The Right Way to Pay

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"Employees don't understand that bonus means something extra. How do I get them to earn their bonuses?"

When you pay more, you should get more. But most bonus plans are based on company-performance measures like revenue growth and net income, and individual employees typically don't understand how they contribute to companies' goals. (It's hardly surprising: most employers can't objectively measure their employees' contributions either.)

Says Coonradt, "For a long time we've had this concept that if everybody gets a share of all of the team's results, we will have some magical bonding and team effectiveness." By and large, that magic doesn't happen, he says. Now he sees a new trend emerging. "We're seeing a lot more companies tying compensation to the performance of the individual or the department manager," he says.

That's not to say that owners should throw out the notion of rewarding employees for the company's overall performance. Bill Palmer believes that a combination of companywide goals and individual incentives works best. Palmer, CEO of Commercial Casework, an $11-million cabinetmaking businesses in Fremont, Calif., ties his company's annual bonus plan to revenues and gross margin targets, then gives his employees shares in the plan based on the value of their position to the company. All 100 of Palmer's employees -- from administrative staff and managers to cabinetmakers and carpenters -- participate in the program. "Our salaries already reflect the differential in responsibility," says Palmer. "But we wanted to have the bonus reflect that, too. It's not a huge range, but we give a little more to say we value leadership."

Palmer's employees can earn more shares by completing classes ranging from advanced carpentry to financial education to English as a second language. The bonus plan pays out quarterly, but Palmer posts weekly updates telling everyone the cumulative value of the bonus and the value per share. That means employees not only can watch the share price rise and fall but can alter their own performance in response. "When you have piece of the action, that motivates you to make the bonus bigger," says Palmer. "It's a great educational tool."

Of course, Palmer has created individual goals that are easy to measure -- an employee completes a class and earns a bonus. It's tougher to measure individual and departmental contributions to a company's overall health. Just ask Brad Borne, CEO of IDEAS Inc., a $2.4-million product-development company in Uniontown, Ohio. Late last year IDEAS was growing at a pace of about 100% annually, but profits weren't growing commensurately. So early this year, seizing an opportunity created by the softening labor market, Borne decided to try to increase profits by dramatically decreasing pay raises and tying bonuses to improved productivity. "We've got a lot more [leverage] as an employer right now, and we're taking advantage of it," he says.

Borne turned his attention first to his manufacturing department, which makes up about a third of the company's 18 employees. "We thought that was the area where we could increase the bottom line the most," he says. "We weren't operating as lean as we possibly could." Each quarter Borne sets a target gross-profit percentage for his manufacturing staffers. Then he tells them how they can achieve that goal. "The quarterly costs for that group are fixed, because we own the machines and equipment, and there's no penalty for using it more," he says. "We wanted to see them do more with their own time, utilizing our resources more and using outside resources less."

CEO Brad Borne dramatically decreased pay raises. "We've got a lot more leverage as an employer right now, and we're taking advantage of it."

After two quarters, Borne says, the new system has elicited about 95% of the effort he was hoping to see from his staff. "I would like to have seen that extra 5%," he says. "Maybe we'll tweak the system and make it a curve instead of a straight line, to give them more incentive to make the goal." During the next year, Borne also wants to experiment with giving employees individual goals, in an effort to tailor the motivational process to a particular person's career path. "The problem is, it's such a difficult process to monitor," he says. "You wind up creating a half-time job just to keep track."

"Annual bonuses don't work. At least, I don't think they do. Do they?"

They don't. Or so say compensation experts, who advise employers to make more-frequent payments -- and, more important, offer more-regular feedback that comes with those bonus payments.

In late 2001, Brad Borne began paying bonuses quarterly rather than annually. "When you break it into smaller pieces, it's easier for people to see the impact of their effort," he says. "It puts the onus on individuals to perform and at the same time lets them reap the rewards from the effort that they put forth." Borne tries to put himself in his employees' shoes. "When I got only an annual bonus, did it really affect my performance in June?" he asks. The shorter time frame also gives Borne a chance to change a compensation system that continues to evolve.

Of course, there is a potential hazard to a quarterly bonus payout. If the company does well early in the year but tanks later on, inflated payouts from early quarters can put the company at financial risk at year-end. Bill Palmer protects his company against that possibility. He has installed an annual bonus system that has quarterly payouts, but each quarter the company holds back 50% of the bonus amount in a reserve account. He can then draw against that money if the company starts doing worse than expected. Of course, the backup system kicks in only when the company is actually able to pay bonuses, which hasn't happened this year. "We're just not hitting the numbers, for the first time in five years," Palmer says.

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