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Making Incentive Compensation Plans Work in Non-Profit Organizations

Prepared by James E. Rocco
  James E. Rocco Associates, Inc.
  Compensation Consultants
  This article has been reprinted by permission of Nonprofit World, http://danenet.wicip.org/snpo/
   For some time now, the business community has recognized the effectiveness of annual incentive compensation award plans. An incentive award program in the for-profit sector can be a powerful motivational tool for attracting and retaining top talent, increasing productivity, and ultimately, achieving corporate goals (increasing profits). As a result, over 80% of top executives in the private sector participate in incentive plans. There is new evidence that the same principle can be applied effectively within the Non-Profit community. In fact, the idea appears to be catching on. Recent studies have found that approximately 25% of Non-Profit organizations offer their key managers the opportunity to earn cash compensation awards in addition to their base salaries. Most of these programs are based on incentives tied to the achievement of performance measures to determine the awards.
In order for a Non-Profit organization to successfully carry out its mission, and fulfill the public's expectations, it must attract, retain, and motivate competent staff, particularly in key management and professional positions. For example, the retention of a Chief Executive Officer in a Non-Profit organization is, in many ways, even more important than in a private corporation. Many successful Non-Profits have been led by the same CEO for a number of years. This continuity is critical because of the organizational complexity of Non-Profit organizations in terms of volunteer relationships, public exposure, Board pressures, fund raising demands and the normal operational issues associated with directing an organization. An effectively managed Non-Profit organization is generally more successful in attracting community, business, and professional leaders as volunteers. Incentive plans can play a key role in the management strategy of a well managed Non-Profit organization in terms of the leadership talent that they help attract.
The successful operation of any organization is dependent, to a large degree, upon the effectiveness in which key managers carry out their responsibilities in today's environment. A competitive base pay program merely compensates staff for carrying out their basic activities and responsibilities. Increased competition for qualified staff, from both the government and for-profit sectors, competition for the fund-raising dollar and changes in tax laws have forced Non-Profit organizations to examine new methods of attracting and retaining a higher caliber of manager and motivating key incumbent managers. To meet these challenges, an increasing number of trade associations, health and welfare organizations, professional associations, and educational organizations are introducing incentive award compensation plans. From a management perspective, an incentive plan places the focus on key results and outputs which tie into the organization's management strategy and what it is trying to accomplish as an organization. Financial incentives, awarded in addition to base salary, provide a recognized, accepted, and effective method of stimulating the productivity of staff in key management positions.
To be accepted, as well as effective, an incentive award compensation plan must be carefully designed, conscientiously administered, and most important, it must conform to the policies, ethical standards and culture of the organization. There are, of course, recognized limitations to the financial rewards that can be expected from employment within a Non-Profit organization. By definition, a Non-Profit organization cannot provide the stock options or profit-sharing arrangements that are often available in for-profit organizations. Since the public has every right to expect that management will carefully oversee the administration of funds allocated for compensation programs, care must be taken to assure that a Non-Profit organization not provide non-performance based bonuses or similar types of rewards in excess of competitive pay levels. However, modest performance-based incentive plans can prove to be valuable to Non-Profit organizations. In a well designed incentive program, both the employee and organization gain from superior results. If set up correctly, an organization will achieve multiple benefits in relation to what the employee receives and should be very eager to establish a plan.
  Identification and Selection of Incentive-Eligible Positions
  A management incentive award program is based on the premise that senior level staff have a major impact on organizational performance, and that it is in the best interests of the organization to motivate senior level staff to exceed established goals and objectives. Thus, only staff occupying such positions should be eligible to participate in an incentive award program. Positions selected to participate in the incentive award program should include those whose inherent decision-making responsibilities and relationships enable the incumbent to directly and significantly contribute toward achievement of major organization-wide objectives.
  The identification and selection of incentive-eligible positions by the CEO and/or compensation committee of the Board of Directors should be based upon a detailed review and analysis of the organization's objectives, with regard to program development, income development, general management, and other relevant criteria. Typically, when a program is inaugurated, eligible employee groups usually include only top management and senior management i.e., CEO, Senior Vice President, Vice President. Initially, it is politically and administratively prudent to limit eligibility in the plan to senior positions: it is far easier to add positions to the plan than to withdraw them. Programs are often later extended to middle management groups. Generally, the larger the organization and the more experience it has with such plans, the further down the hierarchy the program will extend.
