Variable Compensation-What Works and Why – Part II

Published: January 26, 2011 | Topics: Business Best Practices

Part II – Incentive Based Compensation

Incentive programs are one of the few business strategies in which cost can be based on actual performance and paid out after the desired results have been realized.  The right incentive program can motivate ordinary people to do extraordinary things and help reduce turnover, boost morale and loyalty, improve employee wellness, and increase retention.

The Harvard Business Review picked Continental Airlines plan as a classic success.  Continental’s new CEO, Gordon Bethune, took over in 1995 and moved the airline from worst to best within 3 years.  Why was the Continental scheme so successful? HBR identified four factors that contributed to the program’s success.

  1. Right Performance Measure … Continental chose to tie its bonus to on-time departures.
  2. Mutual Monitoring … One of the best ways to ensure the perception of fairness and to avoid free riding is to employ “mutual monitoring” by employees.
  3. Visible Rewards … It may be easier for your admin department to combine everything into payroll, but a separate check always has more impact. If it’s delivered personally by the employee’s superior, that’s even better.
  4. Assured Early Momentum … Variable compensation shouldn’t always pay out – if it did it wouldn’t be variable.  However, it’s critical to have a positive start.  That goes a long way to building support for the program from above and below.

So, if that’s what you should do, what should you avoid? Well, you could just turn around each of the suggestions above.  But perhaps some real life examples are better teachers.  This story is one of my own faux pas.

In 1989, I had just left GE and embarked on my career in technical manufacturing.  I bought into a small company that was machining gas turbine engine parts from high value forgings.  We had lots of orders on the books, but our scrap rate was terrible and costing a fortune.  So I put together a scrap reduction program that had immediate results: scrap rates dropped dramatically – but so did our delivery performance!  Employees had slowed down the whole process to eliminate the mistakes emanating from poor shop floor control, as opposed to management fixing the system.  Murphy’s Law of Unintended Consequences had bit me where it hurt.

Some other factors to consider:

  • Allocations – Set guidelines for how much of the pot goes to different management tiers.  I have always espoused the theory that if the company can afford a bonus for the President, there should be enough for the janitor, too.
  • Approvals – The final “OK” for any compensation plan should be made by someone who is not part of the payout.  Following the “one-over-one” principle for any individual personnel decision is a good guideline.
  • Celebrating Success – Everyone likes to think of themselves as a winner.  Payouts are an ideal time to build goodwill with employees and their families, so don’t let the opportunity go by.
  • Self Funding – All variable compensation plans should pay for themselves.  That can be from profit sharing or cost reduction, but it shouldn’t be a good will contribution.

It is important to note that an incentive program will not compensate for lack of training, a poor product or inadequate sales and marketing.  However, as a part of an integrated business strategy, well-executed incentive programs will successfully motivate a workforce to achieve a company’s goals.

Harry Shimp is the current CEO of Dexmet Corporation, a portfolio company of MCM Capital Partners, a Cleveland based private equity firm focused on acquiring niche manufacturers, value added distributors, and specialy service companies that generate up to $75 million in annual revenues and have enterprise values up to $50 million.  Additionally Mr. Shimp serves on MCM’s Board of Operating Executives.

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