How to Design a Bonus Plan

Contrary to popular belief, when it comes to designing a bonus plan, the 'magic' actually happens towards the ends of the process, not at the start.

I remember one particular initial meeting discussing a new idea for bonus plans, and one member of the group had already modelled the percentages, despite the fact we hadn’t even agreed on the aims or discussed which roles would be in scope. The modelling may become an important aspect of bonus planning, but it comes much later.

My point is, whatever sort of bonus plan you may be considering, there are three critical things that you must consider before moving into the design phase:

1. Aims: Get clear the aims of the plan and design principles
2. Roles: Understand the roles of the groups and potential participants
3. Context: Look at the context within which the bonus will operate

Only once you have worked through all of these three points are you in a good place to start designing the plan.

Aims: Plan & Design Principles

The critical question you must answer to start with is, ‘what is the bonus for?’ This can be a difficult question to answer, particularly if you have had bonuses operating for some time.

You should write down your reasons and have these agreed with whomever the main stakeholders are. E.g. The purpose of the XYZ bonus plan is to... (and I am afraid that ... to help recruit, retain and motivate. is just not good enough). Maybe these questions will help:

If you can really distil the essence of what you are trying to achieve, you may decide that a bonus is not actually the right answer - and that's okay. Just remember to keep an open mind and be honest about your aims.

Once established,

I recommend you also develop a set of design principles that you can agree with the key stakeholders. These are the agreed principles to which the design should adhere. Some may be in conflict but do not shy away from this. The benefit of agreeing on design principles is that you can get stakeholders to focus on the things that are important to help achieve the aims but not get fixated on the detail of the design.

Examples:

1. The bonus should not focus on individual performance at the potential cost of the larger unit to which he/she contributes.
2. The bonus plan should be as simple as possible.
3. The potential bonus will be expressed as both target and minimum. The minimum bonus will be zero.

Roles: Understand the Roles of Potential Participants

You should be clear about the target population of employees who you expect to participate in the plan. You need to be quite specific, put it in writing and agree with it with key stakeholders to ensure there are no misunderstandings.

Ideally, an individual should be able to see the connection between what they do and the outcome. So, if you are going to use individual bonuses, based on individual results, the individual should be able to control the outcome. It is important to question very carefully the nature of any roles for which you are considering introducing a bonus.

In a modern organization, how many people have that degree of control? I would say very few. To achieve a work result, we almost always work either directly or indirectly with others. Even when you look at sales roles you often find that individual roles support each other to achieve the final outcome; whilst the starting assumption might be to introduce a bonus based on individual results, that may not reflect reality. It may even destroy value rather than improve it. For example, if your bonus plan is based on purely individual results, it is likely to encourage selfish behaviours – not supporting others keeping things to yourself and protecting your own results regardless of the corporate consequences.

So, consider carefully if your bonus plan should be on an individual or team basis, or at least with outcomes to which the individual contributes rather than for which they are directly accountable. You may decide to use two or three measures in combination (such as individual and division) to reflect these elements. Some key questions to ask are:

Context: Within Which the Bonus will Operate

I am sceptical of the concept of ‘best practice’; more important is ‘best fit’. It is vital to ensure you have a bonus plan that fits your organization rather than simply trying to replicate someone else’s.

The way things are done will be different from one organisation to another. A bonus scheme needs to work within your culture, communications system, levels of management effectiveness, IT systems and available management information. So you need to really understand these elements and how they may enable or limit a bonus.

Nothing exists in a vacuum, and you must consider the organizational context within which the bonus plan will operate. For example, how effective is your management at communicating messages? How will they be able to operate the bonus plan you are thinking about? Whilst good managers don’t need bonus plans to help them manage, look at how people do manage in the organization and what further training they may require to help embed the bonus to make it as effective as possible. Bonuses do not manage for you and in isolation, they may do very little good. But if a manager believes that they can abdicate responsibility for managing performance because the bonus will drive the right outcomes, you are in trouble.