Wednesday, August 4, 2010

Establishing Incentive Plan Measures: Part 1

In order to appropriately establish measures for a comprehensive incentive plan and determine which core approach will be taken to develop a program, company executives must first understand and embrace a few foundational principles.

These foundational principals boil down to three goals – creation of an incentive plan that not only improves profits but is also drives results and is self-financing (paid for with results realized). These principals pilot two basic approaches that company executives should consider in the development of incentive plan indicators – Profit-Based Allocation and Targeted Key Performance Indicators.

We’ll concentrate on Profit-Based Allocation for this month’s posting, and have Targeted KPI’s to look forward to next time.

Under the Profit-Based Allocation method, a company decides that it will allocate a percentage of annual profits to employees; the award amount is divided among employees based on a pre-determined formula with payouts typically occurring at the end of the year.

A “best practices” framework for a Profit-Based Allocation should address the following issues:

-Define profits, be it net income or another measure
-Establish a baseline upon which contributions to the profit pool will be based
-Identify a threshold to ensure that a certain measure or series of measures will be achieved prior to payments being made
-Select a fixed or tiered percentage to share
-Select an allocation formula to determine how the value will be distributed to participating employees
-Establish a personal performance component to clarify the performance threshold that must be achieved to receive benefits

Keep in mind that since the single focus of Profit-Based Allocation is on annual profits, the value created can lead to some inherent drawbacks. Some examples might be: long term needs are overlooked, individual accomplishments are not recognized and it can be possible to “cook the books” shorterm to impact a bonus. Seeing that this approach has its anchor in company performance, the absence of a strong performance management system or an apathetic workforce can compromise the effort.

Next month we’ll examine Targeted KPIs and how they can lead to improvement in profits.

About our Benefits Installment Author:

James E. (Jim) Moniz, CEO of Northeast VisionLink, a Massachusetts firm that specializes in structuring executive compensation. James E. Moniz is a national speaker on the topic of wealth management and on executive compensation. Jim Moniz will be presenting at this years SHRM conference in Phoenx, be sure to check out our presentation: “Creating and Sustaining a Competitive Advantage, The Role and Impact of Effective Compensation and Rewards Strategies”