Bonus: Friend or foe?

Many companies offer bonuses as part of their compensation packages. When managed well, they can drive behavior that aligns with a company’s goals and strategy – and ultimately overall performance. On the other hand, a poorly designed bonus system, can lead to demotivation, misalignment, and poor performance.

Long-term or short-term? Cash incentives or equity compensation? A mix of financial and non-financial metrics? Bonuses can take many forms – not all of which are possible for every organization.

When creating a bonus system, it is important for managers to think like owners. This will result in an alignment of shareholder and management interest – and a more effective bonus system that works on multiple levels of an organization.

A good middle ground here – and the focus of this article – is the annual employee performance bonus.

Once you have decided on a performance-based bonus system, you will need to set targets. This allows you to measure what you aim to reward. A bonus should always revolve around your organization’s strategic goals, with payouts focused on several factors, such as performance, culture, and ESG compliance.

Performance metrics can be measured on a mix of both financial targets, such as EBITDA, sales volume, commercial margins or working capital, and non-financial targets, such as talent mentoring or completing projects on deadline. Additionally, you can help drive collaboration within your organization by looking further than individual targets, and setting goals that teams or departments can work toward together, improving morale and productivity.

Discussions surrounding target compliance often arise when it comes time to pay out bonuses. These can be avoided by clearly defining targets to ensure that all employees fully understand the bonus system.

Management must be clear that a bonus is compensation for extraordinary performance, not a fixed element of a salary package. This means bonuses can vary from year to year, with management having the ability to adjust payouts to address exceptional circumstances outside an employee’s control, such as import or export restrictions, or, in recent years, COVID-19. Here, however, it is wise to tread carefully – as a company’s ability to pay bonuses may also have been affected by those same circumstances.

Bonuses are certainly important elements that can drive performance – but should never be the only incentive for employees, especially when it comes to talent attraction and retention.

A Forbes article touched on the dangers of relying solely on financial bonuses. “When people feel overly controlled by a reward or incentive, they will backlash and do the opposite,” the article reads. “So even an exciting, effective idea initially may end up being viewed as manipulative and actually decreasing employees’ motivation over the long-run.”

Instead, company leaders would be wise to also focus on creating the right company culture in which people feel safe and happy, defining a clear purpose behind which employees can align, and offering employees opportunities to develop professionally.

Bonuses, then, should be viewed as tools. Used correctly – and with targets that are well-defined and aligned – they can drive behavior and performance. And when combined with additional employee perks and benefits, they can help lay the foundation for organizations that are functional, flexible, and ready for the future.