How to Structure an Employee Bonus Plan
Bonuses are seen as a great motivational tool for employees. Employees work in order to earn the compensation that is negotiated for the work, but they will be inclined to do better – to go beyond what is expected of them in the performance of their tasks as set out in their job descriptions – if they can expect to get more for it, specifically a bonus.
You often hear about companies giving bonuses, not only for higher-than-average productivity and exemplary performance from employees, but also during specific periods of the year.
Examples are specific holiday bonuses and yearend bonuses, which gradually grow into regular annual bonuses.
However, employee bonuses are also seen as a two-edged swords. They are great motivators, but they can also become de-motivators, especially when employees become accustomed to them, to the point that they deem them to be their right, and something that they can demand.
After all, if you look at various definitions of the word “bonus”, you will find words such as “additional” and “seasonal” attached.
Whether employees will motivate or demotivate will depend on how management approaches this whole issue on bonuses from the beginning. It all begins with how they create and structure an employee bonus plan.
In this article, you will learn everything about 1) employee bonus plans and 2) how to structure an employee bonus plan.
EMPLOYEE BONUS PLANS
With so many types of bonuses given to employees these days, there is a need to keep track of all of them and, once in a while, evaluate whether they accomplish what they were supposed to. For that, there should be a system or a plan in place. It is called the employee bonus program or employee bonus plan.
An employee bonus plan, which is also often referred to as an employee incentive plan, is essentially a document that contains the company’s plan for the payments of bonuses to its employees on an annual basis. This is highly encouraged for businesses that regularly give bonuses to its employees.
The importance of bonus or incentive plans can be equated to that of the importance of bonuses and incentives given to employees. Let’s look at some of them.
- An employee bonus plan will motivate employees to improve their job performance and help the business achieve its goals.
- A company tends to be more attractive to prospective applicants or candidates for a job if they know that the business has employee bonus plans for its employees. As a result, it is more likely to attract more skilled individuals who would normally have passed on the opportunity.
- Employees need to be fully informed about their rights and privileges, including their compensation and benefits, and that includes the potential rewards that they can get. This will inform them in advance what they have to do to earn these rewards or bonuses.
- If there is a bonus plan in place, the business will be better able to control the amounts that it will pay in bonuses to its employees. It can set limits and make the necessary adjustments if and when necessary.
- This will also aid management when it comes to budgeting and forecasting expenditures. The company’s financial planning will most definitely refer to the bonus plan from time to time.
Types of Employee Bonus Plans
Let us name a few of the more common employee bonus programs that are being used by businesses. The bonus plans are dependent on the particular type of bonus being given.
- Performance Bonus: The company sets targets that employees must achieve or surpass. Once they do, they will be entitled to a corresponding bonus, in recognition of their very good performance. This type of performance bonus plan is designed to continuously give employees an incentive to perform better than average in their jobs or assigned tasks and responsibilities. It is usually given on a regular or ongoing basis, such as annually or semi-annually. Another reason why performance bonus is encouraged is in order to keep a company’s top talents and skills satisfied.
- Ad Hoc Bonus: When the company gives an unplanned or unexpected bonus as a way to show its gratitude to employees for exceptional performance in a one-off project or assignment, this is referred to as an Ad Hoc bonus. This bonus plan is slightly more flexible, considering the fact that it is largely unplanned. That means that the company is not expected to have an upfront commitment about it; after all, payment of this type of bonus can be decided on the spot – when the results come in. Another advantage of this plan is that little emphasis or importance is placed on the amount. It does not have to be large or substantial to be considered effective. The mere fact that an amount – no matter how small – is given, is already something that the employees will appreciate.
- Milestone Bonus: Milestone or project bonus plans cover the bonuses that are deadline-critical or time-bound. These are usually short-term in nature, usually ranging from a couple to several months. They are also often high profile in nature, which requires that they be well-documented and communicated to all parties concerned.
Elements of an Effective Employee Bonus Plan
There is no such thing as a perfect bonus program. If there is, then we would not hear of issues involving employee strikes, pay hikes, and unmotivated employees.
The best that companies can do is to make sure they have an effective employee bonus program in place. An effective bonus program should have the following elements:
- Simplicity. The bonus plan should be simple and straightforward, so that it is easy enough to understand, not just by the management, but also by the employees, who are going to receive them.
- Equatability. The bonus program should be fair across the whole company. It would not be fair if one department has a bonus program, while the others do not. If you have a bonus program in place, make sure that the terms apply to everyone, not just a select number of divisions or departments or, worse, employees.
- Timeliness. This refers to the release or grant of the bonuses. The frequency may vary according to the achievement of specific milestones set by the company, or according to job level. It could also be according to department. Just make sure there are no unnecessary delays. If the bonus is given as a reward for good performance for a certain period, give the bonuses at the end of that same period or during the next period. It would seem anticlimactic, not to mention disappointingly delayed, if you pay it two or three periods later.
- Relevance. It should be meaningful to everyone – the management and the employees. There should be meaning attached to the bonus, so that the employee will feel a higher sense of fulfillment, knowing they are receiving the bonuses because they deserved it.
- Materiality. If the bonus is so small that it is almost insignificant, employees will not appreciate it. In fact, most of them may even feel insulted by it, and make their motivation to do their work go down. The amount of bonus must be large or significant enough to make a difference to the employee. Otherwise, it would not even be regarded as a bonus or reward.
STRUCTURING AN EMPLOYEE BONUS PLAN
Many companies have experienced having bonus plans that failed, and this failure is blamed on one of two things (or both): the bonus plan was poorly designed or it was not implemented properly.
