Does Incentive Compensation Really Work?

22 Jun Does Incentive Compensation Really Work?

Does Incentive Compensation Really Work? My personal “lessons learned” from using incentive compensation design principles on my children.

By Beth Carroll, Prosperio Group

I have been designing incentive compensation plans for over 15 years and in that time I’ve worked for massive organizations with thousands of employees to small start-ups with one or two employees. I’ve worked with banks, insurance companies, cement, faucet, and wiper-blade makers, professional services and food ingredient manufacturers, and of course all manner of transportation & logistics companies. But some of my most significant lessons learned are from the times I experimented with incentives on my kids.

Lesson #1: Good News/Bad News

As I was starting my career with Towers Perrin (a global HR consulting firm), I was also starting my family. I joined Towers two years after my first child (John) was born and learned the consulting business at the same time I was learning to be a mother.   At age two, John developed a passion for Hot Wheels cars that lasted for many years, so when he started losing his teeth, his father and I decided that the tooth fairy should bring a Hot Wheels car instead of money. When he found it under his pillow the next morning, he was ecstatic; that was the absolute greatest thing ever…loose a tooth and get a Hot Wheels car! (How many of you can see this one coming?) The next night, after we had put him to bed, he came back out to the living room with blood streaming down his chin…proudly holding out two more teeth that he had bashed out by banging his face into the railing of his bed. And thus, my first lesson learned in incentive design…and something we tell to our clients to this day: “The good news about incentives is they work. The bad news about incentives is they work.” So watch out for those unintended consequences.

Lesson #2: Always Define the Rules

About 8 years later, when I thought I was getting pretty good designing incentives, we discovered that we had a dandelion problem in our yard. I now had three children, John (10), Katie (6), and Ellen (3). As I contemplated the yard, and the pile of client work I had to do, I thought to myself: “I have able-bodied children, they could do some of the work, and I can teach them some basic economic lessons and show them the value of hard work.” So, I decided on a piece-rate incentive plan. I would pay them 5 cents for each dandelion they brought me, but it had to be the whole stem, not just the flower. Pleased with myself, I settled down to get a bit of work done. After a time, I realize they should have been finished: there couldn’t have been that many dandelions in our yard. I looked outside but they were nowhere in sight. Our dandelions were also gone, so it worked! When I called for them, they came running back to our yard, each with a small plastic grocery bag FULL of dandelions…from our yard and the three nearest neighbors’ yards.

This was my second lesson: always think through the rules and boundaries of the incentive plan and outline them clearly for your workers. Consider as many of the ways they can (and will) interpret the rules in their favor and lay down guidelines about how areas in gray will be handled. And always have management discretion and gaming clauses in your plan documents. These clauses protect you when the unexpected happens and ensure you do not need to make payouts that will not be financially commensurate with the effort put forth or the business ROI. Needless to say, I leaned on my OWN management discretion clause with my children that day!

Lesson #3: Clear Design gets Clear Results

As my oldest child grew through elementary and junior high, he remained an average student. His standardized test scores were lackluster and in our school district, standardized tests determine placement in high school classes. In ninth grade he was only in one honors class and it was recommended to us that he take a remedial study program. The notes on his standardized test results indicated that it was questionable if he would be able to do college level work.   This was not my son. I knew he could do better but I couldn’t get him to care. He was smart, no doubt, and had figured out how to do just enough work to skate by. Nothing I did or said seemed to get him to realize how critical to his future his high school grades would be.

He finished sophomore year with B+’s in all 6 classes. As I saw the chances of his having a shot at a college of his choice start to fade, I decided to crank up the motivation. We went on a mother/son summer road trip to visit 6 colleges and universities in PA and NJ. I had hoped this would inspire him to buckle down and work harder. It didn’t.

Junior year started, and I met with his guidance counsellor and waived him into 2 honors classes and added an optional 7th class to his schedule. John was less than thrilled and his counsellor gave us several stern warnings that if John couldn’t handle the work, he could not drop back down to a lower level class and his grades could be harmed even further. I swallowed hard, and prayed that I had done the right thing.

