Incentive Compensation

Salaries and wages have adjusted drastically through the downturn. The welcome sight of a returning market brings the inevitable “war for talent.” Incentive compensation directly attracts and keeps the right level of talent. Many companies spend up to 25 percent of their pre-tax net income on bonuses, yet feel as if there is little or nothing to show for it. Is there a better method to ensure improved performance for our money?
FMI’s most recent compensation survey reveals some key points critical to shaping an effective program. Some fundamental concerns are addressed. A common practice among contractors has been to pay discretionary bonuses. This reactive incentive approach yields little to no value. Many companies with structured plans have seen that incorrectly developed plans can result in negative second order effects (i.e. ignore some projects, while focusing on only profitable ones, isolated individual behavior at the cost of teamwork and collaboration and actions that oppose the company strategy). Developing an effective plan is not easy and often leads to great debates in the boardroom and disgruntled employees in the field. This research reveals some critical issues and uncovers industry best practices. They include:

1. A lack of awareness of the most recent “market rate” incentives is a dangerous path and leads to overpaying or underpaying.
2. A structured incentive compensation plan is the most effective as viewed by survey participants.
3. Each company should have a clear pay philosophy that reflects the company culture. This utilizes a varied mix of base pay and incentive pay to attract and retain the right level of talent. It also involves identifying a top-down or bottom-up approach to funding the bonus pool.
4. Incentive compensation must be tied to what is strategically important. The company must first have clarity around strategy.
5. It is not surprising that good leadership is key to success. Communication and transparency in shifting the program are critical and moving forward must include regular communications with employees regarding company performance. This clarity helps develop trust that they are compensated properly.

The purpose of incentive compensation is to reinforce desired behaviors from employees. It communicates that the organization recognizes and values the employees’ additional contribution. It aligns stretch goals with rewards. Organizational alignment is critical in this new economy to find success. Strategy, structure and systems are often included in this analysis, but many companies overlook ensuring compensation is a part of this equation. Others recognize the importance, but lack the expertise to ensure the details of a company incentive compensation plan are developed properly. Done well, incentive compensation can truly be a game changer.

Jim Schug is a Principal and Engagement Manager with FMI, based in Tampa, Fla. He can be reached at 813.636.1254 or via e-mail at jschug@fminet.com.