Bonuses or incentive pay are a powerful strategy—yes, a strategy, not just a tactic—for enhancing employee satisfaction and boosting productivity.
However, the effectiveness of bonuses depend on how well your bonus program is configured and communicated across your organization. You’ll know you’ve got it right when your employees are motivated and you’re not struggling to retain your top performers.
Before designing — or redesigning — the foundations of your company’s bonus pay program, consider and leverage these three principles to ensure your program is aligned to your core values and business priorities: Transparency, commitment and specificity.
Principle #1: Transparency
The most effective variable compensation or bonus programs leverage transparency to build trust and loyalty with employees. But transparency comes in multiple forms: From sharing the overall program design to specific plan calculations and key results.
Bonus Program Design
Exposing the overall program design means that employees have some level of visibility (or complete visibility) of the bonus models used across the organization. This can be beneficial so employees understand both where their plan fits as well as their potential for future growth.
Bonus Plan Calculations
Specific plan calculations are one of the most important and valuable areas of transparency as this allows the individual to understand how inputs result in outcomes. Or, more specifically, how their inputs result in their desired outcomes. Opaqueness in this area is one of the greatest drivers of employee distrust and dissatisfaction with their bonus program.
Key Metrics & Results
The decision to expose the results of key metrics has many considerations. While “radical transparency” has been embraced by many up-and-coming companies, established companies tend to prefer to protect information around performance and results (e.g., monthly revenues or gross profit).
On the one hand, when more employees have detailed knowledge of this information, there is a higher risk of sensitive information being leaked. Public companies have an even greater responsibility to protect such information if it could be beneficial within financial markets prior to public earnings announcements.
Another aspect to consider is whether the employees being exposed to these key results truly understand how these metrics fluctuate period over period. For example, revenue is pretty easy to understand, but EBITDA (especially on an adjusted basis) may be an abstract concept to employees that do not have a financial background.
In these examples, there is a higher burden on the company to educate and communicate. But this trade-off may be worth it in the long-run.
Principle #2: Commitment
Many traditional and legacy bonus programs work like this: At the end of every year once performance has been assessed, executives will unilaterally decide the amount of discretionary funds to use for bonuses. This unstructured approach creates uncertainty in the minds of employees as to whether the enterprise is committed to the program and whether the eventual payout is worth sticking around for.
To demonstrate your organization’s commitment to bonus pay, remove the element of discretion and use a formulaic, deterministic approach to calculating bonus amounts, making it a true variable compensation model.
One financial necessity that supports a structured approach is that the business must fully accrue the expense throughout the measurement period to accurately reflect the payroll liability. Just like regular compensation, variable compensation can and should be modeled in the annual planning and budgeting cycle to capture expected payouts based on “target variable compensation.” This also allows the enterprise to understand the impact of over-performance and under-performance on payroll expenses.
Plus, a structured approach does not preclude an enterprise from providing discretionary or “spot” bonuses which can be used to reward exceptional performance or retain high-potential talent. However, in our experience, it works best if the discretionary pool of funds is small relative to the formulaic bonus program.
Principle #3: Specificity
By definition, incentives should influence behavior. Specific behaviors. This means that incentives should be 1) the appropriate magnitude in terms of value relative to total compensation and 2) have a strong, amplifying correlation to the behavior or performance that you are trying to incent.
Awards, on the other hand, in the context of designing bonus programs or variable compensation models, refer to those measurements that are difficult for the individual team member to influence through their behavior.
For example, it may be difficult for an entry-level employee to draw a correlation between their performance as an individual and the total profits of the enterprise. Even if they perform exceptionally, it is likely that their incremental contribution has a low impact on this measure. Awards can still be effective tools for creating alignment and a group sense of purpose, but they fill a different purpose than an incentive.
As you can see, bonus pay and incentives cannot be an afterthought. In a competitive labor market, they are what set you apart in the eyes of employees and potential employees and serve as an essential part of your total rewards system.
Purcent, the all-in-one incentive management platform, helps you spend less time creating complex spreadsheets that are prone to typos and errors—making more efficient use of time for your people leaders and HR managers.
If you’re looking for a tools to simplify how you manage and administer bonuses, let’s talk.