As an owner, you probably have far more employees who are subject to year-end bonuses rather than commissions as part of their total compensation.

Like commissions though, I’ve found that bonuses often fail to motivate the very performance they’re trying to get more of.

This is typically for a few reasons.

Too often they’re ad-hoc, subjective, or just plain vague in terms of what led to the payout or lack thereof.

Not only does this waste your money, but it misses the opportunity to show your team what to focus on to perform at a higher level. It also strips your employees of the ability to own aspects of their income, which can increase turnover.

Fortunately, there are a few rules of thumb you can use to keep the ROI on these programs positive.

Let’s get into it.

The Four Rules of Thumb

Rule #1: Keep It Written Down & Agreed To

Every one of your employees should be able to articulate how their bonuses are earned, calculated, and paid out without room for confusion. Ideally, this should be revisited annually, and a copy of the original agreement should be made available to them upon request.

Without this level of transparency, your team can be left with the perception that the owner’s year-end mood is actually what determines whether or not they’ll receive their bonuses. Taking as much room for guesswork off the table for your team as you can around the issue empowers them to keep doing their best work with the confidence that their efforts will be noticed and fairly compensated.

Rule #2: Don’t Incentivize More Than 3 Things at a Time

Keep it simple and make sure you’re prioritizing what’s most important for the given role and business overall.

Let’s say one of my business goals for the year is to grow Revenue by 10%. When it’s time to set objectives with my Marketing guy, I need to break down that Revenue goal into a set of metrics that he can hit to directly support my target.

It would be easy to tie his bonus to increased lead generation and leave it at that, but doing so misses the point. If I were to stop there, I’d risk us getting spammed with unqualified leads that would in turn tank my conversion rates and cause my team to do a lot more work just to make less money in the end.

Tying the bonus to the ultimate outcome that you’re looking for ensures that your bonus program pays for itself. This in turn protects your margins, keeps operations efficient, and prevents your team from getting bogged down.

Rule #3: Make Sure Performance Is Easy to Track

Just as your employees need to know how their bonuses are earned and what they’re working towards, they need to know where they stand throughout the year without any room for subjectivity after the fact.

Before putting any kind of bonus structure in place, you need to be sure that you have the right infrastructure in place to track progress toward each set of objectives and can provide updates in a timely manner.

I’ve seen this be as simple as an Excel file up to real-time dashboards that can drill down to the individual level. The exact solution will vary by firm, but the key is having a system that’s reliable, up-to-date, and easy to understand.

Rule #4: Focus on What Your Employees Can Directly Control

I often see bonus structures with the verbiage “paid based on company performance” attached to them. While this sounds reasonable when setting policy, it’s pretty meaningless to an individual contributor.

There are a couple of ways around this.

Option 1 is to give your team an inside look into the company’s finances and work with them from there to set annual objectives. (This does not need to mean showing them a full P&L, however revenue, gross margin or some idea is required to make this effective)

Option 2 is to keep objectives rather granular at the employee level.

Either way, you need your employees to walk away with the belief that their performance alone is what determines what they receive at the end of the year.

All of this is not to say, however, that bonuses should never be paid out based on team performance. Team performance incentives can be a great tool for building camaraderie, increasing efficiency, and rewarding solid teamwork. My advice in those cases is to still keep the majority of the bonus payable based on individual performance. A 70-30 split here tends to work best.

Putting It All Together

Here are your top takeaways from this week’s post.

1. Bonus payouts in the SMB world tend to be ad-hoc, subjective, or just plain vague. As a result, they often fail to drive meaningful performance.

2. Bonuses, when done right, move from being a huge source of waste to a relatively cost-effective way to hit firmwide goals for the year.

3. Making your bonus structures work is as simple as following the four rules of thumb.

4. Keeping bonus structures in writing and requiring employees to formally agree to them builds trust and cuts down on perceived subjectivity.

5. Incentivizing only the top priorities keeps your team focused and increases your likelihood of meeting overall business objectives.

6. Any of the objectives you and your team agree to must be easy to track regularly throughout the year. There should be no question as to where they stand or how they’re trending for the year.

7. Focus on what an employee can directly control when setting performance objectives.

8. Incentivizing team performance is fine, but it should not make up the majority of an employee’s bonus. A 70-30 split is what I’d recommend.

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‘Til Next Time,

Connor