According to research by workforce consultancy Aon Hewitt, U.S. companies are increasingly turning to bonuses and other variable pay awards over fixed raises to compensate valuable employees and motivate performance.
Your small business is likely in a similar situation. But which bonus structure is best suited to get the most out of your workers?
To find out, Software Advice surveyed nearly 200 full-time employees, asking how they’d prefer their bonus to be structured. The results are presented below, along with tips on how dedicated payroll software can make bonus administration easier.
Our Bonus Structure Recommendations:
- Individual performance bonuses are best. Two-thirds of workers prefer a bonus tied to their individual performance over department/company bonuses or those not tied to performance at all.
- Forget hit-or-miss bonus targets. Eighty-four percent of workers would prefer to make a percentage of their performance-based bonus for hitting a percentage of their goal (a tiered bonus) over only making their full bonus if they hit their full goal.
- Ask employees what bonus payout timeline they prefer. The vote was nearly split between 12 monthly bonuses (54 percent) and one annual bonus (46 percent) assuming they total the same amount.
- Consider spot bonuses for special effort. Sixty-four percent of workers prefer spot bonuses over other one-time bonuses like signing bonuses, employee referral bonuses or retention bonuses.
Workers Prefer Bonuses Tied to Individual Performance
When structuring recurring, performance-based bonuses, small businesses generally have three options to consider:
- Bonuses based on individual performance
- Bonuses based on department or company performance
- Bonuses not based on performance at all (e.g., a flat bonus for everyone)
From a worker perspective, there are pros and cons to each option. A bonus not based on performance is guaranteed, but because there’s no performance incentive involved, the payout is relatively small. It’s a no risk, low reward option.
On the other hand, bonuses based on individual performance can be incredibly lucrative—assuming workers can meet often-rigorous performance goals. It’s high risk, high reward.
But when we asked workers which option they prefer, the favorite is clear: 67 percent prefer a bonus tied to their individual performance over a bonus based on group performance, or not tied to performance at all.
Paying out a substantial year-end bonus to every employee in your business can certainly make headlines, but if employees expect to get the same bonus regardless of their performance, there’s no incentive to work harder.
In fact, it could even serve as a negative incentive, encouraging workers to only do the bare minimum.
Dr. Michael Gibbs, professor of economics at the University of Chicago Booth School of Business, says department- or company-based performance bonuses also send the wrong message.
“Best performers will tend to get cynical when a company rewards something else, like the performance of the board or everyone collectively,” says Gibbs. “A bureaucratic approach to incentive pay basically means no incentive in the end. All you’re going to do is make people cynical and disappointed.”
To promote motivation and retention among your best workers, rewarding bonuses based on individual performance is best. This method involves the most work—but software can help:
- Performance management software can help organizations set goals and track employee performance against those goals in a digital environment.
- Compensation management software can align performance goals and compensation budgets to determine optimal payouts.
- Payroll software can ensure that correct amounts for bonuses end up in bank accounts, appropriate taxes are withheld and line items align accurately with the general ledger.
Christian Valiulis is chief revenue officer of HR software vendor APS OnLine. He says having a core HR suite with integrated payroll and performance management capabilities can help facilitate communication between departments—which is necessary when doing performance-based bonuses.
“Managers are doing the reviews and making their recommendations to HR, and then HR … makes the pay rate change, [commits] it to the record and [runs] it through payroll,” Valiulis says. “Having an integrated system facilitates that communication and collaboration between employees, managers and HR.”
Ditch Hit-or-Miss Bonuses
Once you’re monitoring individual performance and doling out bonuses accordingly, you might be tempted to keep things “black or white” to make administration easier: If workers hit their target, they get their bonus. If they miss it, tough luck.
Beware though, this approach can backfire. Employees don’t like it either: 84 percent of workers in our survey prefer tiered performance bonuses over “hit-or-miss” bonuses.
