Motivating employees through performance bonuses

What are performance bonuses?

A performance bonus is extra financial compensation that the employee can earn if they achieve certain outcomes in the business.

“It’s important to incentivize people to do the right things,” Nalepa says. “It’s a kind of map of what needs to be done in the business.”

Here are the most common types of bonuses.

• Annual incentive plan
  A plan to offer financial rewards tied to results on an annual basis. This compensation is usually not discretionary, though part of it sometimes is.
• Discretionary bonus plan
  A plan in which employees get portions of a bonus pool set aside by the company at the end of a period. The portion for each employee is usually determined based on their performance. The bonus pool can differ in size from year to year and isn’t guaranteed.
• Spot awards
  Rewards for an employee’s special contributions for a specific project or task.
• Profit-sharing plan
  A plan in which employees get a share of the company’s profits.
• Gain-sharing plan
  A program to share the results of productivity gains with employees.
• Team incentives and project bonuses
  Incentives that reward employees for the performance of a work team or for completing a project on time.
• Retention bonus
  An incentive outside regular salary to retain a key employee.

Bonuses should be determined as part of the employee’s broader incentive plan (which can include financial and non-financial rewards). Incentives, in turn, are part of a company’s performance management plan and total rewards plan.

Bonuses vs compensation

It’s important to distinguish between bonuses and compensation. Bonuses are tied specifically to performance of the employee, team or business, and they can vary widely. Compensation is usually set over a longer term and based on market standards, inflation and employee experience and expertise; it’s generally unrelated to short-term employee performance.

Some businesses confuse the two and make the mistake of increasing an employee’s salary as a reward for short-term performance. This can create inequity within your team and sustainability issues for your business that could eventually impact finances.

“You should distinguish compensation and incentives, and make them separate,” Nalepa says. “Think about how increasing a salary will affect your overhead five years from now. Also, if you have an outlier in your team who earns significantly more than everyone else, it can create equality issues.”

Bonuses and compensation together make up the employee’s total rewards package. This can also include non-monetary benefits such as:

• flexible hours and remote work 
• vacations 
• employee recognition 
• training and career development 
• promotion, autonomy and responsibility 
• health, disability, pension, daycare and insurance benefits 
• free or discounted products and services
• workplace amenities and activities 

How do performance bonuses motivate employees?

Performance bonuses can be important motivators for employees, depending on their job and position.

For example, salespeople typically receive bonuses or commissions based on performance. Bonuses are less traditionally used to motivate other employees—for example administrative staff, whose performance isn’t as easily tied to quantifiable figures.

Some businesses are adopting new approaches and exploring ways to offer bonuses more equitably among employees. “There has been a shift in thinking about bonuses to looking at it as more of a team approach,” Nalepa says.

For example, some businesses reward not only sales personnel, but also customer service representatives. “After a sale is done, work is still needed to maintain that client,” Nalepa explans. “Customer service is also important to support that sales growth.”

“Regardless of the approach, the key is to use bonuses to promote the right behaviours and help the business move toward its objectives.”

How do I set performance bonuses?

To set effective performance bonuses, it’s important to first take a step back and review your company’s strategic goals.

What employee objectives and behaviours are needed to achieve these goals? What key performance indicators do you track to evaluate employee performance?

You’ll have already addressed these questions if you created a performance management plan for your business and individual performance plans for each employee. (Nalepa recommends both.)

Review cash flow and financial results

Next, take a look at your cash flow and financial results to determine what bonuses you can afford to offer employees. This is a good time to review your financial management to make sure financial reporting is updated, relevant and accurate.

“Make sure you can actually afford to offer bonuses to your employees,” Nalepa says. “The worst thing you can do is create an employee profit-sharing plan if the business is never profitable. Financial acumen is very important for planning bonuses and for the sustainability of a bonus program.”

Robust financial reporting is especially important if you offer a profit-sharing plan. Employees will expect financial transparency to understand how bonuses are determined.

Discretionary versus consistent bonuses

Many businesses start with the first two types of bonuses in the list above—annual or discretionary bonuses. This is because they tend to be the simplest to determine and tend not to require sophisticated financial reporting.

As a company matures, Nalepa recommends shifting to more consistent bonuses, and fewer discretionary ones. “Consistent bonuses help employees know they’re working toward something, and it’s clear and defined,” Nalepa says. “Discretionary bonuses are nice when they happen, but they don’t necessarily create a culture and motivation of working toward the company’s goals.”

Discretionary bonuses can even backfire when they recur over several years, but then are abruptly curtailed. “If the business stops giving them, it sets the wrong expectation and employees can get disgruntled,” Nalepa says.

Profit-sharing plans

In a profit-sharing plan, Nalepa advises against giving every employee the same bonus. “Bonuses should be used to incentivize good behaviours and performance,” he says. “A lot of employees would be frustrated if their peer who slacks off gets the exact same amount as them. That doesn’t incentivize the right behaviours.”

Instead, Nalepa suggests dividing your team into quartiles based on their performance. For example, the four categories could be:

1. excellent
2. completely satisfactory
3. satisfactory
4. unsatisfactory

An alternative method could be:

1. high potential and high performing
2. high potential but low performing (or vice versa), but willing to learn or improve
3. high potential but low performing (or vice versa), but unwilling to learn or improve
4. low potential and low performing

Finally, allocate a portion of the pool of profit-sharing money to each employee based on their category; the portion goes up for higher categories.

Set stretch goals

Nalepa advises against trying to divide your team to put an equal number in each category. It’s okay for the categories not to have the same number of employees.

At the same time, Nalepa says if you find yourself with most employees in the top bonus category, you may want to review your employee and business goals to see if they should be more ambitious. This is especially advised if employees are meeting their goals, while the overall business isn’t.

But if most employees are achieving their targets and the business is too, then be sure to recognize and reward your team. You can even encourage them more by setting “stretch goals.” These are additional, higher targets that, if met, unlock extra bonuses.

For example, if a salesperson meets the normal $100,000 sales target, they still get their usual bonus. But if they attain $125,000, they get an even larger bonus.

Bonuses are just one reward

It’s important to keep in mind that bonuses are part of a broader reward package for employees. Your team is motivated not just by financial and non-financial compensation, but also by intangible factors, such as:

• autonomy, responsibility, engagement and feeling of purpose
• work culture and environment
• personal advancement opportunities
• diversity, equity and inclusion
• environmental, social and governance record of their employer

“People often think pay is the number one reason people stay or leave an organization, but it’s not,” Nalepa says. “It’s usually fourth or fifth on the list. Number one is often career fulfillment and development, the sense of belonging and the employee’s experience in the organization and culture. How are they treated? Do they enjoy going into work every day?

“You have to add more things than just a bonus to fulfill your employees and make them happy. But bonuses can be an important part of the mix.”

Next step

Set clear goals for your staff with BDC’s free Employee goal-setting template