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Incentive schemes: Is it time to have a rethink?

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Incentives: The carrotThere have been several examples recently where an organisation has performed badly, yet the head of it has still received a substantial bonus, easily perceived as a reward for failure. It may be time we looked again at the idea of linking reward to performance, says John Pope.


Linking reward to performance is likely to concern those in HR as activity levels fall, costs rise and the workforce seeks to compensate for the loss of value in their remuneration. We should start thinking clearly about the state of existing schemes and their consequences.

Bonus schemes, where an individual or team is rewarded for some aspect of the results achieved, have been around for many years. And for many years employers have been anxious to have some link between results and the reward to those who produce results as an incentive to increasing performance and profitability.

“A bonus scheme which encourages cheating and undue risk-taking can be extremely dangerous.”

But they can be dangerous – they can be counter-productive, or run away as many organisations have found. And when they do run away they have to be ‘bought out’ which is always expensive.

In the manufacturing industries, there was a long debate on the use and value of such schemes; the debate ran from the 1930s to the 1970s and was pretty fierce at times. There were many studies. For instance, in 1967, before most present day managers were born, the National Board for Prices and Incomes (NBPI) did a very substantial survey of such schemes and repeated the dangers. They recommended safeguards which many of those who had been concerned with such schemes in manufacturing knew well. The principles are fairly simple and still right, even though they are not always easy to apply.

Principles

  • You pay a flat rate, the ‘basic pay’ for normal performance – the performance you expect regularly from those in that group who have the skills needed for the work.

  • You provide those individuals with the opportunities and a supply of work, and expect them to achieve good ‘normal’ performance.

  • If they can further improve their performance through extra effort, you pay an incentive on top of their normal pay.

  • If their work performance depends substantially on the performance of others in their workgroup or team, you pay the incentive to the group, not the individuals – who each get a share

  • Only good work counts – you don’t pay for scrap. If it takes time for bad work to show up, you do not count that work until it proves to be good.

  • You limit the incentive to a reasonable amount – conventionally to one-third of the basic pay. Experience has shown that when the bonus is much higher than that the scheme becomes counter-productive and leads to bad team-work, cheating, high scrap and wastage.

  • You do not ‘guarantee’ the bonus – that is a contradiction in terms

  • You might need to make some short-term arrangement to support a new member while he gets ‘up to speed’. Be careful not to provide that for too long, or to make it too big a prop

  • You manage the workforce so that both good and poor opportunities to earn are shared equally, to avoid getting greedy ‘superstars’ who disrupt the team.

  • You have a rational means of independently measuring or valuing the work done

  • You keep good records so that you know who has produced what

  • You do not let the scheme drift or decay

Above all, you check regularly that the scheme is not abused, or misused, that the managers do not get sloppy and make unwarranted concessions, and especially that the managers are managing rather than getting involved in production and getting into the scheme.

Even in manufacturing, where it is fairly easy to measure input and output, it is difficult to stick to these principles. The NBPI found few schemes over three years old which were not decayed, and only a very few schemes that were maintained regularly – most schemes tended to drift. Incentive schemes for ‘knowledge jobs’, traders, and managers are far more difficult to control.

Applying the principles to ‘knowledge jobs’

It is much easier to have schemes in manufacturing where you can measure the output physically, than it is for ‘knowledge jobs’. It is important not to destroy the ‘animal spirits’ and entrepreneurial skills of the sales-force, dealers, and traders. You want senior managers to use their initiative and achieve outstanding results.

However, a bonus scheme which encourages cheating and undue risk-taking can be extremely dangerous. And one where the results of some deal or new scheme may not show up for years can be catastrophic, as has been shown recently in the financial world.

How will you measure performance?

This is the important and difficult bit. In manufacturing you can use work study to set standard times for the many different activities; you can use ‘rate-fixing’, a loose term for a range of techniques often including an element of guesswork and bartering.

In repetitive clerical work you can do similar things. None of these are exact, but can give a good measure of performance when the work done is recorded in some detail. But minor unrecorded changes to speed the work, shortcuts and the difficulties of keeping up-to-date make it possible for apparent performance to improve without any extra effort.

