Bonus schemes: incentives used to boost performance
Many employers now operate an incentive plan to focus employees' efforts on key business objectives. We analyse the key criteria that determine a scheme's effectiveness and talk to two employers that operate two very different bonus schemes.
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Key points
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Bonus schemes used to be regarded as the accepted way to motivate staff who have hard sales targets to hit. This is no longer the case. An increasing number of organisations have been waking up to the much wider potential that such schemes have to incentivise staff in a number of different performance areas, ranging from customer service to teamwork.
A survey carried out by The Work Foundationin 2003, for example, found that over three-quarters of respondent organisations (77%) operated a bonus scheme, with 38% having one that covered the entire workforce1. IRS's own research into organisations' 2003/04 pay prospects found that around one-third of employers (32.9%) deployed incentive schemes as part of their reward strategy, a slight increase on the previous year's findings.
Bonuses were the most popular form of incentive scheme, with respondents to the survey indicating that they used a wide range of triggers to generate bonus payments, including sales, business performance, factory efficiency and attendance.
Variable results
A bonus scheme is a form of contingent pay but can be further classified within this broad category as variable pay. As Michael Armstrong outlines in the Chartered Institute of Personnel and Development (CIPD) reward text, contingent pay is based on factors other than the rate for the job, and may or may not be consolidated into base pay2. Contingent pay, therefore, comes in a myriad of different forms and includes sick pay, pensions arrangements and service-related pay.
Variable pay, on the other hand, is distinct from consolidated pay, and is awarded as a cash lump sum. Also referred to as "pay at risk", variable pay - such as a bonus payment - therefore has to be "re-earned" by the employee. As such, it is easy to appreciate the attraction that a bonus scheme holds for an employer. The employee carries an equal share of the risk and, if the desired results are not achieved, no payment is made. It is also a far more flexible way of rewarding staff and does not represent an ongoing pressure on the paybill budget.
The more traditional types of bonus schemes, such as shop-floor incentive plans, were found predominantly in manufacturing, and focused almost exclusively on improving production levels. Probably one of the earliest and least sophisticated forms was piecework, where a worker would be paid according to the quantity of goods or "pieces" they produced. There are other variations on this theme, such as work-measured schemes where a bonus is generated if a task or a part of the production process is completed in less than the "standard time" allowed.
Similar schemes still exist today - according to The Work Foundation research, almost one in five organisations link manual workers' bonus payments directly to productivity - but the number of traditional incentive schemes that are based purely on productivity has declined in recent years. This can be attributed partly to concerns that a limited focus on production measures can run counter to other key areas, such as health and safety, teamwork and quality.
The rationale
The thinking behind most incentive schemes is quite simple - that people will be motivated to work harder in return for a financial reward. By directly linking a bonus payment to the achievement of specific targets, the employer aims to channel employees' discretionary effort in a certain direction, be it superior customer service, more sales or better attendance. ASDA's bonus scheme, for example, aims to improve loyalty and retention levels by motivating "colleagues" to believe they have a key role to play in the delivery of the business plan.
The theory that individuals are motivated primarily by money is a contentious one and cuts right to the core of what makes an effective reward strategy. Several high profile reward specialists have expressed serious reservations that extrinsic financial gain is sufficient to motivate staff and encourage higher levels of performance. They argue that the intrinsic value of work and non-financial reward are capable of having a much longer-term impact on behaviour.
This does not mean that a bonus scheme is not capable of playing a powerful role in focusing employees on the organisation's key success factors - but it is perhaps worth bearing in mind that incentives are likely to reap the most significant results when they form only one strand of an organisation's reward strategy.
Designing an effective scheme
Bonus schemes can be designed to operate at a number of different levels within an organisation, such as company-wide, team-based or at an individual level. Or they can incorporate a number of different levels and include targets linked to both individual and corporate measures of performance, for example.
