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Do Bonuses Hurt Productivity?

When everyone gets a bonus regardless of performance, dangling a carrot isn’t as effective as it once was.

[Source photo: wk1003mike via Shutterstock]

If your company awards bonuses as part of its compensation plan, you might be wasting your money and limiting your potential. A recent study from management advisers Willis Towers Watson found that more than 25% of companies pay bonuses to employees even when they fail to meet expectations, and only one in five employers believe merit pay is effective in driving performance. Perhaps dangling a carrot isn’t as effective as it once was.

Bonuses have turned into an expected addition to an employee’s income and are not motivational, says Kris Duggan, CEO of goal software provider BetterWorks. "The old thinking was, ‘Why put money in someone’s base pay if you could get extra leverage by using it to squeeze a little more productivity out of them?’" he says. "These were token bribes for doing work you’re expected to do, but they don’t incent the right types of behavior. In fact, it supports nine-to-five behavior."

Duggan admits that management by objective, which is the process of defining goals and using those as a measure of individual contribution, has been considered best practice for the last few decades, but he believes the system is flawed for five reasons.

1. The Nature Of Organizations Is Changing

Companies need to execute cross-functionally, and you can’t motivate and engage with a payment for performance program, says Duggan. "You have to make sure marketing and sales are working together, for example," he says. "Bonuses don’t foster teamwork."

2. Employees Are Changing

Ten to 20 years ago, people were motivated by pay, title, perks, and getting the corner office. "Today, what motivates people is clarity of purpose and work that matters," says Duggan. "When you understand the big picture and invest in the growth of your people, you’ll see a fundamental difference."

3. Bonuses Provide Administrative Burdens

Managers need to set annual objectives, which can be troublesome for companies and employees if their predictions are wrong, says Duggan. And sometimes managers sandbag the goals so they don’t run the risk of not reaching them.

4. Bonuses Can Feel Inconsequential

If an employee’s base pay is $100,000 and a 10% bonus is divided quarterly, the reward might not be enticing enough, says Duggan. "You can’t set five goals against a $2,500 bonus, for example," he says. "It’s $500 each and barely a piece of cheese. And setting one goal won’t move the company’s needle."

5. Bonuses Stunt Employee Growth

Any time you directly link pay to performance, you stop the learning process, says Duggan. "Employees become super obsessed with hitting the goal, and they don’t get past what they’re working on in the moment," he says.

What To Do Instead

While bonuses are limiting, goals don’t need to go away. Duggan suggests paying a fair wage and setting targets that aren’t tied to a bonus. "Post goals openly and publicly," he says. "Create an environment and culture that celebrate wins and learn from failures. Expect managers to coach employees and people to stretch themselves."

Reward employees for "deep-think" projects, says Duggan; the big innovative projects that will actually move the company’s bottom line. "If you’re rewarding everybody for menial tasks or checking things off a list, then you miss out on tapping the huge potential of your top performing employees," he says.

While Duggan would like to see the practice die, Tim Low, senior vice president of employee compensation software provider Payscale, doesn’t believe that bonuses are going away anytime soon. His company released its annual compensation report based on data from 7,600 employers, and found 81% of highly successful companies reported giving bonuses, compared to 74% overall. In addition, half of top performing companies are increasing the size of their bonus budget in 2016.

"Companies across the board are trying to figure out how to get a better return on their pay investment, and we are starting to see different practices emerge," says Low. "Typically companies without a strategic goal in mind apply a 3% raise each year to employees’ annual salary. This doesn’t reward high performing employees versus those who are average."

While Low calls pay for performance a business cliché, he insists it's valuable at its core. "It’s a smart concept if you don’t reward average performers," he says. "Pay only the highest performers, and that will establish a beacon for other employees to aspire to."

Transparency is key, says Low. "Being honest and somewhat explicit around why you pay the way you do and how an employee can achieve higher pay is a powerful way to increase employee engagement and foster trust," he says. "Variable pay is often linked to overall company performance. Linking pay with individual performance and overall health of the business can be a smart way for companies to move ahead."

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