This is a common question, especially for smaller companies, whose resources are limited.  It’s certainly understandable for a manager to want to develop an incentive plan that only pays out of the company profits (if there are any).

What’s not right with this thinking:

  • The first problem with this approach is it neglects to consider that for employees who are instrumental in generating revenue and margin for the company, individual performance-based incentive compensation should be an essential part of their compensation package (often as much as 50%) and not just a “nice add-on” to payout  only when the company can afford it. You would not opt to skip their base salary payments if the company is below its goal, likewise you cannot “skip” their incentive payments.
  • The second reason serves management’s self-interest.  When employees believe that it’s possible to earn incentives for their individual performance, they will be motivated (assuming your plan has been well-designed) to work to earn those incentives and then earn even more.  If you make it a requirement that the overall company must hit its goal before any individual incentives are earned, then you’ve created a hurdle that may feel unattainable and certainly will feel uncontrollable to the individual employee.  When this happens, the employees are more likely to “just give up”, making attainment of the company goal even more difficult, and the short-fall even worse.

It’s perfectly appropriate, however, to include a secondary or tertiary plan component based on company goal attainment, but even then the payout should begin at a level of performance that is somewhat below goal as this encourages more growth towards goal.

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