What Is Incentive Compensation Management and How Can It Boost Employee Morale

February 1, 2024
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What Is Incentive Compensation Management and How Can It Boost Employee Morale

Company success hinges on the performance of your employees — which is why high-performing businesses place a priority on HR strategies that drive individual performance. 

In fact. research from the Incentive Research Foundation found that 90% of high-performing companies use recognition programs (like incentive compensation) to reward their people. 

Incentives can be a powerful motivator, so it’s no surprise that companies using incentives also have exceptionally high rates of employee satisfaction and retention. Ready to tap into those kinds of results for your own company? 

Here’s everything you need to know about incentive compensation management and its positive effects on employee morale and performance.  

What is Incentive Compensation Management?

Incentive compensation management goes beyond traditional salary structures. That’s because, in addition to base salaries and other non-monetary benefits, incentives are a way to directly connect an employee’s performance to their pay.

Incentives are typically linked to one or more of the following:

  • Individual performance 
  • Team performance 
  • Revenue generated
  • Overall company success

Incentive compensation is often used within sales and marketing teams to encourage employees to meet or exceed their targets. But, these programs can also work extremely well within other departments, for example, customer service. Some companies also choose to extend a range of incentive programs across all staff. 

This compensation model is designed to motivate employees, with research showing that incentives can increase performance by 22%. Interestingly, the same research found that team-based incentives have a far higher effect on performance than individual incentives. 

Key Components of Incentive Compensation Management

A robust incentive compensation management plan needs to set out:

  • What incentives are available, and to whom
  • How these incentives will be awarded 
  • If they’re linked to performance, what metrics will be used to track them

Some of the most popular incentives and reward structures include:

  • Pay rise: Also known as a merit increase, this is one of the most popular incentives. Pay raises are often implemented after a performance or salary review — if an employee has met or exceeded all their targets. They can also be used to adjust salaries in line with inflation or as part of your compa-ratio formulas

  • Commission: Typically used within sales-based roles, commissions make up part of an employee’s on-target earnings or OTE salary. This portion of their pay is usually based on a percentage of the revenue that their sales have generated. Sometimes, companies pay commission-based salaries only, without any base pay, although this is rare. 

  • Retention bonus: This financial bonus is offered after an employee remains at the company for a set period. It’s often calculated based on a percentage of their base salary. 

  • Discretionary bonus: These occasional bonuses are also known as one-time or spot bonuses. They’re sometimes linked to performance, but as they’re handed out at the discretion of leadership, they can also be linked to other reasons including retention or an end-of-year boost. 

  • Nondiscretionary bonus: These bonuses are awarded when an employee meets specific objectives or goals. For example, sales quotas, customer service scores, or performance-based objectives. 

  • Profit sharing: This is received when a company decides to split a portion of its profits with employees. Some companies may choose to award this as an annual cash bonus, others might add the amount to retirement plan contributions, or give employees the choice of which they’d prefer. 

  • Gainsharing: Operating in a similar way to profit sharing, except employees receive varying percentages of the profits, or gains, based on their individual performance. 

  • Equity: Some companies offer employees the opportunity to own stock options or equity. This can encourage performance because employees know that if the company performs well, and its equity rises, they benefit in the long run. 

  • Perks or additional benefits: Generally this category encompasses non-monetary incentives, which can vary depending on the company.

Benefits of Incentive Compensation for Morale

Incentive compensation comes with plenty of benefits. Here are the top three:

1. Drives engagement, motivation, and performance 

For employees, compensation is one of the most important factors when deciding where to work. And if employees feel like they aren’t being paid their worth, that can cause motivation to decrease. 

When employees are engaged and motivated — they perform better. And the collective impact of high-performing employees equates to better business outcomes. 

But when employees feel they’re being paid fairly, they’re more engaged and more productive as a result. Monetary incentives play a big part here, but so does the positive feedback that these rewards indirectly offer — letting employees know they’ve done a good job. 

2. Improves transparency and fairness

Employee morale can take a nose dive when pay inequities are uncovered. Retention rates can also plummet, as employees often start to look for new jobs when these kinds of pay gaps become common knowledge. 

As part of a comprehensive and transparent compensation philosophy, incentives can be used to level the playing field. Once your salaries have been assessed and adjusted to correct any pay gaps, it’s time to get clear on how company incentives are awarded.

