How to Choose the Right Incentive Plan

“The right incentive plan properly implemented can drive your business ahead like a rocket ship. But if expectations increase faster than actual payouts—watch out for trouble!”

I tend to divide incentive plans into three silos: one for salespeople, one for the management team, and one for the rest of the company.

Salespeople: Inbound and Outbound Sales

When I think about incentive plans for salespeople, I quickly divide the work between inbound and outbound sales.

For inbound sales positions (sales reps responding to inbound sales calls or electronic inquiries), I tend to put the base wage at 70 to 90 percent of the total target pay with the rest based on performance.

For these kinds of positions, I tend to have the bonuses be very short-term in nature, such as based on the number of sales closed that day or that week. Then, to make things fun, I might run additional contests, such as “most sales in the next two hours get free lunch” or “most sales for our highest-end product this month get a free computer.”

For outbound sales positions (sales reps who prospect for customers and typically pitch many customers before making a sale), I might put base wages at 40 to 70 percent of targeted total compensation. Where I might be on this wide range would depend upon the difficulty and sophistication of the sales process.

For example, if the sales rep is selling small business insurance and most of his or her sales are updates to repeat customers, then I might be closer to the 70 percent range.

And in this case, I would probably structure his or her compensation as base pay plus a bonus for hitting sales targets and perhaps additional bonuses for selling either new accounts or new products to existing accounts. In this situation, I will most likely pay the bonus annually.

On the other hand, if the sales rep is cold-calling a more intangible product, such as life insurance or advertising, then I might pay a base guarantee but have commission running against the base salary.

So, in other words, as soon as the commission exceeds the base salary, they pocket the full commission over that break-even amount. I might pay out commissions biweekly or monthly in these situations.

Management Team

Compensation for management teams tends to be all over the board. If you are launching a high-risk start-up and your managers are more like co-founders and will be working for token salaries, then granting a decent portion of stock options or equity subject to a vesting period (time they are required to stay at the company) may be appropriate.

In the small companies I have run in the past, I have primarily compensated my managers in base salary.

In addition, they have often been eligible for an annual bonus, typically up to about 15 percent of their annual salary, based partially on the company’s performance and partially on their individual performance.

Company-wide Incentive Plans

I have found that company-wide incentive plans can help pull companies together, even if the amounts involved are not that substantial.

Years ago, the only employees offered incentive pay were salespeople, piece workers, and top executives. Today many large corporations, and quite a few smaller firms, offer an incentive package to all of their employees.

Some kind of incentive pay is an important part of any compensation plan. Incentive pay shows appreciation and creates a sense of participation in the company’s well-being that straight salary dollars, no matter how large, don’t convey.

A well-designed incentive pay plan can also help pull people together, help point them in the direction you want them to go, and give that extra push that every company needs in today’s competitive environment. 

Profit-Sharing Plans Are Common

Profit-sharing plans are probably the most widespread incentive pay programs at larger corporations. They are generally company-wide and made available at least to all full-time employees. Usually the company will contribute a small percentage of its pre-tax profitability to a pool, which is then divided among eligible employees.

Distribution of the profit pool is typically prorated according to the base salary of each participant. Profit sharing is generally done on an annual basis. At some firms, profit sharing may be directly contributed as pre-tax dollars into a retirement program, such as a 401K program.

Profit plans work best at more established firms with relatively steady earnings. The criteria for the profit plan must be carefully defined in advance.

Profit Plans Don’t Always Work

The advantages of a profit-sharing plan include: it pulls people together, because everyone is on the same plan; it gets people to focus on profitability; and its cost to the company goes up and down in sync with pre-tax earnings.

The disadvantages include: it echoes the base salary; it does not take into consideration performance during the year; and it is focused on a single objective.

For smaller companies with erratic earnings, profit-sharing plans can frustrate and irritate employees by creating expectations that are not fulfilled each year.

I switched away from a profit-based incentive plan because I found that a small payout level, following a year of weak profitability, made a low morale situation even worse.

Incentive Programs Reward Achievers

One year at Adams Media we switched to an individual bonus incentive program, where the annual payout was determined by a subjective evaluation of each person’s performance.

The advantages include: unlike a profit-sharing plan, we can dramatically differentiate the payout given to a star performer versus a weaker one; we can differentiate between an individual’s performance and the company’s performance; and there is complete flexibility for a significant onetime payout if an employee has an extraordinary accomplishment that may not be repeated in future years.

The disadvantages include: the payout is subjective, and employees may feel that they deserve a higher payout; it can be divisive when, all too often, a top performer tells other people what a big bonus they got; and employees may focus more on “looking good” than on working to increase corporate profits.

Other Incentive Options

In addition to profit sharing and bonuses, here are some other incentive options:

  • In salary-at-risk plans, which I don’t recommend, employees receive their full base pay only if performance meets minimum goals, but a larger payout is possible.
  • Gain sharing, popular at some manufacturing firms, provides for a portion of increases in efficiency to be shared with employees.
  • Stock or options are available at many public companies, but are less practical at private ones.
  • I’ve successfully used cash awards for specific achievements, such as cost-cutting ideas.
  • Some plans have multiple goals, with a percentage of the payout determined by how well a person performs on each objective.

Although I highly recommend incentive pay plans, design and implement yours carefully! All too often incentive programs backfire when they fail to meet employee expectations.

Takeaways You Can Use

  • Company-wide incentive plans can pull a business together.
  • Profit plans can backfire for companies with erratic earnings.
  • Individual incentive plans can work, but must be tailored to your company.

About Bob Adams

Bob Adams is a Harvard MBA serial entrepreneur. He has started over a dozen businesses including one that he launched with $1500 and sold for $40 million.

He has written 17 books and created 52 online courses for entrepreneurs. Bob also founded BusinessTown, the go-to learning platform for starting and running a business.

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