Choosing Incentive Plan Measures

When selecting performance measures for an incentive plan, organizations frequently lean toward financial measures (e.g., revenues, net income, EBITDA) as indicators of economic success -- success which will in turn be shared with plan participants.  Nothing against financial measures, they have their role in incentive plans and its an important one.  But it may be worth taking a broader look at potential measures to ensure that you end up with a set that really fits your organization and where you (or the powers that be) are trying to take it.

I find it helpful to put measures into three categories:

1. Lead measures are predictive of success, generally over a longer period.  Examples of lead measures might include market share, customer satisfaction or retention, employee satisfaction or retention, or new product development. 
2. Operating measures focus on day-to-day operations.  Examples of operating measures might include output, productivity, or cycle time.
3. Lag measures reflect success which has already happened, typically as addressed through the accounting system.  Examples of lag measures might include net income, return ratios (return on equity, return on sales, etc.), or stock price.

While I am a firm believer that less is more when selecting incentive plan measures (i.e. no more than 3 or 4), I also think that there is a case to be made for balance.  I have heard it said that running an organization solely on the basis of lag measures is like steering a boat by watching its wake.  Lead and operating measures can play a critical role in an incentive plan, particularly if your organization is pursuing growth, re-direction, or performance improvement.  Lead and operating measures can also be an important component of management incentive plans in not-for-profits, which face IRS and other regulatory constraints on tying rewards solely to financial performance.