He finished the first quarter with several incomplete or lost assignments and a weighted GPA of 3.29 (B+…again). And he got a C+ in German, which was the one class he had chosen entirely for himself. Something needed to be done.

At the FIATA conference in Los Angeles, a good friend and former client mentioned paying his child for each A. Why had I not done this before, particularly given what I do for a living? I think I was hoping John’s intrinsic motivation would kick in. But it wasn’t, and time was running out.

I thought for a bit about what I really wanted him to do, and it wasn’t just a matter of getting more A’s. He needed to understand how bad grades hurt as much as good grades help and that a B, given his current GPA, would have no effect. And those of you who know me are now smiling, as you can see this coming. I developed an incentive plan that has both an upside and a downside. It works like this:

 

Quarter Grade Regular Class Value Honors Class Value
C- (1.67) ($250.00) ($187.50)
C (2.00) ($150.00) ($112.50)
C+ (2.33) ($50.00) ($37.50)
B- (2.67) ($25.00) ($18.75)
B (3.00) $0.00 $0.00
B+ (3.33) $12.50 $25.00
A-  (3.67) $25.00 $50.00
A (4.00) $75.00 $150.00
A+ (4.33) $125.00 $250.00

Note: Positive and negative values are illustrative. If you adapt this for your child use values that you are comfortable paying out, yet big enough to get your child’s attention.

The idea was that he would lose more from a bad grade in a class like PE than he would from a bad grade in Honors Physics, but he could gain more from a good grade in Honors Physics than he could gain from a good grade in PE.   But since Honors grades are weighted, a bad grade in one of these classes would cost more than a good grade in a regular class would reward him. Yes, I thought about this a lot and tested many possible outcomes to get it “just right” before I presented it to him. This is a best-practice for any incentive plan.

I showed him the plan and suddenly I had his full attention. He did the math and realized that straight A+’s could net him $1,250 per quarter or $3,750 for the year. I gulped when I realized this myself, but I assessed the risk of his ability to get straight A+’s (small) and then I looked at my upside: if he DID pull off straight A+’s for the last 3 quarters he could be in a position to get enough scholarship money to save me far more than the $3,750; my ROI was just fine. We had a brief negotiation about discrete vs cumulative periods, as he was concerned that his poor performance in Q1 would drag his average down, so I decide to err on the side of motivational value and agreed to count each quarter separately rather than average them together.

It worked like a charm! During second quarter mid-term Parent-Teacher Conferences every one of his teachers commented on his remarkable transformation:   he was taking notes in class, rather than falling asleep; he was paying attention to deadlines and asking for extra credit assignments.

He finished second quarter with a 3.83 GPA, a payout of $425, and a 98% on his German final. Third quarter ended with a 3.73 GPA, a payout of $400, and his first solid A in Honors Physics. In the last quarter, during which he also took two ACT exams, he finished with a 3.97 GPA and a payout of $525. With the $1,350 he had justly earned, he bought himself the 7 string guitar he’d been wanting and I saw his overall high school GPA raise from barely a 3.3 to just above 3.6, with a 17% improvement in his class rank.

For those of you who may be worried that this somehow damaged his intrinsic motivation, he was self-motivated for the ACT exams and finished with a score respectable enough for admission consideration at most colleges and for scholarship money at many. One of the scores is indicative of the change: on all prior pre-tests he’d never broken 20 on the reading portion, and yet he got a 29 on the real thing, and I had offered and paid him nothing for the ACT results. Instead, I simply took him out for a celebratory lunch after the scores came in. It seems that the cash incentive for his grades was the trigger that was needed to get his intrinsic motivation turned on. He learned that he could succeed if he tried, and that has spilled over into many other areas of his life.

Next year will be John’s senior year and he knows where he wants to attend college. I hope he gets in, but I know better than to “count chickens” so I will keep the plan rolling to keep the motivation going, and cautiously breathe a sigh of relief. And, I now have incontrovertible proof, through my own controlled experiment, that incentives really can drive improved focus, clarity, and motivation for the employee, and provide a tremendous (in my case nearly infinite) ROI for management.