Just as a scheme can operate at single or multiple levels, it can also be based on a single factor or on a number of factors. The choice and range of factors should be determined by reference to the overall business strategy and those areas of organisational performance needing priority treatment. The scheme introduced by Goodyear Dunlop Tyres' Wolverhampton plant, for example, is a multi-factor scheme based on both productivity and other measures deemed crucial to overall business success, such as customer service and health and safety.
It is common practice for organisations to operate more than one scheme at a time - The Work Foundation research found that the majority of respondents (76%) operated up to three schemes. Almost two-thirds of respondents to the survey believed that their bonus scheme was "very" or "quite" effective in meeting organisational targets. If designed carefully, with the appropriate factors built in, a bonus scheme can act as a powerful motivator. The success of any incentive scheme depends on the fulfilment of several important criteria.
The key underlying principle is that there is a "clear line of sight" between the discretionary effort made by the employee to meet the set targets and the financial reward. The scheme should not be so sophisticated that employees do not understand how it operates.
Care also needs to be taken with the setting of targets for each factor. A target for customer service, for example, could be to reduce the number of customer complaints by a certain percentage within a set timescale. The crucial point is that the targets must be achievable, with employees feeling they are in a position to have an impact on these key areas of performance and their contribution to overall business performance. Otherwise, there is a risk that the scheme will have a counter-productive effect and demotivate staff. Neither should the targets be too easy or they will also fail to motivate staff to improve performance.
Some organisations deliberately involve employees in establishing appropriate targets, aiming to achieve greater commitment from them. Goodyear Dunlop Tyres, for example, negotiated extensively with the workforce before introducing the scheme at its Wolverhampton plant.
Finally, it may seem obvious but there must be a clear and accurate measurement framework in place that is perceived as fair by all those participating in the scheme.
Bonus time
The beauty of bonus schemes is that they are self-financing, using the additional revenue or cost savings generated by the scheme's operation to fund any payout to employees. The frequency with which payments are made varies considerably, and will depend on the type of scheme and employee group affected. The IRS research found that most payments were made monthly or annually. The Work Foundation survey, meanwhile, revealed that annual payments were the norm, particularly in the case of senior managers (67% of respondents), while weekly payments were very rare (9%). The relatively high incidence of annual payments is most likely to be explained by the number of schemes that link bonuses to annual profit or turnover targets.
It could be argued that, in some cases, the motivational effect of an incentive scheme could be enhanced by more frequent payments. Existing salary arrangements may also have a bearing on how often bonuses are paid out. If employees receive a monthly salary, for example, it would create an unnecessary administrative burden to award a weekly bonus.
The typical approach is for an accumulated bonus pot to be distributed to employees, either in equal amounts or according to a formula determined by factors such as grade or job role. For example, the level of awards made under Norwich Union Life's bonus scheme varies according to individual employee contribution throughout the year. It is a common feature of many of the schemes run by financial services organisations to distribute bonus payments with at least some reference to individual performance.
Communication is key
It is widely acknowledged that the success of any bonus scheme ultimately rests on whether employees and managers understand how it operates and how they can influence performance levels. This in turn depends on how effectively the scheme is communicated. Guidance on how the scheme operates, the reasons for the chosen objectives and targets and bonus arrangements should be disseminated to all participating staff at the outset. ASDA, for example, provides new recruits with information on its bonus scheme as part of their induction.
The launch of a new bonus scheme is, therefore, typically accompanied by a comprehensive communication campaign. This can involve the use of a range of media, such as roadshows, an intranet, team briefings, leaflets and posters. The choice of communication channel will depend on the organisation and employee group. Goodyear Dunlop Tyres in Wolverhampton uses television screens and noticeboards to help promote its scheme to the shop-floor, for example.
It is important to avoid the pitfall of rolling out a new scheme with pomp and ceremony and not following this up with regular communications to encourage ongoing interest. This is true of any new HR initiative, but it is possible to keep the momentum going with regular progress updates against set targets.
Finally, it is worth remembering that every bonus scheme has a shelf-life and will need reviewing and possibly updating to ensure that it remains relevant to the organisation's core objectives.
