Nonprofit Variable Pay

Annual Incentive Plan (STIP)

The annual incentive plan is a short-term incentive plan and is the most common plan in use by nonprofit organizations. The annual incentive plan typically supports an organization’s strategy to attain important tactical objectives which complement the long-term objectives of the organization.

Legal environment. Prior to the implementation of an Annual Incentive Plan, it is important to ensure the legal environment supports the type of plan being considered.

Strategic plan. The strategic plan provides broad guidance and principles to the organization. The strategic plan will support the organization's mission, culture, and establish long-term goals and objectives. The annual incentive plan should complement the organization's overall strategic plan.

Total rewards strategy. Variable compensation is an important component of the Total rewards strategy. The total rewards strategy will influence many items in the design of an annual incentive plan, such as market competitiveness, portion of pay at risk, upside or downside opportunity, and whether the plan will be an individual/team/department/organization-wide plan.

Labor market competitiveness. Several factors should be considered when assessing the labor market when a plan is being considered and designed. Does the market support incentive compensation? How much at risk pay does the market support at each salary grade? Should the incentive plan be managed as a percent of base or a flat amount? How competitive is your organization to the marketplace? If an organization is currently paying at market, how will it transition fixed compensation costs to an at-risk annual incentive plan? If an organization is paying under the market, will the plan be implemented in one year or will the plan be implemented gradually over several years?

Management support. Management support is critical to the success of an annual incentive plan. The most successful plans will have the support of the top management team. Plans influenced and designed at a department level without top management support can create inconsistencies throughout an organization.

Financial ability. It is critical to consider the financial ability of the organization to manage payouts under a plan. The decision to implement an annual incentive plan should be supported by the Chief Financial Officer. Although an annual incentive plan may reduce fixed costs throughout an organization, the design elements of the plan should be closely reviewed with the finance team to ensure the performance measurements, costs, and formulae are effective from a financial perspective within the organization. Does the plan have safeguards in place to prevent inappropriate payouts?

Plan objectives. What are the plan's objectives? Does it complement the strategic plan? Is it market competitive? Does it set an effective precedent for the organization?

Plan type. Does the plan type appropriately meet the needs of the organization? Key design features should be carefully considered to ensure the plan will be effective over the long term.

Eligible participants. Different plans may be effective for different employee groups. It is common to see the executive team, sales or fundraising team, and all other employees managed to their own unique incentive plans.

Performance measures. The performance measures of an annual incentive plan may measure financial results, operational results, SMART objectives, individual performance, or even a combination of measures. The selected performance measures determine the performance that will trigger payouts under an annual incentive plan.

Stability or volatility of organizational results. The stability or volatility of the organizational results over each performance period should be carefully considered in the plan design. Are the organizational results stable enough to effectively budget year over year? For example, if payouts are quarterly and the organization has exceeded the plan for Q1, Q2, and Q3 but is below plan for Q4 and the defined full year results, should the plan really be paying based on quarterly results? SMART objectives may be effectively used for a new nonprofit organization.

Performance unit (individual/team/department/organization-wide). An annual incentive plan may measure results and be weighted in one or more ways. For example, revenue could be weighted 40% for the entire organization; service objectives could be weighted 30% for the operating unit, and SMART objectives or performance could be weighted 30% for the individual.

Portion of variable pay at risk. Variable pay can be managed as a percent of base salary, a ratio to base salary, or as a flat amount.

Performance period (month/quarter/semi-annual/year). Annual performance periods are commonly used in annual incentive plans and annual payouts are made when incentives have been earned. When considering a plan for sales or fundraising roles, monthly or quarterly performance periods are commonly used.

To be effective, an annual incentive plan must:

• set appropriate goals

AND

• clearly state the rewards for meeting performance standards

Management by objectives (MBO) can be used to set individual forward-looking SMART goals and objectives. (See DLC Course 21: Compensation for Business Leaders to learn more about MBOs.)