How to Do Staff Bonus Plans

Paying staff a bonus or other incentive is a well tested method of improving their commitment to the business's management goals.  How to Do Staff Bonus Plans examines ways of doing this that have worked in practice. Yellow Belt

There seems to be ample evidence that a well designed bonus scheme can incentivise staff to be more productive, work safer or whatever other aspect of the business operation the owner wants to focus attention upon.

The bonus goal is a statement that these company goals are so important, we will pay you to focus on them,.

It is a mantra in business that people will focus on whatever is measured which is why having the right metrics is so important and, in this instance, the point is made even more clear by paying staff to head down that path.
Go to the article: Importance of Metrics for Profit

A bonus scheme can be used to;

  • lead to higher profit and/or
  • focus on some vulnerability of the business and incentivise staff to repair it
  • create a team feeling that will spin off to other aspect of the business as well
  • identify ongoing problems if progress is not being made towards the bonus goal fast enough

They may have problems when;

  • staff don't trust management to run the scheme fairly
  • seem to be arbitrary about who gets what
  • plays favourites - either more senior managers or only some departments
  • staff only find out about their reward after the event closes so they have not been engaged in the process
  • when the company is operating with a 'lowest cost' producer in their industry strategy that leaves margin too tight to pay bonuses.

The characteristics of a successful bonus scheme include;

  • put everyone in the same boat so all participate on an equal footing.  This does not mean more senior people don't get more but rather that the formula is clear, easily understood and made available to all and in advance
  • get all departments pulling towards the same company-wide goals so that they share knowledge and resources willingly for the greater good rather than squirrelling them away to boost their own chances
  • limit them to just a few goals.  Too many goals makes it hard for people to keep them in their mind.  Worse, the goals might be in conflict with each other if there are a number of them and pushing one up may damage the success of another
  • probably at least one should be focused on profitability as that helps to ensure survival and growth for the business
  • another might be on a balance sheet item like e.g. inventory reduction, debt repayment, 
  • alternatively, a goal could focus on a vulnerability that the business needs to patch and which would benefit from an 'all hands on deck' approach.  e.g. over dependence on just a few major clients
  • making people wait too long for the first bonus payoff means that they will tend to forget about the scheme or leave their run too late (often called the homework problem - homework is almost inevitably left to the last minute no matter how much time was given to do it).  A progress payment each quarter towards an annual goal will help to keep them focused.  If any quarter is missed, that will also drive home that the game needs to be lifted to reach the annual goal
  • frequent communication of the goal(s) driving the bonus and transparent scores are vital to keep people focused and engaged
  • once set, the ground should not change even it there are unexpected problems in the company.  If the goal is tied to profit and there are unexpected problems, the profit goal may not be reached in any case so it is self regulating
  • if the goal is missed in any period, don't weaken and pay it out nevertheless.  This will remove the competitive element and weaken the drive.  It also sets up a precedent to pay out every time, even when the goal is not missed.  That can be difficult when the goal is close to being met.  If staff have enough notice that it is a close but losing period, they might try even harder
  • one has to be careful that the goals can't be gamed to get a successful outcome despite damage being done somewhere else.  e.g. cutting back on inventory might make a short term success with a goal but a longer term disaster if there is nothing left to sell
  • there are some things like safety that should always get maximum attention for the company and are not suited to a reward system
  • if there are a number of equally deserving candidates for bonus goals, this gives an opportunity for a team approach to choosing so all staff can particulate in the process and thereby get some ownership of the process and the goal
  • the bonus should be announced and paid as soon as possible after the closing date so staff are rewarded for their efforts.  In some countries, bonuses can be paid into retirement savings accounts with a better tax rate.  It would be good to educate staff on such options as the money is saved for the long term and they may not understand that such an option exists.
  • the proportion of the bonus that an individual gets is a tricky issue.  It is not as simple as saying the more senior the staff member, the more they contribute so the more they should get. A junior person can have a great cost saving idea that the senior staff would never have due to their distance from the operational coal face.  Some staff will be casual or part time workers.  Possibly great ideas should be separately rewarded.
  • the goals should be definite and ideally sustainable improvements in the business and not a "vanity" metric that is a flash in the pan e.g. rapid sales growth that is unprofitable
    Go to the article: Importance of Metrics for Profit
  • bear in mind that staff will often not consider some of the business costs they don't see.  Your business will pay tax and interest, property costs and senior staff overheads that the line workers do not really think about.  Any bonus scheme has to appeal to them but must take these costs into account.  It may be difficult to explain that a 10% increase in operating profit will be eroded by tax.  They just see themselves working harder to give "the man" more money.  Communication of these extra 'hidden' costs can help

An Example

Let's say that increasing profit is a goal.  For a business owner, this has two payoffs; they get more income and the value of their business (which is usually a 3-5 time multiple of their operating profit before tax and interest [EBITDA] ) also goes up.

The plan chosen is;

  • allow 20% of the increase in profit to be put into the bonus pool.  With a tax rate of 30%, this is an after tax cost to the business of 14% as the bonus is tax deductible. The business therefore gets to keep 86%
  • to allow time for the business to ramp up once staff begin to see that it can work, it is decided to pay it on quarterly results and with an increasing proportion paid each quarter.  In the first quarter when staff are just coming to grips with the idea and results are likely to be lowest, just 10% of the bonus is paid.  In Q2, 20% then 30% and lastly 40% in Q4 - totalling 100%.  This also tends to make it harder to fudge a quarter because it gets caught up in the next one.
  • if a bonus is not paid in a quarter, it is added to the next quarter's percentage.  This costs the company no more and 'sweetens the pot' for the next quarter so staff are even more incentivised to try harder
  • on the basis that the more someone is paid, the more senior and/or mission critical they are, the bonus is paid out in proportion to their salary for the quarter.  This is a less than perfect system so great ideas might need some other form of incentive if that is considered fair
  • So that everyone can keep an eye on progress, the company accounts are published for all to see or, if it is not wise for full disclosure, a team of staff selected by all levels of staff get access to the accounts on a confidential basis.  In any case, the bottom line metric for the goal - in this case operating profit - does need to be made available frequently enough for people to adjust their effort if coming in under the bonus goal.  In this example, we choose monthly.
  • the accounts for the quarter are finalised, in this example company, by the end of the second week of the following quarter so the bonus is announced then and paid in the next pay run.

Jack Stack Approach

In his book referenced in Resources below and on the website, Stack has developed a bonus scheme as part of a wider "open book" management approach that shares accounting and other management data very widely throughout the staff owned company.  The bonus discussion begins in Chapter 7.

If you are thinking of an all inclusive approach to your business this is a very good text to get you started.  If you had invested $1,000 in his  open book business SRC in 1983, it would be worth $3.4 million today (2013).  By way of comparison, the same amount invested in Warren Buffet's Berkshire Hatharway would be worth $113,000.  Stack clearly has some serious street creds!

Resources

The Great Game of Business: the only sensible way to run a business by Jack Stack is devoted to an 'open book' approach to management whereby all company financial and production data is shared with everyone.  If you had invested $1,000 in his  open book business SRC in 1983, it would be worth $3.4 million today (2013).  By way of comparison, the same amount invested in Warren Buffet's Berkshire Hatharway would be worth $113,000.  Stack clearly has some serious street creds!

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