The Words "Discretionary" & "Incentives" Should Not Be Used in the Same Sentence

Discretionary awards are not incentives, not in the true sense of the word.  Not in my opinion, anyway.  Seeing the words "discretionary" and "incentives" used together, for me, produces an effect similar to fingernails being dragged across a chalkboard.

A discretionary award, typically, is one where the decision whether to grant an award and for how much is left to the judgment of an individual or group.  There are no formal rules, criteria or targets - although sometimes there is a general sense of what the judgment is based upon.

Here is the essence of the issue, for me:  A discretionary plan really doesn't communicate to participants what steps or actions are necessary to earn an award.  So you aren't really directing - or incenting - them to do anything in particular.  (Except maybe hope.)

A recent conversation I had with a manager - someone employed by a company with a history of annual discretionary bonuses - sticks in my mind.  When I asked him his opinion of the bonus plan, and the impact he thought it had on his work, he told me, "It's great when the bonus comes through; I really appreciate the additional money.  But I have no idea what I'm supposed to do to earn it.  I don't think any of us do."  To me, this sums up the entire issue.

I understand and appreciate that leaving a bonus decision up to somebody's last minute judgment seems like a safe thing to do.  It feels way less risky than making that upfront commitment (i.e. if you do X, we'll pay you Y).  The question is: What are you getting for those bonus dollars, other than the warm feeling that you've covered all your bases before handing them out?  You haven't driven any particular results or behaviors, have you?

So, go ahead with that discretionary plan, if you must.  Just don't kid yourself into thinking that you are incenting anyone.

 

Cycling & Award Frequency: What Goes Up Can Also Come Down

In the process of designing incentive plans, discussion will eventually turn to the question of how often; that is, how often to measure and reward performance.  Should it be annually?  Quarterly?  Monthly?  Weekly?

As a general rule, the more closely a reward follows the event or behavior it is meant to reinforce, the better.  Immediacy can be a very powerful force when it comes to rewards.  So, all other things being equal, the more frequently we measure and reward, the better.

Problem is, of course, all other things rarely are equal.  And one of the factors you need to consider when determining reward frequency is something called cycling.

In his book The Reward Plan Advantage, author Jerry McAdams explains cycling as follows:

Cycling is the net effect of performance as it varies from group to group, period to period, measure to measure, or any combination of these elements.  Cycling reduces the organization's net gain in performance if that performance falls below baseline in any one group, measure, or payout period.  For example, ... February's performance can be offset by March's downturn.

The problem, of course, using the last example in the explanation above, is that if you have a monthly measurement and payout cycle, you will have paid out on February's good performance before things tank in March.  And unless you have some kind of hold-out provision in your plan, you can end up - over the course of several months, paying out far more in incentive awards than your net performance truly justifies.

The degree to which cycling presents a challenge will vary from organization to organization, depending on the nature - and specifically the cyclicality - of the business itself.  My point is simply this: Make it a priority to know the cycling issues in your business and factor them into any decisions on reward timing.  It isn't the sole consideration in determining the appropriate award frequency, but it sure is an important one.

How Not to Put Yourself Between a Rock and a Hard Place: The Plan Costing Imperative

I got a telephone call awhile back from the HR Manager of a local company.  We'd had no previous contact, but she was calling with a rather urgent question and was hoping I could provide some off-the-cuff guidance.

After initial introductions and background, the call went something like this:

HR Manager: So, here's the issue.  We put a new bonus plan in place at the beginning of the year.  It's a plan for all our employees.  Top management designed the plan - I was involved, too - and we rolled it out in our all-staff meeting at the beginning of the year, so that employees would understand how the plan worked.

Me:  Mmmm hmmm.  Sounds good so far.

HR Manager:  Well, now the year is done.  I think it was a decent year for us - not great, but decent.  And what that means, in terms of how we designed and explained the bonus plan to employees, and in terms of the company performance measures, is that everyone should get the maximum bonus amount.

M:  OK.