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Case study 1: Goodyear Dunlop Tyres |
Goodyear Dunlop Tyres introduced a new incentive bonus scheme as part of the May 2004 two-year pay deal at its Wolverhampton site. Ray Looker, personnel manager, describes it as a "multi-factor, team bonus scheme". The scheme covers all 520 employees, including management - apart from around 20 sales staff - and is the only one in operation at the site.
The main objective in introducing the bonus plan was to improve productivity by linking pay to measures of production. The plant is fully unionised on the shop floor and extensive negotiations were undertaken with the two recognised trade unions - AMICUS and the TGWU - on the scheme's proposed structure and operation.
The generators and the deductions
As a multi-factor scheme, the level of bonus payment is not determined by production measures alone. The company also aims to improve quality, health and safety, attendance and customer service through operating the scheme, and has therefore incorporated key indicators relating to these four areas into the design of the scheme.
The bonus plan operates in two stages, with "generators" - or measures of production - first generating the size of the bonus pot and, as a second stage, deductions made in the level of bonus payment if other key indicators are not met. There are three separate "generators" that are focused on key areas of the production process at the plant:
- banburies factor: banburies are mixers that produce the rubber for the tyres.
As they form such a core part of the manufacturing process, this factor
determines 50% of the bonus pot and consists of three elements:
- performance against standards;
- "uptime" of equipment; and
- "first-time pass" (the product meets quality specifications). - "X" axis and "Z" calendar
factor: this factor concerns the part of the production process that produces
wire and fabric. The factor contributes 25% to the overall bonus and consists
of two elements:
- performance against standards; and
- "uptime" of equipment.
- "output per associate hour": the final 25% of the bonus pot is an overall measure of production.
Once the overall size of the bonus pot is determined, the deductions are then taken into account. These have the potential to reduce the level of bonus payment that is made to employees and relate to three main areas:
- health and safety: each serious accident at the plant will reduce the overall size of the bonus pot by a set amount;
- damage: an incident where buildings, machinery or a vehicle is damaged results in a deduction from the pot; and
- customer complaints: again, for every complaint made by a supplier, a certain amount is deducted from the overall bonus pot.
The above deductions have been carefully factored into the scheme in order that they encourage the desired behaviour. For example, as Looker explains, the health and safety indicator does not include the reporting of minor accidents for very obvious reasons: "We do not want to discourage the reporting of cut fingers or other small-scale injuries, and so minor accidents have no impact on the bonus plan. Our aim with this factor is to promote associate safety behaviour, so preventing serious accidents. This factor, therefore, only comes into play if someone has had to receive external medical treatment or there is lost time."
Similarly, in the case of the damage factor, the company wants to encourage the reporting of incidents where there has been damage to buildings, equipment and so on, and has designed the scheme accordingly. If the incident is reported - and the person responsible for the damage must report it - only a small amount is deducted from the bonus pot. But if the damage goes unreported and is later, inevitably, discovered by management or another employee, a much more significant amount is deducted.
The final factor is attendance. "We want to incentivise people to come to work and not throw the odd day off sick", says Looker. "In the case of non-contractual absence, the employee does not receive that month's bonus payment." Importantly, if an employee is absent and receives no payout that month, no deduction is made from the bonus pot. The bonus pot is distributed across those associates who have no unauthorised absence.
Bonus payments are made on a monthly basis under the scheme, which makes sense for the company administratively as all employees are paid monthly. As well as making the bonus plan easier to administer, however, it is felt that a month is the right sort of timeframe for the scheme. "We considered the various options, such as weekly or even six-monthly, but to make payments every week would have been nearly impossible given the number of factors involved," explains Looker. "Any longer payment period than a month would also make it difficult to keep the momentum and engage employees' interest in the incentives."
Communicating the scheme
As there were extensive negotiations with the recognised trade union representatives before introducing the incentive plan, there was already a level of awareness among shop-floor employees before it was launched. The unions' ongoing involvement in the scheme ensures that this is the case, but the company also operates an ongoing communication campaign to keep the scheme "alive" in people's minds.
