In this article, we will explore the term ‘incentive compensation’, and look at the 7 types of incentive compensation plans: Gainsharing, Profit-Sharing, Retention Bonus, Spot Awards, Annual Bonus, Sales Performance Incentive Fund (SPIFs), and MBO Bonus. We’ll then discuss the steps to create your incentive compensation plan. This includes planning & design, buy-in from key stakeholders, communication & implementation, and lastly, review & optimization.
Motivation is a fickle friend. Even the most driven employees need to be pepped up sometimes.
When it comes to energizing a workforce, there’s no better tool than a well-structured reward program. The reward doesn’t always have to be money, of course — though it usually is.
One of the most common ways of using rewards to motivate employees is through something called incentive compensation.
In this article, we’ll highlight what incentive compensation is and look at the 7 types of incentive compensation plans. We’ll also cover a step-by-step guide to help you create your plan.
What is Incentive Compensation?
Incentive compensation is a type of compensation strategy where you link a portion of an employee’s pay to performance.
This linked portion can be:
- A part of the employee’s total compensation.
- An additional amount earned upon meeting certain performance criteria.
How is this beneficial?
Allowing employees to earn more if they work harder greatly enhances organizational productivity. It also fosters healthy competition and drives the right behaviors.
You might also like reading: Setting up incentives for channel partners
Top 7 Incentive Compensation Plans
Let’s look at the 7 key types of incentive compensation and how they can be used to motivate your workforce:
Gainsharing
Gainsharing is a reward program where firms look to boost employee productivity through means of financial incentives.
This boost in productivity could be targeted toward one or multiple business goals, such as:
- Increased revenues.
- Improved customer support.
- Lower churn rates.
- Faster production times.
Gainsharing plans don’t hurt company pockets too much since rewards are only given to employees who showed quantifiable improvements in their work.
Additionally, gainsharing bonuses are generally paid monthly. This allows managers to better monitor team progress and make changes to the program if needed.
Profit-Sharing
Profit-sharing is when a company shares some of its profits with its employees through bonuses. Unlike gainsharing, this plan is based on the performance of the company as a whole.
Profit-sharing bonuses are usually paid once a year. The more profitable the company, the higher the bonuses tend to be.
Moreover, some profit-sharing plans cover the entire employee base while others pay out bonuses to particular groups only (like managers and/or executives).
The total bonus amount is then divided among the plan recipients using a distribution formula that varies from company to company. These bonuses can be in the form of stocks, bonds, or good ol’ cash.
Retention Bonus
When a good employee quits or gets poached, especially in times of crisis or during important events like mergers and acquisitions – it can hurt a company.
That’s why companies do everything they can to retain them. And retention bonus is one effective way of doing so.
The length of the stay depends on the terms of the contract drafted specifically for the retention bonus. Retention bonuses can be quite sizable at times, ranging anywhere between 10-25% of an employee’s base salary.
Spot Awards
Spot awards, also known as spot bonuses, are spontaneous rewards that are typically paid ‘on the spot’. They are awarded to employees for outstanding achievements in a particular role or task — achievements not easily measured by a predefined or established standard.
Moreover, spot awards can be in the form of a monetary reward, a vacation/gift of the same (or similar) value, or even some paid time off work.
Some spot bonus examples include:
- Free meal at a fancy restaurant.
- Trophy recognizing a certain trait (loyalty, dedication, etc.).
- Gift cards.
- Cash.
- An all-expenses-paid weekend at a golf resort.
Annual Bonus
Annual bonuses are lump sum payments made by a company to its employees, over and above their regular salaries. These payments can be in the form of money, shares, etc.
Annual bonuses for all employees are usually calculated at the same time, i.e. at the end of a fiscal year. Depending on the organization, the bonus amount will either depend on company performance, employee performance, or a combination of the two.
Here are some examples of annual bonuses:
- A retail outlet announces a fixed $1000 bonus for each sales rep at the end of a great year.
- A software firm declares annual bonuses ranging from 5-11% for all its employees, depending on how well they each did that year.
- A manufacturing firm awards its production team a fixed annual bonus of 10%, to be calculated as a percentage of their base salaries.
Sales Performance Incentive Fund (SPIFs)
A Sales Performance Incentive Fund (SPIF), commonly known as a spiff, is an ad-hoc reward program used to generate speedy, short-term results. They are often planned with a specific sales-related goal in mind.
For example, an enterprise firm selling CRM software operates on a subscription model.
It’s the middle of Q4, and the firm needs 400 new subscriptions to meet its annual sales target of 1500. To spur its salesforce into action, the firm announces a cool $10,000 cash prize for the entire team if the target is met.
Note: While spiffs are primarily used for sales-related activities, they can be structured toward other departments as well.
MBO Bonus
A Management By Objectives (MBO) bonus is a performance-based incentive program where employees’ commissions are linked to the objectives stated in their MBO plan.
These plans are created by managers and their employees after collectively agreeing upon certain performance goals.
For example, an HR manager wants their team to increase the firm’s employee satisfaction index from 70% to 80% by the next quarter.
To achieve this, each member of the HR team might have different objectives in their MBO plan. Some might need to conduct more training programs while others might be responsible for addressing employee grievances.
At the end of the quarter, each member’s bonus will be determined by how well they completed the tasks stated in their individual MBO plans.
How to Design an Effective Incentive Compensation Plan
No matter the department, to design an effective incentive compensation plan you need to follow a systematic, process-driven approach.
Let’s take a look at some important steps for creating this plan:
Step 1: Planning & Design
Are you looking at higher revenues? Greater customer retention? Or perhaps, you want to increase brand awareness?
Start by figuring out exactly what it is you want to achieve and what is the overarching company goal you want to fulfill.
Once you figure out the endgame, you need to decide which type of incentive compensation plan will help you get there in the most efficient way possible.
Lastly, it’s time to bring out the drawing board and chalk out a framework that outlines the plan in detail.
Step 2: Buy-in from Key Stakeholders
Now that you have a detailed framework for your plan, you need to share it with all relevant stakeholders and get their feedback.
This usually includes a couple of upper management execs, senior managers, concerned team leaders, and some senior team members.
Once all key stakeholders discuss, review and revise the plan, it’s time to get their buy-in by having them sign off on the plan and making it official.
Step 3: Communication & Implementation
Now, it’s time to share it with the rest of the company!
Communication plays a vital role at this stage. It’ll be a real bummer if you’ve done the grunt work, and prepared a brilliant plan, but haven’t taken the time to make sure your employees have understood it thoroughly.
Clear, concise, and frequent communication will help you ensure the implementation of your plan is a roaring success.
Step 4: Review & Optimization
This is an ongoing stage that requires conducting periodic reviews of the plan by analyzing individual and team performances.
Is the plan generating the results we set out at the start? Or have we veered off track slightly or maybe even drastically?
It’s perfectly natural for things to go awry at times. What’s important is that you nip such issues in the bud by constantly reviewing the plan and making any required changes as you go along.
Parting Words
Incentive compensation is a timeless concept.
Besides being one of the oldest strategies in the book, it’s also an incredibly efficient way to get employees to work harder, smarter, and as a cohesive unit.
But you have to put in the time and make the effort if you want to see some solid results. That means setting the right goals, choosing the right plan, implementing it well, and reviewing it often.
Use the steps mentioned above to create an effective incentive compensation plan today!