HR Manager:  Here's the problem.  Top management doesn't want to pay out this much money.  It ends up being way more than they expected and they don't feel that the company has performed well enough to justify paying that kind of bonus to employees.

Me:  At the beginning of the year, in the all-staff meeting when you explained the bonus plan to employees, did you tell them that they would receive the maximum award amount if the company performed at this level?

HR Manager:  Basically ... yes.

Me:  So ... did your top management not understand how much these maximum level awards would amount to?  I mean, did nobody sit down and actually do the math?

HR Manager:  I ... I don't know.  I guess not.  It's just way more than they expected.  So, what we wanted to ask you is this:  What should we do?

I'll cut the dialogue short here.  Unbelievable?  Yes, it was kind of a surreal phone call.  My response to her, after a few more moments of fact gathering (to make sure that I was really hearing this correctly):  You pay them.  You pay them, as you promised you would pay them, or you can pretty much kiss morale, trust and credibility (along with your most talented employees) goodbye.  Perhaps there are economic circumstances that would necessitate doing otherwise, but not at the end of a so-called "decent" year.

Top management of this company had been hoping to get the blessing of an outside "expert" to go ahead and payout a more "reasonable" amount than promised, after which they would put in a new and improved bonus plan for the coming year.  As if there would have been even a shred of faith left at that point.

The moral of the story:   Always, always figure out the cost of a bonus/incentive plan before you finalize it.  Certainly before you communicate it to employees.  You'd better be absolutely sure that there is an acceptable balance between the value of the performance improvements to the company (increase in revenues or income, decrease in costs, whatever) and the value of awards to employees.  And do it considering the full spectrum of possible performance scenarios: from worst possible to most likely to best possible.  Then make sure these costs, and this balance, are completely understood by anyone who matters - anyone in a position to toss a roadblock in the path of payment at year end.

There's simply no excuse for finding yourself between this particular rock and hard place.

Leverage in Reward Plan Design: What's it All About?

Leverage is a key factor in reward plan design - particularly with incentives.  A reader question in response to my recent post featuring the "prototypical" performance to award structure inspired the thought that a post about the concept of leverage might be helpful.

Leverage is, at its roots, a mechanical term. 

Dictionary.com defines the word leverage as: The mechanical advantage or power gained by using a lever.

Wikipedia tells us that:  Leverage is a factor by which a lever multiplies a force - it is therefore related to mechanical advantage.

The use of leverage in reward plan design really doesn't stray too far from these mechanical definitions.  Essentially, we apply leverage in reward plan design in order to increase the motivational power of a reward.  The example performance-to-award structure below provides a specific illustration of leverage.

Leverage is present at both the Threshold and Maximum levels in this example.  To better understand, consider that at Maximum, for example, a plan with no leverage would provide an award of 120% of target in return for performance at 120% of target.  Instead, in the example above, we increase the motivational power of the plan by providing a greater reward upside (150% of target) in return for maximum performance.  The same is true, conversely, at Threshold performance.

As stated in the earlier post, the amount of leverage illustrated in this example is typical for management incentive plans.  Sales incentive plans will typically feature significantly more leverage than is shown here, but that is a topic for another post.

Leverage provides us - as reward plan designers - with an important tool, but also one that we must use carefully.  We want to consider not only the motivational and behavioral impact of applying leverage - both upside and downside - but also the cost of doing so.  A sound cost analysis is particularly important in looking at upside leverage, to ensure that there is always an appropriate balance between the value of the performance improvement to the company and the value of the award to the employee (or in plainer terms, not paying out more dollars than the performance improvement brings in).

Helpful?

An Enduring Classic: The Prototypical Performance-to-Award Incentive Structure

When designing incentive plans and, particularly, when working to nail down plan mechanics, I like to trot out a little model that I position as the "classic" plan performance-to-award structure.  I was delighted to learn, in a seminar yesterday, that recent research conducted by the Hay Group (about which I hope to post in more detail soon) strongly validates the model I have been using for years, particularly for management incentive plans.

