9 Rules of Performance-Based Compensation and Incentive Programs

What Are the Main Components of a Compensation System?

Employee compensation systems have three components: 

1. Base salary
2. Benefits
3. Bonuses or incentives 

Each of these is vital to your long-term retention and hiring success as an employer. The base salary and benefits programs must be competitive to allow you to successfully recruit talented employees. 

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The employee bonus or incentive compensation system has the most potential for being the differentiator between your company and your competitors, whether the bonus or incentive is awarded (or offered) in the hiring process—and certainly to help retain superior talent by rewarding and holding employees accountable for their performance. For home building companies, performance-based bonuses also are easier to budget when they are tied to a percentage of employee base salary and/or the volume of homes closed.

Rule 1: Be Competitive

Base salary and the benefits package offered to employees must be, at least, competitive with other local and regional home builders. We suggest they be on the high side of average for the position. You must have a range of base salary budgeted for each position to ensure you can recruit both experienced and raw talent.

The primary determinant of what base salary to offer a potential recruit is what salary they currently earn. They must feel they are making a positive, upward move based on base salary and benefits alone when they first learn of your company and the position being offered. This is a fundamental concept that can’t be overstated nor overcome.

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Rule 2: Tie Employee Compensation to the Company’s Performance Benchmarks

Integral components of your company's bonus/incentive compensation system include: 

• Establishing company benchmarks with measurable goals. Benchmarks are quantifiable measures of performance, such as meeting a build schedule, sales quotas, customer satisfaction ratios, percentage of profit, etc. The important thing here is to make the benchmarks quantifiable so they can be reduced to an easily understood and easily measured number or percentage.
• Comparing quantity measurements to benchmarked performance standards.
• Developing reporting systems to provide consistent feedback on performance against benchmarks.
• Measuring performance on a quarterly basis.
• Reviewing growth as part of the measurement process.
• Rewarding on a sliding scale; the better the performance, the greater the bonus or incentive. Avoid all-or-nothing propositions.

Rule 3: Use Position-Specific Benchmarks 

Some positions lend themselves to easier and more plentiful performance benchmarks, for example, a sales and construction management function. Some other positions, such as receptionist, have fewer opportunities to measure quantifiable performance. 

The superintendent position is often among the first of construction employees to demand a performance-based incentive compensation system. Consider this example of a bonus/incentive program that encompasses four primary performance measurements:

1. Time of construction
2. Variance from job cost budget
3. Customer satisfaction
4. Quality-control scores (implementing a quality measurement inspection program—a topic worthy of its own article!)

Each aspect is measured in a consistent way for each home or event, and each element of the incentive program is assigned a weight, allowing the builder to emphasize the areas of performance where the company or the employee needs the most improvement. Reported data is stored electronically and the measurements are averaged over a quarterly or semi-annual period. 

There is also a subjective or qualitative performance review (or appraisal) element to a performance scoring system for areas not directly measured by the incentive program. 

Once the scores are in and calculated, the system takes the average score and applies a per-house dollar amount that’s flexible based upon the total points earned as a percentage of total possible points. This amount is multiplied by the number of homes closed during the period to calculate the incentive or bonus amount for the quarter.  

Rule 4: Gather Performance Measurements in Regular Reporting

Some performance data is gathered through the normal back office and accounting software systems. This data often tracks profit and transaction numbers from the operational results measured by those systems, or from spreadsheets employed by small- to moderate-volume home builders.

Other data is measured by surveys, special management reporting systems, or inventory counts. These systems are developed internally for the specific performance benchmarks established by the builder. 

Rewards should be based upon a sliding scale, with better performance measurement results yielding a higher incentive. All-or-nothing programs can be very de-motivating once the reward is in doubt or is clearly unattainable.

These builder reporting systems should be measured on a consistent basis and at a consistent frequency. They should be used regularly in management team meetings to stay abreast of performance in the field, sales, and back office. These are the benchmarks around which each employee should focus their daily activity, and these are the performance benchmarks that should be emphasized in the builder’s business plan—measures that tell you when you are winning and when you are losing. 

An employee’s job satisfaction and ability to enjoy organizational teamwork are tied to this concept of winning performance. If they understand the ground rules and have understandable measures of success, they will know when they are winning and when they are failing. Your employees will be more apt to recognize unacceptable behavior and be self-motivated to do something about it. Finally, they will know their roles and the roles of their teammates and will be more willing to sacrifice for the team when there are mutual goals and time to celebrate victories together.