"We use a number of different internal communication channels to keep the workforce up to date, such as noticeboards and the television screens around the site," says Looker. "If there are any queries about how the scheme operates, we are very quick to deal with them and reassure people because we want everyone to understand exactly how it works." Managers are also encouraged to field any questions and, if necessary, feed them back to personnel. The scheme also aims to be as transparent as possible, and all information relating to customer complaints and so on is available for inspection by union executives.
Although the scheme is still in its very early stages, there is a great deal of interest on the part of employees and Looker cautiously reports that he has already identified a noticeable impact on attendance levels.
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Case study 2: Asda |
Supermarket retailer ASDA, which is now part of the US group Wal-Mart, operates a profit-related bonus plan, called the "All-Colleague Bonus Scheme". "It is a single-factor scheme based on how well that particular depot or store performs against its business plan", says Sally Carratt of the reward team.
The scheme was introduced in 2000 and all employees - or "colleagues" as they are known at ASDA - are covered by it. Staff must, however, have achieved at least six months' service with the company by the end of the bonus year to qualify for that year's bonus payment.
Overall objectives
The impetus for the scheme's introduction was the Wal-Mart group's takeover of ASDA in 1999, and the desire to improve the total reward package.
"Our overall aim in operating the scheme from a reward and motivation perspective is to improve loyalty levels and retention rates," explains Carratt. "It also motivates colleagues to believe they have a key role to play in the delivery of the business plan. Although this is not a team-based bonus scheme, it definitely encourages a sense of common purpose and teamworking as all the staff within that store or depot share in its commercial success."
Scheme design
The ASDA scheme operates at a site level and covers all staff - colleagues and managers - within that business unit. It is based on profit. As Carratt explains: "We base the size of the bonus on the store or depot's performance against its annual business plan and set profit targets. This means comparing the store profit levels over the whole year to the store business plan profit projections. The store or deptartment's profits, therefore, have to reach a minimum threshold level to generate a store bonus, although it is still possible that a small bonus would be made if overall profit targets are met."
The bonus pot
If a store hits its business plan profit target, 90% of the bonus is payable. If it outperforms its business plan, it can potentially meet the maximum threshold of 120% of the bonus. Colleagues within that store would then receive a so-called "superbonus".
The bonus period runs from January to December, with payments usually made the following February. This year's bonuses were worth an average £228.73, with the full annual bonus worth £250 to full-time staff, and all stores qualifying for a payment of at least 20% of this amount. Colleagues in 156 stores, which reached the threshold for the superbonus payments, received payments worth up to £300.
ASDA has since reviewed the scheme and the maximum superbonus payment for the 2004 bonus is £360 for a full-time, hourly paid colleague.
Communication and review
Effective promotion of the scheme plays a key role in its overall success. Details of the bonus plan are communicated to colleagues through a variety of different media, such as leaflets, posters and the communication boards that are a feature of every store. Online channels are also used, such as the company intranet.
New recruits to ASDA are provided with information on the scheme as part of their induction and it is also promoted as part of colleagues' overall reward package.
"The bonus scheme has a strong local focus within the company," says Carratt. "As well as site-level initiatives, the reward team also generates company-wide publicity at key times of the year and prepares briefing material for people managers to use. Every store and depot also provides updates on progress against the business plan."
ASDA undertakes an ongoing review of the bonus scheme to ensure that it remains fresh and relevant to business need. For example, "listening groups", involving both managers and colleagues are coordinated in order to receive direct feedback and suggestions from staff. In Carratt's view, a bonus scheme requires a certain level of investment and good systems in place to make it work but, in ASDA's case, the effort has been well worthwhile.
1.Bonus schemes, Managing Best Practice No. 110, The Work Foundation September 2003, tel: 0800 165 6700, price £65.
2."Employee Reward", Chartered Institute of Personnel and Development, 1999, available from www.cipd.co.uk/.
This article was written by Rachel Suff, a freelance employment researcher and writer, rmsuff@dsl.pipex.com.