The model looks like this:

What does it mean?  I explain the terms and the model in this way:

Threshold means the point at which the plan begins to measure and award performance, the lowest level of performance that will earn an award.  In this classic model, Threshold is set at a performance level equal to 80% of Target (or the desired level of performance), and typically earns half the Target award level.  Say, for example, that we are looking at a very simplistic incentive plan where Target performance is simply $10 million in net income, and the participant has a Target incentive opportunity of 10% of their base salary.  Threshold, in this case, would be $8 million in net income, which would earn the participant an award equal to 5% of their base salary.

Maximum is the performance level which earns the highest possible award.  In this classic model, Maximum is set at a performance level equal to 120% of Target, and typically earns one and a half times the Target award level.

This is a model with leverage, as evidenced by the upswing and downswing in award levels relative to performance levels.

Should your incentive plan be designed exactly this way?  Maybe, but maybe not.  Some organizations don't pay any award until Target is reached, while others introduce some level of award at a performance level substantially lower than 80% of Target.  Some organizations prefer more upside leverage, and others prefer not to set a Maximum level at all.  Still others may find that it is helpful to identify five, or six, or more, levels of performance and award.

And - I have found - some performance measures (ratio-based measures, for example) do not calibrate well to this model at all.

What I find most useful about models like this one, is that they give us a starting point for design discussion.  Not a mandate to mimic, but rather a straw man to use as a point of departure.  It is with that spirit that I share this one here!

Hebert's Incentive Manifesto

Referencing Martin Luther and the The ClueTrain Manifesto, Paul Hebert of Incentive Intelligence offers us today the 9.5 Theses of his own Incentive Manifesto.  I particularly like Theses #5, which cleverly addresses one of my personal pet peeves:

5.  Hard measurement is required. Thou shalt not run a program with soft measurements and opinion as the only qualifier for awards. These are called popularity contests – not incentives or recognition. Save it for high school prom night.

Check out this solid advice, and share any thoughts (or suggested Theses) of your own with Paul.

Creating the Conditions for Improvement & Innovation (or First Remove the Large Rocks ...)

How far can an incentive program go in driving the efforts and behaviors necessary for improvement and innovation, when the organization itself has placed large rocks in the way?

Paul Hebert of Incentive Intelligence has written a couple of great posts (see here and here), the latest just today, on motivating people to be innovative.  One of Paul's key points - and I agree - is the importance of creating an environment in which innovation can take hold.  And it is here where organizations often become their own worst enemy, whether in regard to motivating innovation or just driving improvements in performance.  Paul nicely sums up the dilemma of trying to create the conditions for motivation under these circumstances:

My concern - from a motivation standpoint - am I pushing the proverbial rock up the hill to create incentive and recognition programs to drive innovation when the organization that the program resides within is designed to thwart my efforts? Or can my recommendations actually help a company break some of the boundaries the hierarchy imposes - creating an overlay structure that drives innovation?

I encounter this problem often in organizations that are seeking to implement an incentive plan to address an improvement need.  My initial assessment of the situation (I always start by asking a lot of questions) often results in conversation that go like this:

* * * * * * * * * *

Scene 1: Initial interview with top management

Me:  So tell me exactly what you are looking to accomplish with an incentive plan for your patient service providers (PSPs)?

Top Management:  We need to improve their productivity, which we measure as the ratio of patient hours to total hours worked.  Our reimbursement levels, and ultimately our financial viability, depend on improving this.  Our success rides on incenting these employee to be more productive with their time.

Fast forward to Scene 2:  Conversations with PSPs

Me:  What prevents you from being as productive as possible, from seeing more patients during the course of an average day?

PSPs:  We always strive to fill our schedules to the degree possible.  We understand that this is important.  The biggest obstacle we face is Scheduling.  They book all our patient appointments, but they leave holes in our schedules and we can't get them to fill these holes.  And if a patient cancels, we often get on the phone to Scheduling to see if we can fit someone else into that empty hour, but it is difficult to get them to act.

Me:  Schedulers?  Are they part of the Patient Service Division?

PSPs:  No, they report into the Central Administration Division.

