Why is Three the Magic Number for Incentive Plan Metrics?

Why is Three the Magic Number for Incentive Plan Metrics?

The Rule of Threes states that there should be no more than three metrics involved with any incentive plan. But what makes the number three so powerful when it comes to incentive plan design? Let’s explore a few reasons.

For one, having three metrics leaves enough room for differentiation, and enough weight for the metric to have a measurable impact. Think of it this way: If a third of your employees’ total bonus amount depends on them hitting a specific goal, the odds of them focusing on this objective – along with the other two – are likely to be fairly high.

Conversely, with five or more metrics, at least one will be so low in terms of payout that it is essentially designed to be ignored. And if the employee is left to determine the level of importance for each incentive on their own, they may wind up overlooking what matters most.

Finally, focusing on just one or two metrics could work well in theory. Yet, with such a limited number of priorities, leadership may have difficulty coming to an agreement on the right one or two most important objectives.

How Much of Each Metric?

After thoughtful planning and deliberation have led you to determine the three metrics to feature in your incentive plan, the next question is: How much of each incentive do employees need to achieve? According to behavioral economics principles, incentive pay works best when you give employees three performance levels to strive for:

  • Threshold: The threshold performance level is “good enough.” It’s the bare minimum of performance needed to prevent something bad from happening, such as losing a client or getting fired. In other words, employees must achieve this level of effort, or else the company cannot continue operating as it does. Employees should be quite confident that they can hit this level. It should be achievable with 80-90% probability.
  • Target: Achievable but difficult, the target is the equivalence of doing a good job. Employees should feel pretty sure they could make it, but not positive. There should be a 60-70% chance of achieving the target level.
  • Excellence: The maximum level of performance will exceed expectations, and employees should feel pretty sure they won’t hit it. This level is possible but not always plausible, and there’s a 10-15% probability of reaching it. In most cases, this level will only be reached if everything goes right.

 

Some business leaders might question the threshold level or fault it for being too easy. For some employees, it may translate to underperformance. Yet, it’s still enough to keep the company moving forward, and more importantly, it provides a starting point which can be easily communicated to employees for encouragement to do better. Setting the threshold level too high is a mistake many companies make, but it’s one that can backfire, causing demotivation. When employees have performed well and the company is doing better but they fail to be rewarded because it wasn’t “better enough,” they’ll be unlikely to contribute the same level of effort again.

 

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