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Incentives and Innovation: Can Rewards Drive Greater Creativity?

September 13, 2017 • By Ken Gibson

Dan Pink would have a heart attack just reading that question.  I mean, right?  His answer would be, “Of course not!”  Fair enough.  And don’t think this article is going to challenge that response—per se.  But does compensation really have no role in the kind of innovation your company experiences?  It is a question worth trying to answer.  

Highly successful organizations don’t just have a performance culture; they have a culture of innovation.  In fact, you really can’t have one without the other.  Without new product development, market expansion, customer experience transformation and other hallmarks of committed innovators, businesses experience an erosion of confidence—and diminished employee performance soon follows.  So, how do you pay people in a way that fuels the cycles of creative output you need?

The error most organizations make in trying to answer that question is confusing innovation rewards with trying to incentivize motivation.  This happens because most studies and literature conflate the two.  Those reporting on the research suggest that incentives don’t improve motivation; in fact, they often diminish it.  Some reports have extended that same conclusion to paying for innovation.  This is a mistake.  While related, they are separate issues.  In addition, most of the studies on motivation and incentives are performed by psychologists who conduct interviews instead of looking at data in a real business environment where rewards and employee performance results can be assessed objectively in real time. In short, incentives and innovation do not have to be enemies.  They can co-exist. 

So let’s unpack this critical issue and see what we can glean from the studies and reports that have been conducted.  Then let’s apply a practical analysis to what the “experts” are saying and see if we can chart a course that works in real life. 

Micro and Macro Innovation

As a starting point, we need to define the two types of innovation you likely want to encourage in your business.  One is the somewhat routine “idea sharing” you want all of your employees to engage in—particularly as it relates to the customer or client experience.  Let’s call that “micro” innovation.  It is important and useful but not necessarily transformational (although some “mega ideas” are given birth this way).

The other type of innovation is catalytic in nature.  It is those ideas that significantly alter the trajectory of your business. Let's call this macro innovation.  It comes from talent that has unique abilities and insights; typically people who are more entrepreneurial in nature.  There is high competition for this kind of talent because it is in such demand.  This forces every organization to maximize the innovation and performance of the marginal talent available to them.

Rewarding Micro Innovation

In looking at a study conducted within a large Asian information technology services company in 2010, a Harvard Business Review article drew the conclusion that “financial rewards make people suggest fewer but better ideas.”  

Analyzing the data from before, during, and after the experiment, the authors found that when rewards were introduced, more people participated, but there were fewer submissions per person, and these were higher quality ideas — meaning they were more likely to be shared with a client or implemented, or they had a high estimated profitability — than those from people who weren’t offered rewards. Employees at all levels were able to come up with valuable new ideas. The authors said the fewer ideas per employee couldn’t be explained by motivational crowding out, or the idea that extrinsic motivators (money) undermine intrinsic motivation. Instead, offering pay for accepted ideas seemed to focus people on producing better ones.

“It is often argued that incentives ‘crowd out’ intrinsic motivation, but we found the opposite,” said Gibbs. “Our view is that this issue is often misunderstood. Incentives can easily undermine intrinsic motivation, including creativity, if they reward the wrong outcomes or behaviors. But if they reward the right ones, they certainly can reinforce creativity.” (Financial Rewards Make People Suggest Fewer but Better Rewards, Harvard Business Journal, May 2015 Issue, Nicole Torres)

The author of the study also found that the idea stream continued even after the experiment period was over.  In other words, a “habituation effect” kicked in once the desire for ideas had been communicated, a process for submitting them had been established and a rewards system tied to implementation of ideas (as opposed to mere submission) was put in place.  Rewards came in the form of “points” that could be used in an online store.  Points were magnified when a positive response was received from clients via a feedback loop that was set up to measure whether submitted ideas were having a positive impact. 

Certainly, there are variations on this approach that can and have been tried.  The principle is that people respond to rewards if they are not manipulative in nature and there are multiple reinforcement mechanisms that encourage innovative thinking (in this case, monetary rewards and positive feedback from customers and company management).  This kind of micro approach to idea creation fuels a mindset that organizations want in their culture.  High-performing companies want their people observing, thinking, contributing, inventing and re-engineering all the time.  The right kind of rewards system can encourage that kind of innovative involvement. 

Rewarding Macro Innovation

Some business leaders have concluded that you cannot produce higher levels of innovation by simply paying people more.  And they are correct—but not for the reasons they often conclude.  If you do not have the right people in place, paying them differently or offering them a higher salary doesn’t suddenly create a greater ability to innovate.  What is needed is for companies to clearly define the kind of innovation they need, the skill required to achieve it and the recruiting strategy and value proposition that will draw those people into your business.  In his landmark book, Good to Great, Jim Collins said it this way:

The executives who ignited the transformations from good to great did not first figure out where to drive the bus and then get people to take it there.  No, they first got the right people on the bus (and the wrong people off the bus) and then figured out where to drive it.

…The good-to-great leaders understood…simple truths. First, if you begin with ‘who,’ rather than ‘what,’ you can more easily adapt to a changing world. If people join the bus primarily because of where it is going, what happens if you get ten miles down the road and you need to change direction?” (Good to Great, Jim Collins, Harper Collins Publishers, Inc. 2001, pgs. 41-42, emphasis added)

So, the starting point for rewarding “macro” innovation is finding the right people.  Businesses can determine this by developing a framework that examines three interdependent performance elements within their company: business growth, compensation and talent.  The purpose of this kind of performance framework is to define where you’re trying to take the business, what kind of value will be created if you get there, what kind of talent will drive that value and what kind of financial partnership you will need to attract, develop and retain those kinds of people. 

