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The Influencers: Designing Incentives That Work
April 16, 2008

The problem with incentives is that they work, but not all the time … and not always the way leaders would like.
By Ron McMillan

We've all seen reward and recognition programs, bonus plans or commission schemes that create imbalance, degrees of dysfunction, and unintended consequences.

One of my favorite examples comes from the former Soviet Union. The leaders in Centralized Economic Planning wanted to improve production in manufacturing with a pay-for-performance plan. Targeting nail manufacturers, they paid managers bonuses based on the total weight of nails produced. Sure enough, nail production dramatically increased as measured by the total weight of nails produced. However, upon closer inspection, the leaders learned the number of nails produced had not increased; rather, the factory had simply made bigger, heavier nails.

Undeterred, central planners changed the incentive plan and paid bonuses based on the number of nails produced. Lo and behold, the number of nails produced increased dramatically; but the manufacturers used the same amount of raw material to make smaller, and therefore wholly inadequate, nails.

Again, I reiterate: The problem with incentives is they work, but not all the time and not always the way leaders would like.

The Source of Trouble

Certainly, one problem is alignment. The incentives we design must encourage the behavior we desire. Dr. Steve Kerr addressed this in his seminal article, On the folly of Rewarding A, While Hoping for B. For example, do we advocate collaboration and teamwork but then reward individual performance and competition? As leaders, if we do not reward the behaviors that create the results we’re after, then we shouldn’t be surprised when the outcome is not what we envisioned.

Another related problem is myopia. Do we structure our motivation efforts to emphasize one behavior at the expense of multiple, necessary behaviors or the balance between them?

For example, do we recognize and reward the heroes who save the day, the so-called "fire fighters?" Or, do we reward the "building inspectors" who plan, prepare, and prevent the emergencies from erupting? Sometimes, our incentives encourage firefighters to become arsonists—they actually create emergencies in order to be the hero. Building inspectors save a lot more lives than firefighters. But most of our executive compensation plans reward short-term financial results rather than customer satisfaction, employee engagement, quality, innovation, long-term investment or social responsibility.

Consider an example of overcoming myopia and achieving balance. Our team of consultants worked with the leaders of a Fortune 500 company who realized that the financial objectives the organization had historically emphasized compromised their ability to nurture their employees and their culture. The magnitude of their problems convinced them that they needed to create a culture of dialogue where every person, regardless of level, felt safe to speak-up and be engaged.

At their yearly planning retreat, the executive team not only set their financial goals, they also set goals and committed to a plan that they believed would nurture a new corporate culture. Next, they agreed not only to measure the culture's improvement with employee surveys, but to also put one third of their bonuses at risk based on achieving their culture goals. Talk about aligning incentives and results! They put their money where their mouth was and incidentally, they succeeded spectacularly.

One-Hit Wonders and Short-Lived Programs

One of the reasons incentives only work some of the time can be explained by an often overlooked principle for designing incentives called choose extrinsic rewards third.

This powerful principle requires a bit of explanation. The obvious purpose of incentives, rewards, appraisals, commissions, disciplines and punishments is to motivate people to do the things leaders want done. But, these are not the only tools or even the best tools to influence employee behavior. There are other more powerful sources of influence. Think of three sources that influence motivation:

• Personal Motivation: an individual's intrinsic satisfaction.

• Social Motivation: the powerful influence others exert on an individual's motivation to do what leaders want done.

• Structural Motivation: the non-human, motivating factors.

When incentives are put in place without consideration to personal or social motivation, there is no guarantee they will work. If the incentive program—such as "Employee of the Month"—conflicts with social motivation (those who win are considered "kiss-ups" to management), social motivation will usually triumph.

The same is true of conflicts between incentives and personal motivation. However, if both personal and social motivation encourages the desired behavior, then a program that adds extrinsic rewards will likely be very successful in sustaining the behavior over time.

Steps for Lasting Change

When we, as leaders, design a structural motivation to create change, we must first make sure personal motivation for the change is firmly in place. People have to understand the reasons why the change is important and also be willing to enact the change.

Next, we must be sure that social motivation supports the change. Make sure supervisors and leaders actively and visibly support the change; and make sure opinion leaders also agree with the change and support it vocally.

These two sources of influence are the heavy lifting of change efforts. With these two sources in place, we are finally ready to choose the extrinsic rewards that align with the change we want to make and help balance priorities and focus. Now, the incentives you choose will reward the changes that intrinsic motivation is pushing and social influences are supporting. Consequently, three powerful sources of influence combine to create and sustain the desired change.

The Power to Lead

Don't use incentives to compensate for your failure to engage personal and social motivation. The most powerful, predictable and effective incentives build on the foundation of personal motivation and social support. In this way, the most challenging problems with incentives are overcome. Incentives work all the time, every time and exactly the way the leaders intend.

Ron McMillan is coauthor of Influencer: The Power to Change Anything, (McGraw-Hill) and the New York Times bestseller Crucial Conversations. In addition to being an online columnist for Incentive magazine, he is also a sought-after speaker and consultant and co-founder of VitalSmarts, an innovator in corporate training and organizational performance. Visit www.influencerbook.com.

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