The what, how, and why of short-term incentive plans
Short-term incentives, also known as STI, are one of the crucial parts of the total rewards package delivered to an employee. For HR professionals who design total rewards packages, finding the right balance between short-term incentives, long-term incentives (LTI), and salary is important when attracting and retaining the best talent.
Short-term incentive plans were once typically reserved for only a small portion of the employee population, but in recent years have been applicable to more jobs and levels. Because of this, HR personnel need to be familiar with the value they offer, the options available for incentive pay, and their benefits and drawbacks. Keep reading for an overview of the basics of short-term incentives.
What are short-term incentives?
Short-term incentives are flexible and beneficial ways to reward your most valuable and best-performing employees.
They have a performance term of 1 year or less, thus the alternate term “annual incentives.” These could be paid out annually, quarterly, or even monthly, based on a schedule laid out in a formal incentive plan. Employees can earn an STI bonus when they achieve specific short-term goals.
One of the primary benefits of an STI plan is that it helps align an employee’s short-term goals with the company’s goals.
Historically, short-term incentives were often offered to executives and higher-level employees exclusively. That mindset has shifted in recent years, and now many employers extend eligibility further down the organization, including paraprofessionals, sales and support staff, and in some cases hourly employees.
Most US companies have an STI plan in place, whether they are publicly traded or privately owned. Most annual incentive bonuses are paid in the form of cash; however, some companies choose stocks or other compensation options.
For more information on short-term incentives in the United States, take a look at Mercer’s US Incentive Plan Design Surveys, covering both sales and non-sales incentive plans.
Comparing incentive types
Businesses can choose to reward their employees with a wide range of compensation vehicles. How do short-term incentives or annual bonus plans compare to other types of incentives, including commissions, spot bonuses, and long-term incentives?
| |
Short-term incentive (STI) |
Commission |
Spot bonus |
Long-term incentive (LTI) |
| How is it earned? |
Used to motivate employees to reach specific goals |
Based on performance |
Recognition for a specific action or achievement |
Achievement of goals over a long period of time |
| Who earns it? |
Many companies offer STI to most of their employees |
Typically applies to sales staff |
All employees are eligible |
Typically reserved for executive-level positions |
| Is it flexible? |
Yes |
Follows a strict structure with specific goals |
Yes |
Follows a strict structure and payout timeframe |
| How is it paid? |
Typically paid in cash but can also be offered as company shares. Payout is on a set schedule, set as monthly, quarterly, or annually. |
Typically paid in cash with an employee’s regular pay. |
Awarded “on the spot.” Can be in the form of cash or other rewards, such as gift cards, paid time off, or gifts. |
Typically paid in cash or shares in the company. Payout is after the LTI period. |
Examples of different types of short-term incentive plans
There are many ways a business can use short-term incentive plans to reward its employees. Here are 3 examples to consider:
- Team/group incentives
- Profit sharing
- Bonus plan
Team/group incentives
In a team/group incentive plan, the team or group would need to work together to achieve their performance goals. The reward might vary based on how much their performance changes, whether an overall goal or project is completed, or whether the company achieves a positive financial gain from the team’s efforts.
The benefits of this type of short-term incentive plan include:
- Focuses the team on particular performance and behaviors
- Gives the group a “rallying point,” or reason to collaborate and work together
- Discourages individual behavior or performance that would detract from the group goal
There are also some drawbacks to group incentives:
- Takes time to develop appropriate goals
- May include goals that might not be perceived as equitable across the company
- Requires group management to be committed to the program
- May prompt one group to excel at the expense of another
Profit sharing
With a profit-sharing incentive plan, associates share a pool of profits that are generally created by exceeding historic or budgeted levels.
Profit sharing has numerous benefits:
- Helps pull large groups together
- Easily measured and understood
- Stimulates interest in the company’s financial results
- May lead to better associate focus
Profit sharing also comes with some difficulties:
- Possibly involves some factors outside the control of the associate and/or company
- Uses a measurement factor (profit) that’s too broad
- Commonly becomes an entitlement
- May stimulate excessive short-term actions and decisions
- Possibly lacks individual accountability
Bonus plan
A bonus incentive plan applies to individual employees, each with their own set of objectives in addition to some application of corporate or business unit performance.
The benefits of a bonus plan include:
- Considers both individual and company performance
- Aligns individual goals with desired business outcomes
- Highly impacts performance and behaviors
The downsides to bonus plans include:
- Requires a high amount of supervisory effort (including goal setting and calibrating)
- Increases the amount of training required
What role do short-term incentives play in the total rewards package?
When considering which type of annual incentives to offer and how much you want to offer, you need to evaluate your total rewards package. You want to offer competitive compensation in all forms to attract and retain the employees you need.
The incentives you offer plus the base pay are your total compensation or target total cash. In your short-term incentives plan, you need to specify the target total cash available to earn if an employee achieves all goals. Potential employees must understand the difference between their base pay and the nonguaranteed incentive opportunities available.
If you’re unsure what amount to offer, you can use our benchmark salary surveys to find a competitive rate. Consider data for both the split amount (60% base pay, 40% target incentive) and the total compensation amount. For example, if you set a total compensation amount for a role at $110,000, but the market average for that job is $145,000, your job won’t be competitive.
Successful design and implementation of incentive plans ensure that these elements of the total package are covered both in the plan design document and in clear communication to employees.
Consider what’s most important to your employees when you decide what and how much to include in your Total Rewards STI “pie.”
If you’re interested in learning more about short-term incentives, Mercer offers an STI Report for the United States and Canada. This report can help you compare your STI bonus options to those of similar organizations.
About the author
Rebecca Hall, Content Leader, Products - North America
Rebecca spent much of her career working in compensation in various corporate roles then transitioning to consulting with Mercer. Her current role, as the Content Leader for imercer.com, allows her to leverage her knowledge of human resources and talent strategy to create materials supporting Mercer’s Products & Services in North America.