Do Monetary Incentives or Rewards Drive Continuous Improvement?

QUESTION: What is your opinion on the use of monetary incentives/rewards to drive continuous improvement?

ANSWER: This question is often one of the more controversial and hotly debated topics with companies striving to achieve and sustain excellence. There is certainly no right or wrong answer here, but I’m happy to share my personal experience with this dilemma. It’s a very company- and facility-specific set of circumstances that must be understood before embarking on monetary incentives for a large universe of new participants.

First, let’s agree that whether we call it pay for performance (P4P), gainsharing, group incentive or whatever, that the essential ingredient here is to design a compensation scheme that makes the hourly associates’ compensation variable subject to actual performance vs. a predetermined set of objectives.

Often these designs also include salaried folks as well who do not participate in any corporate management incentive program. (Anyone who does participate in a corporate incentive program is excluded from a P4P. No double dipping!)

Rather than go into the mechanics of a system design, I’ll address some of the considerations involved, which are formidable. If you have the right climate in place to entertain the notion of gainsharing then there are experts you can partner with to lead your company through the design process, e.g. Hay Group.

Considerations:

1. Have you been on the continuous improvement journey for at least five years? This is important because the culture change on the shop floor takes time, and it must be far enough along that hourly folks are well educated/trained in how to think about their work, how to use the basic lean toolset for problem-solving and be in control of their own work processes. They must also be equipped to see the linkage between what value they add and the benefit to customers and shareholders and their own job security.  If these basics aren’t well established, you’re not ready to talk about radical compensation redesign.

2. Does your management from the CEO on down understand the commitment that’s being made to sustain such a program?  If they don’t understand or aren’t interested in understanding, forget about it. Reneging on a program such as this will set back, if not kill, your CI program as it will shatter whatever level of credibility and trust other leaders have worked so hard to create.

3. Are your facilities union or non-union? I’ve had a few modestly successful P4P programs in both environments, but the “pilot” program should be in a non-union plant, if possible. It’s simply easier to engage directly with hourly people, learn from mistakes and not have a middle man involved until a basic design is made and a successful pilot has been completed. In addition, it is typically a harder selling job to the unions because it requires change in their basic mindset relative to negotiations. P4P is NOT an entitlement program! Improved performance is measured net of inflation and is tied to business performance. If the company has a bad year, then chances are the individual plants won’t be paying fat P4P bonuses.

4. What factors will be included in the P4P calculations? Will PPV (purchased material price variance to standard) be included/excluded? Will sales price changes in the marketplace be included/excluded? Will GWIs (general wage increases) continue or be eliminated or reduced in favor of more variable compensation via P4P?

5. P4P programs are just that. Leadership must make the linkage clear between shop-floor results and corporate productivity improvements. For example, if the corporate objective is to increase operating margin (OM) by X%, then how much of that should be tied to market pricing vs. product mix vs. factory productivity? It’s a non-start in the plants if things they have absolutely no control over start affecting their ability to meet plant objectives. On the other hand, if a major vehicle to improve OM depends on incremental sales growth of particular products groups, then an appropriate plant objective might be “improve OEE on constrained machine XXX by 10 points from 75% to 85% in order to meet additional demand being brought in by the sales group."

This is how you get aligned objectives top to bottom. If the plant meets their 85% OEE goal but the sales team doesn’t bring in the additional business, will this affect the P4P payout?  These and many other scenarios must be anticipated and played out during the planning process to minimize the surprises along the way. This is why doing a one facility pilot is so crucial. If P4P turns out to be a non-starter, then at least it’s on a scale that is quite manageable to unwind.

6. Are you prepared to meticulously track the metrics so that you can report with confidence at the monthly, quarterly and annual employee update meetings and be completely understood? When the news is bad will hourly associates understand and accept the news? Will there be job actions if failure to have regular payouts persists?  Also keep in mind that if you start this variable compensation system, the record keeping must be above reproach or once again the lack of trust and credibility will be deadly to your CI future.

7. Rather than thinking about P4P as a “corporate program,” instead, think about it one facility at a time. Even in a world-class company there are often facilities that are not yet world-class. Any plant that gets the opportunity to pursue a P4P is selected based on their status as already being one of the best in the world at what they do and how they do it. (See my 12 Principles of Manufacturing Excellence and what it takes to become a Stage 4 operation.)

Few Candidates for Broad-based P4P Scheme

At the end of the day there has to be a win-win-win process. Customers have to win with higher quality, competitive cost, superior delivery performance and customer service. Shareholders have to win via improved returns on investment based on continuously improving results. Employees have to win by sharing in the company’s success based on their positive contributions to an improving business.

Will hourly associates be better off continuing to receive a cost of living increase or will they be better off because they have a chance to earn significantly more in a good year? Can they accept that some years their compensation will be only their base rate since no incentive pay was earned?

In conclusion, there is an extraordinary number of moving parts here. My opinion is that very few companies are candidates to pursue a broad-based P4P scheme. Why? Because the disciplined thinking, meticulous attention to detail required to manage the processes over a long period of time, the long-term leadership commitment and the extraordinary communications that are critical to sustaining such a process are formidable but absolutely necessary.

Finally, since so few companies that start the journey to excellence are still on the journey after 10 years, I’d submit that there is a pretty small universe of entire companies that should be burning a lot of calories worrying about a formal P4P program.

On the other hand, it’s likely that there are many more companies out there where a few plants might be worthy of consideration. Even then, in my opinion, it’s a high risk commitment over the long haul, and you should always define the conditions under which the P4P program will be given last rites so it’s clear to all from the beginning. Having a long-term success with P4P is a long, downhill putt.