Why Most Incentive Plans Fail by Year Two
Incentive plans launch with energy and optimism. Leadership believes they will sharpen focus, motivate employees, and drive performance. HR builds the plan, communicates the metrics, trains managers, and prepares year-one materials.
Then reality sets in. By year two, the plan feels misaligned. Metrics no longer reflect the business. Employees don’t understand the connection between their work and their payout. Managers complain the plan is too complicated. Finance says it costs too much. Eventually the plan erodes.
The cause isn’t poor design. It’s organizational drift.
Businesses evolve faster than incentive plans. Metrics that made perfect sense during design become outdated as priorities shift. Revenue targets change as do customer priorities and cost pressures. Strategy moves, but incentive plans often do not. HR leaders then spend year two explaining why the plan “still works” even though every leader knows it doesn’t.
In the breakdown lane
The first breakdown is metrics fatigue. Plans often rely on four to six metrics. But as the business changes, more metrics are added. Leaders want coverage of every priority. This results in a plan that tries to measure everything and influences nothing. Employees stop paying attention to metrics they see as remote, complex, or irrelevant.
The second breakdown is line-of-sight erosion. Employees engage with incentive plans only when they can clearly see how their actions influence the payout. But when metrics shift to aggregated outcomes (think company EBITDA, multi-year revenue growth, or composite customer scores) employees lose that line of sight. They view the plan as a lottery rather than a performance tool.
The third breakdown is measurement drift. Organizations often change the underlying definitions of metrics without updating the incentive model. For example, revenue may now include subscription renewals, margins may be calculated differently, or customer satisfaction may use a new scoring system. These changes create noise inside the plan, and payouts no longer reflect the original performance logic.
The fourth breakdown is political pressure. Leaders advocate for exceptions, threshold adjustments, discretionary add-ons, or mid-year metric swaps. Each request feels reasonable individually. Collectively, they undermine the integrity of the plan.
To stop incentive plans from failing, companies must adopt a maintenance mindset. Incentive plans require annual calibration, not a once-a-decade overhaul.
Staying out of the breakdown lane
A stable, effective plan includes four disciplines:
1. Annual metric alignment review
Each year, HR and Finance must validate that selected metrics still reflect the business priorities. If a metric no longer drives behavior, it must be adjusted or removed. Simplicity is power.
2. Line-of-sight testing
For each employee group, HR must ask: Can they influence this metric directly? If the answer is no, the metric is misassigned. Plans that preserve line-of-sight maintain motivation.
3. Measurement governance
When definitions change, the incentive plan must change too. Otherwise, payouts become decoupled from intended performance. Strong governance prevents drift.
4. Boundaries around exceptions
Plans need flexibility, but not at the expense of credibility. Exceptions must be rare, justified, and transparent.
Dynamic systems
The most successful incentive programs are those treated as dynamic systems, not static documents or one-time solutions. They are recalibrated annually, simplified continually, and communicated clearly.
Year one enthusiasm collapses when year two reveals misalignment. But the organizations that maintain discipline—light annual tuning, not heavy redesign—enjoy incentive programs that remain strategic, motivational, and credible.
Incentive plans don’t fail because they’re flawed. They fail because they get out of alignment. The companies that avoid this fate understand the truth: incentive design is ongoing leadership, not a one-time event.
How does your compensation stack up?
The compensation consultants at McDermott Associates combine deep business experience with human resources knowledge to help you assess the strengths and weaknesses of your current compensation strategy. Contact us to start the conversation.