Designing an incentive compensation program that works

Healthcare Financial Management, Jan, 1998 by Stephen Laverty, Barbara J. Hogan, Lindalee A. Lawrence

The right incentive compensation program can become an organization's new standard of excellence.

To encourage innovation and improve departmental and organizational bottom lines, Winchester Hospital, Winchester, Massachusetts, developed and implemented a middle management and staff incentive compensation plan. Middle managers and staff who participate in projects that provide savings to the hospital are paid a share of the savings. The plan allows staff the option of designing "horizontal" projects, in which a project leader carries out a project individually or with peers, or "vertical" projects, in which a project leader directs a team of key individuals.

Increasing numbers of vertical projects have been proposed since the plan's inception in 1994. In addition to increasing the hospital's operating income, the program provides cost-effective, variable compensation, which especially appeals to motivated, high-performing employees; motivates employees to overcome roadblocks; facilitates a team approach that bridges traditional departmental boundaries; and encourages a beneficial and collegial competitiveness among managers.

In 1994, Winchester Hospital, Winchester, Massachusetts, implemented an incentive compensation plan, a voluntary program that encourages middle managers and staff to develop cost-saving or revenue-enhancing programs for the hospital by offering them a share of the savings on revenues as an incentive award payment. The percentage of managers participating in the program and the savings realized have been substantial and have increased steadily [ILLUSTRATION FOR EXHIBITS 1 AND 2 OMITTED].

Projects can be either "horizontal" or "vertical." The project leader of a horizontal project carries it out individually or with peers, whereas the project leader of a vertical project forms a team of key individuals important to the project's long-term success. Vertical projects often are more complex to manage because they tend to be wider in scope and involve more people. By the plan's second year, however, Winchester had received several vertical project proposals.

At the team leader's request, trained facilitators may assist in vertical project planning by providing the following input:

* Identifying the goals or projects, or both, that will affect a department's bottom line;

* Helping to develop the cost-benefit analysis;

* Creating the action plan and establishing benchmarks to measure progress and success throughout the year;

* Ensuring participation and inclusion of all key employees; and

* Ensuring that the work moves forward on a timely basis and stays within established quality and cost parameters.

Participants in the program can choose to develop a new project or to modify an existing one. Individuals are eligible for incentive awards of up to 15 percent of base salary, subject to a maximum team pool of 50 percent of the net benefit to the hospital.

Diligent administration, communication, and feedback are provided by two coadministrators representing finance and human resources. A steering committee composed of executives and directors reviews and oversees the proposed projects and helps to ensure that all projects reflect the hospital's business plan and objectives. The committee may reject proposals or request revisions to them. Exhibit 3 outlines key administrative work steps of projects throughout the year.

Success Factors

The success of this program is reflected in the increasing number of projects proposed each year, the savings to the hospital, and the broad participation of managers. Some of the less easily quantified benefits of the program, such as fostering a team approach to problem solving and encouraging a beneficial competitiveness among managers, are listed in Exhibit 4.

While critics of incentive programs argue that employees should not receive extra compensation for doing their jobs, supporters argue that many of these projects would not come to fruition without incentives. Winchester's incentive program coadministrators believe that at least 50 percent of the initiated projects would never have occurred without the added motivation of the incentive rewards.

The success of this program has rested on a number of unique factors, including the following:

* The "artistry" of senior executives in establishing corporate business objectives that stretch employee capabilities, yet remain reasonable and feasible.

* A meaningful reward system that also is a source of recognition for initiative and innovation.

* The organization's support of risk taking.

* The finance department's ability and commitment to help managers develop measurable, quantifiable cost/benefit analyses and then to sponsor the projects to senior management.

* The strong administrative partnership between finance and human resources that provides follow-up, honest assessment, and constructive feedback to managers who submit proposals.

* Manager and employee commitment to designing programs that enhance operational quality.

* Measurement goals - benchmarks used to measure accomplishment of project goals - that are agreed upon and adhered to.