Why are Most Bonus Plans so Ineffective?

The most common employee incentive plan businesses offer is some form of bonus.  Some pay an annual award; others do something quarterly or even monthly.  Some plans are largely discretionary and others are based on detailed metrics.  Most company leaders feel it is an essential part of their pay offering and believe they would be uncompetitive in attracting and retaining talent without it.  And almost universally, those same leaders are unsatisfied with their plan—as are their employees.  So, why is that?

The reason most incentive plans don’t work is because they are built on the wrong premise.  To understand what I mean by that, let’s first discuss what the goals of a bonus plan should be and the essential ingredients that should go into its design.  Then we can talk about where most plans get off track and the fatal mistakes companies make in their development and implementation.

The Goals of a Successful Bonus Plan

If we are going to determine why most bonus plans are unsuccessful, we should start by defining what goals a bonus plan should help a business achieve.  Essentially, there are two core outcomes any incentive plan should help your company fulfill.

1. Align the financial interests of shareholders, company leaders, and employees. This means that a bonus plan’s design needs to lead to a more unified financial vision for achieving an organization’s performance targets.  This occurs when there is not only clarity about what those targets are but what they will mean to the fulfillment of every company stakeholder’s financial ambitions and goals.  When this kind of alignment occurs, employees think more like owners and owners are happy to reward the outcomes that are being produced.  A performance virtuous cycle emerges when you begin with a well-crafted rewards design.  The bonus construct should lead to greater employee focus on the outcomes for which they are responsible.  Focus leads to greater execution.  Consistent execution drives sustained performance.  When consistent and sustained performance is rewarded, focus is renewed and the cycle continues.

2. Reinforce a partnership relationship with employees. This occurs when organizations celebrate their successes and share financial value with those who help create it.  Employees who feel manipulated by bonus plans that are poorly engineered don’t feel like they have a partnership relationship with their company leaders.  They either feel the need to be guarded and suspicious or they act entitled and ungrateful—or both!  Conversely, when a company adopts a pay philosophy that defines how value is created and shared in the business, and that philosophy is communicated and reinforced with employees, the organization’s workforce feels like it is an essential partner in fulfilling their company’s growth goals—and their ambition to fulfill their roles more effectively is increased.

While no organization will fulfill those ideals completely, all organizations will fail in their bonus plan attempts if they don’t start with defining the right purpose for having the incentive.  This is what I mean when I say most bonus plans are built on the wrong premise.  They are designed to reward and reinforce behaviors instead of outcomes.  They produce either a culture of entitlement or one of confusion.  They miss the opportunity to teach employees about what it means to create value and to forge a productive partnership that leads to sustained performance.

The Ingredients of a Successful Bonus Plan

Now that we’ve defined the goals of a successful incentive, let’s turn our attention to the ingredients that will lead to the fulfillment of those aims.  Essentially, there are two key words to focus on here: standards and system. 

Standards

If a short-term value sharing plan is going to “work,” it must meet three standards:

1. It must be comprehensively understood by employees (clear).
2. The expected results must be achievable (credible).
3. The financial opportunity must be worthwhile to each participant (meaningful).

System

To achieve the standards just described, it is critical to adopt a sound System.  The System should consists of three elements:

1. Design—following a proven process to build out the plan details and wisely finalizing all decisions needed for implementation.
2. Operate—carefully handling mid-year plan and participant changes and transitioning to an effective renewal.
3. Communicate—educating employees about the plan and regularly reinforcing its value.

Try now to envision how the goals, standards, and system just described are connected.  For the goals to be achieved you must penetrate the hearts and minds of employees.  They will bind emotionally to the desired outcomes and their roles if they see how they can contribute to them and if the value of the award they will receive for fulling them is compelling.  You can’t achieve that unless you communicate, communicate, communicate.  And you can’t meet the standards unless that communication makes the plan clear, credible and meaningful.  Bonus plans won’t be clear, credible and meaningful if they are made too complicated during design or if business leaders fail to operate them effectively. 

Complexity leads to negative results, frustration for administrative teams and disappointment (morale deflation) for employees.  As a result, you should carefully consider the outcomes you’re seeking and focus employees on those outcomes in the way you design your incentive plan. The better you communicate those outcomes and align your plan design with them, the more likely you will be to achieve them.

The 5 Fatal Errors

So where do companies go wrong in their attempts to create a successful bonus plan?  Why aren’t more businesses achieving the goals and standards just described? 

Essentially, there are five errors we at VisionLink see most companies make that are fatal in the bonus plan world.  There are two in the Design stage, two in the Operation stage and one in the Communication stage. 

In the DESIGN stage:

1. Failure to build the plan primarily (if not exclusively) around company-wide results. Organizations go overboard trying to reward team or department performance and individual results.  Employees need to feel like the entire company lives and dies together.  This doesn’t mean that organizational unit or individual performance should never be components in a bonus plan.  It just means the company results should be primary and that without their achievement the incentive plan doesn’t pay out a benefit. (Yes, there are exceptions but too often the exceptions are the rule.)  This also means plans should not be highly discretionary in nature.

2. Trying to micromanage behavior by including too many metrics. This is the most common “offense” we uncover when examining a company’s incentive plan.  Metric heavy plans lead to confusion and manipulation.  Keep…it…simple.  Period!  (Okay, exclamation point!)

In the OPERATION stage:

3. Having an ineffective system for plan administration (e.g., promotions, salary changes, terminations, new hires)—and/or failing to keep up with changes. When incentive plans are not managed and administered properly, they unravel.  Those responsible for the ongoing operation of a bonus plan need systemic support to effectively execute the ongoing changes that are inherent in all pay strategies but especially value sharing plans.

4. Inability to refine and renew the plan annually (i.e., no enduring plan design). An effectively designed plan should make it easy to refine and renew each year.  It shouldn’t require a need for re-engineering the entire plan every time company leaders are about to announce the performance targets for the next 12 months.  Operationally, there should be systems for evaluating how performance elements should be rebalanced (company versus department versus individual performance) rather than trying to redesign the entire plan every renewal period.

In the COMMUNICATION stage (this is what fulfills the Standards):

5. Failure to communicate to each employee the past, present, and future relating to: 1)His/her bonus opportunity, and; 2) The company (and business unit) results.  Most organizations roll out their bonus plans and then forget about them until it’s time to pay out benefits.  As a result, they miss the opportunity to reinforce the financial partnership they are trying to forge with their people.  Pay programs in general—and incentive plans in particular—should be used as strategic tools by organizations to reinforce a link between the company’s vision, its business plan and model, roles and expectations and rewards.  That is how a unified financial vision for growing the business takes hold.

If you read these guidelines and feel discouraged about your current incentive plan, don’t be.  You’re not alone.  In fact, you’re part of the majority.  Hopefully, now you know the path forward to building a bonus plan that will turn your employees into growth partners and lift the burden of entitlement and confusion you are likely experiencing.

For more help with your bonus plan, check out VisionLink’s new online tool, BonusRight.  It will guide you through the entire process of building a plan that meets the standards just described.

To assess the strength of your current plan, complete BonusRight’s free Scorecard.