Take Our HR Skills Assessment to Get a Custom Learning Plan

Incentive Pay

In your constant search for ways to motivate employees, you may consider adding incentive pay to your compensation program. If you are, you’re probably wondering whether it works or not. Really, whether incentive pay is right for you depends. In this article we define what incentive pay is and lay out the main advantages and disadvantages everyone should consider before implementing their own incentive pay plan.

What is Incentive Pay?

Although base pay garners the most attention in conversations about compensation, there are many other types of compensation that can bring just as much satisfaction to your employees, if not more. One of the more popular types of additional compensation is incentive pay.

Incentive Pay Definition

Incentive pay is performance-based compensation that rewards an employee for meeting set goals or objectives. This compensation can come in the form of money, stocks, additional paid leave, gifts, etc. Although incentives are often created for individual employees, you can also create incentive pay plans for teams or the entire company.

Should You Offer Employees Incentive Pay?

Although incentive pay has important benefits, it also presents unique challenges. Before kicking off a new incentive pay plan, consider the following advantages and disadvantages to see if it’s the right compensation structure for your company.

Advantages of Incentive Pay

  • Happier employees. Incentive pay plans are a great way to keep employees motivated and increase both morale and job satisfaction.
  • Better employee performance and retention. Studies show that happy employees consistently perform better for longer periods of time. By rewarding employees for high performance, incentive pay helps increase employee performance and retention.
  • Better organizational performance. High-performing employees are good for business. If your employees are performing well, your business is likely to do better as well.
  • Helps execute business strategy. Incentive pay is flexible and can be structured to promote the company’s current business strategy.

Disadvantages of Incentive Pay

  • Uncertainty for employees or candidates. Not every employee is attracted to incentive pay. Because it’s not guaranteed, more risk-averse employees may see it as a negative thing, and opt instead for higher guaranteed compensation plans.
  • May not align with business objectives. Incentive pay may not always lead to increased revenues. If this is the case, the incentive plan may only be increasing costs.
  • Some plans cause distrust. Not all incentives are as easy to measure as sales goals. Some incentive plan metrics may be less clear, which can cause an employee to distrust the process or think it unfair. For example, how do you create an incentive for a customer service representative or a tech support employee? What if you base the incentive off reviews, and that employee receives biased customer reviews?
  • Incentives can create conflicts. Incentive pay can create conflicts between employees, particularly if one employee believes that another employee doesn’t deserve the incentive. Some employers try to prevent this by asking employees to keep their incentives confidential, but this violates the National Labor Relations Act (NLRA), and it’s bad HR practice.

Types of Incentive Pay

There are many types of incentive pay. Which types of incentives your company decides to use will depend on your budget for incentives, your company structure, and the industry you’re in. The most common types of incentive pay include:

  • Bonuses
  • Commissions
  • Stock options
  • Additional leave
  • Gifts or gift certificates
  • Vouchers
  • Vacations

Incentive Pay Classifications

Incentive pay can be classified as casual or structured. These classifications help you determine when and why incentives are given.

Casual Incentives

Casual incentives can be awarded to employees at any time for exceptional performance. They are usually smaller payments or gifts used to show appreciation for an employee’s hard work during a particular period of time.

Casual incentives are simple and easy to execute because there are no pre-established schedules or benchmarks. At the same time, because casual incentives have less structure, they can lead to distrust from employees who perceive unfair practices and inequitable pay issues.

Structured Incentives

Structured incentives are awarded according to a particular schedule and specific benchmarks that employees must meet. These benchmarks are typically directly connected to a business objective, such as increased sales, customer service ratings, or efficient production. Structured incentives are less likely to lead to pay inequities. However, they require more planning and monitoring.

How to Launch Your Incentive Pay Program

Launching an incentive pay program is a huge step in any compensation strategy. And, because incentive pay can have unintended negative consequences, it’s important to make sure you do it right the first time around. Below are five steps to launching your first incentive pay program.

Step 1: Understand Your Business’s Strategy and Objectives

The ultimate goal of any incentive-based pay plan is to contribute to the company’s success. To do this, the incentive pay plan should align with your business strategy. Business strategy boils down to two things: what success means to your company, and how the company plans on achieving success. Business objectives provide specific measurable goals that align with the business strategy.

Once you understand the business strategy and objectives, you can structure incentive pay plans to align with both.

Step 2: Put People First

What does incentive pay mean to your employees? Although we’d love for all incentive pay to have a positive impact on our employees, the reality is, not all incentives do. For instance, poorly timed deadline incentives can push employees to overwork themselves. Or if you incentivize your salesforce with low base salaries but high commissions, employees may cut corners to get a sale. So, if your goal is to help employees perform better and stay with you, consider their needs before rolling out any new incentive.

Step 3: Decide Whether to Create Group or Individual Incentives

The most common incentives today are for individual employees. However, incentives can also be created for teams. When deciding how to structure your incentive plan, consider how the company is structured and whether a team-wide incentive will be best to help you achieve a business objective.

For example, if you have a team solely focused on engineering a particular new product and a business objective to be first to market with that product, you may create a team bonus that is triggered by meeting a certain deadline.

Step 4: Choose Casual or Structured Incentives

Decide whether casual or structured incentives are right for your company. As we stated above, both have their benefits and drawbacks. Which one is right for your company will depend on the circumstances. Don’t forget that you can use both.

Step 5: Consider the Potential for Inequities

Incentive-based pay plans can breed inequities if they’re not structured carefully or insufficiently monitored. Before rolling your new plan out, consider the possibilities for biased decision-making or unintended discrimination, and continue to monitor the program after launch to check for any suspicious patterns.

Questions You’ve Asked Us About Incentive Pay

Does incentive pay work?
There is some debate over whether incentive-based pay actually works. Although incentive pay improves employee performance and morale, it can also lead to tension between employees and over-focusing on the incentives. Overall, if the incentive pay helps your company execute its business strategy and is aligned with company objectives, then the benefits will likely outweigh the challenges.
How does incentive pay affect employee engagement?
Incentive pay has been shown to increase job satisfaction, commitment to the company, and trust in management. However, not all incentive programs have the same positive impact on employees. If you’re considering creating an incentive pay plan, make sure you choose one that’s right for your company.
Is incentive pay taxed?
Incentive pay is taxable unless it can be categorized as a de minimus fringe benefit.
Natasha Wiebusch

Natasha Wiebusch

Natasha is a writer and former labor and employment attorney turned HR professional. Her experience as a litigator and HR trainer inspired her to begin writing about anti-discrimination laws in the workplace. As a writer at Eddy HR, she hopes to provide helpful information to both employees and HR professionals who need help navigating the vast world of human resources. When she’s not writing, you might find her cheering on the Green Bay Packers or hiking in the Northwoods of Wisconsin.

Want to contribute to our HR Encyclopedia?

Posts You Might Like

The Top 4 Reasons to Change Your Payroll Provider

The Top 4 Reasons to Change Your Payroll Provider

When it comes to choosing a payroll provider, there is so much more than just running payroll. Unfortunately, many business owners rush to choose the provider without considering many alternatives. Learn more about the four reasons you should consider making a change.

Read More »
What Are Fringe Benefits

What Are Fringe Benefits?

Employee compensation can take many different forms. Most people think of it as the money that ends up in your bank account at the end of a pay period. But for many of us, the fringe benefits we enjoy from our employer play a significant role in our compensation package.

Read More »

Want to join our network of contributing HR professionals?

Scroll to Top

Submit a Question