Discretionary bonus plans have their time and place in an organization. Discretionary bonuses are a plan in which management determines the size of the bonus pool and the amounts to be allocated to specific individuals at the end of the year.
They work well when the leaders who are making the bonus decisions understand what the company can afford. They know the performance of bonus participants, what they accomplished, uncontrollable events that may make results easier or more difficult and how they accomplished those results.
However, they often lack transparency and consistency. Employees might wonder:
- Why do payouts differ year-to-year?
- Am I getting fairly compensated compared to colleagues?
- What behaviors and results are rewarded?
This lack of clarity can lead to feelings of confusion and frustration, ultimately hindering motivation. Although the plan’s administration is easy, management may have a challenging time making distinctions and explaining the payouts.
Structured Incentive Plans: Driving Performance
Structured incentive plans offer a clear alternative. They establish predetermined performance goals with known payout opportunities. This approach fosters a strong link between pay and performance, motivating employees and driving results. The key elements of a structured incentive plan include:
1. Setting Metrics and Goals
The first step is to identify metrics (not more than five in total) at the company and individual (which could be an employee, team, department, or division) level. It is important that the goal expresses a way to measure achievement below the goal, at the desired achievement (target) and when there is over achievement. For example, for the goal achievement of net revenue of $100M, it is easy to measure any other net revenue amounts relative to the goal of $100M. It could be determined that the results must be at least $90M to get credit (threshold/minimum) and anything over $150M (exceptional/maximum) is luck and will be the highest level of performance recognized. One can create goals for qualitative metrics too (see our blog on setting qualitative goals).
2. Avoiding Unintended Consequences
Do not rely solely on one metric, like revenue, which could lead to neglecting other performance areas like profitability. Balanced metrics give a holistic view of performance. Too much focus on revenue, for example, may be at the expense of profit. Other common metrics to balance company performance metrics include customer satisfaction and employee retention/engagement.
3. Determining Payout Opportunity
Other key elements of a structured plan are that there is a (a) bonus target percent of base salary assigned to each job, job level or grade and (b) known range of payout opportunity. If goals are achieved, the participant receives a stated percent of their base salary assigned to their job. If the achievement is above or below the goal, a calculation is done to determine the payout. In the prior example, a company may pay 50% of the target payout if $90M is achieved and 200% of the target payout if $150M or more is achieved. It is important that employees understand the payouts and calculation process.
4. Creating Line of Sight
Determine the level of metrics most appropriate to incent eligible employees, that includes (a) if the metrics should only be company, or should the plan include metrics related to an individual, team, department, or line of business and if both are included, and (b) the weight of metric at each level of employee incentive participation. By including metrics participants can influence directly or for which they are accountable, they can better drive results and be paid accordingly.
5. Considering the Need for Discretion
But what about uncontrollable events, such as when an employee does or does not deserve to be rewarded for the achievement of goals and there was an unintended obstacle that made it hard or external events that made it easy? Approaches include:
- Implementing a mid-year goal review to adjust for unforeseen circumstances
- Excluding consistently underperforming employees from payouts
- Including a discretionary multiplier to account for exceptional circumstances. For example, if the total bonus payout is 20% of salary but if the company has defined two or three ways the payout can be increased, their total payout adjusted up by 10%, or get a 22% payout instead. It is important to define the multiplier levels and apply it fairly to all employees in the plan thoughtfully and transparently. A performance rating is one way that organizations have accounted for the “how the performance was achieved” but there are other options with qualitative goals.
Implementation and Communication
A well-designed incentive plan is only effective if communicated effectively. Here are some crucial steps:
- Clearly explain the plan’s objectives and potential payouts
- Outline earning conditions and payout timing
- Involve employees in understanding goal development, building credibility and acceptance for the plan
- Ensure transparency with a plan description that includes the plan objectives, how much they can earn and under what circumstances, when it is paid and what happens if they leave before payouts or go on a leave of absence
- Set achievable goals for the plan’s first year that will ensure some level of payout
- Communicate progress quarterly to maintain employee engagement
Wilson Group: Your Partner in Building a Structured Incentive Plan
By implementing a structured incentive plan, you can move away from the confusion of discretionary bonuses and create a system that motivates employees, drives performance, and fosters trust. Let Wilson Group help you transition from discretionary bonuses to a clear, performance-driven system. We will guide you through the entire process, from designing goals to implementing the plan and ensuring successful communication.
A consultant-led approach will provide specialized knowledge and experience in incentive design, an objective perspective to avoid internal biases and ensure fairness and a streamlined implementation process with guidance from experienced professionals.
