The Art and Science of
Incentive Plan Design
David Neilly
Managing Director
PeopleCOMP, Inc.
HRPA 2009 Annual Conference
January 28, 2009
This presentation is the property of PeopleCOMP
Inc. and may not be reproduced or distributed
without written consent (PeopleCOMP Inc. 2008)

Objectives
Provide you with ideas and perspectives to evaluate

the effectiveness of your current annual incentive plan
Make you a stronger advocate of the “right” annual

incentive plan for your organization
Provide you with ideas and examples that you can

apply to your organization
Make you a more effective change agent regarding

incentive plan implementation
2

The art and science of incentive plan design
Art
Strategy alignment
Modeling
Communication
Analysis
Training
Surveys
Values alignment
Budgeting
Change leadership
Differentiation
3

Enterprise Software Company-
Is anybody happy with the incentive plan?
An enterprise software company sold $million software requiring annual service implementations
worth tens to hundreds of thousands of dollars per year. It was imperative that the company
operate as a team between sales, service and engineering to balance new product introductions,
new features, new software sales and maintenance sales. Teamwork was essential all around.
But it didn't happen, and it turns out much of the problem was rooted in misaligned incentive plans.
The services team was compensated on margin while the sales team was compensated on
software sales. And just to add a nasty twist, the head of engineering was also being compensated
on new sales. What happened? The services team component of sales quotations would come in
too high (because they wanted the margins) so in order to secure the sale, the sales team got
quotes from engineering for the services component at very low margins. Engineering then
delivered the service and was late delivering features for future releases.
Much friction ensued and it was estimated that close to $2M was lost in revenue while customer
satisfaction dropped.
4

Assessing your existing annual incentive
plan
Cannot articulate strategic goals

Little differentiation

Perceptions of “unfair payouts”

Counter-productive behaviour

Too complex

So vague that employees suspect the plan is designed

to keep them from earning the bonus
Your goals are too high and employees feel “ripped off”

Your goals are too low and the company overpays for

mediocre performance
5

The benefits and risks of a performance-
based incentive plan
The benefits:

A variable cost is better than a fixed cost

Send a powerful message about whatʼs important

Deliver competitive cash compensation

The risks:

Resentment

Gamesmanship

Disengagement

Counter-productive behaviour

6

An effective incentive plan operates within a
broader “performance” culture
Align
The belief that
organizations must
Measure
Differentiate
continuously adapt
and strive for higher
performance
Performance
Culture
The belief that Reward
Improve
planning, alignment,
measurement and
rewards promote
Hold
Coach
higher performance
Accountable
7

How much business impact do you want your
incentive plan to deliver?
Minimal Significant
BUSINESS IMPACT
8

Successful incentive plans are…
• Grabs attention, sends strong messages about expectations and
Motivating
priorities, rewards for winning and going the extra mile
• “Rules of the game” applied consistently across the company
• Link between executive, management and production employee
Fair
incentives
• Perception that goals are achievable and have consistent stretch
Challenging
components
• Performance measures focus employees on key drivers of business
Linked to the
business
performance
• Employees “own” the plan
Internalized
• Plan is tweaked year over year to address business shifts and to learn
Evolving
from experience
• Drives business performance
Value-producing
• Business infrastructure
Supported
• Training and communication
9

Considerations for incentive plan
review or design
Culture
Shareholder Best
Expectations
Practices
Incentive
Plan
Industry Competitive
Design
Economics
Practice
Business Business
Drivers
Strategy
10

Designing an Incentive Plan
Competitive Governance &
Number of Plans Objectives Business Drivers
Assessment & Planning
Practices Involvement
Individual, Team,
Eligibility Funding Measures Formula
High level design
Company
Performance
Payout Range Target Setting Thresholds What-if Modeling
Detailed design
Range
Documentation Business
Systems Training Communication
Implementation
& “Fine Print” Updates
11

Incentive plan- main ingredients
Target Annual Max Annual
Employee
Incentive as % Incentive as %
Category
of Base Salary
of Base Salary
(
)
Corporate Individual
Incentive Bonus
Base
Performance +
Performance x
Target
x
Salary
Director
15%
30%
Award =
Factor
Factor
Manager
10%
20%
Professional
5%
10%
Individual Individual Incentive
Performance
Performance Factor
Exceeds
150-200%
Expectations
Fully Meets
100-150%
Expectations
Minimally Meets
50-100%
Expectations
Falls Short Of
0-50%
Expectations
12

Eligibility
What are some valid reasons to make all staff eligible

for an annual incentive aware?
What are some valid reasons to limit eligibility to senior

managers and executives?
13

What do think are the pros and cons of building a
team component into your annual incentive plan?
ABC Company
Individual
Team
Company
14

