Workplace Issues

A Call to Expand Worker Incentives

Companies should make more and better use of performance-based, variable-pay programs, a veteran human-capital expert insists.
David McCannSeptember 16, 2011

In the community of human-capital academics, there is no longer any debate whether employee incentive programs – profit-sharing or “gain-sharing” plans where front-line and other employees get incremental pay based on company or business-unit performance – actually work. They do, in fact, motivate workers to try harder and do better, research consistently shows.

Judging by a new study from Aon Hewitt, companies seem to have thoroughly embraced that fact. This year 92% of surveyed employers offer at least one such program, up from 78% in 1995, says the consulting firm, which focuses on Fortune 1000 companies.

But the story goes deeper. A large company might offer one or a handful of these plans – often called variable-pay plans, because the extra pay depends on hitting performance thresholds and also because high-performing employees usually get bigger payouts – to specific business units the company wants to prop up. Why many don’t seize the opportunity to spread the concept more fully across the organization is a mystery to some.

“It just drives me crazy,” says Gerry Ledford, a former college professor and now president of Ledford Consulting Network. “Company after company just puts a toe in the water on this. They very gingerly move incentives from one unit to the next. It should be a managed, corporate-level strategy, not just a one-off in a local unit.”

A lack of centralized management may be evident even at companies that heavily use such employee incentives. Ledford tells of two financial-services firms that “literally have hundreds” of the programs yet don’t manage them centrally. “They are not handled consistently in a way where best practices in one program are put into others,” he says. “They all have different metrics and slightly different purposes.”

The variable-pay plans that do exist “are usually not variable enough,” continues Ledford. In other words, the amount paid out does not correlate well enough with performance. In bad years, the typical company ought to be paying out nothing, or close to it. But if a program is in place, there is usually some payout, even to low-performing employees. Ledford advises clients that top performers should get at least twice as much as average performers.

Still, workers may be motivated by even smaller rewards. Ledford worked with a large paper mill in Mississippi that had an incentive plan for years under which high performers topped out at about 5% of pay. “But the employees took it as a sign they were doing well,” he says. “It was feedback from management that they got the most they could get, and so they felt they and the plant were secure.”

Further, Ledford characterizes the amount of compensation that’s at risk in the United States as “small” – around 10%-12% of pay, compared with 25%-30% in Japan.

Even 10% may sound like a lot to companies that have been giving minimal or no salary increases for the past few years of economic havoc. But Ledford insists that incentive plans can pay off at the bottom line. You can have 1,000 people working at $20 an hour who are less productive and profitable than 900 people at $22 an hour (after translating the incentive to an hourly rate).

In reality, of course, it’s not so simple. Practices can and should vary for different types of employees. Salespeople often do not operate in a team or group, and it is sensible to focus on individual performance incentives that have strong line of sight between behavior and payouts, and therefore high motivational value. Conversely, it may not be easy to differentiate individual performance in most factories today, so rewarding at the group or unit level makes the most sense. 

Plus, it is possible to have tiered incentives – for example, both individual and corporate incentives, or operating-unit and corporate incentives. Either way, it rarely makes sense to reward more than two levels of performance; adding more just sends mixed signals to employees about what they should be doing and exponentially increases the communication challenges, says Ledford.