank
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Frank

What is a “goal ratio”?

James Anderson
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James Anderson

I couldn’t agree more when you said that a good incentive plan should be tied to larger business goals. I am part of the sales department in our company, but it does not have a sales incentive program for us. I am not sure if this can be implemented, but I’ll surely suggest its importance and share this information so that they can develop a good incentive plan for us. Thanks!

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