Effective Bonus Plans, CompDoctor Feburary 2000

Q: Our executives have been debating the effectiveness of bonus plans. One of them flatly states that bonus plans do not work, they can be "gamed" and that we should just pay a good salary. Another is adamant that bonus plans work and that the bonuses must be substantial in order to motivate employees. What is the reality?-P.M.

CompDoctor™: This may seem like a non-answer, P.M., but in reality they're both right. Even human resource directors and their compensation staffs will have mixed feelings about bonuses. Your question reminds me of the spirital seeker who spent torturous hours climbing the mountain to learn the meaning of life, only to reach the mountaintop and find a placard reading, "I don't know." But I don't want to leave you high and dry, so I will try to explain it from both points of view.

The first bigwig you mention, whom we'll call Executive A, shrewdly notes that bonuses sometimes are rewarded more subjectively than salaries and can be "gamed," or manipulated, which throws your entire compensation strategy out of whack. Executive B, on the other hand, is right to say that bonuses, especially big ones, are great motivators. And the trend toward performance-based pay structures clearly adds weight to the B-side of the argument.

Unfortunately, it's fairly easy to create a bonus system that fails to motivate. That's why creating an effective plan can be so much of a challenge. Believe me, the CompDoctor has seen it all: "team pay" bonus set-ups that end up rewarding individuals at the expense of their teammates; bonus payments tied to profits that never materialize; and the list goes on.

So, P.M., my advice to you will take the form of a checklist that every company should use to evaluate the wisdom of bonuses. However, I must warn you that for every "No" answer that you utter, you must reduce your salary by $10,000, diverting the total amount to the CompDoctor, in care of Ventures magazine. (Just my own little way of saying, "Those who cannot manage to bonus their people, no matter how challenging it seems, should not be making so much. How's that for a bonus plan!)

The checklist:

1. Is your bonus plan available to all employees who can actually make a significant difference in whether your business is successful? Careful here. If you are small, more people will qualify than if you are a company of 1,000.

2. Can employees earn at least 5% of their base compensation in bonuses? Does the rate increase for higher level jobs? The theory here is that busting your rear for less than 5% is meaningless even to hourly employees. Bonuses must be significant in order to motivate employees. Bonus amounts should be greater for higher level jobs because those jobs tend to have more impact on the company's financial success.

3. Did the design of the plan involve employees who will be affected by the plan? The most effective bonus plans are those in which employees have invested their time on design and development. When employees are involved in the design, they are in effect making a promise to the company that they can meet the goals of the plan and want to be measured by them. They are also making a promise to themselves. Few people will break promises to themselves, especially if the promise is made in the audience of others who can call them to task later.

4. Are the goals stated in the bonus plan directly related to criteria that determine the success and failure of your company? If bonuses are not related to meaningful criteria, the program is a waste of time.

5. Can you measure the goals reliably? Ah ha, this is a killer isn't it? Here is where the gamesmanship comes in. If employees can really impact certain measures, then they can manipulate them to their advantage, thus receiving a bonus when they don't deserve one. The key is to keep the goals simple, easy to understand, and related to outcomes, not activities. Then agree to specific measures and how they will be tracked.

6. Do you communicate regularly to employees about their progress toward the goals? In other words, do you track progress weekly, monthly or at least quarterly? Do you let everyone know, in a public setting, the results? An old story about a steel company illustrates why it's so important to communicate results. The company employed workers in three shifts, and bonuses were based on productivity. At the end of the first shift, the workers had produced an admirable 7 tons of steel. So they wrote the number 7 on the company cafeteria wall. Determined not to be outdone by the first shift, the second-shift worked furiously to produce 8 tons of steel. They erased the number 7, replaced it with an 8, and went home. The third shift, in like fashion, decided to outdo the second. They produced 9 tons of steel, and wrote the number on the wall. When the first shift came to work the next day and found that they had been left in the dust, they invented ways to work more efficiently and were able to produce 10 tons of steel. The power of bonuses plus publicly communicating the results.

7. Are you measurin threshhold, target, and maximum performance? You should have a payout for meeting minimally acceptable standards, as well as a stretch goal for really knocking the socks off the competition. This acknowledges to the participants that goal setting is not an exact science and that rewards will be given for good, steady performance as well as for stardom.

8. Are some goals based on the overall success of the company? Company-wide goals should be part of every bonus program. Otherwise, employees may will work feverishly to maximize their own bonuses to the detriment of the company. And you don't want to wake up some morning to discover that you have created successful business units, but an unsuccessful business.

9. Do you have 5 or fewer goals in your plan? Most employees cannot stay focused on any more than 3 to 5 goals at a time. If you have more than 5, they get confused about what is important. Keep it simple.

10. Do you spell out events that may be excluded from the bonus program? To paraphrase the vernacular, "things happen" which prevent payouts, or which may improve the company's position but are not the result of employee performance. For example, what would happen if, out of the blue, Company X said, "We're going out of business and we'd like to shift our customers to you." (Hey, it could happen.) The surge in business would affect most bonus measures but would not reflect employee efforts. Or, suppose your company is hit by a natural disaster and must close the plant for 3 months. Should the decrease in productivity, for which no employees were at fault, reduce bonuses? Most companies make exceptions so that such events can be excluded from bonus calculations.

Well, there you have it. Hopefully you have answered every question with a resounding yes, and I am the poorer for it. But in case yours is among the legions of companies that have rendered their bonus plans ineffective, and you have therefore answered "No" to one or more of the above, please let me know so that I can get my broker prepared for a large infusion of cash.

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