Factors to Consider When Designing an Employee Bonus Plan
- Business Goals: What are the ultimate goals that the business wants to achieve? By identifying these goals, management can then proceed to identifying the steps that must be taken in order to attain them. If the business intends to become profitable and expand globally, then it will no doubt recognize the importance of its human resources. Investing in its human resources, such as recruitment of brilliant minds and top talents, as well as training them, will rank high on the list of priorities of the management. The importance of the employees will most certainly be underlined.
- Business and Financial Constraints: If businesses had a bottomless pit of cash to get their resources from, then there would be no issues at all to consider. However, this is not the case. Small companies, particularly those that are just starting out, may not afford to give too generous bonuses to their employees. Some companies may be bigger and have more assets, but are strapped for cash that will be paid to employees as bonuses. It is possible that a company’s cash reserve may be tied up in a project, so there is no ready or available source for bonus payments. These are only a few of the constraints that businesses have to consider when designing its employee bonus plan.
- Market and Industry Trends: Of course, the business should also take note of the bigger picture. There may be industrial standards that they can base their employee bonus policies on. In many instances, these standards are used as the minimum. Some companies may also be motivated to give their employees higher bonuses so they would not be tempted to jump ship and look for employment elsewhere, say, in one of their competitors.
- Employee Demographics and Preferences: It is the employees who will receive the bonuses, and it is also the employees that you aim to reward and motivate. Therefore, they should also be considered, particularly their preferences. Their demographics should also be taken into account.
- Desired Results and Behaviors from Employees: This is in line with the reason why businesses give bonuses to their employees in the first place: to reward them for a job well done, and to motivate them to do even better. When structuring a bonus plan, the business should know exactly what it wants to achieve, or what results it expects to see once the bonus plan has been implemented. This will make evaluation later on much easier, when it is time for the business to assess whether the bonuses are truly motivating their employees and improving employee performance.
How to Structure the Employee Bonus Plan
Now we have come to the part where we are going to structure the bonus plan. We have already gone through the key elements that an effective employee bonus program should have. From these elements, management may already get an idea on how to go about designing their programs.
Some first ideas on how to structure your employee bonus plan can be found in this short video.
Before you can start structuring, however, it is imperative that you are clear on why you are creating the employee bonus plan, to begin with.
Maybe you want to reward your employees and encourage them to perform better. Maybe you also want to boost their morale and cement their loyalty to the company. Or it could be your way of responding to how your competitors are treating their own employees, so you can keep your own reputation high. Your reasons will dictate how you will structure the plan.
- Put the employee bonus plan in writing. We have already established that the employee bonus plan is a document containing the details of the bonus program. The details must be put down in writing, and subsequently communicated to all the employees, for their information. The bonus program will not be of any use, and will not achieve the desired results, if it remains in the hands of the management, and the employees are not aware of what it contains. This is also to avoid any misunderstandings about the company’s policies about giving bonuses and incentives to employees.
- Base the bonus on results that are measurable or quantifiable. The rewards must be directly traceable to measurable performance standards. Opinions, which are mostly subjective, are not acceptable. The performance standards must not only be identifiable, but also quantifiable. They should be specific, so it is easier for employees and management to immediately recognize how the bonuses are contingent on the achievement of these standards.
- Give incentives to employees to meet goals. The incentives should be convincing enough for the employees to help the company meet its goals. It is a reality that some employees are only working for their own interests. They have their own financial goals (e.g. buy a house, buy a car, build a retirement fund) and they are likely to focus on that. If you can somehow make the employee bonus plan coincide with their individual financial goals, then that would definitely generate good results, since it is a win-win situation for the employee. They will recognize that, once they help the company grow and earn a profit, they will also earn more money for themselves in the form of these bonuses.
- Be clear on the WHAT, the WHY, and the HOW. Specifically, you have to be up front about what bonus is being given, why it is being given, and how the employees can get them, or what the employees should do in order to be entitled to the bonuses. Identify what the bonus is about. If you do not establish clearly why these bonuses are given, the employees might get the wrong idea. They will be motivated to do better, yes, but they may end up focusing their efforts in the wrong direction.
- Make sure everybody gets something. In the spirit of fairness and providing equitable bonuses, the bonus should be structured in such a way that the lowest levels are easy to achieve. Setting the lowest levels very high means there is a chance that some of the employees that do not perform as well as the others may not get anything. Doing this will ensure that everybody gets something, at least, even if it is a minimal amount. More importantly, it will motivate the less-performing ones to step it up and do better in order to get more bonuses in the future.
- Make the financial reward a strong enough incentive. If it is a very minimal amount, then employees would not feel as motivated as they should. Usually, employees appreciate bonuses that are a certain percentage of their basic salary or compensation, instead of getting a one-time amount.
This is the part where a bonus program can be a source of great frustration among employees. They become extremely disappointed when they realize that, after putting in so much work to achieve superior results, they get only a meager or modest amount for their efforts.
If you are running a sales team and are thinking of introducing an employee bonus plan for them, then learn from this presentation.
There are two approaches that are commonly used by businesses when structuring their employee bonus plans. These approaches are based on the achievement of goals of each individual employee, or of a team or department.
- Per employee – In this approach, the plan revolves around the achievement of specific goals of each employee. The bonus is based on the individual performance of the employee, so it is almost entirely up to the employee whether he will be entitled to the bonus or not. If he does not perform up to the standards, then he will not be entitled to a bonus, or he may be entitled to a small amount than those who managed to achieve their individual goals.
- Per team or department – Each team or department has its own goals, and the employees who are members of the team or department will work together towards the attainment of these goals. The bonus plan may be structured such that they will receive incentives upon achievement of these goals.
It is in the best interests of any company to have a well-designed and well-structured employee bonus plan in place. Business owners and management may think that these plans are only for the benefit of the employees but, in the long run, even the administration and the overall performance of the business will be affected by how these bonus programs are designed, and subsequently implemented.
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