How a Bad Incentive Plan Can Hurt Your Bottom Line

During the first couple years of my entrepreneurship, I'd spend a good amount of time reading the works of great businessmen like Warren Buffet, Steve Jobs, Bill Gates, Arianna Huffington, and others alike. In every book that highlights the journey that led to their greatness, you'll always find a few pieces of wisdom, advice, or an incident that stay with you for the rest of your life.

In most cases, unconsciously though, these anecdotes help you formulate your journey to achieving the type of success you are setting out to, in my case, it was the product I was working on.

What clicked for me at that time was a simple, yet powerful statement made by Charlie Munger in The Psychology of Human Misjudgment, a speech he gave in 1995. You can watch the video here.

“Never, ever, think about something else when you should be thinking about the power of incentives.”

Those who don’t know about Charlie Munger, he is the American Investor and vice-chairman at Berkshire Hathaway, the conglomerate controlled by Warren Buffett. Both Warren Buffet and Charlie Munger share a profound feeling about incentives. Every business leader would be wise to learn from their experience and stories.

Incentives - The Good and the Bad!

In business, the power of incentives is huge! They motivate a person to perform a certain action and those actions are always in line with the incentives they’d earn at the end of the task. So if you expect your sales rep to sell 100-holiday packages during the holiday season, and offering a sponsored holiday for achieving the target - you may never see him motivated enough to meet the target. He could have made a lot more, enough to sponsor two family holidays a year had you offered him financial rewards for each sale.

The surest way to get people to work towards the organizational objective is to provide them with incentives that keep them motivated and hungry. This is so obvious that you might think it hardly deserves mention. But it does.

Creating a successful incentive plan is more about tapping into the employees’ psychology. You win at all levels if you understand their motivation triggers.

Bad Incentive Examples

Let me explain with a few anecdotal examples how bad incentives can be detrimental to an organization’s bottom line.

Poor employee attendance can be expensive

A Midwestern laundry company introduced an incentive program with the objective to encourage good attendance and minimize tardiness. Those with perfect attendance during the month were rewarded with a raffle.

After running the program for 9 months, it was found to be ineffective in encouraging employees to meet attendance standards. Instead of coming into work late, employees started taking the full day off, decreasing total productivity by 6% and costing the company nearly $8,500 a month.

Despite aiming for a positive change in the work culture, the implementation lacked clarity in terms of objectives and expectations. All in all, it failed to communicate effectively with employees and they misused it.

Abuse of Incentives

When incentive programs are introduced without a thorough thought process, you may find that your program actually starts to show an "incentive-caused bias." The following example will explain the same.

Early in the history of Xerox introduced new machines with better features, functionalities, and enhanced safety. Of course, the company expected to sell more of the new machines in the coming months. But it didn’t happen.

Joseph Wilson, who was then working with the government, couldn't fathom why the new machines were selling so poorly while the older and inferior machines continued to contribute majorly to the bottom line. After a thorough analysis, it was found that commission arrangement for inferior machines was way more lucrative for salespeople resulting in an incentive-caused bias.

When new incentive plans are introduced without taking into account the existing ones, and if the existing ones offer high revenue earning opportunities, the employees will, by nature, gravitate towards the high-paying program - which may or may not be in the best interest of the company, as well the customers.

How Bad Incentives Can Hurt Your Business?

Extinguish Intrinsic Motivation

The most compelling reason that incentives fail to deliver the desired results is that extrinsic motivators are less effective and/or no longer serve the purpose of self-fulfillment that employees strive to achieve while performing their tasks.

A study revealed that the organization employees who won the “best employee of the month” award initially and received only internal recognition or an e-certificate were less motivated to win the title in the subsequent months and recorded low performance compared to the ones who were already performing well and weren’t competing for the title.

Crush Creativity

A badly implemented incentive system or applying for an incentive program at a place where it’s not even required can demoralize the most talented employees as well. Sometimes employees simply enjoy their work and strive to perform at their best - but introducing incentives can slow down their creativity productivity and divert their focus towards the reward.

Encourage Wrong Behavior

It can be argued that rewards tied to monetary benefits can pressurize sales reps to give in to their temptation to meet the targets, sometimes neglecting the morals and ethics of the business world. When an incentive plan solely focuses on financial gains, the employees could be so focused in achieving them that they may end up cheating or cutting corners, especially when they fall short of their goals.

Power-up to make the right decisions!

So how can you change it? How can you ensure that the incentive planning for the forthcoming period serves in the best interest of you, your employees, and your customers?

The first thing to note is that no incentive plan is bad, the real culprit is the wrong implementation, at the wrong time, in the wrong place. All incentives don’t have to be financial rewards and all financial rewards don’t necessarily have to be tagged under the incentive scheme.

Next, familiarize yourself with the characteristics of a good commission plan. The secret to a successful incentive plan lies in a better understanding of your team, their work patterns, and their expectations from the organization. A thoughtfully designed and implemented incentive plan has the power to drive the entire organization, let alone a department, towards a certain destination safely and conveniently into a pattern of accommodating behaviour at both ends. While you are at it, also think about how they may fail, which will help ensure you start off on the right foot.