Strategies For Incentive Compensation

You can look outside for help and inspiration, but the answers are all close to home.

 

There are no real shortcuts to creating an effective incentive compensation system. No matter how you approach it, you still have to ask, and answer, dozens of difficult questions about your goals, your people, and your business. It helps, however, to have a strategy for dealing with these questions. There are essentially three to choose from:

THE COPYCAT METHOD

One strategy is to adapt somebody else's plan to your own circumstances and needs. It's particularly appealing if the other company is similar to yours, and if its system has worked well.

That was the case with Nicolet Instrument Corp., which developed its plan back in 1981 after chief executive officer John Krauss saw an article in the Harvard Business Review about the incentive compensation program at Analog Devices Inc. As it happened, Analog had management and operating structures strikingly similar to Nicolet's. So Krauss copied Analog's incentive compensation program, and it worked effectively for several years.

There are pitfalls in the copycat approach, however. To begin with, no two companies have identical cost structures: if your costs are higher than those of the company you're copying, you may be stimulating behavior that you can't afford. Nor can you assume that the other company's market position or goals are the same as yours. If they aren't, the performance criteria are liable to be off as well. "Copying another incentive plan," says one consultant, "is like trying to learn Jimmy Connors's backhand when you don't have his serve." It may work; then again, it may throw everything out of whack.

THE CONSULTANT ROUTE

Another strategy is to hire a specialist to design your compensation program for you. That's a natural impulse, and consultants do have much to offer in the way of advice and experience. But many have worked only with large companies, which does not help them in understanding and solving the compensation problems of smaller companies.

James Bernstein learned that lesson the hard way when he brought in a wellknown consulting firm to design an incentive plan for his $4.5-million health risk-management firm, General Health Inc., based in Washington, D.C. He wanted a compensation system that would encourage employees to focus on sales volume and building market share. With that mandate, the consultant produced an elaborate plan under which all 80 employees could earn handsome bonuses by meeting individual and company objectives. "The consultant gave me his best advice," says Bernstein. "It sounded just terrific." Unfortunately, it wasn't. Not only did the system demand hours upon hours of management time to review each employee's objectives, but it also completely overlooked the company's need to change direction and shift people around on short notice. Objectives that made perfect sense one week were outdated the next.

Within a year, General Health scrapped the consultant's incentive program and installed a simpler one designed by Bernstein himself. Dispensing with individual goals for everyone but salespeople, the new system rewards employees for meeting quarterly profit objectives. It takes a lot less time to administer, notes Bernstein, and yet it's enough to send the message that "everyone needs to put their shoulder to the wheel."

THE TAKE-YOUR-LUMPS APPROACH

Bernstein's experience illustrates a fundamental fact of incentive compensation: sooner or later, you have to develop your own system. There are no blue-prints, and there are no outside cures. You may discover some interesting features in other companies' programs. You may also find consultants who can help you think through your company's needs. But don't expect anyone to understand your company as well as you do.

"There's no substitute for sitting down, locking yourself in a room, and thinking about what's really important to your business," says Bernstein. "Otherwise you'll end up with a cookie-cutter approach that was designed for the company next door." So, in the end, most companies wind up developing their compensation programs the old-fashioned way -- by doing it themselves.