Create an incentive plan that motivates employees with these 7 steps

Ask yourself one question: Is your incentive plan changing employee behavior in a way that drives better business outcomes? If the answer is no, it’s time to rethink your strategy.

Profit sharing, stock options, and employee ownership are popular tools, and in many cases they’re useful. Employees generally appreciate them. But here’s the catch: Appreciation doesn’t equal action. And more importantly, satisfaction isn’t engagement. Too often, these programs fail to move the needle where it matters most: day-to-day performance. If your performance compensation doesn’t change performance, it’s not performance compensation.

Over the past three decades, working with hundreds of companies, we’ve uncovered a proven path to building incentive plans that don’t just look good on paper—they energize employees and fuel real, measurable growth. Here’s what you need to do.

1. Define the right team

Business is a team sport. And, like any sport, performance hinges on clearly defined teams. For small companies, this often means everyone is part of one incentive group. For larger companies—think several hundred employees or more—the game changes.

Here, success lies in breaking the business into smaller, functional units—branches, departments, value streams, or what appliance company Haier refers to as “microenterprises.” Once defined, each team can be treated like its own business, with an incentive structure tailored to its unique goals and challenges.

2. Do the homework—with everyone

The best incentive plans begin with a 360-degree understanding of your business. That means gathering:

• Customer insights. What do your customers truly value? Asking them this question directly, in a real conversation, deepens relationships and boosts repeat and referral business.
• Employee input. What opportunities or roadblocks do they see on the front line? This step transforms employees from task-doers to trusted partners.
• Manager perspectives. Do their views align with employees’? If not, that’s a conversation worth having, and having often.
• Financial trends. Review the last five years to spot patterns in profit, debt, and cash flow. Your numbers will tell a story. Listen closely.

3. Identify the right metric to rally around

Once the homework’s done, form a working group of leaders to interpret the data. What’s the one performance metric that best defines success for your business right now?

If you’re in survival mode (drowning in debt or bleeding cash), then liquidity becomes the metric. But most often, the focus is operational: cost per ton in a mine, job margin dollars in landscaping, or throughput in a bottlenecked department. Whatever it is, it must be specific, measurable, and universally understood by the team. It should be something they already have their hands on every day.

4. Build a scoreboard everyone can read

How can you win if you don’t know the score? Once your team has a metric, you need a visual scoreboard that updates frequently and clearly communicates progress. When people can see the real-time impact of their efforts, engagement soars. Tap into your existing systems whenever possible.

Your scoreboard should do three things:

• Show current performance versus baseline and budget
• Make it obvious whether the team is winning or not
• Include a forecast element to encourage forward-thinking

Here’s an example:

It’s clear when this team is winning—that is, beating prior performance and budget. There should be ongoing discussions as to why and how. You’ll also note the forecast line: This motivates everyone to see what can be done to improve future performance.

5. Craft a self-funding incentive plan

With your metric and scoreboard in place, it’s time to build the plan. Start by calculating the value of improved performance. If a department boosts output or gross margin, what is that worth in dollars? This becomes your bonus pool.

We recommend a simple, equitable formula:

• 33% to employees (the incentive)
• 33% reinvested in the company
• 33% set aside for taxes

This is what we mean by “self-funding.” Everyone wins—employees, leadership, and the business itself.

Next, decide how to distribute the bonus. A commonly effective approach is to base it on a percentage of each employee’s base pay. It’s transparent, scalable, and easy to explain. Express payouts in terms employees understand, like hours of pay, to boost resonance and clarity.

Don’t forget edge cases. How will bonuses work for those on extended leave? Address these details upfront to prevent confusion later.

6. Roll it out and rally the group

Once the plan is ready, bring your people together. Thank them for their contributions and explain how the performance metric was chosen based on current challenges and opportunities.

Walk through the scoreboard and incentive structure. And then, perhaps most importantly, challenge every employee—including managers—to submit one idea they believe could improve performance (and their bonus) in the next two weeks.

Remove names, share the ideas, and spotlight the most promising ones. This creates a culture of continuous improvement.

7. Work the plan, week in and week out

Incentive plans are not “set it and forget it” tools. They’re living systems. Leaders must stay close to the action—tracking performance, celebrating wins, learning from missteps, and keeping everyone’s eyes on the scoreboard.

When done right, these plans do more than move numbers. They reshape culture. They turn passive employees into active business partners. They provide a sense of purpose and psychological ownership, making work feel like a shared mission—not just a job.

If you’re ready to build a culture of what we call Economic Engagement, start with the steps above. And when the results start showing up—in your numbers, your morale, and your momentum—don’t forget to share your success story. Make sure to celebrate with your employees, a.k.a. your trusted partners. After all, they’ve earned it. —Julia Banks

Julia Banks, a former Harvard Business School research associate, is the director of research at management consulting firm Economic Engagement.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.

This article originally appeared on Fast Company’s sister publication, Inc.

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