A noted CEO explains why most variable-pay plans -- except one -- fail to deliver results.
Just about every variable-pay plan around fails to deliver its promised result--except one
Variable pay is hot these days, and companies are going for bonus programs like bass in a feeding frenzy. The idea is to give people an incentive to work harder and smarter, while keeping fixed costs low. People will do more when they know they'll get a nice reward if the company has a great year, outperforms its competitors, and increases its value--or so the theory goes.
In fact, most of those programs provide no incentive to anyone and never deliver the promised results. Why not? Because in 9 cases out of 10, they are not true bonus programs at all. They are simply profit-sharing programs, and there is a world of difference between the two.
By profit sharing, I mean the practice of taking a percentage of a company's profits, putting it into a pool, and disbursing it to the company's employees, usually sometime after the close of the year. Understand, I'm not saying that this is a bad thing to do, just that the benefits of doing it are limited. For openers, the recipients seldom know exactly how they helped generate the profits, beyond just doing their jobs. No doubt, they enjoy getting the money. They may even be grateful for it. But they aren't likely to think or act differently because of it or to be greatly motivated by it.
What's more, if they keep getting it, they will eventually come to expect it, depend on it. If they don't know what they've done to deserve the extra money, they will begin to view it as part of their regular compensation--that is, as an entitlement program. At that point, the profit-sharing check is a bonus in name only, no matter how much the amount may vary from year to year. Meanwhile, you're getting results that are the opposite of what you're paying for. You're promoting the same attitudes you had hoped to change by moving to variable pay in the first place.
A bonus program, a real bonus program, is altogether different. Its whole purpose is to make the company stronger, more competitive, able to survive and prosper in the months and years ahead. Earning a profit is just part of it. What really determines a company's success, after all, is its ability to generate cash and make smart decisions about how to use it.
A good bonus program draws people into that process. It drives the value of the company by educating people, not with formal training programs but through the work they do every day on the job. It gives them the tools they need to make and understand decisions. It provides them with business knowledge they can use to enhance their own standard of living and job security as they're making a measurable difference to the company as a whole.
And, believe me, there is no greater motivator in the world than the opportunity to make a difference, to contribute, to do something significant for yourself and your community, by which I mean the people you work with, the company you keep. I'm not denying that money can be a motivator as well, but it has much more power when it's earned rather than bestowed.
So what are the essential elements of a good bonus program? I believe there are four.
First, you need clear goals that people understand and accept because they've had a voice in setting them, goals that affect the health and the wealth of the entire community.
Second, you need to provide frequent feedback--on a weekly, even a daily, basis.
Third, you need to give people an opportunity to work with one another to achieve the goals.
Fourth, you need targets that require some effort. The payoff shouldn't be a sure thing. I'm not talking about having stretch goals, which are almost always demotivators, but neither should the targets be so easy that people can take them for granted.
A good bonus program is a kind of insurance policy. It gets everyone involved in going after a company's greatest weakness--something that represents a threat to its long-term survival. Such weaknesses can usually be expressed in the form of a financial ratio, but you don't start with the ratio. You start by asking people to talk about the greatest threats to job security. You bring them into a discussion of the company's vulnerabilities and then identify the ratio that targets the most critical one.
That's your critical number. It's the number through which you can have the greatest impact on your company's value during the coming year. In effect, you put a bounty on that number and say, "By hitting these targets, we can drive out this big weakness and strengthen the company, and so we're going to give ourselves a reward if we do it."
Notice, I'm not saying profit should be a goal of the bonus program. I'm saying it should be a goal only if lack of profit is one of your company's greatest weaknesses. Even then, I'd say you should target a profit driver rather than profit itself. By profit driver, I mean the number that determines profit in your business--such as the occupancy rate in a hotel or billable hours in a telemarketing business. (For more on critical numbers, see "The Logic of Profit," March 1996.)
