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Two Approaches to Calculating Bonuses

There are a lot of traditions surrounding the distribution of bonuses ranging from timing to eligibility, from merit to patronage, from celebration to stomach ulcers. The less pleasant traditions are usually a result of poorly defined structure or “bias bonuses” that reward people based on favoritism and politics rather than contribution.

Photo by Frédéric Bisson, Flickr

To ensure that bonus time creates a positive tradition in your organization, here are two vastly different approaches that strive to address common bonus time inequities.

The Standard Approach

The annual bonus is a common approach used by businesses concerned with preserving cashflow. Typically, bonuses are closely connected to each business’ vision of success.

To ensure that bonuses are distributed fairly, they’re often tied key performance indicators (KPI’s), which then vary by department and job role. Managers may also give out discretionary bonuses, which should be linked to specified goals and objectives (MBO).  

Calculating how much an employee will receive is a function of the intersection of company performance and individual performance during the year. In this way, top performers (who have contributed more to overall company performance) are rewarded accordingly. Of course, annual bonus decisions are also are grounded in one other essential question: can we afford this?

Assuming the company is financially healthy, a bonus scheme is usually calculated based on a percentage of NET profit tied to a minimum benchmark. When the benchmark is exceeded, a contribution to the bonus pool is triggered. The bonus pool is then shared among employees, based on policy (e.g seniority), job roles and performance.

According to Salary.com, the following are typical bonus levels (as a percentage of salary) for industries that commonly issue bonuses. Some exceptions to this example include the high-tech and investment banking industries, which may offer more generous bonus structures, and the healthcare and nonprofit sectors where bonuses are rare.

Base salary

Target bonus (%)

 Less than $75,000

 0*

 $75,000-$99,999

 10-15

 $100,000-$149,99

 15-20

 $150,000-$199,999

 20-30

 $200,000-$299,999

 30-40

 $300,000-$499,999

 40-60

 $500,000 or more

 60-100

*Bonuses for this range are not typical, and if rewarded, are usually discretionary.

Something Completely Different

So many aspects of today’s workplace are evolving in interesting and challenging ways that we shouldn’t be surprised at the emergence of unique bonus structures. The way Shopify handles bonuses, for example, is highly exceptional. They crowdsource their bonuses based on peer feedback and hand them out monthly. At Shopify, a person’s bonus is “determined by the gratitude of her peers for a job well done.”[1]

Their logic for this approach is as follows: although good work ultimately benefits external customers, it also makes the lives of co-workers easier. While dissatisfied customers can complain or shop elsewhere, the people we work alongside see (and have to live with!) the impact of our behavior and our efforts every day.   

Which is why, following the internal implementation of iDoneThis as a team productivity tool, Shopify introduced what they call the Unicorn system. Colleagues log instances when the people they work with have done something awesome. These comments drive the bonuses distributed each month. As a result, praise and bonuses are handed out when deserved, based on real contributions as determined by peers. According to Shopify CEO, Tobi Lutke, “Unicorn discovered top performers among employees who might otherwise have been overshadowed by more charismatic colleagues.”

With this non-traditional approach, Shopify took the politics out of bonuses. Also, by giving bonuses every month, they tied feedback far more closely to results, taking advantage of the fact that timely reinforcement is so much more powerful than delayed recognition when it comes to performance.

Whether your company subscribes to the more traditional approach to calculating performance bonuses or is stretching the envelope like Shopify, it pays to put some time and thought into the way bonuses are determined and distributed. If employees believe that a bonus structure is inherently unfair, instead of motivating them to excel, bonus time may usher them out the door.

 

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