6 steps to an incentive compensation program for contractors

Is your construction company struggling to attract and retain quality workers in today’s tight labor market? A well-designed incentive compensation program may help. The right approach can increase productivity and profitability while boosting employee satisfaction and company culture. However, you’ve got to have the cash flow to fund it and be prepared for administrative challenges. Here are six steps to launching and managing an effective incentive program:

1. Determine eligibility

Many construction businesses limit their incentive programs to high-level executives and other key employees who are essential to landing, managing and completing projects. Typically, these are individuals with critical relationships, hard-to-find skills and institutional knowledge. The costs of replacing such employees — which include recruiting, hiring, onboarding and training — would likely exceed the cost of incentive compensation that keeps them on the team.

Offering a cash bonus or another type of incentive to lower-level workers may also pay off in productivity and retention, especially during jobsite labor shortages. When offering incentives to nonexempt employees, however, be sure to confirm that the program complies with applicable overtime and wage-and-hour rules.

And you don’t necessarily have to offer cash bonuses. Instead, you might reward top performers with noncash items, such as personalized gear, or high-quality boots or tools purchased at supplier discounts. Just be sure such rewards are structured and administered properly: Noncash compensation can still raise tax, payroll or wage-and-hour considerations in some cases.

2. Identify the right reward triggers

It may be tempting to tie incentives directly to profits, but this can backfire. You might inadvertently incentivize behaviors that harm your construction company in the long run. For instance, project managers might opt for lower-quality materials to cut costs and meet profitability goals.

Generally, a better approach is to choose triggers that align with business-specific goals and each employee’s job description. Incentives for project managers, for example, might be triggered by:

• Consistently meeting deadlines,
• Staying on budget without sacrificing standards, and
• Achieving clearly defined quality, customer service and safety objectives.

It’s worth repeating, however, that basing an incentive on any one of these priorities could push some project managers to cut corners and raise project risk. Consider offering tiered incentives that provide greater rewards as accomplishments become more difficult. Also, exercise caution with safety-based incentives to ensure they encourage best practices, training and hazard reporting — not underreporting incidents.

3. Establish metrics

Carefully choose and implement key performance indicators (KPIs) to assess whether incentives have been earned. Announce the baseline for these metrics at the program’s inception, so you and employees have specific measures to compare against.

Pick KPIs that are straightforward and understandable for the applicable workers. Examples might include:

• Labor efficiency,
• Rework rates,
• Project completion time,
• Budget performance, or
• Safety training and hazard mitigation.

Make each metric’s goal attainable but not too easy. Include some room for subjectivity, too. Doing so can help ensure employees assigned the toughest goals aren’t unfairly disadvantaged by project complexity or factors that are out of their control, such as weather delays, materials shortages or change orders.

4. Determine incentive structure

Incentive compensation typically comes in the form of cash, equity or a combination of the two. Cash bonuses are a relatively straightforward motivational tool for both employers and employees. However, you must carefully forecast their impact on your construction business’s cash flow. In addition, cash bonuses are generally taxable as wages when paid, and employers must follow the appropriate payroll withholding rules. So, you’ll want to prepare participants for this eventuality as part of a clear program communication strategy.

Equity rewards include restricted stock units, stock options and phantom stock. They usually vest based on years of service or satisfaction of performance goals. To offer actual stock, your construction business generally must be organized as a C corporation. Indeed, the right long-term incentive depends on your entity type. Contractors operating as S corporations, limited liability companies or partnerships may need to consider alternatives to traditional stock compensation.

The tax treatment of equity-based incentives varies significantly. Depending on the award type, taxation may occur at vesting, exercise, settlement or payout. And some arrangements may trigger current tax consequences or special compliance requirements. Nonetheless, equity incentives give employees a stake in company performance and can increase the likelihood that they’ll stick around to participate in your business’s long-term success.

When feasible, a combination of cash and equity can be a highly effective motivator. But you’ll need to design a program like this with great care and in consultation with your professional advisors.

5. Time cash payouts strategically

Remit cash bonuses as close as possible to the performance being rewarded. Many businesses offer annual bonuses as a year-end gift, but employees may come to expect them as a matter of course rather than as an incentive to go above and beyond.

To truly connect the reward to the desired behavior or achievement, consider dividing cash bonuses into monthly or quarterly payouts. Doing so can keep workers engaged with the program and improve retention. That said, the appropriate payout schedule should reflect the nature of your company’s cash flow, its administrative capacity and the goals you’re measuring.

6. Evaluate results and continuously improve

The last “step” in the rollout of any incentive compensation program is to recognize that it’s probably not a finished product. You and your leadership team should review its results, assess its financial impact and make adjustments as necessary.

If you’re interested in exploring incentive compensation options, contact us. We can help design or refine a program to align with your construction company’s goals, address tax implications and regulatory compliance, and evaluate its ongoing efficacy.