You can fix a few measures of output or targets, accepting that it will not be absolutely fair, but believing that it will even out in the long run. You can expect that some people will seem to do badly even though they are working hard and well, while others seem to be doing well when it is clear that they have had a lucky streak. Performance targets or objectives must be realistic but stretching; they must be clear and fixed. Remember that over-emphasis on a target can easily be very damaging, as the NHS and police have found.

Better do the sums too and check that you have not made financial promises that you cannot keep.

Fraud and ultra-sharp practice

Incentive scheme fraud and sharp practice is never easy to control. In a manufacturing business, where individual’s bonus depends on jobs completed, you can find workers banking job tickets so that they contribute to bonus for payment in a particular week, variously called ‘bull-week’ or ‘pudding week’. Periodically, a junior manager has to go round and verify records, find documentation, and sometimes you have to check on the figures.

Incentive schemes decay

There is no doubt that well-designed incentives can encourage extra effort and better results. However, schemes tend to decay. Contrary to the general impression given by the media, the workers in manufacturing are not greedy, certainly not on the same scale as very senior managers. But they will attempt to make a scheme pay out more than it should, and when times are difficult and the bonus level falls, they will try to get round some of the restrictions and safeguards. This is very likely to happen if bonus has been very high by comparison with basic pay. If managers are weak, they will quietly condone bad practices to avoid unrest or loss of key staff.

“There is no doubt that well-designed incentives can encourage extra effort and better results. However, schemes tend to decay.”

Schemes decay for many reasons, when the pattern of business or trading changes, when new products or services are introduced and a temporary rate is agreed, and left too long.

They decay when schemes are not regularly reviewed or audited, or when people talk about leaving for more money and are retained by ‘secret’ concessions which no-one is supposed to know about. And all these problems are usually the result of sloppy and inattentive managers, and are certainly the responsibility of managers to resolve.

These hazards and lessons are easier to see in manufacturing; they are more difficult to see in the sales-force or administrative world, but they apply just the same. The only difference lies in the size of the bonus.

Incentives and behaviour

You use incentives to encourage your people to adopt behaviours which you believe are profitable. Those behaviours include the attitude to risk, to competitiveness and collaboration, to assessing and grasping opportunities, to winning business from others, and more. My questions are:

  • Are you clear on the behaviours you want?
  • Do your present arrangements encourage the right ones?

  • Do they encourage harmful or dangerous behaviours?

  • How do you design your scheme to avoid the risks which can result?

Careful though, beforehand – vigilance in application and good management is essential if incentives are to be effective.


John Pope has been a management consultant for over 40 years, and has had his own practice as an independent consultant for over 30 years. He has worked in a wide range of businesses where performance and service were the keys to success. He continues to advise businesses at senior level on their direction, strategy and especially on the management of change. John can be contacted at [email protected]

5 Responses

  1. The Destructive Effect of Incentive Schemes.
    I have never seen an incentive or pay scheme that had anything except a destructive effect on performance.
    Whatever was driving performance in the past goes out of the window when an incentive scheme is introduced.
    The workforce become entirely focussed on achieving their bonus to the disregard of other considerations, customer satisfaction, quality etc.

    The worst aspect is that although incentive schemes are designed to increase performance by offering the incentive for a change of behaviour, in most cases the workforce can figure out how to achieve their bonus without changing their behaviour one jot.

    The only way to change performance sustainably is to change the way that the workforce feel about what they do and in most cases the person who has the ability to do that is the manager.

    Unfortunately most managers do not understand this and fewer realise that it is their behaviour that is preventing their workforce from performing.

    A perfect example of this managerial misunderstanding is the pay and incentive schemes that managers implement.
    They believe that by implementing these schemes they are having a positive impact on performance, the real effect is the exact opposite.

    The whole concept of incentive schemes has been given consideration by the most respected gurus in business.
    .
    This view is the result of practical experience supported by their writings.

    John Seddon, Author of “Freedom from Command and Control” Said;
    Incentives are commonly used to motivate sales forces. In every case I know where the incentive scheme has been scrapped and replaced by salaries the result has been improvements in cooperation between sales people, better customer service as a result and best of all improved sales.

    W Edwards Deming said,
    To release the power of the human resource we have to release the power that the workforce were born with, ignore the extrinsic motivators, and instead nurture the intrinsic values of the workforce.