Illustrative incentive formulae
What messages Corporate
Incentive Bonus
Base
Performance x
Target
x
Salary
does each formula Award =
Factor
send?
(
)
Which formula Corporate Individual
Incentive Bonus
Base
would you prefer as Performance +
Performance x
Target
x
Salary
Award =
Factor
Factor
a participant and
why?
Corporate Individual
Which formula Incentive Bonus
Base
Performance x
Performance x
Target
x
Salary
Award =
would you prefer as Factor
Factor
a shareholder and
why?
15

Illustrative payout curves
200%
Performance Factor
What messages does
Corporate
each payout curve 100%
send?
50%
Which payout curve 0%
would you prefer as a 50% 80% 100% 120%
participant and why?
EBITDA as % of Target
200%
Which payout curve
Performance Factor
would you prefer as a
Corporate
shareholder and why?
100%
50%
0%
50% 80% 100% 120%
EBITDA as % of Target
16

Benefit and practicality of customized
incentive plan
High
Accountability and measurability
Sales
Manufacturing
of business results
Call
Centre Customer
Service
Marketing
Finance, IT,
Legal, Corp.
Affairs, HR R&D
Low
High
Low
Direct impact on business results
17

Customized plans must have pay components
which are appropriate to the functional area
Scope of
Measure Mechanics
Measure
Bonus
New
Team product paid over
R&D Engineer
revenue 3 years
Customer
Team & Quarterly
retention &
Call Center Rep
individual bonus
satisfaction
Monthly
 Revenue
Individual commis-
Sales Rep
 Profit
sion
$0 $50,000 $100,000 $150,000 $200,000
Annual Compensation
Base salary
Target annual incentive
Maximum annual incentive
18

Your business planning and performance
management process is critical
Set
Organizational
Goals
Set Team Goals
Set Individual
Goals
Provide Rewards Provide
and Feedback
Coaching
Evaluate
Performance
19

Summary of design trade-offs
Simple
More Complex
Company performance only
Company, teams, individuals
Typical
Single plan
Customized plans for functions
design
Single or few measures
Multiple measures
features
Simple payout curve
Complex payout curve
Easy to communicate
Customized value drivers
Pros
Easy to measure
Participants have stronger sense of
Easy to administer
control over measures
Participants are more remote from Significant communication and
Cons
measures and probably less engaged administration
with the program
Many moving parts
More of a pay delivery vehicle and less Lots can go wrong
of a value driver
Higher risk of counter-productive
behaviours
20

Example 1-
Media and Entertainment Company
• One team culture
Background
• History of profit sharing and reluctance to
differentiate payouts to individuals
• Strong focus and tools for performance
assessments, not as strong for goal setting
• Stronger incentive to achieve stretch financial
Objectives
objectives
• Transition to performance-based individual
payouts
• More transparency to employees
21

Bonus payout curve
“Elite” - Strongest performer
205%
Bonus Payout
“Meets Expectations” performer
100%
*If greater than 110% of
50%
EBITDA is achieved
further bonus payments
will be discretionary and
subject to approval by
the Board
90%
100%
110%
Actual EBITDA vs. Target
22

Budget implication
$1.95M
Bonus Payout
$1.3M
$0.65M
$0.00M
90%
100%
110%
EBITDA vs. Target
23

Example 2-
Telecommunications & IT Outsourcing
• Almost all individual bonus arrangements-
Background
administrative nightmare
• Inconsistent bonus targets by level
• Pure focus on short term business results
• Shift to strategic initiatives requiring multi-year
effort
• Focus team on both near-term business and
Objectives
longer term strategic initiatives
• Create alignment from owners, executives
management and between business units/
divisions
• Create excitement to achieve and exceed goals
• Balanced focus on company, team and individual
performance
24

Incentive formula (simplified)
[(
)
(
)]
(
)
Bonus =
Company
X
Company
Team
Team
Individual
Individual
Bonus
Base
+
Weighting
X
Performance
+
X
Performance
X
Target
X
Salary
Performance
Weighting
Weighting
Key messages from the incentive formula:
1.
The individual portion of the incentive is fully budgeted and fixed, while the corporate/team portion of the
2.
incentive is funded by free cash flow performance in excess of a threshold
There is a portion of incentive available to every eligible employee based only on individual performance
3.
(i.e. no matter what happens at the corporate or team level, an incentive payout is possible)
If the Company does not achieve a minimum financial performance threshold, the Company and Team
4.
incentive components are zero (as well as the variable portion of executive individual incentive component)
Company, Team and Individual weightings vary by employee level, but generally the higher your
5.
management level, the more weight is placed on corporate performance
Incentive targets are the same for all employees at the same organizational level
6.
25