Hit-or-miss bonuses have two negative effects:
- High performers with nothing else to work towards will call it a day after hitting their mark.
- Lower performers won’t even attempt to reach their goal if there’s a risk their efforts could all be for nothing (e.g., if a salesperson has an annual goal of 300 sales, why work harder and risk getting no reward for 299 sales?).
What’s the solution? Set multiple performance goals for each employee, and reward them a percentage of their bonus for hitting a percentage of their goal. This way, you can promote continuous effort among your employees without seeming unfair. It’s a small consideration, but one that is often overlooked.
Monthly or Annual Bonuses? Ask Your Workers
The last thing small businesses need to consider with recurring bonuses is a payout schedule. Should do pay employees 12 smaller monthly bonuses or one large annual bonus?
Unlike the rest of our findings, the answer here is uncertain: Assuming they total the same amount, 54 percent of workers prefer 12 monthly bonuses while 46 percent prefer one annual bonus.
If results at your workplace are similarly split, you may have to consider other factors. Gibbs says the nature of the employee’s job is a crucial one.
“In some jobs, it doesn’t make sense to measure and reward performance every month,” says Gibbs. “In almost any kind of white-collar job, the things you do have long-term effects, and trying to measure them month-to-month doesn’t make sense. In a sales job or a customer service job, maybe it does, though.”
You may decide to have different bonus timelines for different jobs. If that’s the case, you can use your payroll software to set up various timelines, then link them with your accounting general ledger to keep things organized.
Employees Prefer Spot Bonuses for Special Effort
Besides recurring bonuses, one-time bonuses given out for specific actions can also motivate employees. These may include:
- Employee referral bonuses
- Retention bonuses during mergers and acquisitions or tumultuous periods
- Signing bonuses when accepting a job offer
- Spot bonuses to acknowledge special effort
We asked employees which of these one-time bonuses they’d prefer, if they could only be eligible for one. The result: 64 percent say they’d prefer a spot bonus for special effort.
Spot bonuses are often up to managers’ discretion, and limited to small amounts ranging from $25 to $500—but they’re a great way to reward and acknowledge special effort by employees.
With a modern payroll system, managing spot-bonus budgets and allocation is simple. Many systems allow for ad hoc payroll amounts to be added to payroll runs: For example, if Employee A gets a $37 spot bonus, you can add that amount to their paycheck manually.
Some systems, Valiulis adds, allow users to set amounts for custom line items that can dropped in with one click: Employee A gets a “Bronze Level Spot Bonus,” which is automatically $37, for example.
Utilize Software to Manage Your Bonus Structure
If there’s one trend that ties our findings together, it’s this:
Workers want their bonuses to be as closely tied to their performance and their impact on the business as possible.
It can be challenging to administer these types of bonuses—but Gibbs says it’s a worthwhile endeavor.
“It’s important to motivate and reward your best performers. You have to identify them and you have to reward them, and you’re going to get a lot of benefit out of doing so. It’s the kind of headache that you should be taking on.”
Here are some key things to remember when designing your bonus structure:
- Creating an effective performance review process is priority number one. “Spend the most time worrying about evaluation, trying to do it carefully [and] trying to avoid evaluations that are too narrowly focused,” Gibbs says.
- Meet employee preferences in the middle. Have employees fill out a random survey to get exact details on what types of bonuses would motivate them. Then determine how you measure success and what resources you have available. This will lead to a solution that satisfies management, HR and employees alike.
- Integrate technology to maximize communication and automation. Awarding performance-based bonuses takes effort from multiple departments. By integrating payroll, performance review and even accounting systems, you can create a seamless bonus process with less errors and duplicated entries.
In the market for one of these systems? Give our Software Advisors a call at (855) 998-8505 for a free, 15-minute phone consultation to determine the best system for your needs.
In terms of gender, 55 percent of our survey respondents are male while 45 percent are female.
In terms of age, 35 percent of our respondents are between 26 and 35 years old, making them the most common age group.