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Rule 5: Never Pay Employees Based on One-Job Measurements

Averages and trend measurements are better applied to bonus/incentive compensation systems than to single event or job measurements. To reward an employee on the performance of each home individually leads to padding one home for reward while ignoring another home where the reward may be more difficult to earn, which is obviously counterproductive. Never use an incentive system that rewards based on performance of a single house or project. 

Instead, we want employees to concentrate their efforts on the hard-to-solve issues … and to actually solve them. Keeping each home or event’s measures as part of the overall employee performance average keeps the employee concentrating on doing the best possible job on each home or measurable event. The good and the poor are averaged together. These averages over the period of the incentive (quarterly is ideal) can be monitored and used as cumulative measurements on a rolling 12-month or calendar year basis.

Also, as mentioned above, rewards should be based upon a sliding scale, with better performance measurement results yielding a higher incentive. All-or-nothing programs can be very de-motivating once the reward is in doubt or is clearly unattainable. It’s much better to average the results and pay on a sliding scale, allowing as many employees as possible to gain from the incentive program and to find motivation to improve performance during the ensuing measurement periods.

Rule 6: Tie Incentives to a Performance Review System

The subjective portion of the scoring described in the Superintendent incentive program example in Rule 3 is earned via a Performance Review Form used as an overall performance evaluation tool. The scoring is on a 0 to 100% scale and is worth 10% of the point total in the Superintendent program.

For other positions, the Performance Review portion may take on a much larger role to determine and award bonuses or incentives. In some companies, all administrative employee incentives are based exclusively on the quarterly Performance Review score. 

NOTE: Performance reviews should be done at least once every six months, and perhaps even quarterly, on a standard schedule.

Rule 7: Budget for Incentive Compensation

The development of every incentive program should start with the question, “How much am I willing to budget (in total dollars or per employee or department) in bonus or incentive compensation this budget period?” This amount should be predetermined and is often set as a percentage of base salary.

The incentive is generally not 100% earned, as performance is rarely perfect and the best programs reward on a sliding scale. However, the 100% number may be exceeded if the volume of closings and/or revenue greatly exceeds the amount projected in the budget. This situation would make the incentive a variable amount based upon volume, and any budget overruns as a result would be more than made up by the revenue exceeding budget.

The ideal reward limits are tied to variables such as revenue and closing volume, which keep the company’s potential compensation liability easily measurable. Rewards can be pooled and unearned money carried over into future periods to increase the potential rewards and therefore stimulate even more intense performance awareness.

Rule 8: Never Pay Bonuses More Than Quarterly

If you pay bonuses monthly, they quickly stop being something special and instead become an expected part of the normal paycheck. Employees will quickly learn to live on a monthly income that includes bonuses or incentive pay. Then, as soon as the bonus amounts drop (due to performance or market conditions), employees are less able to live on their base salary—a demotivator that defeats the purpose of the incentives. 

Pay incentives quarterly, semi-annually, or annually, and keep them as a special part of why employees love working for your company. 

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Rule 9: Conduct All Employee Performance Reviews During the Same Month

Do not use the anniversary date of an employee’s hire as the date of an annual or semi-annual Performance Review. Conduct all of the reviews in the same month. Not only are all due dates for such reviews to a central location the same, it helps prevent someone’s review from falling through the cracks. 

The Bottom Line on Employee Incentive Programs

Company incentive programs for employees must be well-designed and simple to administer. They should also be easy to understand. Remember, we want everyone to know the rules of the game and to understand them so they are motivated to participate to the fullest extent possible.

When in doubt, a bonus/incentive program and its measurements should err on the side of the employee. We never want the program to be a de-motivator or to be looked upon as more advantageous to the company than to the employee.

These programs can be altered from year to year to emphasize new measures or to improve the employee reaction to the incentives. Employee incentives can be paid quarterly, but a percentage of the earnings can be held until the end of the year or the full measurement period to help employees manage their money.

With more than 40 years of home building management experience, Bob Whitten leads the management consulting and training systems at SMA Consulting, in Windermere, Fla., where he is a managing partner. Go to smaops.com.