Modern compensation strategies and philosophies come in all shapes and sizes but knowing how to design a short term incentive plan effectively is very important. But almost all of them include short-term incentives as a crucial way to drive employee performance.

No organization wants or needs their employees to only consider the immediate future. At the same time, a short-term incentive plan can play a central role in driving business results and aligning employee behaviors to company goals.

While long-term compensation incentives can drive employee loyalty and improve employee and executive advancement and performance over time, strategic short-term incentives are designed to reward employees for their performance. Get your STIP right, and your monthly, quarterly, and yearly performance could benefit greatly.

Defining a Short-Term Incentive Plan

As its name suggests, a short-term incentive plan (STIP) provides financial and compensation-related reasons for your employees to perform well over a relatively short period. Typically, that period is defined as the fiscal year or an individual quarter within that year. 

Incentives in a STIP often come in the form of cash bonuses. For example, an employee reaching key metrics may be eligible for cash in addition to their regular salary and compensation. But incentives may also go beyond cash, including additional time off, stock options, and more.

Short-term incentive plans can also play a significant role in determining fair and competitive executive compensation. CEOs and other executive leadership may be encouraged to hit key performance targets such as sales, revenue, costs, employee or customer retention, and others through incentives such as bonuses and stock options. The result is a greater focus on hitting the objectives that ultimately help the company succeed.

Short-term incentives are different, but not in opposition to long-term incentives. The latter typically describes any target-based performance incentives for periods greater than 12 months. Stock options become a more common incentive here, as do increased retirement contributions and other incentives with a less immediate benefit for reaching less immediate goals.

The Essential Components of an STI Plan

For any short-term incentive compensation to be successful, the plan has to incorporate a few central elements. These elements can be defined before putting the plan in place, or refined during the execution of the plan as potential issues among executives and other employees become apparent:

• Simplicity. Employees have to understand intuitively how the short-term reward system works. The more complicated the plan is, the more difficult that understanding becomes, leading to potential confusion and frustration with employees not hitting the goals they think they should.
• Alignment. Short-term incentives should always tie directly to your organizational objectives. That avoids potentially arbitrary bonuses for work that doesn’t benefit your organization, while also helping employees understand the reason behind the reward system. 
• Reward Amounts. For employees to be motivated by short-term incentives, the rewards they may receive have to be high enough to be perceived as meaningful. On the flip side, rewards that are too high could cut into revenues and nullify the benefits the organization received from the higher performance.
• Employee Control. All rewards should be tied to goals and objectives that employees can directly control. Every employee who is part of the STIP should have a chance to receive rewards based on their performance, not external factors outside their control. 
• Payment Type. STIP payments are most commonly a percentage of the employee’s salary or flat dollar amounts. While flat amounts are easier to plan for, salary percentages may make the rewards more consistently meaningful for all employees in the program.
• Defined Timelines. Most short-term incentive plans are based on either annual, quarterly, or monthly rhythms. Determining which of these cycles is most beneficial for your organization can help to plan better, set goals, and communicate with your employees.

Evaluate any incentive compensation plan you create based on the incorporation of these elements to maximize its chance of success as you begin to roll it out to your employees.

Communicating Your Incentive Plan

A central component of a successful short-term incentive plan is ensuring that all of your employees understand it. At its most comprehensive, that means making the full STIP document available for anyone who would like to read and understand its nuances. But it also helps to provide some shortcuts to understanding the plan, including:

• A 1-page overview that helps employees quickly understand the metrics, timeline, and incentive(s)
• A calculator that provides your employees the means to evaluate their progress toward the incentive(s)

When first rolling out the plan, consider offering an employee all-hands meeting to provide an overview along with opportunities for questions. Regular emails at the beginning of each period can serve as helpful reminders for new opportunities to reach that incentive. Finally, as a compensation benefit, the STIP should be part of the onboarding process for new employees who will be able to gain the incentive.

Depending on how many employees take part in the program, regular individualized updates on progress may also be beneficial. In an executive compensation program, for example, these updates can serve as recognition of success to date as well as motivation to continue toward the right goals and metrics.

Short-Term Incentives as Part of a Holistic Reward System

While short-term incentives can be vital in driving short-term performance and goal achievement, only focusing on these short periods may not be beneficial. Long-term incentive plans are just as important to drive long-term employee and executive loyalty and alignment with long-term strategic goals.

For example, a short-term incentive plan may be focused on quarterly sales achievements, while a long-term incentive plan may drive toward higher employee retention or more efficient spending. Both are vital company goals but require different approaches and time horizons for executives to pursue and achieve.

Within the context of his more holistic short-term and long-term reward system, the impact of variable pay and profit sharing in your employees’ total compensation become potential considerations, as well. Variable pay tends to be tied to short-term incentive plans in the form of bonuses or commissions. While profit sharing is also a type of variable pay, it may be more relevant for long-term incentives as a means of tying your employees—and especially your executives—to your organization long-term.

Evaluating your STIP and long-term incentive plans together ensures that you can retain a comprehensive picture of your employees’ total compensation, which in turn enables you to create more meaningful payment amounts in both areas. Give out too much, and your profitability may suffer; too little, and the incentive may not be enough to drive meaningfully more positive performance.

And of course, in both the short-term and the broader holistic incentive plan, care should be taken that the targets set will drive employees towards company goals. It’s the best and only way to ensure that the cost of providing short-term and long-term incentives is offset by the benefits gained through the plan itself.

Overcoming Obstacles in Short-Term Incentive Implementation

No short-term incentive program is automatically successful. A few common obstacles can prevent it from benefiting your organization; overcoming them will be crucial for a successful implementation.

• Budgeting: especially when first implementing the plan, it can be difficult to estimate how much you can and should budget for incentives. Not accounting for these incentives in your regular budget planning and forecasting can cause further issues with your balance sheet.
• Adoption: Even the best incentive program matters little if your employees don’t adopt your short-term incentive plans. Comprehensive communication, as outlined above, can help to overcome this challenge.
• Engagement: Beyond the initial adoption, how are your employees engaging within the system? A plan that is difficult to understand and incentives that are difficult to reach can prevent them from being as active as they should be even after opting into pursuing these incentives.
• Ensuring fairness: Especially for STIPs that span multiple salary levels or functional units, ensuring fairness can become complex. A perception of unfairness, on the other hand, can cause frustration and a potential refusal to participate for your employees.
• Ensuring simplicity: The more complex the plan, the more difficult it will be to understand. Only a straightforward goal-and-incentive program can get the engagement and goodwill of your employees and help you reach your goals.

The right compensation tools can help you overcome some of these challenges. With the right tool, for example, you can better understand industry standards in incentive programs and build your own plan accordingly, increasing perceptions of fairness among employees with experiences at other organizations.

Concluding Insights on Short-Term Incentive Plans

Put simply, short-term incentive plans can play a vital role in achieving company goals. They enable any organization to tie tangible incentives to metrics that matter for success, providing additional motivation for executives and their teams alike. The advantages of reaching goals now extend from the company to the employees, creating a more mutually beneficial system.

To drive employee performance, short-term incentives need to be both straightforward and fair. They also need to be significant enough to make a difference for every employee in the program. Finally, a transparent implementation process can help employees better understand the incentive structure while also building more initial goodwill that translates into better adoption and engagement.

With these goals in mind, short-term incentive plans can become a central way of your larger compensation strategy. A tool like CompTool can help you get there. Book a call to learn how our solution can help you gain a picture of compensation strategies and amounts in your industry, allowing you to shape your own approach accordingly.