Pay-for-performance approaches, once exclusively the domain of sales departments, are becoming widespread. The intent is to give employees a stake in the company’s success, with the hope of improving individual performance. These incentive systems can be effective but they can also produce the opposite effect. Some organizations see these systems as a quick-fix even for complex work situations. They are deceivingly powerful, but without sufficient anticipation and planning the long-term impact is often negative.

A poorly conceived incentive system can damage a company’s culture for years to come. Incentive systems could be called the management equivalent of blasting caps.

What about the intent? Is it wrong to want to give the best employees more money? We’ve spent years studying how organizations encourage effective behavior and there is no single, best incentive formula. Every situation is unique with its own culture, history, and goals. We use a careful, deliberate approach to improving and aligning work activities. If your organization is considering incentives, however, be sure to consider the following in your assessment:

Opportunity

Is the opportunity to participate equal for all concerned or will some people have an advantage? One bank executive wanted to increase deposits. The plan: give employees 1% of each new deposit as a commission for bringing it to the bank. This commission was less than the amount that the bank was spending on advertising to obtain new deposits. In this case, though, future problems were easily seen. An employee who gives bank-sponsored retirement seminars would meet hundreds of people a month while a data-entry clerk in the proof part of the bank may never meet any new people during working hours. The potential to steer deposits and the opportunity to benefit from the incentive would be unequal and would quickly cause hard feelings.

Proportion

The incentive should be sufficient to award extra effort without warping the existing compensation strategy. Take the bank example above. If an employee convinced someone to deposit their retirement savings of $1 million, the commission would be $10,000. Is this sum sufficient to drive some pretty weird behavior? Absolutely! If a clerk earned a $30-40k salary, the one percent commission in the above example would mean that three or four retirement accounts could equal a year’s salary. Employees would be tempted to take extra-ordinary steps to get large deposits. It wouldn’t be long until individuals volunteered at senior citizen’s homes while carrying account application forms. The bank’s reputation could be tarnished, however, if details about the incentive plan became public.

Reasonably Objective

Is the incentive based on objective input? Sales dollars are more objective. A customer satisfaction rating will have to be very carefully constructed to ensure continued objectivity. Incentives work best when based on consistent and objective information – whether from available performance metrics or from a well-designed and well-tested sampling approach such as a survey. Both have problems. The metric(s) used can distort the work environment as people seek to improve metric-gauged performance, while more balanced sampling methods are criticized as subjective. The goal is to use objective, hard-to-distort data.

Trust

Do employees trust those who will evaluate and tabulate the information for the incentive? If not, the incentive will not have the desired result. Also, trust can not be manufactured quickly. It is fragile and earned over time. One breach and years may be required to heal a situation. A climate of trust is therefore an essential prerequisite for a performance management system.

Bottom Line

An effective performance management approach considers the full range of components that drive employee activity, not just the financial ones. Incentives can make a positive contribution by making it clear that the organization considers certain strategic activities important. Incentives become a way to share the benefits of this desired activity with the employees involved. A poorly-implemented incentive system, however, can disappoint employees and clearly reveal management’s inability to think through a situation. Handled with care, considered with attention, and placed well, this powerful management tool can produce substantial results.