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Effective bonus programs encourage top-notch performance

Bonus programsYour arch competitor just made your top producer a better offer.

One with a generous bonus program.

With sales goals you and she know she'll meet.

What do you do?

That's right: whisk her away to lunch and match their bonus -- with a nudge.

During the past decade, companies of all sizes have migrated away from the traditional model -- seniority pay and annual raises -- and toward variations on performance-based pay and incentive bonus programs. Many view the move as essential to reducing fixed costs while still remaining flexible enough to attract top talent in a tight job market.

The pay-for-performance trend is yet another acknowledgment of the sea change under way in America's work force as the employee surplus of the baby boom gives way to a tighter seller's market. Demographics alone indicate that today's employees are likely to enjoy their new free agency well into the future.

The precipitous swan dive of technology stocks over the past year also finds workers looking less to stock options and more to the bird-in-hand security of creative base-and-bonus pay structures.

"You're going to start to see some pressure on base compensation and cash bonuses as people become less enamored with stock options," says Keith Kefgen, president of HVS Executive Search in Mineola, N.Y. "If your comp program has been in place for 10 years, maybe you need to rethink that you have a whole different group of people with a whole different set of priorities in life."

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Once courted, now courting
Making the switch from being courted to playing the courtier hasn't come easily for many small companies, according to Lisa Audi, compensation consultant with Chicago-based Buck Consulting. The lucky ones are financially able to simply add an incentive component to their existing compensation plan -- what worker would complain? Many, however, must reserve a small percentage of employee base pay in order to fund a bonus program -- a far more delicate proposition.

"If it's an add-on, that's one thing," says Audi. "But sometimes companies go into it and say, 'We'll put 5 percent of your pay at risk but if we meet the goal, you'll earn 15 percent.' OK, that's a good deal. But if we say we're going to put 5 percent of your pay at risk but you have the opportunity to earn 7 percent, that's not a very good deal. I think employees are looking for at least a two-times payout of what they put at risk."

Employers may find that workers balk at having their base pay tampered with at all, even if the upside potential is significant.

"Sometimes it's hard to sell any kind of base-pay decrease," Audi admits. "In that case, a company may just stop giving base-pay increases and put that into the incentive plan."

Different folks, different strokes
Bonus programs are as varied as the companies that offer them, as this list of plan profiles illustrates. No one program fits all needs.

But most aim to encourage one of two basic corporate objectives: teamwork or individual accomplishment.

  • For companies with relatively flat organizational charts where most employees do the same thing (manufacturing and banking, for instance), team-building techniques such as group-incentive and gain-sharing plans help everyone pull together toward specific corporate goals.
  • Companies that are more entrepreneurial or sales oriented may get better results by rewarding individual performance through a merit-based bonus program.
  • Companies with high turnover or varied skill sets may want to consider competency-based, skill-based and small-group incentive approaches.
  • If there are already too many rungs on your wage ladder, you might consider broadbanding, which allows for greater flexibility to reward top producers but still encourages teamwork.

Regardless of which plans you use, it's important to set realistic goals that your employees will view as fair and achievable. A 20-percent projected increase in sales may delight shareholders and pump up your sales team, but you'll need a more conservative target to interest the rank and file.

Kefgen advises letting the nature of what you do help guide how you choose to motivate your employees.

"I counsel most people to blend most of these in order to add two to four counterbalances," he says. "If you only rewarded attendance, for example, someone could come to work every day and goof off.

"Small companies need to be a little bit more creative about all of the things that motivate people," he adds. "Many of them can't afford to compete with the larger companies. The key for them is, don't try to. Create an environment where people want to work for you for a fair and good wage, treat people right, treat people fairly, give them an opportunity for creativity and to make an impact and give them a lot more contact with decision-making. You're not going to compete in pay, but you can do it in lifestyle and decision-making."

Tip

When determining whether your company can afford an incentive bonus plan, don't forget to consider overtime laws. Under certain circumstances, the Fair Labor Standards Act requires that you include bonus pay in the base salary of employees when calculating overtime. If your employees regularly work overtime, the increased cost could break your bonus budget.

Inside the incentive curve
While bonus programs may vary widely, they all face the same tendency to degenerate from incentive to entitlement if not properly managed.

Ideally, yours should be clearly linked to company objectives and do what you promise it will do, in good years and bad. The quickest way to get your employees to lose interest in the program is to cave in and pay a bonus when none was earned.

"An incentive plan that works does not pay out when performance is bad," says Audi. "That's when employees start thinking, 'Well, this is a rip-off.' It takes some work to keep it from being an entitlement."

Audi suggests renewing your bonus contract with your employees every year, using last year's met goal as this year's threshold for minimum payout, raising the bar slightly for the top payout.

"You want to keep employees in what we call the incentive curve, to where what they got last year for their performance should at least pay out as a threshold of this year's plan," she explains. "The goals they met last year should be at the minimum of this year's plan, plus a little stretch. If they made 5 percent last year for meeting three goals, if they meet those goals this year, they might at least expect a 2-percent minimum payout, depending on circumstances."

If you're in a fast-moving industry or experience considerable turnover, you may want to offer quarterly bonuses to encourage retention.

"If you do that, and it's based on annual goals, there are two things you should do," Audi cautions. "First, you want to hold some retainer so that each quarter, if your payout is at the 10 percent level, maybe you pay out only 8 percent for the quarter and hold that 2 percent just in case the goals should really go astray at the end of the year, to make sure you haven't overpaid. You would usually pay out that retainer as an end-of-year kick.

"Also, as you pay out quarterly, look at the annual goals and adjust them as needed. Either hold those fourth-quarter bonuses against performance or possibly pay out a larger bonus if goals are exceeded."

No more Santa Clauses
If you're one of those generous souls who take great pride in doling out holiday cash to the troops, the shift to a performance-based incentive program may seem cold and uncaring at first.

Kefgen says in reality, it's just the opposite.

"The bonus programs that tend to go wrong are the ones that aren't grounded in quantitative measures, they're totally qualitative. I call them the Santa Claus bonuses," he says. "They breed expectations. People work hard, or at least they think they work hard. It sets people up for disappointment."

By contrast, performance-based bonuses don't depend on you -- they depend on them.

Ask yourself these questions after you've designed your program:

  • Are my objectives clear? Do my employees know exactly what is expected of them and exactly what they will receive if they meet those objectives?
  • Is the plan based on quantifiable measures?
  • Is the plan flexible? Does it compensate all employees fairly and equitably?
  • Are the plan's goals realistic and achievable?
  • Is the plan simple to communicate?
  • Will it elicit employee enthusiasm and buy-in?

If you answered "no" to any of the above, go back to the drawing board.

Will everyone love you for your performance-based incentive program the way they welcomed that envelope of cash in the old days? Not likely.

But if it's designed correctly, they will work hard to earn that extra income rather than spend the year wondering how generous you'll be feeling come December.

"You can't have a goal of wanting to make everyone happy because people just don't tend to be happy about their pay," admits Audi. "I think the key is to make sure you're doing it in a fair and consistent way."

Jay MacDonald is a contributing editor based in Florida.

-- Posted: April 27, 2001

 

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See Also
PLUS: Types of bonus plans
What's out -- casual. What's in -- dress codes
Better benefits make more productive workers
More Small Biz stories

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