How to Design an Effective Compensation Plan

This week’s Wall Street Journal headline says it all:

The Big Shift From Salaries to Bonus-Based Pay

More Americans are in jobs where a chunk of their pay isn’t guaranteed.

And I’m all for it.

Variable compensation -call it bonuses, commissions, or something else- are a wonderful way to motivate your staff. And it separates the A-Players from all the rest. Because A-Players are hard-wired to achieve & accomplish. Might as well reward -and thus- retain them for that outstanding performance.

And the B-Players… well… when you convert from fixed compensation to variable, they tend to not be so excited. And thus they leave you, which is fine. Or they don’t join in the first place, which is even better.

In short, effective variable compensation plans are crucial for driving your company’s success and motivating your employees.

Unfortunately, so many (!) managers face challenges in their implementation, leading to disengagement and underperformance among their teams, including their rockstar performers.

Here are some critical mistakes that I see leaders make:

Overcomplication

Complex plans are hard to understand and can demotivate staff, including your top talent. A survey by WorldatWork reveals that 27% of companies have difficulty maintaining their employees’ understanding of how incentive plans work.

Too many variables

Incorporating excessive performance metrics can dilute focus, especially for rockstar performers who may excel in specific areas. Plans with more than three metrics tend to spread effort too thinly across multiple targets, decreasing effectiveness. If your employee can’t calculate their expected bonus in a minute or two, it’s overcomplicated - and thus, not motivating.

Lack of transparency ("Black Box" syndrome)

When the criteria for earning bonuses are unclear, it can lead to mistrust and reduced effort across the board, affecting even your most dedicated rockstar employees.

Delayed payouts

Compensation that is not timely can lose its motivational impact. Immediate rewards have been shown to increase performance by up to 20%, whereas delayed rewards can significantly decrease motivation, particularly for those who consistently exceed expectations.

Inflexible goals

Setting rigid targets that do not account for changing market conditions or business needs can demotivate employees. I.e. factors that are out of their control. This is especially true for rockstar performers who may be capable of adapting quickly and could contribute more effectively with more dynamically adjusted goals.

One-size-fits-all

Not tailoring incentives to different roles can result in reduced effectiveness of the compensation plan, as what motivates a salesperson might be different from what motivates an engineer.

To convert these challenges into opportunities, leaders need to adopt a strategic approach in designing compensation plans. Here are actionable strategies that can enhance the effectiveness of your incentive programs. They’re the best practices outlined in our book (download free copy here ):

Simplify the plan

A clear and straightforward plan enhances understanding and engagement for all employees, including your rockstar performers. Limit the number of performance metrics to a maximum of three. This focus will help employees concentrate on what’s most important, driving better results.

Ensure transparency

Transparency in how bonuses are calculated and distributed is crucial. This involves open communication about the criteria and the process used to determine bonus payouts, ensuring that even your top performers understand how their efforts are rewarded.

Align bonuses with broader company goals

Linking bonuses to company goals reinforces their relevance and shows employees the impact of their work on the company’s success. This alignment is particularly motivating for rockstar performers who often drive your company's strategic initiatives forward.

Offer timely rewards

Deliver rewards as close as possible to the associated performance to maximize motivation. Consider setting quarterly bonus payouts rather than annual to keep motivation high throughout the year. I even prefer monthly when possible.

Personalize incentives

Different incentives motivate different types of employees. Use surveys & direct discussions to understand what drives each employee, including your rockstar performers, whether it's cash bonuses, additional time off, or personal development opportunities.

It’s the law

Ensure your incentive plan complies with all legal requirements and maintains fairness. Regularly review your compensation plan with HR and legal teams to ensure it meets all regulatory standards and is applied uniformly.

Celebrate achievements

Regularly recognizing and celebrating achievements, especially those of your rockstar employees, can boost morale and encourage continuous high performance. This can be integrated into the compensation plan through annual awards or public acknowledgment in company communications. Some employees prefer private vs. public.

Continuous feedback

Incorporate continuous feedback mechanisms to provide ongoing guidance and recognition. This helps keep all employees, particularly your high achievers, engaged and aware of their performance in real-time. I.e. No surprises.

Adopting these best practices -and avoiding the common pitfalls- builds a more engaged and productive team, including your Rockstar performers.

And when they hit their goals, you hit yours.

Ain’t life grand?

Jeff