Don’t Design Incentive Plans That Fail—or Backfire!

Beware the Cobra Effect

The term “Cobra Effect” stems from a British program in colonial India where administrators paid a bounty for killing cobras to reduce their population. Eventually, many people started breeding the venomous snakes to collect the rewards, significantly increasing their numbers. What does this have to do with organizations creating incentive plans?

If not designed properly, adverse outcomes result from well-meaning but perverse incentives.

Gathering actionable data and setting quality goals avoids inefficient incentive programs and unintended consequences

Incentive plans often seem like a straightforward way to improve employee engagement and productivity and a company’s bottom line. Set the goals you want individuals and the organization to reach, assign a value to hitting them, and pay out for success. But unfortunately, things aren’t always so simple.

Poorly considered programs based on insufficient information can waste time, stress capacity, or even limit productivity. In the worst cases, they actually harm companies.

Here’s a look at some of these challenges and the information needed for a well-designed incentive plan.

When incentives “break bad”

Wells Fargo’s experience about ten years ago is one of the most well-known and dramatic examples of a program that went off the rails. The bank gave its workers “cross-sell and customer-service targets” with significant financial incentives. So, many employees responded to the new incentive program in a way that was not anticipated. Bank employees opened “at least 3.5 million fraudulent accounts for unwitting customers” because they were driven by the targets. Ethics and customer respect went out the window.  

The bank suffered massive reputational damage and had to pay “$3.7 billion in penalties and victims’ compensation.” Nobody can argue that Wells Fargo’s goal of growing accounts was inappropriate, but with the wrong incentive structure … well, be careful what you ask for; you might just get it.

It’s just one example of what economists dub “perverse incentives. Many exist, from employees in Veterans Health Administration hospitals possibly gaming patient service targets to Sears, Roebuck & Co. eliminating bonuses for salespeople after customer accusations of “rip-offs.” The key is not to let your incentive program ‘break bad.’

There are many other instances where issues with incentives are more subtle, however. Companies may not identify these problems for some time, reap limited benefits from programs, or create demand for products or services they can’t handle.

Incentive plans with uncertain goals can lower productivity or stress resources

We’ve encountered businesses that want to redo incentives because of an all-too-common problem faced by many sales-based programs. A company’s salespeople receive a monthly target and earn bonus compensation until they hit it.

The problem? If an employee hits the maximum early, there is no reason to continue selling until the next period. The best performers might sit around and do little for a week or two.

This scheme can fail to maximize everyone’s potential, so management naturally wants to fix it. Unfortunately, many company leaders face challenges in devising a new, quality plan because doing so relies on knowing some essential information.

Crucially, leaders must understand the economics of creating performance targets and only drive behavior after understanding what they want to accomplish. Here are some examples of questions organizations may need to answer:

• How do you set sales, service, or other targets?

• How much more do you want to sell; is the sky the limit, or will you have constraints?

• If the numbers become wildly successful, could you expand production or services to meet this demand?

• What’s the incremental cost of a new sale, in time or other resources, at specific quantities? Is there a point at which it’s not worth the investment?

The answers to some of these questions might mean that an incentive program capping sales isn’t a bad idea. It could be wise if incremental sales have a low or negative ROI or can’t be fulfilled and damage the company’s brand. The real solution in that scenario might be fewer salespeople.

The main takeaway is that businesses should not fly by the seat of their pants while designing these programs. Planners should answer data-based questions to set realistic targets while accounting for the human factors determining success.

Consider this example recounted by a management consultant:

[An IT company] gave salespeople incentives for meeting monthly quotas. But managers ended up giving all the best leads to the top sellers, who didn’t pursue them if they had already met their quotas. Nor did they share leads, or anything else, with other salespeople who might be a better fit for a particular client, because the top sellers saw colleagues as competitors for the incentive dollars. The company thus left big money on the table.

In this situation, the company might first assess how many ‘units’ they want to and can sell effectively, reviewing new client resources, onboarding times, and incremental ROI. If leaders see untapped room for growth, they should adapt the incentives to encourage sharing leads and helping teammates, with top sellers viewing coworkers as allies instead of competitors.

Every good program relies on marrying a data and reality-based assessment of achievable goals with inducements that accurately motivate behavior. It’s a mix of art and science, and many companies neglect both aspects while initially falling short of collecting the data.

Tips for designing effective and practical incentives

It all starts with a deceptively simple question: “How do you want to run your business?”

The specific answer requires looking at the relationships between different company functions, including sales, marketing, operations, finance, and human resources. Collaborating with these business units to learn their individual goals and limitations provides a realistic assessment of what you’re selling and your ability to do it.

This, in turn, determines realistic targets. At this point, company leaders, often with the help of a consultant, can design an incentive plan that effectively meets these goals, which relies on creating rewards that motivate workers to really accomplish them.

Qualified experts can help companies with this process, including by posing the fundamental questions that inform realistic targets. However, don’t just implement an incentive plan that sounds great and seems to work without genuinely knowing your business.

Failing to grasp the fundamentals that set valuable targets could result in a wasted effort—or something that does more harm than good.

Karp HR Solutions helps businesses master the mix of finance and human resources. Contact us today for a free consultation.