How to Create an Effective Employee Bonus Plan

One of the most effective ways to increase the productivity and motivation of your employees is to incentivize them with a bonus program. This article walks you through how to create an effective employee bonus plan, and what you need to consider to make it work.
How to Create an Effective Employee Bonus Plan
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As we enter the final months of the year, one common question will be discussed in offices and living rooms throughout the country. “Are you getting a bonus?” For some companies, the end-of-year bonus is an annual tradition that employees look forward to for months. For other companies, they pay out bonuses on a quarterly basis, or may even pay them out based on when performance milestones are reached. The real question you need to ask yourself is whether or not your employee bonus program is effective in achieving its goals. Or, if you don’t yet have an employee bonus plan, we’ll help you learn how to create one.

Employee Bonus Plan Basics

Let’s start at the beginning. When it comes to creating an effective employee bonus plan, the first question you need to ask yourself is, “what will the company achieve by offering employees bonuses?”

Typically, bonus plans (also known as incentive compensation plans) are used to promote higher productivity, efficiency, and focus within a company. If the company has goals and wants everyone to pull in the same direction towards those goals, they may decide to offer additional compensation for reaching the desired outcome.

The theory behind an employee bonus plan is that extra incentives are a great way to drive behavior. A common example of this can be found in the commission paid to salespeople. Many salespeople are given a base salary, but are incentivized to perform in order to earn commissions on each sale they make. Similarly, you can incentivize employees outside of sales in the same way.

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Why Create a Bonus Plan?

The next question to ask yourself is whether or not employee bonus plans actually work? The data suggests that they do. According to multiple studies, including a joint study between Harvard and Yale, employers found that bonus opportunities do increase the overall productivity of their workforce.

Another reason to create a bonus plan is that it can act as a win-win for the employee and the employer. If your bonus plan is created properly, both the company and employee should be extremely happy with the outcomes. The employee will be rewarded for high performance and hitting goals, while the company will reap the benefits of that performance by increasing revenue and profits.

Finally, creating an employee bonus plan can be a great way to retain your best employees. When it comes down to it, money is still the thing that employees value most when evaluating job opportunities or employers. By showing your willingness to provide extra income for good work, you put your money where your mouth is. A financial bonus after a big project or achievement is much more rewarding than a simple pat on the back. A great way to keep your best employees engaged, motivated, and happy, is to reward them for their efforts.

"By showing your willingness to provide extra income for good work, you put your money where your mouth is."

What to Consider When Designing an Employee Bonus Plan

Creating a strong employee bonus plan can be challenging for many reasons. We encourage you to take the time to think about each of the following considerations. For both the business and the employees to find value in your bonus plan, it’s important to think through these ideas.

1. Business goals: The first thing to consider when designing your employee bonus plan is the business goals that you wish to achieve. At the end of the day, if your plan doesn’t help employees push harder to achieve the goals of the business, then what’s the point? Start first by understanding your goals, and then work backward to formulate a plan to incentivize the achievement of those goals.

2. Financial constraints: Of course, you cannot freely give away money your company doesn’t have. You also cannot reward employees with bonuses that do not mirror the impact of their work. For example, paying a salesperson a $500 commission for a sale that net the company $300 simply would not make sense. Similarly, you’ll need to consider the appropriate bonus compensation for each role in the company and tie it to specific goals or performance that have a measurable impact on the business.

3. Measurable and quantifiable outcomes: Going along with the point above, it is ideal if bonuses are tied to measurable and quantifiable outcomes. If the goal or outcome is vague, hard to quantify, or otherwise ambiguous, you’ll open yourself up to arguments with employees when it comes time to reward bonuses. To the best of your ability, make the criteria as clear cut as possible. Every employee should know where they stand. There should never be ambiguity about whether a bonus will be rewarded or not.

4. Eligibility: When creating your employee bonus plan, you’ll need to decide who is eligible for a bonus. Are all employees eligible? Do they have to belong to a senior management team? Do they become eligible after their first year of employment? Set clear rules around who qualifies for a bonus.

