What is incentive pay?

Incentive pay is a type of compensation awarded to employees based on their individual or team performance. You can offer it for various reasons, such as achieving sales goals, improving productivity or meeting deadlines.

Supporters of compensation incentives argue ‌it is a powerful motivator that encourages employees to achieve better results. Based on a study of 13,657 employees, Harvard Business Review reported that performance-related pay is positively related to overall job satisfaction, organizational commitment and management trust.

Critics of incentive pay, on the other hand, argue that it can lead to unethical behavior, such as cheating or bribery, and can create discord among coworkers.

There is no one-size-fits-all answer to whether incentive pay is good or bad. The answer largely depends on your company’s work culture and the specific goals you’re trying to achieve.

Incentive pay: Casual vs structured

Incentives fall into two categories: casual and structured. Casual incentives are usually small gifts such as vouchers to show appreciation for an employee’s hard work during a given period, based on no predetermined schedule.

Meanwhile, structured incentives are planned and monitored to achieve a certain sales or production target, such as sales growth, customer satisfaction or production efficiency. Year-end bonuses are its most common form.

When does incentive pay work best?

Incentive pay can work in several ways. An important consideration is the kind of work that needs to be done to accomplish the desired result. For instance, you may want to introduce a commission-based incentive pay program to motivate employees to achieve higher sales numbers.

If the work is complex or requires special skills, performance incentive pay may be more effective in motivating employees than a standard salary. However, it is important to ensure that the goals are realistic and the payout is worth the expense.

Types of incentive pay

You can offer a diverse range of incentives in the workplace, which can be monetary or non-monetary. Both can be beneficial on their own, depending on the incentive plan.

Although monetary incentives provide a short-term boost to employees’ motivation and recruitment, non-monetary incentives primarily let a company’s culture shine.

Here are the most popular types of incentive pay:

• Cash bonus (ex. signing bonus, performance bonus and year-end bonus) – a monetary reward given to employees in recognition of their excellent work
• Commission – a type of variable pay typically based on sales volume or the number of new customers acquired
• Company stock options – a form of equity compensation that gives employees the right to purchase company shares
• Company car – a vehicle provided for business and personal use, typically given to salespeople or employees who frequently travel for work
• Holiday pay – a type of compensation that covers the cost of an employee’s time off on holidays
• Paid time off – a benefit that allows employees to take paid days off work, used for vacation, sick days, personal days or any other purpose
• Voucher – a non-monetary incentive that can be used to purchase goods or services

Pros of incentive pay

There are many advantages to using compensation incentives. They can help improve employee productivity, motivation, and morale. When done correctly, you can also use them to align employee goals with your company’s overall objectives.

The pros to providing incentive pay include:

Improves employee productivity

When employees know you will reward them for meeting specific goals, they are more likely to work harder. In addition, incentive pay can help motivate employees who are not currently meeting their goals.

By setting specific goals and rewarding employees for meeting them, you can create a positive incentive system that encourages employees to do their best work.

Increases employee retention

Employee retention is important because it allows your company to continue running smoothly and avoid the costs and disruptions associated with hiring and training new employees.

High employee turnover can also demoralize other employees, leading to a loss of productivity. In addition, if your company has a low employee retention rate, it may be seen as unstable.

Your ability to show appreciation for good work, such as through incentive pay, can build loyalty. Employees who are recognized or rewarded for their accomplishments feel valued by their peers and management.

Enhances organizational climate

Organizational climate is determined by a combination of factors that affect how employees perceive their workplace. Motivating employees, boosting morale, improving your company’s profile and attracting new talent are all benefits of a great organizational climate.

Incentive pay motivates employees and helps recognize company culture. Also, team-based incentives enhance collaboration among members in reaching their goals. This may also decrease barriers as it motivates employees to work together.

Cons of incentive pay

Incentive pay has its own set of disadvantages. A fine line exists between employees being motivated to improve their work or focusing more on the reward rather than overall performance. Consequently, coworkers may work less cooperatively and produce lower-quality work.

Incentives have several cons, including:

Only provides a short-term benefit

Incentive pay can be very effective in creating short-term motivation. However, this can also have negative long-term consequences if not properly implemented.

One of the main problems with incentive pay is that it can create a “tunnel vision” mentality, where employees focus exclusively on meeting the specific goals tied to their pay. This can lead to a reduction in creativity and innovation as well as an increase in stress and burnout.

Affects employee ethical behavior

Incentive pay can potentially lead to unethical behavior among employees because it creates a system in which employees are rewarded for meeting certain goals, even if those goals are achieved unethically.

This type of compensation can lead employees to feel pressured to cut corners or engage in dishonest behavior to achieve their goals and earn a bonus.

Unhealthy work environment

Incentive pay can create an unhealthy working environment where employees can steal from each other or cheat each other to advance. This is often rooted in jealousy among co-workers.

Providing incentive pay to some employees can make other employees feel undervalued and unappreciated, resulting in workplace tension and conflict.

Creating the right incentive pay program

Ensure employees understand the ethical implications of incentive pay and design an incentive pay program that is fair, transparent, realistic and achievable.

Incentive pay programs, at their core, should encourage employees to think beyond short-term goals and contribute to your organization’s success. Further, the overall strategy should be properly communicated to employees, rather than focusing only on metrics.