Fast forward to Scene 3:  Conversations with Schedulers

Me:  Tell me how you work with the PSPs in scheduling their patients.

Schedulers:  PSPs are always after us to squeeze in more patients, even at times that are not the most convenient.  We strive for happy and satisfied patients, and try to always give them their first choice of appointment times, no matter what.  Just because a PSP wants to fill an opening in their schedule, that doesn't mean that it is a convenient time for the patient to come...

* * * * * * * * * *

And this is just the beginning, but you probably get the drift.  Without deeply understanding the nature of the performance problem, along with the structural impediments and competing objectives that underlie it, it would be pointless - and perhaps counterproductive - to simply plop in an incentive plan.  The best value that an HR or reward professional can contribute under these circumstances, I believe, is to clearly define the obstacles and help define a plan for creating the conditions under which improvement or innovation is more likely to occur.  And then - and probably only then - introduce a reward plan that helps focus employees on the the efforts and behaviors most likely to produce success.

Rewarding Employees with Time Off

Days Off are the New Short-Term Incentive say Frank Roche and Sarah Chambers of KnowHR.  And I think they're on to something.

I worked a few years ago with an organization that would award a half-day off with pay to all employees as a reward for meeting certain organizational goals.  In this case, it was the same half-day for everyone; they literally shut the place down for an afternoon.  I conducted employee focus groups there about a month after the first half-day was awarded, and people were still talking about it.  They loved it.  LOVED it.  And because they all earned it and enjoyed it as a group, it was huge for the esprit de corps.

I have also partnered with a couple of clients to create a reward element that combined time off with a developmental opportunity.  Employees who performed exceptionally well, in addition to earning bigger salary increases (this was a merit pay shop), also received a day or more off with pay, along with a professional development allowance to spend as they wished (within certain guidelines).

I think what Frank and Sarah have in mind is something more fundamental than that: the introduction of time off as another currency to consider in designing incentive and other reward programs.  And the potential applications are probably limitless.  Time off is an increasingly valuable commodity in our too-hectic lives, and not just for Gen Y and Millenial workers.  A number of us time-off-starved Baby Boomers have seen the light here as well.

And if belt-tightening is in our organizational futures, time off could be a cost effective and  appreciated addition to our portfolio of employee rewards.

Bonus/Incentive Trends in Nonprofits: Interview with Paul Gavejian of Total Compensation Solutions

Total Compensation Solutions (TCS), a human resources consulting firm, has published its most recent edition of its annual Not-For-Profit Survey, which reveals some interesting data regarding current trends in non-profit compensation; in particular, the growing prevalence of formal bonus plans and some shifting in the total compensation mix. Paul Gavejian, TCS’ Managing Director and a former Watson Wyatt colleague of mine, graciously agreed to an interview to shed a little more light on the survey’s findings in these areas. In Part 1, today, we talk with Paul about formal bonus/incentive plans in non-profits. Later this week, in Part 2, Paul will address TCS survey findings regarding the mix of compensation (relative proportion of cash versus benefits) in nonprofit organizations.

Q: Paul, the press release for the most recent edition of your Not-For-Profit Survey notes the growing prevalence of formal bonus plans for nonprofit executives. How prevalent are these plans now – what percent of non-profit organizations (according to your survey) have such a plan in place for executives? And what about practices for non-executive nonprofit employees?

A: The 2007/2008 survey indicates that 42 percent of all nonprofits have a formal incentive compensation plan in place. The percent receiving an actual payout, by employee group, is illustrated in the table below. As the table shows, our survey indicates that 35.6% of all Executive Director/CEOs received an incentive payout and 29.7% of all Vice Presidents received an incentive payout. Exempt and non-exempt employees also received bonuses as shown below.

Q: Do you note differences in the prevalence of executive bonus plans between smaller and larger organizations, or among different subgroups within the nonprofit industry?

