Designing Incentive Compensation Plans: A Complete Guide

1. Consider your culture.

Incentive-based compensation is standard in many roles. For example, sales teams and executives often consider commissions or profit-sharing a given. But not every team thrives under this model. When asked whether a company should implement incentive pay, the first question Paul Wise, principal product adoption manager at CaptivateIQ, a maker of sales commission automation software, asks is this: "What's the culture, and how will it be perceived?”

After all, commissions and bonuses are a form of “risk pay,” he said, with no guarantee that employees will earn them. Economic downturns, industry volatility, or a competitor’s unexpected product launch could all have an outsized impact on an employee’s productivity and an organization’s success.

For incentives to drive performance, there has to be an intrinsic motivation.

“If, in your culture, introducing incentive compensation will feel like a takeaway, meaning you're taking money out of my pocket, then your culture for that role, for that department, may not be suited at this moment for incentive pay,” Wise explained. 

What’s more, for incentive pay to work, you need a workforce motivated to be top performers. Some employees meet job requirements but lack the drive to go above and beyond. "For incentives to drive performance, there has to be an intrinsic motivation,” said Jennifer L. Massey, founder and CEO of Integra HR, an HR consulting and training and performance development firm.

2. Consider the metrics.

Incentive compensation plans correlate worker performance to specific metrics, including organizational goals and business strategy. But, often, employers don’t take the time to determine realistic metrics, Wise said.

Sometimes goals are set so high that even top talent can’t meet them, which demotivates employees at every level, he explained. Or, conversely, some employers set goals too low, and every employee earns a bonus, which is costly for an organization. 

It’s looking at data, perhaps bringing in a specialist, and then tying everything back to your revenue generation.

To set the right benchmarks, look back at six or 12 months of data, such as sales data, rate of on-time project completion, and other company goals you’re tracking, Wise recommended.  

As part of the analysis, also talk to your employees to fully understand what each individual is doing and whether it aligns with their job description, said Delaney Silver, an HR professional with expertise in talent management. Some employers may want to reward a certain behavior, but conversations with employees and managers may uncover that that behavior actually isn’t what’s driving the business. In fact, it may be another behavior altogether.

As you analyze past sales or productivity, consider regional, national, and industry trends too, Massey suggested. A certified compensation specialist can help. “It’s looking at data, perhaps bringing in a specialist, and then tying everything back to your revenue generation, and making sure that those goals align,” she said.  

3. Tie incentives to specific roles.

In organizations with an incentive compensation plan, employees may earn rewards based on both the business’s overall success and their individual performance in their specific roles. Employers should be careful to set clear, measurable targets for each position, so employees know what’s expected. 

For example, a sales rep’s incentives might consider lead generation and closed deals across a sales cycle. A vice president of customer success’s rewards might be based on net revenue or customer service satisfaction scores from surveys, Wise said. And a human resources manager might be measured based on non-regrettable departures trends or the time it took to hire new people. 

4. Ensure transparency.

Transparency builds trust — especially in compensation. Employees should know how much they can potentially earn and how they can do better. Because incentive programs tie pay to individual, company, or shared performance, employers must be transparent about how well employees and the business are meeting their goals.

Any organization with an incentive compensation plan should prioritize regular check-ins between managers and their direct reports to ensure everybody is kept abreast of their individual progress. Company-wide updates should also be held to provide clarity even if full financial statements can’t be shared. Those broad updates also are an opportunity to praise high performance and nudge workers where needed, Wise noted.   

“That will give people a good sense of where things are heading,” he said. “And then remind them that, ‘Hey, we're not doing so hot on the customer satisfaction. Don't forget, that's 20% of your bonus. Let’s maybe put a little bit more effort into that area.’”

5. Adapt compensation strategy as needed.

Companies should regularly reevaluate their compensation strategy, adjusting quotas and incentives to match market shifts, new product launches, overly ambitious goals, or other business needs, Wise suggested. 

“Most companies I've been a part of that have set too aggressive of goals have come back on those goals and said, ‘Hey, let’s reassess in July or August,’ or ‘Hey, we missed our goals, but we're going to take a little bit of a discretionary pot and dole it out, because we know you guys worked really hard,’” he said.

In other years, the business and its employees could exceed every expectation. “[In] blowout years, they’ll say, ‘Hey, we have to raise the quota a little bit, so we can keep pushing towards the end of the year,’” Wise explained.