5. Employee psychology: A bonus plan is only effective when the employee cares about the reward. If you’re incentivizing employees with cash bonuses, make sure the reward is sizable enough to get the employee excited and engaged. If you’re incentivizing employees with non-cash rewards (like trips, PTO, and other fringe benefits) you have to ask yourself if employees actually care about those things enough to work harder or be more productive. If you do not understand what your employees care about, your bonus program will likely fail.

6. Incentivize the right thing: Finally, there are countless tales about companies incentivizing a certain result or behavior, only to have it completely backfire. A recent example involves Wells Fargo bank. Wells Fargo had created incentives (with financial compensation tied to it) for managers and salespeople to significantly increase the number of accounts each of their customers had with the bank. This led to employees participating in a variety of illegal tactics to create as many accounts for customers as they possibly could. Ultimately, Wells Fargo was forced to pay a $3 billion fine. The moral of the story? Make sure you’re incentivizing the behavior you wish to reward.

7. Easy to Understand: When you roll out your plan to employees, if they can’t easily grasp the structure of the plan, they’ll immediately lose motivation to participate in it. Do not overcomplicate the details of the program. Make your plan as simple and straightforward as possible.

Check out EddyHR’s employee bonus calculator!

Common Types of Employee Bonuses

So now that you have an idea of how to structure your plan and what things to considering when forming it, here is a list of the most common employee bonus programs:

  • Signing Bonus: A bonus paid to an employee when he/she commits to come and join your company. Usually used to incentivize a highly talented employee or executive.
  • Retention Bonus: A bonus to retain an employee during a merger, acquisition, or company management shakeup. In order to avoid losing key people during a transition period, companies will pay a bonus to incentivize them to stay. 
  • Referral Bonus: This is a bonus that rewards a current employee for referring a job candidate who the company ends up hiring. Employee referrals are often the best source of qualified candidates, so it’s beneficial to reward employees who refer friends or former colleagues.
  • Annual Bonus: A bonus that is paid annually (usually near the end of the calendar or fiscal year) that rewards an employee for hitting certain targets. It may also reward an employee if the company hits its goals or targets.
  • Quarterly Bonus: A bonus that is paid quarterly (usually mirrors the fiscal quarter breaks) that rewards an employee for hitting certain targets, or for the company hitting its targets.
  • Discretionary Bonus: This type of bonus is left to the discretion of a manager or executive. Typically, a budget will be set aside for bonuses to be paid, and the manager or executive will determine the amount to be allocated to each employee based on performance or other criteria. As the name explains, it is discretionary, and therefore is not tied to a specific plan or promised reward.
  • Ad Hoc Bonus: This is a “spur-of-the-moment” type incentive that is promised or given when an employee goes above and beyond for a task or project. These bonuses are sometimes promised before the target is hit (i.e. “The next person to make a sale gets an extra $100 on their commission check) or given to express gratitude after the accomplishment (i.e. “Because you worked so hard on this project, we wanted to give you an extra $1,000).
  • Profit-Share: Some organizations allow employees to share in the profits of the company. This is motivating to employees who will focus on activities and projects that increase company profits because they know they’ll be able to benefit from them. These plans usually have a predetermined percentage of profits that will be shared with employees. Those profits can then be shared on a discretionary or formulaic basis.
  • Team Bonus: Occasionally, organizations will decide to reward teams instead of individuals. This helps teams come together, synergize, and accomplish more than they would individually. Rather than just reward individuals, the entire team is rewarded and incentivized equally.

Choosing the Plan That’s Right for Your Company

Every company has different needs and is dealing with its own financial situation. Your company’s bonus plan will likely not be the same as any other business. In the end, you have to find a plan that works for you.

As you consider the different bonuses we listed above, think about combining multiple bonus types into your plan. For example, it’s good practice to offer a referral bonus in order to bring in better talent. It may also be advantageous to offer both individual and team bonuses in order to bring the best out of everyone.

Remember, whatever you decide to do, make sure your plan aligns with the company’s goals, properly incentivizes the employees, and bases performance rewards on measurable, quantifiable outcomes.

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