Behavior Economics is a field of study that considers the influence that psychological, emotional, and social factors have on decision making. Although it is often applied to how consumers make buying decisions but can also be applied to the design of variable pay plans. This is because compensation is more than a financial payout for the incentive plan participant; it’s a psychological one.
Here are some ways that behavioral economics can guide the design of incentive plans that truly influence employee behavior.
Influence Future Behaviors
Variable pay plans are surprisingly ineffective as a reward for specific, past behavior, but they have a significant impact on influencing future behavior. The most successful plans are forward-looking tools that shape the way employees approach their work, not just retrospective thank-you notes.
Avoid Small Payouts
The research is clear: if a potential payout is so small as to be meaningless, employees may actually do less work. A negligible bonus transforms the job into an extrinsic, transactional relationship, replacing the intrinsic satisfaction and personal motivation that drove the work in the first place. For a variable plan to be a motivator, the potential reward must be perceived as substantial.
Set Realistic Goals
Plans are effective when they create and fulfill clear expectations. When goals are too challenging where employees perceive them as unattainable, the motivational influence drops fast, regardless of the potential payout. Targets must be challenging yet realistic enough to be believable. Define threshold and exceptional performance goals with targets to describe an acceptable range of achievement.
Leverage the Fear of Loss
Behavioral Economics confirms that the fear of loss is a more powerful influence on behavior than a gain of equal value. This principle, known as loss aversion, is when people tend to seriously discount the value of a future promise (like a bonus). To leverage this, structure incentives as money that an employee must try not to lose through poor performance, rather than a payout they must earn from high performance.
Limit the Number of Incentive Criteria
Companies may measure dozens of metrics and goals, but employees focus on what has a consequence. If your company tracks ten goals, but you only attach a financial consequence to one, that is what will get done. Ensure your incentive criteria are tied to the most important outcomes that genuinely drive your organization’s success.
Communicate Strategically
Finally, the most overlooked factor is communication. How a plan is communicated often has more influence on employee motivation and behavior than the actual design mechanics. A well-designed plan with poor communication will fail; a mediocre plan with brilliant communication can succeed.
The psychological component of your plan is a critical consideration as to how effective it will be in influencing behaviors that create the intended financial and strategic results.
Wilson Group consultants can partner with you to design your plan in alignment with these best practices. We guide you through four steps with a collaborative approach: 1. assessment of the current situation and your business and culture, 2. development of a design framework, 3. detailed design of the plan and 4. implementation and communication.
Footnote: What is Behavioral Economics?