    And “If management sets quantitative targets and makes people’s jobs depend on them – they will meet the targets – even if they have to destroy the enterprise to do it”

    “When You Instil Into A Workforce The Reason To Do Things Based On External Rewards They Learn To ‘Work’ Only When They Can See A Direct And Tangible Reward”
    Judith Germain FCIPD, MCMI

    “There is no contest between the company that buys the grudging compliance of its work force and the company that enjoys the enterprising participation of its employees.” Ricardo Semler

    To create a sustained improvement we have to change the way that the workforce feel about what they do.
    We have to allow the workforce to care about what they do.
    When the workforce care about what they do their performance becomes astonishing and any suggestion that their performance is the result of an incentive scheme will be treated by them as an affront.
    They will have become proud of what they do.

    Peter A Hunter

  2. Don’t destroy teamwork
    Yuvarajah,
    Thanks for your comments. You are absolutely right, it is so easy to destroy a team by favouring one member over the others. At best it leads only to discontent; at worst it leads to members competing against each-other more strongly than they do against the external competition. If managers only went back to first principles before they took their decisions about motivation and reward many of these problems would be avoided.

    Where the team is a big one and there are members at very different levels and very different pay rates bonuses are best awarded as a percentage added onto the fixed pay rate. Even so, big differentials in pay between members working closely together generally cause enormous trouble in the end. Why produce extra envy with enormous bonuses? It always lead to trouble.

    Promote harmony; a strong team is stronger than a group of strong individuals.
    John

  3. Back to the Basics
    Don,
    Many thanks for your comments, I am glad you liked it. I guess that at the root of the problem is the rush by managers to ‘do something’ without going back to the first principles and thinking clearly. As you say we would not make much living as consultants if managers really thought what they were doing before putting sticking plaster over a problem. The law of unforeseen consequences applies everywhere. A good deal of the present problems in the financial world, and the losses on ‘sub-prime’ mortgages is that managers, traders, dealers, were given enormous incentives to produce volume, and of course did so without thinking about the quality. An article written jointly with a specialist in financial risk management should be being published in the financial media shortly. I do not know how to incentivise sportsmen, I thought they were supposed to be self-motivated!
    John

  4. Individual Incentive at Team’s Expense – An Oxymoron
    John,

    A very good piece of information, in particular on the principles that should govern incentives scheme.

    I would like to seek your view on giving incentives to individuals in a team. As we all know, unless you work alone on some isolated project, the reality of organisational life is invariably based on the concept of inter-relationships – functionally between departments and spiritually amongst team members. We all know that, even in our own family context, the smallest operating unit is a team.

    It sounds an oxymoron why organisations resort to rewarding at the individuals level yet, ignore at the team level. This I cannot understand nor appreciate.

    I would say, most organisations adopt this practice without due regard and evaluation to the extend of damage on the collective spirit of teams and its consequential impact to the bottom line – potential yield and earnings.

    The worst part of this flawed and blatant absurdity is the audacity of management to wonder why teamwork is failing. Eventhough they recognise and champion teamwork as critically imperative for operational outcome, they do nothing via incentive to encourage teamwork. It amazes me how people in top leadership ignore the simple rule of causal and effect relationship when it comes to promoting and modifying behaviour towards teamwork.

    This is not to suggest I do not support individual incentive. But, it should not be done, at any cost, to team spirit and teamwork. The case is even more pressing in organisations with loose and subjective performance management system, compounded by incompetent managers lacking the necessary managerial skills.

    Yuvarajah
    Malaysia

  5. Incentives
    Cheers John……….so pleased to see that someone from the other side of the world reinforces sound thinking and most important, practical application. I still see examples of incentives schemes that [unfortunately] please me as a business adviser, where I just know they will fail. Oftentimes the reason I see them is that they have failed and I am being sked to fix. Consistently the reason centres around performance criteria which people do not understand, like being ‘professional’; like completing jobs in a ‘workmanlike’ manner; like ‘meeting production targets’……..and so it goes on. As you so rightly point out, the crucial determinant that should undeerpin any incentive scheme is determining the extra being pursued and not for simply doing the job properly. Good stuff. Have you in recent weeks had input into your national cricket side??

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