The kind of talent Jim Collins refers to as the “right people” has come to be termed “strategic leaders.”  A Strategy+Business article based on a 2015 PwC study explained it this way:

Most companies have leaders with the strong operational skills needed to maintain the status quo. But they are facing a critical deficit: They lack people in positions of power with the know-how, experience, and confidence required to tackle what management scientists call “wicked problems.”  Such problems can’t be solved by a single command, they have causes that seem incomprehensible and solutions that seem uncertain, and they often require companies to transform the way they do business.  Every enterprise faces these kinds of challenges today. (10 Principles of Strategic Leadership, Strategy+Business, May 18, 2016, Jessica Leitch, David Lancefield, and Mark Dawson)

These findings reveal several critical issues that today’s chief executives must address if they expect to compete in the transformation business environment that now exists.  Achieving and sustaining a culture of innovation and performance requires them to attract, develop and retain people who can provide strategic leadership.  To accomplish that, they must be able to frame and articulate a compelling financial partnership; one that will draw superior people to the business, reinforce the performance expectations associated with their roles and then compel them to stay and drive sustained success. 

In the Strategy+Business article just referenced, the authors offered this profile of a strategic leader:

The [PwC] study suggests that strategic leaders are more likely to be women (10 percent of the female respondents were categorized this way, versus 7 percent of the men), and the number of strategic leaders increases with age (the highest proportion of strategic leaders was among respondents age 45 and above). These leaders tend to have several common personality traits: They can challenge the prevailing view without provoking outrage or cynicism; they can act on the big and small picture at the same time, and change course if their chosen path turns out to be incorrect; and they lead with inquiry as well as advocacy, and with engagement as well as command, operating all the while from a deeply held humility and respect for others. (10 Principles of Strategic Leadership, Strategy+Business, May 18, 2016, Jessica Leitch, David Lancefield, and Mark Dawson)

A few years ago, in a Harvard Business Review (HBR) article,  Scott Anthony put a different label on the kind of leaders businesses need; but one consistent with the concept of strategic leadership just discussed. He called them catalysts:

It’s early still, but the evidence is compelling that we are entering a new era of innovation, in which entrepreneurial individuals, or ‘catalysts,’ within big companies are using those companies’ resources, scale, and growing agility to develop solutions to global challenges in ways that few others can…These companies have pushed into territory that was once the province of entrepreneurs, NGOs, and governments—from delivering health care technology, clean water, and new agricultural capabilities in developing countries to managing energy, traffic, public transit, and crime in the world’s major cities. (“The New Corporate Garage”, Harvard Business Review, September 2012, Scott D. Anthony, 44-53)

So what kind of pay strategy attracts that kind of talent?  Given the “right people” demand just described, it should be obvious that the financial part of a company’s value proposition must evolve to meet the demands of a culture of innovation.  “Old school” approaches need to give way to pay strategies that reinforce the strategic outcomes key performers are being asked to help companies achieve.  Here are a few of the compensation and rewards trends I’ve seen emerging to address the innovation imperative we’ve been discussing.

Performance Agreements—innovation catalysts individually negotiate a “deal” with the organization’s leaders that defines financial, operational and leadership expectations. It likewise defines the value of the award that will be generated if the results are achieved as agreed upon. The agreement is memorialized in a “deal sheet” that becomes the basis of a consistently scheduled (typically quarterly) self-evaluation the participant engages in with company officers.

Opt-In Plans—employees are given the option (opt-in or opt-out) of having either a “higher” salary and modest incentive or a “lower” salary with higher, even unlimited upside earnings potential (through short and long-term value-sharing plans).  In some opt-in arrangements, key producers’ entire compensation can be variable, receiving payouts solely based on a formula (percent of revenue, profits, etc.).  Opt-in duration may differ from organization to organization or even between employees.

Internal Venture Capital—a venture capital “account” is established and criteria for its access are defined.  The company makes a point of publicizing that it wants to “fund” great ideas that will bolster its business model and is willing to “finance” them through the organization’s venture capital account.  Innovative, creative catalysts and other strategic leaders relate to this kind of opportunity because it’s like running their own business. When this approach is adopted, compensation will often be tied to either a performance agreement or opt-in plan. Commonly, value-sharing will be aligned with the performance criteria that have been set for the venture capital account. The intent is to create a highly entrepreneurial experience within an existing business.

Long-Term Value-Sharing Plans—for years, companies have been using various programs for sharing value with those who help create it.  Long-term value-sharing is not a new concept.  This includes plans such as stock, phantom equity, SARs, profit pools, performance units and strategic deferred compensation.  However, in the future, the ability of a company to clearly define value creation and then have a mechanism for sharing it with key producers (in a way that properly reflects the organization’s pay philosophy) will be more critical than ever.  

Certainly other approaches can be employed, but hopefully you see the level of creative thinking that is needed to create a pay strategy that will attract talent that can provide strategic leadership and encourage the kind of macro innovation you seek. 

So, how do you reward innovation?  You do it by taking an innovative approach to your pay strategy.  When you offer the kind of value proposition just discussed,  a unique sense of partnership is formed with your strategic leaders.  It makes them feel like the company’s vision, its business model, their role in the company and their financial rewards are all connected.  These tenets represent a change from “yesterday’s thinking” in the way companies view and design compensation.  They match the business reality CEOs face in trying to attract, develop and retain the kind of talent they need to sustain innovation.

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Ken Gibson

Ken is Senior Vice-President of The VisionLink Advisory Group. He is a frequent speaker and author on rewards strategies and has advised companies for over 30 years regarding executive compensation and benefit issues.