Performance-based compensation is the variable component of total compensation that may be paid to an individual, team or even companywide upon achieving some defined performance metric. For instance, when a salesperson is paid a commission for achieving a sales target, or an annual bonus is distributed after meeting a companywide goal.

“You need some form of performance-based compensation to keep top performers motivated and happy,” says Brian Berning, managing director at SS&G’s Cincinnati office. “They want to believe that they can make as much as they possibly can if they are able to achieve goals. And with a variable component, there’s rarely a ceiling on it.”

Smart Business spoke with Berning about using incentives to benefit both the employee and the company.

How do companies typically pick incentives for performance-based compensation plans?

It’s largely based on defining goals and setting performance benchmarks around them, which can be for an individual, team, companywide or any combination of the three. It’s important to understand that without consequences, positive and negative, it’s not a goal — it’s a wish. The best companies develop incentives with clear, objective and measurable goals, stating exactly how to successfully get to the target.

You also want to target the right people. A shop foreman of a manufacturing company can influence on-time delivery but shouldn’t be tied to goals for meeting sales initiatives.

Which incentives can be problematic?

Those that are difficult to explain, to measure or achieve are prime for failure. Remember you’re trying to reward results that are largely influenced by behaviors in connection with the company’s goals. So, if the incentive is tied to a behavior that the responsible party has no control over, or the performance measurement isn’t in alignment with meeting the desired goals, it simply won’t work. Employees must be able to understand it, measure it and achieve it.

Why is it important to avoid rushing in?

Look at various scenarios and test to make sure that they mathematically work — that they’re achieving your desired goals. There’s nothing more embarrassing than implementing a performance-based incentive structure that doesn’t work.

On a commission-based structure, for example, be careful when trying to reward certain behavior. If you sell two products, product A and product B, and you want to encourage additional product B sales, you may increase B’s commission. But if everyone is focused on selling product B, there could be a loss of sales in product A. It’s better to use minor awards or only change the commission structure minimally, enough to keep people conscious of it, but not enough for them to ignore product A.

So, talk to your staff and others, and make sure the plan is designed properly.

How can awarding equity in a private company be problematic?

There seems to be two situations that prompt a company to look at a plan like this.

1. Senior management thinks that by giving employees ownership, it is going to motivate results. But by giving stock, you haven’t tied that to goals. The award isn’t instantaneous; employees don’t have more cash. As an owner, how is an employee going to behave any differently?

2. The business uses this as a tool to recruit talent when cash flow is tight. It may work, but it can have consequences later if it doesn’t work out with that employee.

There are other options that look and feel like equity, such as contractual arrangements that don’t necessarily result in the award of true stock or units in a partnership.

What should management be doing to measure, review and adjust these plans?

Measure it frequently and pay promptly. Otherwise, people will lose interest in it.

When reviewing or adjusting the plan, that should be far less frequent. If you’re continuously tweaking your plan, you’re going to create confusion. If there’s some anomaly, fix it immediately, but if you’re making wholesale changes right away, you made a mistake and didn’t do your due diligence. A well-defined performance-based compensation plan provides employees with an upside they feel they can achieve that ultimately helps the company.

Brian Berning is managing director at the Cincinnati office of SS&G. Reach him at (513) 587-3270 or BBerning@SSandG.com.

Website: SS&G was named a top workplace in Northeast Ohio.

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Published in Akron/Canton