Many of the companies I advise are looking for the best way possible to structure their compensation. They know there’s a correlation between achievement and reward, and they want to find the structure that leads to the most company success and the best outcomes possible for team members.
Those are the right goals, so let me start with the first step necessary to achieve those goals: Get rid of bonuses.
“In most people’s minds, the bonus is essentially a gift.”
I’m not saying no one should receive anything beyond their salary or wage. In fact, I’m saying the opposite of that, as you’ll soon see. But the bonus is the least effective and least logical way of doing it.
In most people’s minds, the bonus is essentially a gift. They often associate it with Christmas. When they receive it, it feels like a gigantic act of benevolence on the part of their employer – maybe something that will pay for that year’s gifts or a special holiday trip.
I can understand why employees would like receiving a bonus. But as a business strategy, giving out bonuses doesn’t make any sense for a simple reason: They’re not tied to anything the employee accomplished.
There are two better ways to do this. I’ve got two ways in mind – similar, but with important distinctions. One is incentive pay. The other is at-risk pay.
Incentive pay is more familiar to most people, so let’s start with that. It’s basically the idea that you can earn something over and above your salary or wage by accomplishing certain things. I’m convinced that every employee should have the opportunity to earn some sort of incentive that’s tied to the employee’s performance.
It should not be based on time worked, because time isn’t necessarily achievement. And it should not be based on overall company performance, because that could rob a high-achieving individual of the incentive to do well.
An incentive-based pay structure should be based on something measurable the employee can achieve that’s directly related to the company’s own strategic goals. It should come in addition to the employee’s salary or wage, and should be structured in such a way that the company can always afford to pay the incentive because it comes out of real rewards the employee’s achievements earned for the company.
Granted, this is easier to do with some positions than it is with others. For a salesperson, structuring incentives is easy. You just give them a percentage of what they sell. It’s harder to come up with metrics for, say, a mail room employee. But that doesn’t mean you can’t do it. If you’re paying someone to do anything for your company, you should have some sense of how the company benefits when they do that job well. So yes, a good performance in the mail room should accrue to the company’s benefit in ways that can come back to that employee in the form of an incentive.
That also adds to the motivation of every employee to increase the value of what they do for the organization. It should even work for nonprofits and government entities, because both have goals employees can work toward achieving. And they’re easier to defend against public scrutiny than the payout of “bonuses,” which might sound like sheer favoritism. If the extra compensation is based on incentive goals you can show were attained, that should end the criticism right there.
“An at-risk compensation arrangement has the benefit of focusing the employee very intensely on the goals that matter most.”
At-risk compensation is a little different, although it’s roughly based on the same idea. In the at-risk model, there is a defined amount of compensation an employee can receive (whereas the incentive could theoretically be limitless if they achieve enough). Maybe the employee’s total potential compensation is $100,000. But a portion of that – let’s say $40,000 – is “at risk.” The $60,000 is locked in (assuming no firings or anything of that nature), but the employee can only earn some or all of the additional $40,000 by reaching certain goals or performance measures.
An at-risk compensation arrangement has the benefit of focusing the employee very intensely on the goals that matter most. It means there’s a defined amount of money you’re leaving on the table if you don’t hit your goals.
A difference between the two is that incentives are usually a small percentage of an employee’s compensation (although they could theoretically be larger for a very top performer), whereas the at-risk portion of compensation under the at-risk model is usually more significant.
You frequently see contracts like this in the National Football League. They’re called “prove it” contracts, and they pay only a small base salary with the potential for more if the player hits certain goals in terms of games played and other performance measures depending on his position.
How much you’d want to put at risk is obviously a question to be worked out with the individual employee based on lots of variables. But it protects the company against paying too much for an underperformer, while giving the employee every opportunity to earn the top of his or her potential pay package.
It also helps to answer a frequently asked question among employees: Why is this person paid more than that person? If the answer is based on measurable metrics, there should be no argument. The person who made less can get every opportunity in the following year to make more. They just have to perform.
Understand this: Even the best compensation scheme won’t matter if you don’t hire the right people, put them in the right roles and give them every opportunity to succeed at their jobs. You can’t incentivize a bad worker into being a good one, but you can incentivize a good one to achieve optimal results.
By the same token, a company with a bad purpose or bad values can’t escape the consequences of those problems by trying to incentivize people to do every little thing. But for the right company with the right mission, structure and leadership, incentive-based and at-risk compensation structures are far superior to simply handing out bonuses. They give employees the chance to earn more, and to do so in a way that makes you more prosperous as well.