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Annual incentive plan: Is yours the right fit for your business?

Let’s face it, the real reason 99 percent of the population heads to the office rather than the golf course or shopping center every day is for a paycheck. But if they don’t think their pay matches their efforts, employees are bound to complain, put forth less effort or worst of all, quit.

So what does that mean for your business? You need to develop an effective incentive plan.

Overall, the most common strategy is an annual incentive pay plan. In 2014, 90 percent of publicly traded firms offered such plans, according to a WorldatWork and Deloitte Consulting LLP report.

But is an annual incentive pay plan really the best way to motivate employees?

How an annual incentive pay plan works

With an annual incentive pay plan, employees earn a payout, often expressed in terms of percentage of salary, when they achieve performance-related goals. This payout is in addition to their base pay.

Goals are clearly outlined at the beginning of the year, and may be based upon individual performance or that of a team, department, the business as a whole – or even some function of all.

An annual incentive pay plan should:

  • Reward high performance
  • Retain and motivate the best workers
  • Be aligned with business priorities
  • Be based on a straightforward review process

When it follows these rules, annual incentive pay undoubtedly achieves the intended goals of an incentive plan. However, this is not always the case.

Where annual incentive pay plans fall short: “equal pay”

If your company’s incentive plan ties payout amounts to the individual performance levels of your employees, you run the risk of creating some discontent among your workforce. Some employees may find out that certain top performers are receiving more than everyone else. This can lead to gossip of favoritism or complaints regarding out-of-reach expectations.

When these circumstances arise, you may be inclined to hold back from really paying the best performers more. In hopes of achieving a more “equal” system, you may give only slightly different incentive payouts to all employees, regardless of the differences in their performance levels. Such wealth spreading approaches may quiet frustrations, but can disregard the value of higher performing employees.

So is that really fair for either party? Your best employees aren’t getting the payout their roles deserve. But on the other hand, if given a true-value incentive, how will their coworkers feel?

Talk about employee unrest.

How to create a “fair” incentive pay policy

You don’t have to settle on a single, one-size-fits all incentive plan for your business. After all, your business is as unique as you and your employees – so why should you expect to find perfection with a standardized solution?

You shouldn’t.

An annual incentive pay plan is the most common choice because it meets most business needs. But you can make up for its shortcomings by supplementing with the addition of one or more alternative incentive plan options out there:

  • Bonuses: A one-time reward for attaining a goal (not necessarily year-end, within any agreed-upon time period)
  • Commissions: Financial reward given as a percentage of each incremental sale (best for sales employees)
  • Piece rate incentives: Compensation based on the level of individual output produced (best for manufacturing or production roles)
  • Stock options: Time-sensitive option to purchase shares of company stock at an exclusive rate

Creating your own unique recipe can help balance the pros and cons of each plan for a more universally accepted and effective strategy.

And selecting which ones to add isn’t as hard as you think.

Start by doing industry research on the incentive plans used by your competitors. Have they been effective?

Really think about how your business operates. If you have mostly sales-oriented employees, you might want to consider adding a commission-based incentive, whereas many individual contributors may be more motivated by a bonus program.

And finally, talk to your employees. By understanding their perspectives, you’ll be in a better position to tailor your plan closer to their needs.

Taking the time to evaluate the ins and outs of your current incentive plan and make effective changes can be a daunting task. Especially on top of the daily responsibilities of running your business.

Help is just one click away.

For greater insight into best practices in payroll and personnel management from seasoned HR professionals, download our guide, 7 most frequent HR mistakes and how to avoid them.