5 tips for building an incentive compensation program

As the economy continues to struggle, many construction companies are tightening their belts. Often, one of the first items on the chopping block is the annual bonus. But rather than eliminating such financial incentives, consider developing an incentive compensation program that's designed to help achieve your firm's goals.

Here are five tips for designing a program that works.

1. Reward the right things
Incentive programs frequently backfire because companies reward employees for the wrong things. Bonuses tied strictly to profits, for example, can motivate employees to adopt short-term strategies that increase their pay at the expense of the firm's long-term performance.

Unfortunately, these strategies usually sacrifice quality or safety to boost profits. Cutting corners on jobs may create short-term savings, but it will hurt the firm's bottom line over the long run. And safety issues can threaten a contractor's very existence.

It's important to take a holistic approach that ties compensation to all aspects of an employee's job. Suppose you're designing an incentive program for superintendents. Good supers get projects done on time and within budget - while maintaining quality and safety standards. But if you offer bonuses only for staying on schedule, then cost, quality and safety may suffer. Instead, make sure your program rewards excellence in all four areas.

2. Link pay to results
For incentive compensation to work, it's critical to reward employees for achieving quantifiable results that are within their control. Discretionary annual bonus plans are often ineffective because employees typically view bonuses as a "gift" rather than a reward for good performance. If year end bonuses become an expected component of compensation, not only are they poor motivators, but they can quickly turn into "demotivators" should they be reduced or taken away.

Establish performance goals that are attainable with hard work, but not too easily achieved. The goals should be simple and straightforward enough so that employees understand both what they're expected to do and what they stand to gain if they do it. Sometimes companies create incentive pay formulas that are so complex and difficult to understand that employees become disillusioned with the program. As you develop your plan, seek input from eligible participants to gain employee buy-in.

3. Establish benchmarks
The only way to gauge employee performance is to measure your firm's recent performance and establish goals for improvement. You can't reward employees for reducing the time to completion unless you know what your average building time is on similar jobs.

To reward cost reduction, for example, you might measure decreases in labor hours or overtime. To reward quality improvement, you might track defects per square foot or amounts spent on warranty calls. The right benchmarks depend on the nature of your firm and its specific goals.

4. Time it right
For your incentive program to be truly effective, timing is everything. To maximize the impact, compensation should be linked closely in time with the performance that earned it - by paying bonuses quarterly, for example, rather than annually.

Consider deferring part of the bonus, however, to reflect future events that bear on an employee's performance. Some firms hold back a portion of the bonus and reduce it based on warranty expenses during the year following a project's completion, for example.

5. Think long term
To align your employees' interests with the company's long-term goals, consider using stock options, restricted stock or other equity-based awards. Giving employees an ownership stake in the business provides them with a financial incentive to stay with the company and maximize its long-term value.

To be effective, these incentives should vest over a substantial period of time. Otherwise, they might encourage actions that artificially boost the value of the company's stock or other equity interests in the short term.

Tying it all together
By tying compensation to performance, you can identify, motivate and retain your most valuable employees. And, unlike across-the-board bonuses, a carefully targeted incentive program can pay for itself. Some contractors have even convinced employees to accept lower base salaries in exchange for an opportunity to earn higher performance pay.