When we work with organizations to design strategy management systems, we say that one of the most effective ways to make it work or "bring it to life" is to tie compensation to it. Employees listen when their managers tell them about new policies and new strategies of an organization, but if you really want them to pay attention, explain how it affects their pay.

I have sat through hundreds of conference presentations over the last 10 years about performance management. Time and time again, the speaker says, "once we tied it to compensation, people really got engaged in helping us execute the strategy." I am a strong believer in incentive compensation, when used the right way. Thus, I was caught off guard by an article in the October 2008, INC MAGAZINE, Sins of Commissions. The article, by Joel Spolsky says "Employees will always game incentive plans – because the geniuses who design them don't anticipate how employees will respond."

His article cites some great examples from personal experience about how employees will take advantage of an incentive program to the detriment of their company's performance. It made me think of the time I was brought into a power company because the company had just paid out their biggest annual bonuses and had one of their worst years on record.

So, how do you design a compensation system that works? You can find many experts in compensation, so let me briefly give you my views on what is key to making the system work.

• Funding Mechanism: Incentive compensation is meant to reward behavior that increases the performance of the organization. Thus, the bonus pool should be funded by meeting financial targets. Employees need to understand that money is flowing into the bonus system only when the company is growing successfully. Usually organizations define revenue and net income targets. When the organization achieves those, money starts filling the bonus pool.
• Payment Frequency: Bonuses make a difference to employees when they are most closely linked to the correct behavior. Paying a quarterly bonus is much more powerful than paying an annual bonus. It is hard to stay motivated for an annual bonus that is already out of reach because of one quarter of bad performance. Organizations, so ensure they do not pay out too much each quarter can withhold some of the bonus, but employees should see a tangible benefit to having a great quarter. It will motivate them to work hard every quarter.
• Alignment: A manager should ensure that her employees have measures or goals that directly support her own goals. The easiest way to do this is to link all of the employees to a strategy map or Balanced Scorecard. A few quick exercises in coverage will ensure that everyone is working to execute the strategy.
• Participation: Variable compensation should apply to those other than salespeople. Many organizations are successful by putting an entire team or department on an incentive program that has some portion of the bonus tied to the performance of the team. This will ensure that bad behavior is spotted quickly and that team play is encouraged.
• Rules: Joel Spolsky does point out at the end of his INC MAGAZINE article that it is important to establish rules for compensation systems and not to tolerate gaming the plans or any behavior that might adversely affect the customer or business. These types of rules allow the plan to invalidated or changed if the wrong behavior is occurring within the organization.

I am very interested to hear how compensation works at your organization. What do you think works and what doesn't?

• Is Your Staff Resistant to Change? (July 31, 2012)
• On Employee Performance Reviews (July 8, 2012)
• Making Strategy Execution Personal for Staff (May 21, 2012)
• A Case of Conflicting Incentives (August 3, 2011)
• Overcoming a Tsunami (November 26, 2010)