Why We Need to Pay Attention to Performance Incentive Problems
From the moment we can first walk and talk, we are motivated, controlled, and rewarded using a combination of targets and incentives. Which parent hasn't used a sticker chart in a desperate attempt to get the kids to cooperate with them?
Incentive problems occur because targets and rewards are so deeply embedded in modern society that many people donโt realise how often they fail. Every time you open a news website, youโll see bad incentives examples that show how poorly designed incentives can cause serious consequences. Take these, for example...
- Ex-Audi boss stands trial over 'dieselgate' scandal in Germany - fallout from Volkswagen Audi manipulation of EPA emissions tests.
- Lloyds profits nearly wiped out by ยฃ1.8bn PPI hit - financial mis-selling scandal driven by aggressive sales targets for highly profitable 'payment protection insurance' products.
- ...how some funds hide poor performance that can derail your retirement - a lack of rules around reporting and intense commercial targets drive jaw-dropping liberties when it comes to the reporting of fund results.
A Quick Refresher
What is a Performance Incentive?
If KPIs provide objective numerical quantification, andย targets provide the context, then incentive design is what adds behavioural motivation. An incentive can be either positive (e.g. I buy myself a new smartwatch if I hit 80kg), negative (e.g. I will put a padlock on the fridge if I hit 85kg), or some combination of the two. But badly structured rewards often lead to incentive problems, resulting in demotivated teams, disengagement, and even unethical behaviour.
What is Incentive Plan Design?
The process of creating incentive programs is all about establishingย rewards that actually motivate people to do the right things. Itโs more than just handing out bonuses or setting targetsโitโs about making sure incentives and compensation push people toward real, long-term success, not just short-term wins. A goodย incentive plan keeps things fair, keeps people engaged, and helps the organisation hit its goals without running into common incentive problems that backfire.
The Impact of Performance Incentive Problems
There is a high chance thatย incentive problems are already seriously impairing your organisation's success. The big challenge is that these issues are often silent and invisible, draining valuable time, energy, and resourcesย without anyone realising. However, there are several key symptoms to watch for, including...
- High team attrition
- Lots of management time spent on performance target disputes
- Disappointing organisational achievement
- Missed targets and goals
- Team apathy and cynicism
- Rule breaking, use of loopholes, and even lawbreaking
Why Performance Incentive Problems Kill Your Team's Success
Bad reward schemes can create all kinds of visible and invisible issues. The impact of poor incentive management can range from despair, high attrition, disengagement, frustration and failure through to anger, unexpected bonus costs and lost customers. Think of incentives as a bucket of gasoline, and you get a good idea of how carefully they need to be handled and used!
How to Fix Your Reward Scheme Problems
The first step in fixingย incentive problems is diagnosing the underlying causes. The good news is that we see many of these issues coming up repeatedly across many types of organisations. This means we can learn from the failures of others and apply a proven solution. Whether you're a team leader, executive or a manager, understanding these patterns can help you design incentives that work rather than backfire.
I analysed a set of such real-world cases in my book,ย GAMED: Why targets and incentives fail, and how to fix them,ย and then used the lessons learned to create a step-by-step method to fix these issues for good. Some of these cases include Audi's dieselgate, the UK's ambulance dilemma, Toyota's GT-One racing car, and the UK's A-levels inflation.
To help you, Iโve listed below some of the most common bad incentives examples and then outlined how you can fix them with betterย incentive planning using my structured method known as ROKET-DS.
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The 8 Most Common Performance Incentive Problems
Bad Incentives Examples
1. Low Perceived Incentive Value to Extrinsically Motivated Parties
Description
This performanceย incentive problem is where a person is motivated by external reward, but the rewards on offer don't match their expectations.
(Check out this post for more information on the difference between intrinsic and extrinsic rewards: What are extrinsic rewards and do they work)
Why This Is an Issue
If an extrinsically motivated person is offered a reward below their expectation for hitting a given target, then a partial or complete loss of motivation can be expected. In other words, they disengage because the incentive no longer sparks a desire to perform.
Example
In a manufacturing business, which I worked with in the 1990s, the factory bonus was fixed so low that one of the workforce painted the words โbonus shifterโ on the side of a wheelbarrow and left it in a prominent position on the shop floor. Clearly the bonus did not have the motivational impact intended.
2. Extreme Reward or Punishments
Description
This is where the external reward is of huge importance to the person being incentivised, in other words, the stakes are high. Prison, death or public humiliation are examples of extreme punishment. Extreme rewards might include significant wealth, a major sporting title, or a prestige job.
Why This Is an Issue
Where extreme rewards or punishments are offered, it can push people to extreme, dangerous or illegal behaviour in an attempt to achieve/avoid that incentive.
Example
Successful sales professionals are often motivated by reward, but at the other end of the achievement spectrum, those showing poor success often have a justified fear of being fired. Fear of job loss or the prospect of big compensation often drives extreme behaviours such as selling to customers that they know will not be able to pay, will return the product, or will not yield a profit.
3. Non-Differentiated Incentive Types
Description
This issue crops up where graded (or tiered) rewards are used (e.g., first place, second place, etc.) and making the lesser prizes an inferior version of the first prize. Using inferior versions of prizes results in lessening the motivational effect of the inferior prizes.
