19 April 2008

Bonus: To Pay Or Not To Pay

Setting up a bonus system is difficult enough. But if you don't think it through, you will be completely screwed once you have to start paying hard cash to employees.

Ann Bares at Compensation Force discusses how a company put a bonus system in place and tried to find a way out when they realized how much it would actually cost them.

HR Wench turned this into a HR pop quiz.

Here are my replies to Wenchie's 3 questions.

I'm pretty tough on the HR Manager in question. I don't know her personally and base my comments solely on what I read in Ann's post. Maybe she is incompetent, inexperienced, or maybe she's an excellent HR Professional and we just don't know enough about her situation.

1. What mistakes did the HR Manager make prior to calling Ann?
The bonus system was set up by Senior Management while HR was "involved". The HR Manager's job is to give advice to management and to warn them of possible problems.

The HR Manager should have prepared a cost projection. Ideally she would also have talked to Finance about bonus accruals (see also my "napkin advice" below) and given feedback on the planned targets.

A former boss once told me "bring me solutions, not problems." What he meant was that he wanted me to think before bothering him and he expected me to make at least one suggestion that we could discuss. The HR Manager called Ann and basically said: "Help! Solve my problem!"

2. What, if anything, is wrong with the bonus plan?
The way the targets are set up, employees get the maximum possible bonus for an average company performance. If you link the bonus to the success of the company, well duh, you should only pay great bonuses if the company is doing great.

Here a purely fictional example:
  • company target is to earn 100 cookies
  • 100% bonus for 100 cookies, 50% bonus for 80 cookies and 0% bonus for 50 cookies or less
  • replace "cookies" with your local currency
In an ideal world the company should be happy to pay 100% bonus for 100 cookies earned. Otherwise the bonus targets are wrong or the company should just stay away from any bonus system and stick to base salaries.

By the way, I heard that revenue is not a good indicator of a company's success, but this is just a simple example. And since I'm in HR, I don't really know the difference between revenue, benefit, cash flow, EBITDA, etc. All I know is that it's complicated ;-)

3. What would you do if you found yourself in this situation?
My job would be to remind management that they made a commitment to their employees and that keeping promises is usually considered a good thing.

Then I would have to bite my tongue really hard. Otherwise I might tell them that they're just a bunch of dumbasses who should have used their brains before launching the new and shiny bonus system.

Finally, if they still planned on not paying bonuses, I would mention the consequences listed by Ann ("kiss morale, trust and credibility - along with your most talented employees - goodbye"). As a last resort, I would mention legal implications.

Oh yes, and it might be a good time to update my CV!

Napkin calculation:
The most advanced compensation calculations probably require a degree in Quantum Physics. But for a very general idea of the costs of a bonus system, take a napkin and make the following calculation:
  • assumption: 100 employees, average base salary 50k, average maximum bonus 10% of base salary
  • payment for 100% bonus achievement: (100% achievement) * (100 emps) * (50k salary) * (10% bonus) = 500k
  • add social security costs (useful for bonus accruals): (500k bonus) + (20% soc sec costs) = 600k
For a more precise projection, make this calculation per employee. And if the targets are good (i.e. difficult to reach), then change the expected achievement to something more realistic.

Feel free to tell me in the comments where you agree or disagree with me.


Andres said...

Dear Happy, Nice post. I think you're answers are spot-on.

Judging from the quality of your posts, I also don't buy for a second your ruse of false-modesty when you say you don't know the difference between revenue, benefit, cash flow, EBITDA!

Perhaps the perception of finance-challenged HR is a ruse to keep your collaboration with finance problem-free?

Happy Employee said...

Andres, thank you for the compliment!

And regarding the "ruse": having a big mouth and knowing how to put one word before the next doesn't mean that you know stuff ;-)

Anonymous said...

Excellent analysis my dear! Thanks for playing. When it comes to EBITDA and stuff like that I understand it when a finance pro talks to me about it but I'm not interested in it enough to really know all the nitty gritty details. Which, some think, is very bad of me as an HR pro.

Happy Employee said...

Wenchie, let me guess, do you just "feel free to NOT care" about all that financial stuff?

Anonymous said...

Pretty much!