Insights

In this series of articles, we’ll review some of the most common mistakes that privately held companies make in approaching the question of incentives, before looking at a sketch of what I have seen work well.

Let’s start with mistake #1: no incentive plan

My experience is that most privately-held businesses in Australia would say that they do not use any sort of structured incentive plan; they just pay their people a fixed salary which is subject to some kind of annual review. But this approach can have a number of unintended consequences.

No incentive opportunity means higher fixed costs…

Offering no incentive plan usually leads to higher levels of fixed pay, to allow for the lack of bonus opportunity. A competitor’s offer of $180,000 salary with a bonus opportunity of $50,000 may need to be countered with a $215,000 salary with no bonus opportunity, for example.

And it doesn’t stop there. In the absence of an incentive plan, if the employee has a good year, he or she will often expect some recognition of that in the form of a raise. But this again locks in higher fixed costs that will survive long after the employee’s performance has returned to normal levels.

Higher fixed pay means higher fixed costs that put more pressure on the bottom line when business inevitably turns down.

…a risk-adverse culture…

A lack of incentive opportunity also influences the type of people attracted to a position: a well structured bonus plan will attract someone that is prepared to back their skills and abilities, someone that is more comfortable with a little risk. But a position that offers a higher level of fixed remuneration, with no bonus will attract risk adverse managers more interested in peace of mind than performance.

…and a resistance to change

With no upside, managers with no incentive opportunity often advocate against change. As one manager put it to me when the owner wanted to expand internationally, ‘How do I explain all the extra hours away from home to my wife and kids? There is absolutely no upside in it for me.’

But even those companies that do use incentives often make costly mistakes. In the next few articles we’ll look at some of the worst to watch out for.