Why This Is an Issue
If a lower-tier prize is seen as simply an inferior version of the main prize, it removes the ability of the winner to rationalise that they 'preferred the prize they won anyway' and so reduces the motivational power of that prize.
Example
A non-differentiated set of prizes isโฆ
- 1st Prize: 5 days in a 5-star Hawaiian boutique hotel
- 2nd Prize: 4 days in a 4-star national hotel chain
- 3rd Prize: 3 days in a 3-star national hotel chain
A set of differentiated prizes would beโฆ
- 1st Prize: 5 days in a 5-star Hawaiian boutique hotel
- 2nd Prize: A weekend for 2 at a PGA golf resort
- 3rd Prize: A supercar track experience
4. Winner Takes All
Description
This issue occurs where there is a single winner with no reward for any other achievements. This is 'winner takes all'.
Why This Is an Issue
A 'winner takes all' prize will normally only motivate a small section of the population: those who think they have a reasonable chance of winning that prize, while having no motivating effect on the remaining majority.
Example
Many elite sports competitions, such as The World Cup or the Tour de France, are โwinner takes allโ (at least in terms of prestige and recognition).
5. Capped Rewards
Description
A capped reward is where there is a ceiling, or maximum, on the reward that can be won for an open-ended task (e.g., sales). Past the upper limit there is no further reward.
Why This Is an Issue
A capped reward completely removes any further incentive once that cap has been hit. Studies show that a capped reward will have a reduced success benefit compared with an uncapped reward. This is especially problematic in sales incentive structures, where commission caps can lead high performers to stop pushing for additional sales once they reach their limit.
Example
An extrinsically motivated salesman is one that is motivated by external reward. Assuming that the external reward has driven him to achieve his sales target, it is not unreasonable to assume that once he achieves his target and no extra reward is available, his motivation will be capped too. In other words, once he reaches his target, he may slack off until his target and reward reset.
6. Low Attainability-Driven Disengagement
Description
This issue occurs where a target is regarded as 'unattainable' by the recipient (regardless of whether it really is unattainable or not). This can lead to a problem best described as 'disengagement'.
Why This Is an Issue
A target will only motivate if an individual has some belief that they can reach it. If there is no belief that a target is achievable, then it will have no motivational benefits.
Example
This is a direct quote from an employee review of their employer, summarising the impact of โunattainableโ targetsโฆ
"The people you work with are great people. However you're expected to achieve unrealistic targets every day, which is highly demoralising. If the company asked you to try and reach a realistic number, people would be motivated to work hard. Instead they constantly put pressure on you to reach a target which can only be achievable if every email is a simple case that can be resolved in a few minutes; most are not this easy. Management need to realise these targets are doing more harm than good if they want a company people want to work for."
7. No Over-Achievement Rewards
Description
The โno over-achievement rewardโ failure is a type of performance incentive problem where a high performer exceeds their targets but the incentive scheme does not reflect this over-achievement though an increased reward rate.
Why This Is an Issue
Studies have shown that offering a (progressively) increased reward when an individual exceeds their targets will lead to 17% higher levels of achievement. In not offering over-achievement rewards, we miss this opportunity. (Check out the work of Thomas Steenburgh)
Example
One practical use of an over-achievement reward would be when selling a house. Offering the estate agent/realtor a very high commission rate for any sales price premium they achieve, perhaps anything above 105% of the current market rate for a property, will give you a good chance of outperforming the market average price.
In this situation, you offer the sales professional a generous slice of revenue they might not otherwise realise, so it is low risk to the seller and beneficial to both parties to be generous with the commission on the โsurplusโ sales revenue. Of course, you should agree this type of deal after the salesperson has valued the property and do a separate market check to avoid the sales agent โgamingโ the expected market price and commission.
8. Offering Material Rewards to Intrinsically Motivated Parties
Description
Our final common performance incentive problem is where a person is driven by intrinsic motivation, such as satisfaction or altruism, but is offered an external (extrinsic) reward.
Why This Is an Issue
Offering extrinsic rewards to intrinsically motivated individuals (for example, charity volunteers) has been shown to reduce levels of effort in those intrinsically motivated individuals.
Example
A study of Swiss volunteers by Frey, Bruno, Gรถtte and Lorenz found that offering a small financial reward to volunteers decreased the number of hours they worked, compared with those offered no financial reward.
Radically Improve Your Incentive Design with the ROKET-DS Approach
Theย performance incentive problems listed in this post are part of a larger diagnostic tool called the ROKET-DS diagnostic. Itโs laid out to help leaders avoid bad incentives examples by improving their overall incentive strategyย and ensuring that rewards actually motivate the right behaviours.
The ROKET-DS diagnostic tool is Step 0 of the ROKET Design System (ROKET-DS), a step-by-step method to take you from your organisational goals right through to fully implemented and tested KPI targets and incentives that won't backfire. Check out our Ultimate Guide to Incentive Design, where we break down this method to help you set up fireproof incentives.
For more in-depth guidance, you can explore these ideas further in my book,ย GAMED, practise them in the GAMED online course, or master the entire performance measurement landscapeโincluding KPIs, performance measurement, and incentivesโthrough the KPI Black Belt programme.
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