Leverage in Reward Plan Design: What's it All About?

Leverage is a key factor in reward plan design - particularly with incentives.  A reader question in response to my recent post featuring the "prototypical" performance to award structure inspired the thought that a post about the concept of leverage might be helpful.

Leverage is, at its roots, a mechanical term. 

Dictionary.com defines the word leverage as: The mechanical advantage or power gained by using a lever.

Wikipedia tells us that:  Leverage is a factor by which a lever multiplies a force - it is therefore related to mechanical advantage.

The use of leverage in reward plan design really doesn't stray too far from these mechanical definitions.  Essentially, we apply leverage in reward plan design in order to increase the motivational power of a reward.  The example performance-to-award structure below provides a specific illustration of leverage.

Leverage is present at both the Threshold and Maximum levels in this example.  To better understand, consider that at Maximum, for example, a plan with no leverage would provide an award of 120% of target in return for performance at 120% of target.  Instead, in the example above, we increase the motivational power of the plan by providing a greater reward upside (150% of target) in return for maximum performance.  The same is true, conversely, at Threshold performance.

As stated in the earlier post, the amount of leverage illustrated in this example is typical for management incentive plans.  Sales incentive plans will typically feature significantly more leverage than is shown here, but that is a topic for another post.

Leverage provides us - as reward plan designers - with an important tool, but also one that we must use carefully.  We want to consider not only the motivational and behavioral impact of applying leverage - both upside and downside - but also the cost of doing so.  A sound cost analysis is particularly important in looking at upside leverage, to ensure that there is always an appropriate balance between the value of the performance improvement to the company and the value of the award to the employee (or in plainer terms, not paying out more dollars than the performance improvement brings in).

Helpful?

Comments

[Michael Haberman, SPHR]

Hey Ann, this helped alot. Can you give an example of how this would play out in a discussion with the employee? How would you tie it to a performance and pay discussion?

[Ann Bares]

Michael:

In presenting this kind of performance-award schedule to employees, I don't typically spend time explaining the concept of leverage (which is really a design concept). I think what employees care most about (and so would I, standing in the shoes of a plan participant), is what has to happen in order for me to earn the different levels of award. And then, how am I/are we going to make that happen?

I don't get questions about or sense a lot of interest in plan design issues like leverage. And I tend to think it's because - at least at a fundamental level - the leverage in a plan is self-evident and doesn't require a lot of explanation.

That's my take, anyway. Thanks for the follow-up question.