- Start with a small bonus pool an let it grow as the year goes on, so that people have the opportunity and incentive to meet all the goals – and earn the entire bonus – right up to the end.
By “bonus pool” I mean the total amount of money available to be paid out in bonuses during any given period. I’m saying the pool should start small and grow form month to month or quarter to quarter.
This is a very important point. If you are not careful, inadvertently build some subtle demotivators into your plan. Suppose you decide to give people the chance to earn 25 percent of the annual bonus in each quarter of the year, and they come up short in the first two quarters. That would take a lot of the steam out of the program. People might well get demoralized and stop trying. Suppose, on the other hand, they simply had to the achieve the goals at any point in order to earn the bonus for the entire year – and they got everything done by the middle of third quarter. Chances are that the company would be headed for big trouble before the year was through.
We avoid these pitfalls by increasing the stakes as the year goes on and by rolling any unearthed bonus form one quarter into the pot for the next quarter. Here’s how it works: the bonus pool for the first quarter is 10 percent of the total for the year. For the second quarter, it’s 20 percent; for the third quarter, it’s 30 percent; for the fourth quarter, it’s 40 percent. Let’s say we hit half of our targets in the first quarter and thus earn half of the available bonus. That amounts to 5 percent (half of 10 percent) of the total bonus we are eligible to earn during the year. We get paid the 5 percent we’ve earned right away; the unearned 5 percent is rolled over into the second quarter pool. So now, in the second quarter, we are going after 25 percent of the annual bonus pool (the 20 percent share for the second quarter, plus the 5 percent share left over from the first quarter). Suppose we don’t hit any of our targets in the second quarter. In that case, the entire 25 percent gets rolled into the third quarter, which means we are now shooting for 55 percent of the annual bonus (the 30 percent share from the third quarter, plus the 20 percent from the second, plus the 5 percent from the first). Even if we hit all of our highest targets in the third quarter, there is 40 percent of the bonus pool available to go after in the fourth quarter. If we don’t hit any of our targets, we still have a chance to earn the rest of the annual bonus (95 percent) before the end of the year.
As a result, people stay in the game right up to the last whistle. We can win one quarter at a time, or we can pull it out on a Hail Mary pass in the final seconds. Like the man said, “it ain’t over till the fat lady sings” – and, by then, we have another game ready to go.
- Communicate, Communicate, Communicate
Above all, make sure people understand how the bonus program works and are kept up-to-date on how they’re doing. Bad communication is the main reason most bonus systems fail. … Of course, if the bonus program makes sense, explaining it shouldn’t be that difficult. … Go ahead and launch the program. Most people are going to learn about the bonus game the way people always learn about games: by playing it.
What’s crucial is to have an effective system for keeping track of the results and communicating them throughout the company. Set a day and a time when the latest score will be announced each week .. and then make sure you hit it. People will start looking forward to these updates. Do no disappoint them. If you are late with the scores, you will feed people’s doubts and suspicions, dampen their enthusiasm, and undermine your chance of success.
Obviously, we are talking about fundamental questions of management here. That’s perhaps the most important benefit of a good bonus program. It provides a powerful incentive to make sure people throughout the organization have a clear understanding of their roles and the information required to perform them as well as possible. A company’s ability to manage the flow of information will go a long way toward determining not only the effectiveness of its bonus program but its ultimate success in the marketplace.
- Don’t Pay the Bonus Unless It Is Earned (But Do Everything You Can to Help People Win).
This is a simple point, but it is fundamental. The bonus program should be a tool for putting people in touch with the realities of the marketplace. A bonus should not be seen as a gift from management. It should be a reward people earn by doing a better job than their competitors who are out there vying for the same customers. You undermine that message if you pay the bonus when people come up short on their targets.
Bonus Math, or How It All Adds Up
- Set the profit targets and the maximum bonus payouts
- Decide on a Balance-Sheet goal
- Set the targets on the Balance-Sheet goal
- Protect your equity
That can be very, very tough for a CEO. If people have tried hard and missed by a tiny amount, there is a big temptation to pay the bonus anyway. Resist it. Once you start changing the rules of the game, you step onto a slippery slope, and it’s hard to go back. … So now, as we near the end of the quarter, our accountants come into the weekly meeting with sheets showing exactly what we must do to get to the next level on each goal. You can always come up with a few thousand dollars extra in some area, if that’s what it takes.
The real power of the bonus program lies in its ability to educate people about business. Once they understand the math, they see how everything fits together, and how business can be a tool for getting them what they want. And it all doesfit together. The system really works. You can’t criticize it because it is simply a reflection of reality. You can criticize individuals. You can take people to task for the way they do business. You can go after the ones who are greedy, who only want to help themselves, who exploit other people for personal gain. But the fault lies in those individuals, not in the nature of capitalism.