An Overview of Performance-Based Short-Term Incentive Plans

Written by Connor Harrison

August 28, 2018

An Overview of Performance-Based Short-Term Incentive Plans Hero

Providing monthly, quarterly, or annual short-term incentives to employees can – when administered correctly – drive engagement and retention.

There are a whole range of short-term incentive plans (STIPs) that your organization should consider offering to optimize the employee experience, but here, we will hone in on performance sharing plans and individual performance-based plans, and explore some of the standard metrics and measurement methods that dictate payouts. Employees are more willing to work towards larger goals if they are part of a group. Therefore it is often beneficial to reward bonuses that advance the goals of the entire organization, with consideration given to individual contributions.

Performance Sharing Plans 

Performance sharing plans focus around specific improvement goals for the organization, and reward employees based on how much improvement is made on these goals within a certain period of time. These incentives foster a sense of unity among employees, and engage teams to work towards one set of organizational objectives.

Individual Performance-Based Plans

Of course, some employees might have a stronger influence on final performance outcomes than others, so it is prudent to also use incentive plans based on individual performance. These plans are often based on predetermined, measurable business objectives (MBOS), or can be output-based. Output-based plans work best for employees in a manufacturing or processing role who have more independent control over the pace and quality of their output. In sales roles, on the other hand, employees might receive a commission incentive for each unit of sales made, usually calculated from the sales revenue, a percentage of the total profit, or as a set award value per unit sold.

The Combined Matrix

Given the importance of both team-based and individual performance goals in rewarding and engaging employees, many organizations have adopted ways to calculate the total payout based on both. This method is known as a merit matrix. And no, we’re not talking about the 1999 Keanu Reeves movie.

Some organizations use a 2 X 2 payout grid with individual objectives on one axis and a corporate goal on the other. Under these types of programs, the actual award can range anywhere from half the target to double the target – or nothing.

In some programs, broad organizational targets may need to be met for any employees to receive an associated bonus. For example, the organization may need to meet a certain minimum net income, a certain level of customer satisfaction, or a certain competitive position in the market.

When the number of goals includes many variables reflecting not only the employee’s primary responsibility, but also how they manage their relationships and broader goals throughout the organization, their bonus grid becomes what is known as a “balanced scorecard.” This approach is becoming popular as organizations recognize the complexity of a position’s overall contributions, and want to evaluate its performance holistically rather than from only one metric.

Challenges of Performance-Based Short Term Incentive Plans

As we discussed, incorporating both group- and individual-based performance bonuses can help mitigate some concerns related to “fairness” in payout and employee influence over the results, but other challenges may still arise when implementing these short-term incentive plans.

Performance Sharing Plans

  • Some employees might have stronger influence on final performance outcomes. For example, if an organization rewards teams based on customer satisfaction, the customer service team will likely have a more “direct” impact on that goal. It’s important for teams to be measured based on their realistic contribution – whether it’s direct or more tangential - in influencing that goal.
  • These types of plans require significant upfront work to forecast predicted improvements. It’s important to set realistic goals so that your budget can accommodate varying payouts. Companies should ask themselves: “What’s the likelihood that teams will meet these goals, and how should we budget accordingly?” For instance, if almost no one meets their goals, it can foster a negative atmosphere within the organization overall, but if everyone meets their goals, it might be a great morale booster for the organization, but could be very tough on the budget.
  • Multiple success metrics require more complex education and communication plans for employees. Having different plans for different teams may be necessary, but employees may have concerns about how varied goals among different teams impact pay equity. For instance, if customer satisfaction is the overall goal, how is the marketing team being compensated fairly compared to the customer service team for their contribution towards this goal?

Individual Performance-Based Plans

  • Employees may focus on individual goals to the detriment of organizational performance. Ideally, employees’ individual objectives will align with organizational goals, or multiple plans will incentivize employees to focus on both. However, there can be cases where an employee can take very a narrow-view of how to maximize their own payout
  • These types of plans can promote negative intra-team competition.Competition within the same team isn’t always a bad thing, but organizations should be wary of how individual performance-based incentives could create tension among employees in similar roles.
  • High performers can contribute to salary compression. This tends to happen more in sales environments with commission plans, but good planning and budgeting can ensure that no one group of employees is jumping ahead or falling behind in the organization’s salary ranges.
  • High administrative requirements to measure and implement. Since these involve having one plan for each employee, with separate goals for each role, there’s a great deal of work for HR personnel and hiring managers alike to plan for, forecast, and pay out these rewards.

Every organization has their own systems for calculating and rewarding short-term incentive payouts. Deciding which short-term incentive plans are right for your organization vary widely depending on your business, organizational goals, and how you want to motivate and evaluate your employees.

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