  Performance Measures
  To ensure the integrity and effectiveness of the incentive program, it is critical that the Non-Profit organization clearly specify, in advance, the performance measures against which the incumbent's actual performance will be measured. Performance measures fall into two categories: organizational and individual objectives. The process of identifying appropriate performance measures and standards places added responsibility upon top management to devote more attention to the planning process. Of course, these performance measures must be achievable but they should also reflect the goals and objectives that are vital to the success of the organization, as well as the less tangible aspects of a manager's overall responsibility (such as quality of service and teamwork), along with the more common "bottom line" measures (such as financial performance or fund-raising volume). To be effective, an incentive plan should not simply focus on organization performance, but also focus on individual performance. Therefore, individual objectives need be defined for each position as well.
  Generally, there should be three to six performance measures, which will vary in their mix of organizational and individual factors, based on the position's level within the organization. Typically, only one or two measures are designated as organizational objectives and they apply to all participants. The remaining individual objectives are evaluated on the basis of the existing performance appraisal process or a Management-by-Objectives system. While it is easier to measure results with an MBO system, the organization should use the approach that best fits its management culture.
  Since higher level positions tend to have a more direct impact on an organization's performance, the higher the level of the position, the greater the emphasis on organizational goals. Usually, all of the target award for a CEO is based on achievement of organizational objectives. Conversely, as you move down the organization, greater emphasis should be placed on individual goals. Organizational performance criteria such as income growth, increased funding, cost savings, publicity/public awareness campaigns, quality of service or care, staff utilization, fund-raising and program development are generally used. Performance scales for both organizational and individual measures should be established to indicate the relationship between achievement of performance measures and incentive award payout. For some positions, a large amount of quantitative data might not be available. However, this should not prevent the position from being designated as incentive eligible.
  Criteria to Determine the Award Amount
The amount of the incentive award should be sufficient to instill motivation. For each participant or group of participants the plan should state the minimum award, target award, and maximum award levels for each corresponding level of performance. The minimum, target, and maximum amounts are generally related to the individual's base salary, and are usually expressed as a percentage of base salary. The incentive award must be treated as a special reward for above average individual and/or organizational performance and not as a normal and expected payment within the annual compensation structure. Remember that the purpose of the plan is to motivate managers to higher than anticipated levels of performance. It should also be clearly stated that the identification of a position as incentive-eligible does not automatically qualify the incumbent to receive an award. If the organization and/or incumbent does not satisfy minimum performance criteria there should be no award. Thus the minimum award is usually set at zero.
The target award is the amount that will be paid to the participant for achieving targeted performance levels. It must be sufficiently large to be recognized as a reward for above average achievement by the recipient. While rewards of 50% to 100% are not uncommon in the profit sector, targeted incentives of 10% to 15% and maximum incentives of 20% to 30% in Non-Profit organizations are more appropriate. For example, a non-profit Chief Executive Officer generally would be eligible for a target award of 15% of base salary and maximum award of 30%. Senior executives would be eligible for a target award of 10% and maximum award level of 20%. In establishing the most effective target award levels, a market pricing study (or compensation survey) of competitive and comparable organizations (i.e., that might attract talented personnel away from your organization) should be conducted to determine the competitiveness of the organization's current base salaries. This study should also determine, to the extent possible, incentive award levels and practices in these competing organizations. The prevailing rates of base salary and incentive payments in the marketplace will guide plan designers in calculating a competitive total compensation package.
 Incentive programs will continue to grow in importance in the Non-Profit sector because they are an effective management tool. Non-Profit organizations face ever increasing competition for staff from both the government and for-profit sectors and increasing demands for efficiency and productivity from contributors. A move in this direction requires careful planning and implementation focusing on the organization's goals. If not well designed, an incentive plan can result in either excessive payments to executives or performance goals which are unattainable. However, the benefits and rewards to both the executive and the organization makes these efforts worthwhile and such programs attractive to Non-Profit organizations.
    † James E. Rocco Associates, Inc. is a Compensation Consulting Practice based in Rye New York, specializing in working with Non-Profit Organizations. They have extensive experience in conducting a wide range of studies in the compensation / human resource field and in designing innovative compensation plans for both staff and executives. James E. Rocco can be contacted at 914 925-3402.