As companies begin work on incentive plans (whether executive plans, management, or sales plans) for the upcoming year, there are 3 critical mistakes companies often make in their zeal to  “pay for performance”.

1.  Incentive rewards not aligned with business goals and strategies. It’s essential that organizations (and employees) know what they want to accomplish in the upcoming year.  This varies year to year, certainly the measures do. The leadership must be clear of the direction, how the goals will be measured (revenues, % of market, ROI, etc.)  and what strategies will be implemented to achieve them.   Incentive plans from the top down should be aligned with those measures and reward the desired performance.

2. Vague, unmeasurable objectives. Quantifiable  goals, such as Revenue and Net Operating Income (NOI) are easy.  Customer satisfaction is an admirable goal, but often a challenge to really define and measure effectively.  How is satisfaction determined, is that measure accurate, and how does the employee’s performance affect it?  If  employees know they cannot impact the results, the incentive plan quickly turns into a negative, adversely impacting performance and morale.

3.  Plans too complicated and poorly communicated.  I’m a strong believer in the Power of 3.  Not more than 3 measures rewarded in a plan, incentives pay easy to calculate, they’re well understood by all.  I’ve seen too many plans with up to 6 or more incentive components for which the employee is paid.  Too many components diffuse focus on what’s really important and the dollars paid on them are not meaningful.  If there not enough money at risk, why bother?

Years ago, I was on a sales team with a plan so complicated and so poorly communicated no one, including the sales manager, understood what the plan actually paid for, or how it was computed.  When we got our quarterly checks the amount was always a total surprise and made no sense.  Fortunately we all loved the work we did and the dollars were so insignificant it didn’t matter to us at that time.

Pay for performance is a well meaning and often powerful compensation strategy.  However, it is critical that incentive plans pay for what is important to the business, the measures are clear, and the plans relatively simple.

Hay Group (a premier consulting firm) earlier this year produced a report about Strategic performance management is based on research among 1,660 senior decision-makers in large firms across more than 30 countries worldwide. In the U.S., 250 senior decision-makers participated in Hay Group’s research. “U.S. business leaders face a significant challenge as they work to achieve aggressive growth targets with a workforce that is already stretched thin,” said Katie Lemaire, Vice President at Hay Group. “To fully harness the power of their employees, executives need to take a fresh look at how performance is really managed to ensure people are enabled to drive organizational performance.”

While organizations project modest growth for 2011 and beyond, more than half (54 percent) of those CEOs surveyed fear their employees are already too stretched to deliver current business objectives.

Following 3 years of  controlling costs, there is heightened focus now on managing performance, primarily “discretionary” performance.  Recent findings indicate 40% of an employee’s performance is considered discretionary, which means, they choose to do more or not.  While leaders recognize the need to improve individual performance, the systems to do so, remain inadequate or ineffective.

I continually see 3 critical mistakes in performance management systems.

1. Individual performance is not aligned with the business objectives and strategies. Employees needs to know how their role affects the company goals.  The Hay Study found less than 13% of companies did so.
2. Performance expectations aren’t clearly defined and the individual’s performance reviewed or communicated in real time. Employees need to know what’s expected from them and how and when that’s  measured, reviewed and recognized.
3. Poor performing employees are rarely addressed soon enough.  Leaders need to provide guidance, support, and coaching to improve performance to the required levels, or manage the employee (legally and humanely) out of the organization. sooner than later.

Most organizations have a performance management process, but it can be improved to encourage employees to perform in new and beneficial ways–for the employee and the company.   A few improvements can reap great rewards in tapping into higher levels of performance.