Think Twice Before Substituting Incentives for Competitive Base Pay

I have been involved in several conversations recently where the topic at hand is a less-than-competitive base salary structure and one of the solutions tossed out is to add in an incentive plan to make up the difference.

I'd like to urge a bit of caution and present some thoughts to ponder for anyone considering this route.

Incentives - variable pay in one form or another - are potentially powerful reward mechanisms that can (when well conceived and implemented) accomplish a number of things, including (but not limited to):

• Focusing attention on critical objectives or business imperatives
• Rewarding extraordinary effort and/or outcomes, individual or group
• Providing a means by which to share the value of collective success

What incentives are not - I believe - is a simple substitute for a competitive wage or salary.

I don't mean to discount the concept of a total reward portfolio and a relative mix of reward elements (like salary, incentive, benefits, development opportunities, etc.), nor will I deny that there are situations where a particular strength in one area can and should "compensate" for a shortfall in another.  Many of us recall the dominant start-up model of the dot com boom of the late 90's:  very little cash, heavy on the stock options.  It's simply that we have to approach these trade-offs with care, especially in a competitive labor market.

For most organizations, an employee's base salary is the foundation of the reward package, and of the employee-employer economic exchange.  It is the purchase price associated with bringing a particular set of skills and capabilities to the table, and delivering them consistent with a set of performance expectations.  And it represents, in most cases, a fixed cost.

Incentive compensation, on the other hand, assuming it hasn't denigrated into an entitlement, is a variable cost.

The problem with the idea of substituting incentives for base pay is that you are trading variable dollars for fixed dollars.  They don't have equal value, for the obvious reason that one is contingent - on performance achievements or the largesse of management or whatever - and the other is not.  That is why the general rule of thumb says that it takes two or even three variable dollars to equal the value of one fixed dollar. 

So, to begin with, you would need to figure out what it will take to address the base salary shortfall, which will undoubtedly be more than you had in mind.  And then, as one of the conversations I recently overheard detailed, you have to figure out what to tie the incentive dollars to.  Particularly important if we're talking about a lot of money.

Which is a completely bass-ackwards way to conceive and design an incentive plan.  Given the power of incentives to influence behavior and outcomes, sometimes in ways unanticipated and unintended, the approach of piling a big (but not well conceived) incentive opportunity on top of a less-than-competitive base salary sounds to me like a disaster in the making.

My advice:  Get your base compensation act together (whatever that act might be), and then pursue incentives, with a clear set of business objectives in mind.   

Comments

[The Career Encourager]

Outstanding post - well said! Timely for me personally, and also "timeless" for business professionals involved in comp conversations.
You rock!

[Wally Bock]

Great post, Ann. The way I've always understood this is that basic compensation is a hygiene factor. If it's OK, there's no incentive value. If it's not OK, then it's a strong negative factor.

Incentives are something else entirely. Many years ago I joined a company as a sales office/distribution center manager. One of the salespeople took me around the territory my center served.

We stopped at his house for lunch. Over and over again, he pointed out with great pride, the things he had "won" in various sales contests. There was a dining room suite and a color TV and more. The tangibility of the incentive was important for him. "Otherwise," he told me, "it just goes to pay the phone bill."

[Ann Bares]

Peggy (aka Career Encourager) - thanks for the comment, and the encouragement!

Wally - thanks also for your comment. Good point about base compensation being a hygiene factor, and incentives being something else entirely. At their most fundamental level, they are intended to perform different tasks for us (as your example so succinctly illustrates), so we need to be careful when we consider switching one for the other.