One thing we can say with certainty is that incentives create behavior in humans. The question is whether they create the right behavior. A lesson from Benjamin Franklin’s Poor Richard’s Almanack is instructive here: “If you would persuade, appeal to interest and not to reason.” What is buried in Ben's quote is that people will likely act in their own self-interest – at times, irrationally so – when interpreting what is best for them in achieving an incentive. The incentives you put in place in your organization deserve constant attention, especially as your business and strategy change, to make sure that they are influencing the right behavior and getting the proper result.
As I have worked with more and more companies, I have begun to study and pay more attention to their incentives. And as I have looked more closely at some of the highest performing companies, I have begun to see differences in how their incentives work compared to everyone else. This is not a one size fits all situation. Every company is different; each has its own strategy that requires its own incentives. But the best incentive programs I have seen share four common characteristics:
- They are tightly connected to the company’s strategy and goals. One of the most common mistakes I see is a company that develops and communicates its strategy to its employees but creates incentives that are not in sync with that strategy. This is most evident in the area of sales incentives. Plenty of companies have both growth and profit goals, but incentivize their sales staff solely based on gross sales (i.e. growth, but not profit). The companies that perform at the highest levels either incentivize on gross margins or on gross sales with controls over the sales team’s ability to cut prices.
- They are simple and clear. Complex formulas and tracking mechanisms only serve to confuse the point of the exercise. If the system is too complicated, the intended behavior will not materialize because your employees won’t be clear on what they need to do. Complex systems also unfortunately make it easier for people to “game” the system. Our behavioral instincts often drive us to figure out the best way to benefit ourselves from an incentive system – whether or not it is best for the company.
- Feedback and rewards are quick. The traditional concept of the year-end bonus means that a long period of time elapses between the activities we want to see in people and their rewards. The best incentive programs offer feedback and rewards in the near term. I had a recent experience with this when I was at a client for a meeting and we were interrupted because it was “pizza day.” The Chairman had to leave our meeting to go to the cafeteria and hand out free pizza to everyone in the company because they had surpassed their monthly shipping/production goal the day before. Beyond the free pizza, the company has a monthly gainsharing program which all employees participate in based on production and gross margins. Everyone at the company keeps a close eye on these two numbers to see how quickly they can hit the goal each month. While I could see that the employees enjoyed the free pizza the day I was there, the Chairman told me they enjoy the monthly production incentive bonus far more.
- Everyone participates in the incentive. The performance of ESOP-owned companies is probably the best evidence of the power of including everyone in incentives. In the largest and most significant study to date of the performance of employee stock ownership plans in closely-held companies, Douglas Kruse and Joseph Blasi of Rutgers found that ESOP-owned companies increase sales, employment, and sales per employee by approximately 2.3 percent to 2.4 percent per year over what would have been expected absent an ESOP. These statistics show that incentives (in this case, the satisfaction of watching your shares in the company grow in value) are more effective when everyone participates and is working toward the same goal.
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