As we have mentioned before in this series of articles, the design of incentive systems are often undertaken much too quickly and without proper thought being given as to how actual results will be measured against the goals on a consistent basis. In addition, poor incentive design can easily result in a misalignment between the goals for the individual and for the organization.
As a Toronto-based head-hunting firm, and with our deep experience in running large organizations, we are very familiar with the surprising power that can be unleashed as a result of carefully constructed incentives that put the individual and the organization on the same path to success. We are also painfully aware of the problems that can arise when an incentive system puts individuals and their employer at cross purposes.
An Example of What NOT To Do
A number of years ago, a company won a contract for a large utility construction project. The project required digging and laying underground cables across thousands of residential properties in a major city. The deadline was tight and the stakes were high, since the agreement with the municipality called for penalties for late completion and also required the company to restore properties to their pre-construction condition.
In view of the importance of meeting the deadline, the decision was made to offer an incentive of a new sports car to the executive in charge of the project for on-time completion as per the contract with the municipality. Faced with this powerful incentive, the executive was focused only on that single goal – on-time completion.
Subcontractors were brought on board to supplement the in-house construction team and authorization was given for over-time work at extra cost. Crews assigned to restoring properties to their former state were reallocated to digging and laying new cables. Complaints to the municipality from property owners about holes dug but not filled in, grew exponentially. All resources were focused on one goal – on-time completion at any cost.
In the end, the project was completed on time and the executive in charge got his sports car. However, a colossal mess was made that cost the company dearly to repair. Not only did the cost of construction rise dramatically because of the extreme measures that were taken to achieve it, but the company’s reputation was damaged with the municipality and the residents.
In retrospect, it is easy to see where this situation came off of the rails. The incentive was based on a single, narrow objective that took into account only one aspect of success for the company. The person who had the incentive had the power to negatively affect other aspects of the company in order to achieve his narrow goal.
What’s To Be Learned From This Situation?
- Specific, narrow incentives work best at the lowest levels of the organization where the individuals involved don’t have the power to tilt the playing field in their direction to the detriment of the overall interests of the company.
- Incentives at higher levels in the organization must be aligned with the best interests (some would say, the best LONG-TERM interests) of the company.
- Failure to consider the unintended consequences of poor incentive design will result in a kind of “zero sum” game where a gain in one area will result in an equal (or worse) loss in another area.
- Focusing on one dimension of success is the equivalent of willful blindness.
An Example of The Right Thing To Do
Designing an incentive system for individuals at the General Manager level requires the incorporation of a few different concepts.
- What items to measure that are broad enough to be totally aligned with the long-term, best interests of the organization as a whole?
- How to ensure that the goals are graduated so that there is a payoff for different levels of achievement and not just a “yes/no” payoff for hitting a certain result?
- How to avoid unintended consequences that result from unusual circumstances?
Our favourite goals for individuals at the General Manager (P&L responsibility) level include:
- Year-over-year growth in EBITDA (earnings before interest, taxes, depreciation and amortization – commonly referred to as “Operating Cash Flow”). There could also be an absolute $$ target as well in an “either/or” scenario to compensate for a situation where the previous year’s results were unusually high or low.
- Year-over-year growth in working capital (basically the net change in items on the balance sheet that use cash). The basic objective would be to decrease accounts receivable, decrease inventory, increase accounts payable (without causing supplier problems) and increase unearned revenue (if there is an opportunity to invoice in advance of service delivery). Again, an “either/or” target that includes an absolute $$ target can be helpful in addition to a Y/Y % change target.
- Employee turnover reduction (annualized %)
- Specific project achievement (subjective rating by the supervisor of the person being measured of several projects assigned and agreed on at the beginning of the year).
For each of these goals, it is important to have a payoff matrix that indicates clearly what the reward is ($$ or % of salary) for each level of achievement vs. the goal. The payoff should start at less than 100% achievement to keep motivation in place even in the face of failure to exactly meet the target. For example, a small reward might still be available at only 90% achievement of the target, 100% of the reward paid at 100% achievement, and an accelerating payout available for reaching 105%, 110%, etc. to really encourage a stretch to achieve higher levels.
This level of detail in incentive planning takes time and must be both well communicated and well administered or else it will fail based on poor measurement and reporting.
Done properly, the organization will benefit multiple times over the cost of the incentive payouts, and it’s among the most worthwhile strategies that company ownership can focus their time on getting right.
Kathbern Management is a Toronto-based executive recruiter focused on working with organizations who are seeking to find and hire the key people who are critical for their success.
Contact us today for a free consultation about your key person search.