As a small business owner, one of the most critical elements of your company’s success is the alignment of your team with your goals for your company. If you’ve ever felt that (a) you lack employee buy-in on strategic initiatives or (b) that your employees are not acting like owners, you likely have an opportunity to improve your company’s performance by implementing or revising your incentive compensation plan(s).
Why Incentive Compensation Matters
Money talks. When you tie an incentive to a desired outcome, you can bet it will guide your employees’ behavior. When properly designed and implemented, a well-designed incentive compensation plan can improve alignment between employees and business owners and greatly accelerate your company’s progress toward strategic and profitability goals. When not designed properly, on the other hand, the outcomes can be less than ideal.
Common Pitfalls
To understand how to create a well-designed incentive plan, it is important to understand some of the common pitfalls:
Revenue-Centric Plans
If you have had frustrations about top-line growth not translating into profitable outcomes at your company, a sales-oriented mindset and incentive compensation plan could be at the root of the issue. In fact, the most common incentive plan pitfall in small businesses is an over-emphasis on sales.
In particular, it is quite common for salespeople to be incentivized based on sales without adequate consideration for how profitable those sales are. These types of incentives allow for gamesmanship and can reward the wrong behaviors (e.g. prioritizing large sales volumes at lower gross profit margins).
To realign salespeople with broader company profitability, consider restructuring sales commissions around gross profit. This small shift can have seismic results by ensuring that your team’s sales efforts are properly aligned behind profitable sales.
Opposing Departmental Incentives
If you have conflict between departments, opposing or conflicting incentives could be at the root of the issue. Consider an example where a sales team is incentivized by project gross profit and the operational team in charge of completing the project is incentivized to maximize billable hours (i.e. utilization). Such a design creates a natural point of friction and conflict, and you can expect the sales team to be at odds with their operational counterparts with regard to the number of hours billed to their projects in this type of environment.
To avoid such misalignment, ensure that your incentive compensation plans are not directly opposed in a way that creates conflict. It’s essential to create checks and balances in your incentive compensation design but not explicitly create incentives in opposition across the organization.
If interdepartmental friction is an issue, consider instead aligning your incentive plans behind common goals (i.e., the operational team is also incentivized by project gross profit [but counterbalanced by accountability for issues on the project]). Also, consider creating a quarterly or annual team or company-wide incentives that celebrate company achievements and encourage departments to work together cohesively.
Unreachable Incentives
If your incentive plan doesn’t seem to be producing the intended results, you may have an unreachable incentive. In many cases, if performance against an incentive metric is significantly underwater, employees determine that their incremental efforts will not result in additional rewards and that the incentive is no longer effective.
For example, suppose your company has realized a sizeable loss through the first six months of the year. In that case, an incentive that pays employees at a 5% Operating Profit Margin is unlikely to motivate an employee to put in any extra effort.
Ensure that your incentive compensation plans are reasonably achievable to avoid such demotivation. It’s important to have stretch goals, but setting those stretch goals as the baseline for your incentive compensation plan can result in a loss of motivation to achieve what is seen as an unrealistic goal. If your budget is optimistic, make sure to calibrate your incentive so that some incentive is paid for improvement from the prior year (even if it doesn’t achieve optimistic budget levels).
Lack of Control Incentives
Like Unreachable Incentives, employees may not be motivated by an incentive whose outcome they don’t substantially control. Company profitability metrics are an excellent example of this. While it is great to include company profitability as an aspect of your company’s incentive compensation plan, it is common that any employee does not meaningfully control the entire company’s profitability. For less intrinsically motivated and team-oriented individuals, there is likely insufficient control to motivate the employee to put in additional effort to achieve the desired incentive.
To avoid this issue, we recommend creating a two-pronged incentive compensation plan: (a) a monthly or quarterly incentive that is tied to a metric or metrics that is/are controllable by the employee and (b) a quarterly or annual incentive that is tied to company profitability. This structure creates an environment where the employee is motivated to drive improvement in their areas of control while simultaneously having a stake in the company’s overall success.
Linking Incentives to Strategic Planning
Integrating annual or quarterly incentives with the strategic goals identified during the budgeting and planning process is another opportunity to enhance alignment between your team and your company’s goals. For example, if expanding into new markets is a strategic goal for the year, tailoring incentives to provide additional rewards for performance metrics related to market penetration in that area of strategic focus could be a prudent strategy to ensure those goals are realized.
Conclusion
Incentive compensation is a strategic lever that small business owners can pull to align their team’s efforts with the company’s overarching goals. By integrating well-designed incentive compensation plan(s) into your strategic planning process, you can ensure that every employee is aware of and driven to achieve the company’s objectives. This alignment ensures that every team member is informed about where the company is headed and personally invested in the journey.
Call to Action
Think about how your current incentive structures drive business outcomes. Are they aligned with your strategic goals? If not, it might be time for a redesign. At Gray Feather CFO, strategic financial planning is our business, and incentive compensation is one significant aspect of that process. Please reach out if you need help aligning your compensation strategies with your business objectives. Let’s ensure your incentives are designed to motivate your employees to act like an owner.
