Long Term Incentives vs. Short Term Incentives
As previously mentioned, incentive compensation can take several different forms. These are often placed in one of two different categories– long term incentives and short term incentives.
Long term incentives are awarded over several years or even decades. These incentives may include stock options, restricted stock units, performance shares, or other equity-based compensation that vests over time. LTIs are designed to align the interests of the employee with the long-term success of the company, as the value of the incentive increases over time and is tied to the company’s performance.
Short term incentives, on the other hand, are typically awarded and paid out within the current fiscal year, quarterly, or semi-annually. They are usually tied to specific performance goals or targets, and may include bonuses, commission, or other performance-based rewards. These are often used to drive short-term performance and provide immediate gratification to employees for achieving specific goals.
Other types of incentive compensation include:
Let’s look at some of the incentive programs that fall under the umbrella of long term or short term incentives:
- Performance-based bonuses: Rewards employees for achieving specific goals or targets.
- Stock options: Gives employees the option to purchase company stock at a discounted price, encouraging them to work towards the company’s success.
- Profit-sharing: Shares company profits with employees, incentivizing them to work together to increase the company’s overall profitability.
- Commission-based pay: Provides a percentage of sales revenue to employees who generate sales, incentivizing them to sell more products or services.
- Equity: Provides employees with shares or options to purchase shares in the company, aligning their interests with the company’s long-term success.
Some organizations use only one type of incentive pay while others use multiple types of incentive compensation to create a more well-rounded incentive compensation program.
You’ll also see each type of incentive plan leveraged differently. Some companies pay teams only in commission while others pair commission with a base salary. What works for one company might not work for another. It’s best to test out different combinations until you find what works best for your specific goals and objectives.
Benefits of incentive compensation
Incentive compensation can provide several benefits to both employers and employees, including:
- Increased motivation: By tying compensation to specific goals, employees are motivated to work harder and achieve better results. When pay is based on their performance, employees have more incentive to achieve their goals.
- Better alignment of interests: Incentive compensation can align the interests of employees with high level company strategies, encouraging them to work towards the company’s success.
- Improved retention: Incentive compensation can help retain top-performing employees by providing rewards and recognition for their efforts.
- Greater accountability: By setting clear goals and objectives, incentive compensation can increase accountability among employees, leading to better performance and productivity.
- Flexibility: Incentive compensation can be customized to fit the unique needs and goals of individual employees, allowing for greater flexibility in compensation packages.
Drawbacks of incentive compensation
Incentive compensation isn’t for everyone. If used incorrectly or designed poorly, incentive compensation can have some drawbacks.
- Undermines teamwork. If an incentive compensation plan is designed to encourage individual performance, it can create a culture based around individual achievement which can undermine teamwork and collaboration.
- Incentivizes bad behaviors. Poorly designed incentive plans can inadvertently motivate the wrong types of behavior. Employees are more likely to try and game the system with unethical or illegal tactics to ensure they earn the maximum incentive. This can negatively impact results, morale, and productivity.
- Difficult to maintain. Incentive compensation can be costly for employers to administer and manage. Without the right resources, manual efforts to track and measure employee performance can be time consuming and frustrating. The admin work alone can reduce an organization’s profitability if not managed well.
Designing Effective Incentive Compensation Plans
While there’s no right or wrong way to design an incentive compensation plan, there are a few key factors that will ensure you’re setting yourself up for success.
- Defined structure: Start by defining which teams will earn incentive compensation. Then consider the goals of each of these teams. Develop your plans around the factors directly within this team’s control and pay close attention to the behaviors you want to incentivize. Check out our other resources for additional information on building an effective commission plan.
- Clear and measurable performance metrics: You want to make sure you are measuring the same core metrics consistently, over time. Particularly the metrics you team members for. For example, closed won revenue, demos booked, or qualified leads.
- Fair and consistent payouts: You also want to make sure your employees are rewarded for their contributions in a fair way. Employee engagement and morale will suffer if you can’t pay team members fairly and consistently. If accuracy and consistency become an issue, you’ll soon see increased rates of sales turnover.
- Communication and transparency: Your employees should be able to understand how their performance tracks to their goals, what it is they get paid for, and how to access and understand their commission statements. Clear communication and transparency increase adoption and engagement of team members and help to instill trust in leadership.
- Regular reviews and adjustments: If an incentive plan isn’t working out as intended (or at all), then it needs to be adjusted before it does more harm than good. We recommend regularly reviewing your goals and KPIs to catch and resolve issues before they happen.
- Incentive compensation management: What systems or tools do you have in place to help you manage and maintain the manual work that often goes into managing an incentive program? Be sure you have the answer to this question before rolling out your plan. While this doesn’t necessarily mean you need to invest in an incentive compensation management software right away, it’s an option to consider if you have a large team or limited bandwidth.
Incentive Compensation Examples
Let’s look at an example of a few well-designed incentive compensation plans. This example in particular is an example of Inbound SDR’s compensation plan:
This plan is well-designed because it incentives behaviors the SDR has direct control over (lead response time) but also uses closed won revenue as an incentive to focus on activity quality rather than just speed of activity. This next plan is for an outbound SDR and uses different levers to incentivize other behaviors:
You’ll notice different factors at play in this example. Instead of lead response time, the Outbound SDR is compensated using meaningful touch points as the main KPI. This is intentional as the Outbound SDR doesn’t field inbound inquiries. Instead, this plan is intended to incentivize high-quality, two way communication between rep and prospect.
Again, the Outbound SDR has a component tied to closed won revenue- slightly higher than that of the Inbound SDR. This is because, typically, getting a cold prospect to become a customer is more difficult than, say getting someone who signed up for a demo to become a customer.