Carrots Are For Horses: 3 HR Rules For Managing Incentives at Startups

Dangling carrots in front of your employees won’t work; not unless your employees are horses! This argument is propounded by renowned business & management writer, Dan Pink, in his book - Drive: The Surprising Truth About What Motivates Us and in his 2009 Ted Talk on The Puzzle of Motivation.

Financial incentives work for mechanical or completely rules based tasks. When tasks require some thinking / cognitive skills, incentives work the other way round. Pink quotes several studies including early work by Sam Gluckberg using the candle problem, research by the US Fed at MIT and in Madurai, India using simulations and by London School of Economics, in their study of actual performance and incentives at corporate organizations.

Here are 3 rules for managing incentives at startups:

1. Award, don’t reward:

This is not semantics; it’s an important distinction. When you reward an employee, you are giving something - generally money - in return for service, merit etc. Expectations are set in advance – if you meet X milestone, you will get Y bonus. An award on the other hand, is an honour (generally non monetary) that is conferred with no prior expectations being set.

Startups should pay employees a fixed monthly salary but not have defined performance bonus plans. Performance planning is critical but adding the bonus shifts focus from milestones to money, making the employment deal more transactional. Bonus plans could work against you for 2 other reasons:

a) Business goals are very dynamic for startups. Setting clear performance metrics linked to money could be tough in an environment where metrics themselves may change frequently.

b) Failure to earn the expected bonus payout could lead to de-motivation as employees tend to perceive bonuses as entitlement. For an employee who is already de-motivated after missing the goals, taking away this ‘entitlement’ makes it worse. Not getting the entitlement after meeting personal goals (if the company didn’t meet its overall goals) could be disastrous.

You should have annual / quarterly awards to recognize high performing employees. Celebrate the achievements of your top performers and showcase this role model behaviour to inspire others. After all, actors don’t act in a movie to win an Oscar. But when the Oscar is won, it is a huge intrinsic motivator.

2. Award with experiences and memories, not money

Money is important; it is the single universal denominator for meeting all our material needs. But it is this same universality that takes away the effectiveness of money as a means of recognition. It brings in little emotion and the moment the money is spent, it also loses connect. Let us take up 2 situations:

a) You gift your employee a 2,500 rupee watch for a major achievement. Every time she looks at the time, she remembers what the watch stands for – an appreciation from her company for a job well done. She even buys bragging rights when she shows off the watch to friends and family.

b) You credit the employee’s account with 2,500 rupees, with which she buys a watch. Now, the watch is something the employee bought for herself. When she shows the watch to a friend 2 months later, she is unlikely to share that the watch was bought with money that she got as an award.

Several global studies have found non financial incentives to be highly effective. A recent study by the Incentive Research Foundation (IRF) and the Incentive Federation - The State of Tangible Incentive Research: Use of Tangible Incentives - indicates that “noncash awards can capture employees’ imaginations better than cash—thereby motivating them to increase performance.”

Avoid cash for awards. Plaques, trophies and certificates are a winner because the employee can showcase these. A team outing to celebrate an employee’s achievement is awesome – you are creating a collective memory that honours the employee. You could also nominate the employee for external learning programs. Not only are you are showing genuine interest in investing in the employee, you are also creating a more able resource. Such learning programs contribute towards the sense of Mastery that Dan Pink mentions.

3. Equity is king

When a startup that makes it big, there is a killing to be made out of stocks. Finance folks will add that equity makes it possible for startups to offer attractive pay packages to employees without putting a strain on the company’s cost structure and cash flows.

To me however, the biggest advantage of giving equity at a startup is to create a sense of ownership. With equity, you are no longer just an employee in the company; you own part of it! It adds to the sense of Purpose that Dan Pink elaborates on in his book and talk. Imagine telling an employee, “Given the value you brought for us, you now own x% of the company” as opposed to “...you will get y% of your salary as a bonus”.

Equity also plays another important role – driving longer term value creation as opposed to short-termism. Even for short-term results, equity will drive a more aligned and synergistic approach to achieving those results. The key here is to establish job levels and then allocate equity commensurate to contributions. According to Bill Coleman, Vice President of compensation at Salary.com, “Each tier in the organization should get half of the options of the tier above it.”

There are a few areas where monetary incentives are effective. One is when using the services of a short term contractor. Tying in a portion of the fees to “successful completion” is a way of protecting your interests. It is also argued that for sales employees, incentives play a vital role in achievement of targets. In both cases, I would contend that if not the tasks themselves, at least the nature of work is more quantifiable, measurable and hence rule driven.