Six Key Factors in Developing an Effective Annual Bonus Scheme

All forecasts are suggesting lower funding levels than last year, and we can expect questions over how to best distribute the money that is available to benefit the business and its people. As part of this discussion, we should also expect the debate around the effectiveness of an annual bonus scheme to reignite.

Common questions that emerge almost annually around annual bonus plans centre around whether they are a source of employee engagement or disengagement and whether they represent a good investment of time and money or not. Regardless of the arguments for and against these plans, the simple fact is that they are a core part of most reward packages, and we need to find a way of making them work.

I have set out below six key factors which, based on my own experience, are key to developing an effective annual bonus scheme that delivers value for the business and for employees:

Culturally aligned

Perhaps the most important differentiator between great schemes and others is that great schemes embody and reward the organisation’s culture and values. For example, in organisations that want to be highly collaborative, a bonus scheme which is based purely on personal performance and contribution is not going to work. Such schemes run contrary to the desired culture and create conflict between what an organisation says is important, and what it pays people to do.

While this sounds obvious, a large number of employers put themselves in exactly this scenario. Organisations with highly valued schemes recognise the importance of cultural alignment and the need to use the scheme to help embed and drive the desired values and behaviours.

Clear and transparent

Increasing regulatory emphasis on pay transparency (e.g. in the EU) is welcome when it comes to an annual bonus scheme. Schemes which simply give a bonus pool to a manager for them to distribute amongst their team as they see fit are rarely a good idea and usually fail to deliver a positive, value-adding impact on the business. To act as an incentive, employees need to understand what factors influence the bonus and therefore what they can do to impact that. Ideally, this includes the ability for the employee to understand how they/ the business are tracking against that during the course of the year.

Highly discretionary schemes are often described by employees as a ‘survivors bonus’ in that you simply need to be in the business on a certain date to get one or as ‘free money’ because they don’t know what they have done to earn it. Clearly, this terminology is not particularly helpful for the business wanting to see a positive return on their investment.

Increasing regulatory emphasis on pay transparency (e.g. in the EU) is welcome when it comes to an annual bonus scheme. Schemes which simply give a bonus pool to a manager for them to distribute amongst their team as they see fit are rarely a good idea and usually fail to deliver a positive, value-adding impact on the business. To act as an incentive, employees need to understand what factors influence the bonus and therefore what they can do to impact that. Ideally, this includes the ability for the employee to understand how they/ the business are tracking against that during the course of the year.

Highly discretionary schemes are often described by employees as a ‘survivors bonus’ in that you simply need to be in the business on a certain date to get one or as ‘free money’ because they don’t know what they have done to earn it. Clearly, this terminology is not particularly helpful for the business wanting to see a positive return on their investment.

Performance oriented

The most effective schemes are linked very clearly to performance outcomes which might be business, team or individually related depending on the desired business culture. Helping employees see that link and understand the impact of over/ under performance is a powerful engagement tool.
In considering the alignment with performance it is also important to consider the metrics used. Having a very simple one-size fits all approach may be appealing from an administration and communication perspective but this approach can present other challenges.

One client I worked with had very simple business-wide performance criteria on their bonus which resulted in 95% of employees at the same grade getting exactly the same amount. This business found it incredibly difficult to retain its highest performers who felt that their contribution and extra performance was never recognised and that it allowed poor performers to ‘hide’ within the team.

At the opposite end of the spectrum, one former client had an incentive plan in place where awards were determined based on a performance dashboard that contained 45 distinct metrics. In this scenario, scheme awards were remarkably consistent from one year to the next as individual metrics were continually cancelling each other out.

There is clearly a balance to be achieved and while there is no right answer, four to six feels like a reasonable compromise (can you really focus on more than six key metrics?) and they should be reviewed each year to determine their suitability for the year ahead in light of changing business priorities.

Communication

As a general guide, if you cannot communicate the core components of an annual bonus scheme on one side of A4, then you cannot communicate it. I helped to redesign a scheme a few years ago where the communication manual was 47 pages long and was written in pseudo-legalise. When I spoke to employees about the scheme, most admitted that they had given up on the manual and just waited to see what they received at the end of the year.

Rewards that are meaningful

About 10 years ago, I was working with a well-known financial services company who had a personally driven performance related bonus scheme operating at all levels of the business. At the lowest two grades, employees, line managers and HR were involved in an extensive process over approximately three months each year to determine and calibrate performance levels across the business and to link this to bonus awards. All of this work helped to determine an average annual bonus award at the lowest two levels of around £250. The scheme was known internally as the ‘pizza pay policy’ as it was worth the equivalent of a large pizza and soft drink each month! When presented with this evidence, the organisation was quick to remove the scheme at these levels.

Rewards that are Differentiated

Attention should be given to the gearing of the award levels to ensure they recognise performance appropriately. Schemes with small levels of differentiation in the awards for poor, positive and outstanding performance will not be adding value in the minds of the employee.

Outstanding performance is difficult for employees to deliver and often requires going well above and beyond the normal contribution required and this needs to be reflected in the level of award payouts available. Positive differentiation would often be funded by having poor performers receiving no, or very little, bonus.

As evidenced by the number of employers who tolerate under-performing annual bonus schemes year-after-year, designing an effective scheme can be challenging. They need to be culturally aligned, transparent, easy to communicate and offer meaningful and differentiated reward levels. When they follow these principles, schemes can add significant value to employees and to the business alike as they help to drive desired behaviours and outcomes and create a sense of shared purpose which is both engaging and motivating.

Would you like to know more?

If you have any questions about the above and how it applies to your business, please get in touch with your usual Blick Rothenberg contact or Stuart Hyland using the details on this page.