The annual bonus – why it will never disappear…

Two conversations this week about bonus plans.?Both underpinned by a broad dissatisfaction as to their effectiveness, and (perhaps more tellingly), a concern about whether they offered a comfortable “cultural fit” for the organisations in question.?It raises the interesting (and oft asked) question, “are they worth it?”.

The answer is, of course, yes – but only if used correctly.?As a general rule, dissatisfaction arises when either:

1. An organisation adopts an approach that is misaligned with its intent;
2. An organisation adopts an approach which is aligned with its intent, but implements it badly.

Evaluating intent

You can’t adopt a bonus plan without being very clear on what its purpose is.?There are methods we can use to elicit this – but in general terms we are interested in the interplay between whether we seek an incentive or a reward.?It is difficult to adopt a plan that can deliver convincingly to both agendas.

It may be that people consider the difference between an incentive and a reward to be blurred.?I am not so sure this is the case.?At its simplest, we can reward shared endeavour – this seeks to deliver equity in our reward outcome.?Or we can incentivise results people can affect.?This has got nothing to do with equity – it seeks to drive an outcome.

You can see where this takes us in the context of my conversations which were the catalyst for this piece.?If a business feels its bonus is not effective, then it may need to sharpen its “incentive” effect.?If it thinks its bonus is counter to its culture, it may wish to turn up the “reward” dial.?

You can’t turn up the dial on both, I am afraid.

Delivering on intent

Delivering on the intent is not straightforward.?There is a lot of noise in the system about bonus and it makes seeking a clear outcome harder than it should be.?There are four areas to traverse:

• Market practice:?much of the noise comes from the sentence “when I worked in “Organisation X”, we did this”.?This is interesting but unhelpful.?Be informed by models you see out there.??It is most unlikely that looking at a lot of them will get you any closer to an answer relevant to you.
• Spend: you have to spend the right amount of money.?In data terms, for target performance, this is the difference between base salary and total target cash.?By which I mean, spending less on bonus does not offer a saving – it simply requires your base pay offer to be higher to make up the difference. It may sound rude, but if you can’t afford to pay a bonus then you are either paying salaries high enough to mean you don’t need one, or your operating model is not quite “target”.
• Discretion:?discretion requires trust.?If you have a trust “issue” then a plan built around discretion is not your friend.?We see this often – many businesses actually have a high “bonus” spend, but it is delivered post year end, when the results are known, on an entirely discretionary basis, to people who are viewed as having had a good year.?This is not a bonus.?It is a piece of long-range recognition (if that is even a thing) – and is ignored by recipients in assessing the value of a total reward offer and candidates thinking of joining.?The definition of the worst of all worlds.?
• Individual performance:?if individual performance factors into your bonus calculation you have to be comfortable that you have a sensible basis for measuring individual performance.?It may not be fashionable, but a performance management system with no ratings is not much use for determining governance framed reward outcomes.?The number of businesses that dispensed with performance ratings because they were counter to good performance management but then introduced them under the table to calculate bonus outputs tells us how little interplay there is between the reward function and the talent function in a business.

Who has got it right??You can spot the businesses that have cracked the code.?They don’t all do the same thing (quite the reverse), but we can generally see:

• Differentiation of outcome: either year by year and/or between individual (if the plan measures individual performance).?It is called variable pay, after all.
• Clarity: this is not about dumbing down an incentive.?It is OK to have three measures, or a multiplier, or a scorecard.?But you still need to be able to say in a sentence what you are rewarding.
• Segmentation: most organisations will struggle to adopt one plan for everyone. So, they will have more than one plan – whether it be adjusted for salespeople, or tailored for their captive start up, or de-leveraged for their compliance teams.?We used to view one approach as a virtue – now we can see the merits of diversity.
• History: you have to stick with it. Adjusting the plan every year to make it work better never produces a better outcome. Much better to look at this once, properly, and maintain the model.?With a three-year cycle you will have enough time to see how it is working.?With a one-year cycle you have either a lot of happy people, or a lot of unhappy people. This is not a compelling data set.

So is the bonus here to stay??

With inflation running at c.10%, delivering the annual pay review is proving to be a difficult exercise. ?And simply increasing the salary bill without a clear path to profitable growth is not an option for most businesses.?Hence we shall see, for senior people in particular, an increased focus on variable pay.?With a higher earnings opportunity, but the requirement for a corresponding level of growth - to maintain margin.?

Our annual bonus is here to stay.