Welcome to Incentives to Performance!
Hello there! Welcome to one of the most practical chapters in your E3 journey. Think about this: even the most brilliant strategy in the world is just a piece of paper if the people in the organization don’t want to carry it out.
In this chapter, we explore how to motivate managers and employees to work toward the organization's strategic goals. This is a vital part of Strategic Control because it ensures that everyone’s "internal compass" is pointing in the same direction as the company's "North Star." Don’t worry if this seems a bit abstract right now—we’ll break it down into simple, manageable pieces!
1. The Core Challenge: Goal Congruence
The main reason we use incentives is to achieve Goal Congruence. This is a fancy way of saying that we want the personal goals of the employees to match the strategic goals of the organization.
The Agency Problem: In big companies, the owners (shareholders) aren't the ones running the day-to-day business; the managers (agents) are. Sometimes, managers might do what’s best for themselves (like buying a private jet) instead of what’s best for the owners (increasing profit). This gap is known as the Agency Problem.
Analogy: The Pizza Delivery Driver
Imagine you own a pizza shop. Your goal is to deliver pizzas quickly so customers are happy. Your driver’s goal might be to drive slowly to save energy and listen to the radio. If you pay the driver per hour, they might take their time. But, if you pay them a bonus for every "on-time" delivery, their goal (earning more money) now matches your goal (happy customers). That is Goal Congruence!
Quick Review:
• Goal Congruence: When individuals pursue their own interests, they also help the organization achieve its objectives.
• Principal: The owner (Shareholder).
• Agent: The person hired to do the work (Manager).
2. Types of Rewards: Extrinsic vs. Intrinsic
Not everyone is motivated by the same things. To build a good strategic control system, we need to understand the two main types of rewards:
A. Extrinsic Rewards
These are "external" rewards given to an employee by the organization. Think of these as the "carrots" at the end of the stick.
• Examples: Salary increases, bonuses, commissions, share options, or a better company car.
• Best for: Motivating people to hit specific, measurable targets.
B. Intrinsic Rewards
These are "internal" rewards that come from within the person. It’s the "warm fuzzy feeling" you get from doing a good job.
• Examples: A sense of achievement, feeling valued, enjoying the work, or having more autonomy (freedom) to make decisions.
• Best for: Long-term engagement and creativity.
Memory Aid:
• Extrinsic = External (Money/Stuff)
• Intrinsic = Internal (Feelings/Satisfaction)
Key Takeaway: A successful strategy usually requires a mix of both. Money gets people through the door, but job satisfaction keeps them working hard toward the strategy.
3. Financial Incentives in Strategic Control
In E3, we look at how financial rewards can be tied to strategic performance. Here are the common methods:
1. Performance-Related Pay (PRP): Bonuses linked to achieving specific KPIs (Key Performance Indicators).
Example: A sales manager gets a 10% bonus if the team grows market share by 5%.
2. Share Options: Giving managers the right to buy company shares at a fixed price in the future.
Why this works: If the manager makes the company successful, the share price goes up, and their options become very valuable. It aligns them directly with shareholders.
3. Profit Sharing: Distributing a percentage of the company’s total profit among employees.
Why this works: It encourages teamwork across different departments.
Did you know?
While financial incentives are popular, they can sometimes lead to Short-termism. This is when a manager focuses only on this year's profit (to get a bonus) and ignores long-term investments like Research & Development (R&D).
4. Non-Financial Incentives
Money isn't everything! Many modern strategies rely on non-financial incentives to keep staff motivated without breaking the bank.
• Recognition: "Employee of the Month" or a simple "thank you" from the CEO.
• Career Progression: The promise of a promotion if strategic targets are met.
• Flexible Working: Allowing staff to work from home or choose their hours.
• Training and Development: Investing in the employee’s future skills.
Common Mistake to Avoid: Don't assume non-financial rewards are "weak." For many highly skilled professionals, the opportunity to lead a prestigious project is more motivating than a small cash bonus.
5. Designing an Effective Incentive Scheme
How do we make sure the incentive system actually helps the strategy? CIMA emphasizes a few key principles:
The Controllability Principle
Managers should only be rewarded or penalized for things they can actually control.
Example: It’s unfair to cut a factory manager’s bonus because the global price of electricity went up. They can't control global energy markets!
Step-by-Step: Setting up a Scheme
1. Identify Strategic Objectives: What are we trying to achieve? (e.g., Innovation).
2. Select KPIs: How do we measure it? (e.g., Number of new products launched).
3. Set Targets: What is "good" performance? (e.g., 3 new products this year).
4. Link to Reward: What does the employee get if they hit the target?
5. Monitor and Review: Is the scheme causing any bad behavior?
Quick Review Box:
A good incentive scheme should be:
• Clear: Everyone understands how it works.
• Fair: Targets are achievable but challenging.
• Aligned: It rewards behaviors that help the overall strategy.
6. The "Dark Side": Dysfunctional Behavior
Sometimes, incentives go wrong. This is called Dysfunctional Behavior—when people follow the "letter" of the incentive but ignore the "spirit" of the strategy.
Common examples:
• Gaming the system: Manipulating data to make performance look better than it is.
• Smoothing: If a manager has already hit their target for this year, they might "hide" extra sales to use for next year’s target.
• Cutting Corners: Focusing so much on a "speed" target that quality drops significantly.
Real-World Example: The Call Center
A call center rewarded staff based on how many calls they finished per hour. To get the bonus, staff started hanging up on customers as soon as the phone rang! They hit their "speed" target (strategic failure), but customer satisfaction (the real goal) plummeted. This is a classic case of a poorly designed incentive.
Summary: Key Takeaways for your Exam
• Incentives are tools of Strategic Control used to bridge the gap between managers and owners.
• Goal Congruence is the ultimate aim—making sure everyone wins when the company wins.
• Use a mix of Financial (extrinsic) and Non-financial (intrinsic) rewards.
• Always remember the Controllability Principle: only measure what can be managed.
• Be aware of Dysfunctional Behavior: if you measure the wrong thing, you will get the wrong results!
Keep going! Strategic Management is all about understanding how to steer the "ship" of the company, and incentives are the engine that keeps it moving!