Linking incentives and rewards to performance

In an ideal world it’s all straight forward for businesses that want to provide incentives and bonuses to those who deliver outstanding performance. They simply define performance goals, measure the delivery of the goals and link incentives to the achievement of their performance metrics. So what could possibly go wrong?

Reading the front page of the Financial Times brought it all back. The FT reported how major banks are now reviewing the sales incentives they were providing to staff for selling products. The background here is that major banks had incentivised staff to sell payment protection insurance (PPI) to their loan customers. PPI is basically a cover that customers take out to cover their loan repayments in case they fall ill or lose their jobs. Because so many of these PPIs were miss-sold to customers banks are having to compensate them. The bill for miss-sold PPI now runs into billions of pounds.

The first of the banks to come out with a statement that it would review and revise its incentive systems was Lloyds. It announced that it would replace the existing product sales incentives with a pilot scheme that will use a more balanced set of metrics to determine rewards and incentives, including customer satisfaction. According to the FT, Barclays also announced it would stop product incentivizing staff on the volume of products sold and others including RBS and HSBC are reviewing their systems.

As a father of three I always find raising kids a great source for analogies. And when it comes to incentive it’s a bit like telling your kids to clean up their rooms. And to incentivise them you tell them that they will get a treat if they do it. However, then you go on and tell them that you will only check one corner of the room and if this corner is clean they will get their treat. We all know what is likely to happen -that corner will be spotless but all the toys will be stuffed under the bed and into the cupboards. If this sort of incentive system doesn’t work with your offspring – why do companies think it would work any better in their businesses? Remember – you get what you measure!

So what can we learn from this? Here are my key recommendations when it comes to linking incentives with performance targets:

• Reward all key areas of performance, not just one or two
  Basically, use a balanced set of metrics to reward and incentivise performance. If we link single measures to incentives there is a huge likelihood that staff will optimize the performance against this measure to the detriment of other areas .
• Don’t ‘hardwire’ your measures to incentives systems
  For example Shell leant the hard way that linking (even a balanced set of measures) too tightly to an incentive and reward system can drive the wrong behaviours (e.g. overstating their oil reserves). What they are doing now is that targets are defined for each area of performance (e.g. financial, customer, health and safety, etc.) but at the end of the year a committee will sit down and assess the delivered results in the context of the economy, competition, etc. to ensure the right bonus pot. This is a nice way of creating a sense check on performance.
• Balance incentives for individual, team and corporate performance
  If you only incentivize the performance of individuals then you create a maverick culture where individuals just optimize their own performance and often don’t care about (or worse drive down) the performance of others. I have seen this too many times where individuals or teams work against the interest of the overall company to maximize their own reward. Just think of a company with many branches and a central warehouse in the south. If branches want to optimize their own performance there is nothing stopping one of the branches in the far North undercutting the prices of branches in the South only then to take deliveries from the warehouse in the South and transport them back South again. Branch performance maximized, group performance destroyed! The flip side is that if you only reward group performance then individuals may free ride on the hard work of others.
• Use the whole spectrum of rewards and recognitions
  It is important to understand that there are many ways to recognize and reward people without spending anything. Research has also shown that non-financial rewards can be even more effective and powerful than monetary rewards. I believe the most powerful recognition and reward is the one we tend to forget too often  to say thank you! Please don’t underestimate the power of a 'thank you’. If said in earnest by manages or senior leaders a simple ‘thank you’ can be very effective in promoting performance.

Linking reward and recognition to performance sends a clear and unambiguous message to the organization that performance management and performance improvement matters.