A: TCS did not specifically survey the relationship between size of a nonprofit and prevalence of executive bonus plans. However, an analysis of the industry subgroups indicates that health and welfare organizations (mostly hospitals and organizations that work on health care policy issues) offer an annual incentive more frequently than other organizations. Research and environmental organizations offer incentives as well. These organizations generally have to attract employees from private sector companies that do offer bonuses and that may explain why they also offer bonuses. The practice is not as prevalent among membership, cultural and social service organizations that do not have a private sector counterpart.

Q: To what would you attribute the increasing use of formal bonus or incentive plans in nonprofits?

A: With the exception of labor markets that are heavily weighted towards the public sector (e.g., Washington, DC, various state capitols, etc.), non-profit organizations need to compete with for-profit companies in the overall labor market. For-profit companies typically offer at-risk pay and provide a mix of compensation that recognizes the value of the position in the external market through base salary and the value that the incumbent brings to the position (performance) through bonus/incentive pay. As non-profits adopt incentive plans, they increase their ability to recruit highly qualified employees from the private sector, especially among those organizations that have strong counterparts in the for profit sector (health and welfare; and research and development). They also increase their ability to recruit recent college graduates who want to work for a mission driven organization.

Total Compensation Solutions (TCS) is a human resources consulting firm dedicated to assisting clients in achieving their strategic compensation objectives. The firm uses market data to identify best practices in a variety of topical areas including: compensation; performance management; organization structure; health and welfare; and retirement benefits.

More on Signing Bonuses for New Grads: Compensation Force Interview with the National Association of Colleges & Employers

A recent post here highlighted the growing practice of offering signing bonuses to new college graduates, as reflected in recent research conducted by the National Association of Colleges & Employers (NACE). In response to some good probing questions about the practice raised by Wally Bock (of the Three Star Leadership Blog) in the comment string (thanks, Wally!), I approached NACE to see if they could share additional information about this trend. Andrea Koncz, NACE’s Employment Information Manager, graciously agreed to this brief interview and offered some additional information and responses.

Q: Your latest survey (2008 Job Outlook) reports that nearly 54% of responding employers plan to offer signing bonuses to new graduates in the coming year. Do you know what percent of college graduates typically get an offer that includes a signing bonus – and is this percent also growing?
A: We don’t track the number of graduates who actually get an offer that includes a signing bonus, so there’s no way to know if this is growing. We only survey employers as to whether they will offer them, and this number is growing.

Q: Are there certain majors or certain hiring industries where signing bonuses are more prevalent than others?
A: Manufacturers are most likely to offer signing bonuses, with 60 percent of their respondents reporting that they will offer them to new 2008 graduates. This compares to 52 percent of service employers and 20 percent of government/nonprofit employers. As far as specific types of employers, here are the top 3 most likely to offer signing bonuses – computer & business equipment manufacturers, accounting firms and utility companies.

Q: Are there certain majors or certain hiring industries which feature the largest signing bonuses – on average?
A: As far as majors that will most likely be offered signing bonuses, they are the more “technical” fields, such as computer science – avg. bonus of $3,959, mechanical engineering - $3,667, chemical engineering - $3,361, and computer engineering - $3,286.

Q: What is the underlying reason for the increasing popularity of signing bonuses for new grads?
A: Competition is most likely the main reason for more employers offering signing bonuses.

Q: Some might see it as risky to offer a signing bonus to such untried, inexperienced employees. From your viewpoint, are employers attempting to mitigate that risk by making part of the signing bonus contingent on staying with the employer a certain amount of time or contingent on performing at a certain level?
A: Most employers pay the bonus at the start of the job, but there are a small percentage who may wait 3 or 6 months before paying it. In my opinion, I don’t think they see it as a tool for retention, but more of a way to attract candidates to their company.

Q: Do you or does NACE provide counsel or advice to employers on whether signing bonuses are a good idea? If so, are there a few tips you could share with us?
A: We don’t offer advice to employers on signing bonuses at all. We haven’t done any specific research as to whether they are a good idea or not.

A big thank you to Andrea and NACE for being willing to share some additional interesting details regarding the apparently growing phenomenon of offering signing bonuses to newly minted college graduates.