Bonus program features
Corporate Team Individual
How funded Variable (funded by Excess Free Cash Flow) Budgeted and Fixed
0-200% of target
Award range $0 to unlimited $0 to unlimited
(Zero-sum)
Strategic or continuous
Performance metric Excess Free Cash Flow Varies by team
improvement goals
Allocation to
Management allocation
individuals at end of Formula Formula
based on performance
year
26

Bonus weightings
CEO Execs Sr. Mgrs Mgrs Prof
Corporate performance weighting 50% 50% 40% 30-40% 30%
Team performance weighting 0% 0% 40% 40% 20-40%
Individual performance weighting 50% 50% 20% 20-30% 30-50%
27

Bonus payout scenarios
Bonus =
[(
)
(
)]
(
)
Company
Company
Team
Team
Individual
Individual
Bonus
Base
Performance
X
+
Weighting
X
Performance
+
X
Performance
X
X
Weighting
Weighting
Target
Salary
Scenario Corp. Team Indiv. Bonus Bonus Bonus Total
Assume:
Perf Perf Perf from from from Bonus
Base salary = $50,000 per

Corp. Team Indiv.
(30%) (30%) (40%)
year
1 100% 100% 100% $1,500 $1,500 $2,000 $5,000
Bonus target

= 10% of base salary 2 50% 100% 100% $750 $750 $2,000 $3,500
= $5,000
3 200% 100% 100% $3,000 $3,000 $2,000 $8,000
Bonus weightings:

4 0% 100% 100% $0 $0 $2,000 $2,000
30% Company

30% team

5 100% 0% 100% $1,500 $0 $2,000 $3,500
40% individual

6 100% 100% 0% $1,500 $1,500 $0 $3,000
28

Total spending vs. excess free cash flow
Uncapped
Target
29

Project governance
Large Organization, Critical to Business, Small Organization, Minor
Significant Program Change, Vocal Group Change, Cooperative Group
Steering
Steering
Committee
Committee
(Leadership)
(Leadership)
Organizational
Cross-
Technology Design Team
Change
Functional
Implementation (Design &
Implementation
Design Team
Team Implementation)
Team
(Design)
(Technology)
(Communication)
Challenge
Team
(Involvement)
30

Implementing an annual incentive plan
Use challenge teams to test design and communication materials

Involve Finance early and often

Allow plenty of time for target setting and modeling

Sequence the roll-out from the top-down

Give executives and influential managers responsibility to explain and lend

support to changes
Provide a document to each employee explaining the program and ask

employees to sign the plan indicating their understanding
Make plan document and details available on company intranet

Communicate, educate and motivate through detailed plan documents and

earnings calculators for incumbents to model plan payouts under different
performance scenarios
Post quarterly performance reports

31

Enterprise software company re-visited-
What would you do differently?
An enterprise software company sold $million software requiring annual service
implementations worth tens to hundreds of thousands of dollars per year. It was imperative
that the company operate as a team between sales, service and engineering to balance new
product introductions, new features, new software sales and maintenance sales. Teamwork
was essential all around.
But it didn't happen, and it turns out much of the problem was rooted in misaligned incentive
plans. The services team was compensated on margin while the sales team was
compensated on software sales. And just to add a nasty twist, the head of engineering was
also being compensated on new sales. What happened? The services team component of
sales quotations would come in too high (because they wanted the margins) so in order to
secure the sale, the sales team got quotes from engineering for the services component at
very low margins. Engineering then delivered the service and was late delivering features for
future releases.
Much friction ensued and it was estimated that close to $2M was lost in revenue while
customer satisfaction dropped.
32

Key messages
You get out of an incentive program what you put into it

Most incentive programs are low effort, low risk, low return

Incentive plans should be designed and operated to create

value, not just to deliver pay
There are best practices in incentive programs, but no two

are identical
Successful incentive programs have as much to do with

change management, communication and training as with
analysis and design
High ROI incentive programs are highly dependent upon a

sound corporate planning and performance management
process
33

When you get back to the office…
How much value is your current annual incentive plan

creating?
Start a conversation with HR and business leaders

about how to drive stronger business results with an
annual incentive plan
Are there elements of this presentation that might

strengthen your organizationʼs approach to annual
incentives?
34

Questions?
35

About PeopleCOMP
The issues we address:

Employee engagement:

• Measure employee engagement and workplace effectiveness
• Identify opportunities for improvement
• Assist with workplace Improvements
Compensation:

David Neilly
Link pay to performance
•
Managing Director
Design and implement incentive plans
•
PeopleCOMP Inc.
Design sales compensation
•
david.neilly@peoplecomp.ca
Design executive compensation
•
Our approach:
905-829-4572

Drive business performance

Strategy + design + implementation

Why you can trust us with these important issues:

23 years of HR experience

Sensitivity to your business model and culture

Specialization and focus

36