Incentive pay—A remedy rather than a disease
The motivation side of incentive pay is vastly overrated, says John McGill. It assumes a very simplistic view of why individuals do things. Rather, he says, incentive pay is all about the organisation and its success.
Drawing near contempt from some quarters, incentive or variable pay plans also have their true believers who know they can answer virtually any remuneration problem. I sit closer to the latter rather than the former for reasons that focus around organisation success rather than motivation of individuals.
When talking about pay, a good place to start—and the easiest to have a clear and unequivocal opinion on—is the market rate of pay. I mention this as it is also a good place to start when talking about incentive pay. The term “market rate” is so commonly used that many people believe it is real. Unfortunately it is not real. There isn’t a market rate of pay for any job. Generally a market range exists, even in environments where collective agreements are strong. So no magical dollar figure exists ever, anywhere.
The link to incentive pay is that thinking in terms of a market rate draws an individual’s focus away from organisations and takes it to the broader marketplace. Incentive pay, however, is all about the organisation and its success. This concept is critical and draws the line clearly as to where I believe pay should have a focus (although, of course, the wider marketplace is important as well). It is the place where the pay cheques are actioned, the organisation itself.
Another useful point to bear in mind is what incentive pay should be used for, as distinct to what we hear it described as. For me, the usefulness of incentive pay is in its alignment of organisation success to individual and collective achievement. The clear message of linking your pay to that of the organisation (and your own efforts) is where it can work for all parties.
So, no talk of motivation towards stretching individual or team efforts to reach a specific goal or goals. My own view is that the motivation side of incentive pay is vastly overrated as it is assumes a very simplistic view of why individuals do things. Some jobs, I admit, do seem to work in what appears to be a motivation driven arrangement, particularly those with high commission structures, but they are relatively unusual both in terms of the nature of the work and the people that gravitate towards them.
So why do I rate incentive pay? The power of a linkage that is self-correcting is I think a robust tool in any pay structure. If the organisation is doing well financially or against other indicators deemed important, that success (via a well-structured incentive plan) can carry through to all employees (not just senior or designated employees) provided you include their efforts as well. If the organisation’s performance is less healthy, then the incentive pay on offer will be that much less or not available at all.
Getting employees to better understand how organisation fortunes can vary, and having in place a counter to the prevailing entitlement mentality that is very pervasive in our society and haunts pay structures, is a positive alternative to how we currently view our remuneration and its determination.
This self-correcting element is important for organisations. It means they can vary pay levels to some extent, in line with their financial health. Of course, such a rosy picture is dependent on a number of other factors being in alignment.
For the employer or organisation these include:
- •Target setting is appropriate and achievable;
- •Clear and well understood organisation and individual targets are agreed amongst all parties;
- •There is agreement on review and pay-out dates, revising targets for the new financial year;
- •Ownership and commitment from the organisation and the individuals affected is real;
- •Costing potential pay-outs may seem obvious but it is often not done. To be able to show the senior team or the board what the organisation risk is, is not only good financial practice but assists in their buy-in and understanding as well;
- •I generally favour setting minimum and maximum pay-outs (especially maximum pay-outs as I have assisted a number of organisations’ buy-out schemes that were poorly defined).
For the employee:
- •Line of sight is important. Incentive schemes can become a form of Lotto if individuals have no understanding of outcomes or ability to affect them;
- •Good financial information for employees is communicated on a regular basis throughout the year;
- •Clear, straightforward design parameters (a good test is whether you can explain your incentive scheme in plain language in two minutes).
There are a number of other essentials that go into a sound incentive pay scheme which I have commented on in previous articles. They are, not surprisingly, universal, they change rarely, but unfortunately are not well understood.
Of course, the stereotypical pay structure we are familiar with involving CPI alignment (not heard much in recent years as such movements have been very low), across the board movements and locked in relativities (this is one of the downsides of many collective agreements) in recent years has become less common.
Not only are jobs and careers changing more frequently, but generational issues figure more prominently (what do Millennials really want?) and attitudes to pay are changing as well. Some groups, for example in primary and secondary education and parts of the health sector, continue to determine pay on relatively conservative lines within a traditional unionised environment. While strong in these and some other sectors, such arrangements are now much less common.
For younger professionals, and many older ones, the more frequent changes of organisation, the option of actually changing careers, the portability of savings (through KiwiSaver rather than the super schemes that dominated until the 1980s) has produced a different, more flexible, mindset. Incentive pay fits into this well as it gives the employer a counter-tool to the new mobility their staff have and turns their mind at least to the current financial year in terms of what the priorities are for the employer.
THE PRACTICE OF INCENTIVE PAY IN NEW ZEALAND
Widely used, often without fanfare, incentive pay is a solid and widespread practice in New Zealand. Our database shows this clearly and has done so for many years. The table above is taken from our 2017 Policies and Practices Review.
Our regular consulting assignments in this field confirm interest is strong in this option around pay. Discussions with fellow human resource professionals at regular meetings and industry conferences also show a clear understanding that this form of pay is seen as an important part of remuneration structures—more so, but not exclusively, in the private sector.
We see antagonism in parts of the public sector towards this tool and frequent use of “research” to prove it doesn’t work. I read with interest this analysis when it comes to hand, but have to contrast it with life in the real world where the tool is alive and well accepted, despite whatever shortcomings some commentators come up with or get apoplectic about.
THE FUTURE OF INCENTIVE PAY
Incentive pay continues to be contested as being invalid in some sectors. While I agree it is not for everyone, its use could be much more widespread both across and within organisations. I note outside New Zealand, for instance, uptake is not unusual, for example in the education sector—and not just private education providers. The concerns about it fuelling excessive pay packets are legitimate, and the issue of it enriching only senior roles is also a valid concern in some circumstances.
I would argue this has as much to do with poorly designed and managed schemes as anything else. I emphasise that the link to organisation success should be the key issue around incentive pay. I believe many of our pay structures in New Zealand have become closely linked to entitlement, woolly views of how the marketplace works (admittedly poor information can be an issue here), and a reluctance to try new means of structuring pay. These are major impediments and not easily overcome.
Before introducing an incentive pay scheme there may be some internal barriers to overcome—including not only employee resistance, but also the communication of good information. These are very real impediments in some organisations and unless they are overcome they will make introducing such a scheme very difficult. Remember, incentive pay schemes are not an easy option, but they are, in my view, a powerful option that is too often neglected or, worse still, poorly managed.
Incentive pay is one tool organisations can use from their kitbag. To see it as the silver bullet is wrong. Career development, job satisfaction, and how individuals relate to their employer are amongst other important considerations employers understand and juggle. Getting and keeping the mix right for your organisation is the challenge management teams and human resource professionals face when it comes to the interface with employees. Any tool that can advance this should be used.