Incentive-Based Pay: Is it Right For You?

Incentive based pay – bonus payment for achieving pre-established levels of performance – can be a great thing for building profit. It can also be a nightmare if it’s not planned properly.

Let’s look at the possible upside of doing this. First, compensation tied to performance can keep you from overpaying team members when times are slow. If done correctly, extra money is paid out only when the business can afford to pay it. This can help solve the dilemma of how to compensate long-term employees. The tendency is to continually bump up their hourly rate because they have been with you for so many years. Problem is, when things get tough, they suddenly make more than the company can afford to pay – maybe even more than the person paying them.

Secondly, incentive pay can produce better company results. Better company results can produce more pay with everyone pulling in one direction to build a better company. Incentive based pay can also keep a team focused on the things that truly build business- not an easy task in today’s workplace.

An incentive program that rewards your team for enhancing your business can build morale, create a single focus, and make you more profitable.

Incentive programs that are created incorrectly can actually hurt a business and its team. If incentives are based on unrealistic goals, team members feel they are being underpaid. If goals are based on the wrong criteria, the business could easily overpay team members and loose valuable profit dollars. If goals are inconsistent with true profitability, team members will concentrate on building the wrong programs. Sounds complicated. But I really believe that the custom framing industry is ideal for using the correct incentive based program. Why? Because business is often inconsistent and if better pay is tied to better business, it really helps. It also makes sense that better pay should be associated with better performance. I think we all understand this as business owners. That’s one big part of why we work so hard. So why can’t the same philosophy work with your team?

I’ve been using incentive based payment programs in framing for years now, but in order to gain more insight into how to structure an effective program, I thought it would be a good idea to speak to someone from a larger company in the industry that uses incentive pay. Tom McCarthy, a long time manager with the Larson Juhl Company, has had many years of experience with incentive based pay, not only with Larson but with other companies and he has many helpful ideas for designing an effective incentive program.

Tom shared that in his experience, sales people want to be in charge of their own destiny. If their incentives are totally based on company results, salespeople often feel they cannot really have enough impact on the outcome. Tom suggests setting individual goals with each designer. His experience has shown that they often even set higher goals than management would have set and by letting the salesperson be involved, you create joint ownership in the goal. Regardless of how the goal is set, it must be perceived as attainable by those striving to achieve it.

Tom also shared that the budget for a yearly bonus will be perceived as worthwhile if it is about 8% of the employee’s base rate of pay. Anything less than this would be considered too little to be valued. An 8% increase in pay for a 12-13 dollar per hour person would be about an additional $2,000 per year. The great thing about incentive based pay however, is that if you are willing to share great results and base the incentive on the correct criteria, you can pay well above these levels if results exceed your goals. This is where you can create some real enthusiasm for achieving incredible results. So how do you keep from basing bonus pay on the wrong criteria? The biggest mistake made is that companies offer large bonuses on sales numbers instead of profit numbers. That often occurs because profit is harder to determine than sales. Just remember that when you sell something for $100, it cost you something to produce it. The profit (meaning the money you actually keep from the sale) is far less than $100. You need to subtract the cost of the materials to make the project and operating expenses that are part of producing that sale. Knowing this number is the key. It’s a number you should know anyway, even if you don’t base incentive pay on it. Use that magic number to calculate what the business actually keeps on a $100 sale. That lets you set a number you can use as incentive for producing the sales above company goals.

Let’s do a quick example: if your cost of materials is 30% of your retail sales and your operating costs are 50% of retail sales, then 80% of each sale is a cost of doing business to get the sale. That means 20% is actually earned. That 20% is the amount available for incentives. A certain portion of that profit stays with the company and the team member receives the % you have both agreed upon. The key here is to focus on PROFIT and share profit goals with team members instead of focusing only on sales. Remember, incentive programs based on sales figures alone can encourage salespeople to make unprofitable sales. That’s because they are being rewarded on the sale- not the profit of the sale.

Other tips from Tom McCarthy included the need to have multiple levels of winning for contests that rewarded performance. He warned that winner-take-all bonuses can be de-motivating and sometimes unfair. He also stressed the need for public praise and accolades for those achieving or exceeding goals. Money is just one component of a good incentive program. A big part of creating an atmosphere where team members work toward common goals is positive reinforcement. Simply put, it is very important to catch team members doing things right. Immediate recognition of employees doing the kind of work that builds business is often more effective than money. Money is an important part of why we work but true satisfaction comes from knowing you a valued for your contributions. A good incentive program has lots of little ways to recognize team members for doing things right and doing it in a very public manner. While Tom believes that individual goals are most effective because it allows each person to feel in control of their own outcome, he also advocates tying in group incentives when the entire company achieves its goals. These multilayered incentive programs have the ability to reward for individual and company wide performance. Programs like this require you to share company profit results. Doing so keeps the most important aspects of business out in front of everyone. When everyone is interested in being profitable, it becomes much more likely to happen and the result is a team of people pulling business in the right direction.

I encourage you to create an incentive program that rewards your team for building a profitable business. Doing so builds morale, creates a single focus and can make you more profitable. Brainstorm some ideas for beginning an incentive based program with your team. If you make it fun and reward the results that truly build a profitable business, it will be one of the best things you’ve done for your company.

Categories: Management and Published Articles.

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