How to Implement an Incentive Pay Scheme

Perhaps the most effective way of motivating employees, you have a number of options when it comes to incentive pay...

How to Implement an Incentive Pay Scheme

There is no better universal motivator for employees than extra pay, and with a smart incentive pay system you can reap the productivity rewards in your business.

Put simply, money talks.

This article explains how you can implement a well-thought-out incentive pay system in your own business, including whether you should use cash or shares, and how to implement such a scheme. Read on to find out more.

How do I set objectives for an incentive pay scheme?

You should always have a goal in mind when designing an incentive pay scheme.

When setting objectives, ask yourself:

What results do I want to achieve?

As with any business objective, your goals should be ‘SMART’ (specific, measurable, achievable, realistic, time-limited).

Perhaps you might set a sales or revenue target, or try for improvements in the customer experience.

Who should take part?

Decide whether you want a specific team to get involved, or whether the incentive pay scheme should run throughout your business.

Sales teams normally work well with incentives, and you could use incentives to retain key managers in your business.

How long should it run?

Depending on your goals, the scheme could run for a set time or simply operate indefinitely.

When should I use cash as an incentive?

By far the most popular form of incentive, cash should be your go-to option for motivating employees.

There are various ways of using cash as an incentive, each with associated advantages and disadvantages.

Commission is generally used to incentivise employees to hit sales targets. It is usually calculated as a percentage of sales, meaning if the sale is not made, the commission is not earned.

The pros of commission as an incentive are well documented and include the fact high-performing sales staff will rise to the top, that different rates can be used to reward varying levels of difficulty and that you only pay for what you earn.

The cons, however, are that staff may cut corners to close deals. Furthermore, high commissions may cause resentment amongst other staff and it can be difficult to scale back on without upsetting people.

Piece work pay is used to incentivise production or factory staff. Under a piece work system, you pay a small incentive for each piece made.

An advantage of piece work is that if nothing is produced, you pay nothing; incentives are directly linked to output.

However, a disadvantage is the incentive to produce more could see a decline in standards

Bonuses are generally used to reward improvements in areas other than sales, such as manufacturing or customer support.

They can be flexible and offered on a team or individual basis. Also, you can directly link bonuses to cost savings

On the other hand, as it’s not directly linked to production, a bonus can easily become an additional cost with improvements in productivity actually masking a decline in standards

Furthermore, team bonuses could see freeloaders unfairly benefit

Finally, performance-related pay increases are useful for encouraging ongoing improvement, rather than just goal-based improvement as you can determine the pay increases by progress made and it provides constant motivation not linked to short-term goals.

Once again, however, it could lead to accusations of favouritism and resentment

When should I use shares as an incentive?

This is a more complex way of incentivising your staff, but can be extremely effective at ensuring loyalty and long-term commitment to your company, by aligning your interests with theirs.

In addition, if you give employees shares through an approved Employee Share Scheme, they will generally be free of tax and National Insurance obligations.

Remember that any gains in the value of shares may be subject to Capital Gains Tax (CGT) if it exceeds a person’s annual exempt amount (£11,100 in 2015/16).

If you wish to incentivise key people or management staff to stay in your company, an approved share option scheme such as the Company Share Option Plan (CSOP) could work well.

This scheme gives employees options to buy shares in the company at the current price, at a later time. So if your company increases in value, they can buy their optional shares and make an instant profit. However, the limit of the value of options an employee can hold is currently set at £30,000.

The options are also time limited as they can be exercised after three years, but no later than 10 years.

Also, employees who already own more than 10% of the company are barred from taking part.

If you are a smaller company (your gross assets are worth £30m or less), you can also offer share options through a scheme known as Enterprise Management Incentive, or EMI.

If you’re unsure whether you qualify for this, you can contact HMRC.

With regards to EMI, the total value of the options must not be more than £3m with all employees allowed to take part as long as they spend a substantial amount of time at work – either 25 hours a week or more or 75% of their total working time.

Shares are exempt from income tax and National Insurance if exercised within 10 years but the value of options must be agreed with HMRC when the scheme kicks in.

The Sharesave scheme was launched by the government in 1980 to encourage employees to take a direct stake in their company.

Under Sharesave, also known as Save As You Earn (SAYE), employees save an amount of their salary with a bank or building society (from £5 to £250 per month) and have the right to buy shares at a discount with the company after three, five or seven years.

All employees must be able to take part.

It also offers no risk for employees, as if the shares go up, they can exercise their options and make money, but if the company drops in value they can just take their savings instead.

There are also unofficial share schemes you can set up, which allow senior people in your company to buy shares on whatever terms you decide.

However, the shares will count as assets so they will be subject to Capital Gains Tax (CGT), and employees will also have to pay income tax on any gains in value.

What other incentives can I use?

Other than money, there are various other ways you can provide employees with perks to increase their morale and productivity. In particular, think about:

  • Company cars

Top-of-the-range models will always be an incentive, but this is generally a very expensive option.

  • Foreign holidays

You could use an expenses-paid trip as an incentive for the best performers in sales teams, or as a reward more generally.

  • Vouchers

You can ensure the money is spent on something fun by offering incentives in the form of retail, online or holiday vouchers.

 How should I implement an incentive scheme?

To ensure the success of your scheme, it needs to be managed in such a way that your employees are fully behind it. Make sure to outline fully how the scheme will work.

It is normally a good idea to prepare a written document which sets out a strategy and list of objectives, and how performance will be measured and pay calculated.

In addition, you should talk to each employee individually about their role within the scheme.

Manage the scheme closely and give staff regular feedback on how they are doing, and get their feedback on how the scheme is working.

Finally, review the scheme regularly. Analyse how well it is going and make the necessary changes if something’s not working.

Where can I go to find help?

The Institute and Faculty of Actuaries has a database of actuaries across the UK, some of whom specialise in employee incentive schemes.

The Employee Share Ownership Centre has various guides and can provide advice on share ownership schemes in the UK.

GOV.UK  also has further info on employee share schemes.

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