Business Advisory Blog

Bonus Versus Pay For Performance

Bonuses paid when a job or a year “goes well” or “you make money”, or worse, paid as a Christmas bonus inevitably become ENTITLEMENTS.  When the incentive is not paid based on the job and/or the year EXCEEDING your planned profit and performance, when it’s not based on the employee or employee group (as applicable) exceeding their specific standards in their jobs linked to your MINIMUM ACCEPTABLE PROFIT, simply the bonus becomes a gift and eventually becomes an expected entitlement.  When it becomes an expected entitlement and it’s not paid on a job or at the end of the fiscal year or in December, the reverse often occurs…productivity declines – another waste of profit and cash flow with a potential decline in business discipline, poor attitudes, and more lost profit and cash flow.

In order for a performance compensation system to work it should have the following qualities:

  • Specific standards for the job and year must be clearly established, defined, and measurable both by position and overall job and company results in terms of PROFIT.
  • There must be a method of timely, accurate, and easily understood measurement by those performing the tasks comparing actual results to standards both at the job level, individual performance level, and at a defined company level.
  • Payments should be made routinely throughout the year, not just at year end.
  • Incentives paid on a specifically awarded job should have a portion deferred for quarterly or annual incentives to avoid the trap of one big win…followed by a bigger loser…and you just can’t ask for a refund from your employee when you lose.
  • Incentives should be proportioned to the individual exceeding his/her job performance (when measurable), proportioned to the awarded job, and proportioned to the company meeting its overall profit goals.
  • Lock in a portion of the annual incentives earned as deferred beyond the current year that will vest after 3-5 years to lock in good employees (golden handcuffs) and not over compensate inconsistent employees.
  • Eventually migrate to incentive compensation over raises at the various job levels.  You’ll find that over 1-3 years you’ll attract better performers who want to work in a higher paying performance environment, you’ll make more money, and have a better basis for new employee marketing and recruitment.

Achievable minimum acceptable planned profit control, coupled with individual accountability to specific standards tied to incentives, makes you more profit.