Why? Because you want people to think for themselves, to figure out on their own what they can do to improve the critical number. The better they understand the different elements of the business, the more likely they are to make the big plays. But, to make any plays, they have to be able to see the connection between their actions, decisions, and participation, and changes in the critical number.
That connection is difficult to perceive with profit alone, which represents an accumulation of everything that happens in the business over a given period of time. You're far better off with a critical number in which the connection is clear, one that each person can relate to his or her job. Then people can use the number to identify the specific problems they must solve to reach the goal.
And they'll learn more as a result, because learning is problem-driven. People do more and learn faster when they're trying to solve problems. They teach themselves. With straight profit as a goal, they usually wind up depending on you to tell them what to do, and then they learn very little.
So what exactly is the management's role if not to tell people what to do? It's to provide constant feedback on the program, to give it high visibility and total support. No bonus program will work if you don't work at it; people won't believe it or care about it. You have to sell the program all year long. You have to keep it out in front of everybody at all times. You have to use every tool in the book--learning maps, thermometers, weekly huddles, daily chalk talks, posters, balloons, celebrations, you name it. I suspect more bonus programs die from lack of rah-rah and hoopla than from any other single cause.
If your bonus program is a good one, it's delivering a huge message that should be easy to understand. You need to make sure the message is repeated over and over in ways that are interesting and fun. Because repetition is essential to education, and education is what the bonus program is all about.
In fact, I know of no better way to teach people what it takes to be successful in business, and you don't have to take them away from their work to do it. With a good bonus program, you're providing on-the-job training in basic business skills. Every year, you have an opportunity to introduce a new ratio or concept and let people go after it, learning in the process how their actions affect their job security. At Springfield Remanufacturing, we've had 21 different goals in the past 14 years--including the debt-to-equity ratio, inventory accuracy, the current ratio, the charge-out rate, return on assets, and diversification. That's a lot of education, and it has given us a very smart workforce, a clear competitive advantage.
If we weren't educating through the bonus program, we'd have to set up all kinds of additional training programs at considerable expense, and they wouldn't be nearly as effective. Because education in this form is not a burden or a chore. It's a motivator. People like to use their brains on the job. They like to be smart. They like to be going somewhere, to feel that they've achieved something. With the right critical number, you can use a bonus program to create a whole series of little games in which people can expand their education, improve their standard of living, and see how they're making a difference--all at the same time.
And when the bonus comes, they know they've earned it. They know they're getting the reward because they took responsibility, because they increased the economic value of the company and strengthened the community. It's not a gift, and it's not an entitlement. It's payment for a job well done.
And they come to expect and look forward to a new challenge in the following year, and another in the year after that.
With a profit-sharing program, you get none of that. You're just giving away money. You may please some people by giving them a chance to earn more if they work harder, but you're not giving anyone the tools to work smarter. People don't take responsibility for themselves. Whether they want to or not, they don't know how. As a result, you may wind up reinforcing the old bad habits you want to get rid of--the us-versus-them, it's-not-my-job, just-tell-me-what-you-want attitudes of the past. And when the level of profit sharing declines, it's top management that gets the blame.
Of course, profit sharing does have one advantage: it involves a lot less work than a bonus program does. You may not see a need to invest the time and effort a real bonus program demands. Perhaps all you want is a carrot you can hold out to people at a time when you can't afford to give regular merit raises. If so, profit sharing may be just right for you.
As for me, I like to get the maximum benefit from the dollars we spend on bonuses, and I sleep much better knowing that everyone is worrying about our company's vulnerabilities, not just me. Yes, we've had to work at our bonus program, but it's been worth everything we've put into it. It has become, quite simply, one of the most powerful tools we have for keeping our jobs secure and our company strong.
Contributing editor JACK STACK is president and CEO of SRC Holdings Corp., based in Springfield, Missouri. The company's innovative style of open-book management -- financial information is shared among managers and employees -- is summarized in Stack's book The Great Game of Business, coauthored with Inc. editor at large Bo Burlingham.