My definition of an incentive is variable compensation designed to encourage specific behavior. The challenge is to make sure that behavior is really something you want to encourage.
A home building company bonuses purchasing managers based on their ability to reduce the cost of construction. Not surprisingly, those managers negotiate aggressively to lower bids from subcontractors. The lowest bidder frequently wins the work with a price that is a few hundred dollars per home less than his competitor.
Unfortunately, in one case the lowest bidder is a firm that is notorious for falling behind schedule. They frequently delay the closing by two weeks or more, at a carrying cost to the homebuilder of about $150 a day for the delay. Despite the cost, the purchasing manager continues to award the subcontractor new work. Why? Because the manager’s bonus doesn’t consider the complete scope of building costs, but only direct construction pricing.
A Wholesale Distributor compensates salespeople on total sales. He also instructs them to never lose a deal to a competitor because of price. The salespeople regularly sell products at a margin that doesn’t completely cover costs.
A provider of home security services scales compensation based on each salesman’s ranking at the end of the month. The company also promises installation within ten working days of purchase. Every month there is an influx of sales as month-end approaches. The first two weeks of the next month require substantial overtime among the installation crews to meet the guarantees, although those same crews are frequently idle during the last half of the month.
As you read this, it is natural to say “That’s easily solved, Just change this, or stop doing that.” In fact, that kind of objective viewpoint is one of the primary benefits of the peer groups we run in The Alternative Board®, and is frequently the first level of value I deliver in my consulting and coaching practice. “Why are you doing that?” is sometimes surprisingly difficult for an owner to answer.
Usually the response is “Because it works.” The definition of “success” in these cases is that the employee is engaging in the behaviors expected. He or she is selling more product or cutting costs. The owner is afraid of what will happen if the incentive is changed. Will expenses spiral out of control? Will revenues plummet?
Adding conditions to existing plans (“You can now meet price only as long as it isn’t below a certain margin.” or “You can hire a low bidder only if his job performance record is satisfactory.”) is inevitably perceived by the employee as restricting his or her ability to maximize the incentive, and often leads to gaming the system.
Incentives are an ongoing balancing act between what is best for the individual and what is best for the organization. When the results don’t serve both parties, they have to be restructured. The short-term impact of a disgruntled employee is more than offset by the improvement to organizational health.