Relying on manager discretion used to be the norm when it came to performance-related pay increases, but this isn’t a reliable or fair method. While some managers may award pay increases based on their gut feelings, others may rely on a more stringent process. And those differences can lead to inequalities. 

Creating a clear, transparent pathway for incentives means all managers and employees are on the same page. Everyone knows how incentives are calculated, what targets they need to meet to qualify, and what their incentive will look like. 

3. Offers a sense of recognition 

Employees intrinsically want to know they’ve done a good job, and that their efforts are worthwhile. Incentive compensation directly links their day-to-day actions and how those benefit the business.

Tying performance to pay in this way also helps create a strong sense of purpose and reinforces your company culture, which can boost employee satisfaction.

Tailoring Incentive Programs to Employee Preferences

Incentive programs suit a wide range of companies — but it’s important to choose the right type of program for your company culture. 

Here’s how to get it right:

1. Uncover employee preferences — then tailor your incentives

Not all job roles suit incentive-based compensation — and not all employees want to work under this model either. Certain departments, like sales and marketing, tend to suit a percentage of an employee’s pay being incentive-based. Others, like data entry or factory work, simply don’t. And some employees may prefer the stability of a steady salary over the potential to earn more, but only with the added pressure of hitting certain targets. 

Ultimately, the decision around whether to use incentive compensation and how to implement it lies with business stakeholders and leaders. 

But it makes sense to gauge employee sentiment first — because the success of these kinds of programs hinges on employees getting on board. 

Once you’ve uncovered your employees’ preferences, it’s time to tailor your incentives to meet their needs. This may mean a wide range of incentive options, to suit a diverse range of requirements. 

2. Revisit and update your incentive program regularly 

Once you’ve launched your incentive program, the hard work isn’t complete (sorry). You’ll still need to assess how effective the program has been at regular intervals. We recommend carrying this out shortly after your first incentive cycle has been completed, whether that’s annually, quarterly, or something in between. 

You could track metrics like employee performance, engagement, and productivity, to ensure the program is having the desired effect. 

Employee feedback is also crucial here. Engagement surveys and shorter pulse surveys can give you a good indication of how the program has been received. 

Is there anything your employees might want to change? Did they think the program was well implemented? Did everyone understand what goals or objectives they needed to meet? Use this feedback to continuously refine and improve your incentive strategies.  

Another crucial element to get right is open and transparent communication around your incentive programs. Let’s take a look at what that might look like in practice. 

The Importance of Communication and Transparency

The power of incentive programs to boost employee morale and performance is clear. But to get these programs right — communication and transparency are critical. 

Before any incentive program launches, clearly explain to employees what kinds of incentives are on offer and how these will be calculated. You may want to put together a one-pager explaining the program, hold FAQ sessions, or produce online resources like a video walkthrough. 

Employees may have concerns — and that’s to be expected. Make sure everyone knows who their point of contact is in case they have any concerns, worries, or questions. 

Transparency around how these incentives will be calculated is also crucial. Make sure all employees know what targets they’ll have to hit to qualify for an incentive. This information could be included within their total compensation statement, or as a separate document outlining your incentive program in detail.

Measuring the Impact of Incentive Compensation

When done right, incentive compensation offers a great return on investment (ROI). But the only way to know if your programs are delivering is to measure their impact. Here’s how to make that happen: 

  • Define your goals: what’s the purpose behind your incentives? Maybe you’re aiming to boost employee performance, increase sales, or improve customer satisfaction scores. Setting clear, measurable, and specific goals at this point makes it easier to track the impact of your programs. 
  • Select your metrics: These should align with the goals you just defined. Examples of metrics to track include the percentage of employees meeting their performance goals, sales revenue, customer satisfaction scores, or profit generated. 
  • Collect your data: Capturing data is much easier if you’re using an incentive compensation management software that tracks key metrics. 
  • Evaluate the impact: Some questions to answer include, has employee engagement and performance improved as a result of your incentive programs? What impact has the increased turnover generated by higher sales had on your profit? 
  • Adjust and optimise: As your results come in, you can refine this process and identify areas where you could make improvements or adjustments. 

Driving business performance with the right incentives

Employee incentive compensation programs can have a powerful transformative effect on wider business outcomes — but for best effects, these programs need careful management. 

Ready to discover more about how to get incentive compensation management right? Read our sales guide for everything you need to know. 

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