B2 - Bonuses and Incentives

Understand the basics of bonuses and incentives, the trends in their application, and how to design and operate schemes effectively and ethically.

Introduction

Whether used proactively to influence behaviour or retrospectively as part of a reward package, bonuses and incentives can have various benefits for organisations and employees.

The success of any bonus or incentive scheme is based on an understanding of the context in which they operate and an appreciation of how individuals may respond differently to the same stimulus.

We explore the various types of bonuses and incentives, the trends in their use, and the potential benefits and drawbacks of these reward arrangements. It provides an insight into how bonuses and cash or non-cash incentives suit a variety of contexts, and what to consider when designing and operating such schemes.

What are bonuses and cash incentives?

Bonuses and cash incentives are a form of variable pay based on the use of cash lump-sum payments linked to an individual, collective or organisational performance (or some combination of these). They are not consolidated into base pay, though in certain situations (such as due to cost constraints) they can be given as part of, or instead of, a pay rise.

It's important to draw a distinction between the cash incentives and bonuses, although the two terms are interlinked and often used interchangeably.

Incentives aim to influence future employee behaviour or performance, usually using targets: if a specific target is met, the employee will receive a cash payment.

Bonuses cover a wider range of purposes and can be discretionary or non-discretionary. Like incentives, they may be used to influence employee performance or behaviour to meet pre-set objectives, but they could also be used to reward past achievements.

What are non-cash incentives?

Non-cash incentives, sometimes known performance improvement plans, are forward-looking, formal schemes. They aim to affect directly employees’ future performance by awarding prizes or ‘gifts’, such as merchandise, travel or retail vouchers, associated with some performance measure, such as sales volume. Employee recognition schemes are retrospective as they recognise past performance rather than incentivising future efforts. They may be informal and discretionary. Such schemes may be linked with non-cash incentives.

Purpose of Bonuses and Cash Incentives?

The desire to incorporate bonus and incentive plans into reward packages has been partly driven in part by the influence of the ‘new pay’ philosophy. This advocates that ‘guaranteed’ basic pay should comprise a smaller element of the overall reward package, with a shift towards strategic reward linking employee performance and pay to the wider business strategy.

There's also been a move in certain sectors towards market-based pay, whereby an employee might only receive a pay rise if the market rate for the role had increased: in this scenario, an individual contribution could be recognised via a bonus instead of a pay rise.

For the employer, the advantages of bonuses/cash incentives over consolidated salary increases include:

• ongoing motivation as bonuses must be re-earned
• lack of impact on certain employer on-costs that are linked to basic salary levels, such as overtime rates.
• capacity for maintaining market pay competitiveness without necessarily inflating the annual pay bill
• flexibility through, for example, the ability to reduce or even halt payments during economic downturns.

For the employee, the main benefits are:

• greater control over their own level of remuneration
• higher payments are potentially possible.

But the downside for employees includes that:

• non-consolidated payments must be re-earned and may not count towards pensionable pay
• payments may be unpredictable or lower than expected if targets cannot be met.

Types and Coverage of Bonuses and Cash Incentives

The payment of bonuses and cash incentives is generally linked either to the quality and/or quantity of work, on an individual or collective basis, or to some measure of company performance such as profit levels (or both).

Schemes may be broadly divided into the following categories although definitions vary, may overlap or be linked.

• Individual-based - payment of the bonus/incentive is calculated by some measure of individual performance, hence there should be a considerable incentivisation effect. Sales commission could be included within this category (although this may be regarded as a distinct form of remuneration in its own right).
• Schemes driven by business results - company profit levels or customer satisfaction may be used as measures to help determine bonuses.
• Team-based - links the bonus with some measure of collective performance, often with the aim of fostering effective teamworking.
• Project-based - might be used when a deadline is important, for example, to reward construction workers for completing a building project on time, although such schemes may be open to manipulation.
• Department/site-based - payments that could be used to reward, for example, workers who attain productivity improvements in one factory.
• Gainsharing - the idea that employees should be able to share in financial gains achieved through improved performance (particularly enhanced productivity).
• Combination - based on two or more of the above schemes.

The Purpose of Non-Cash Incentives

There are also more specialised bonuses, for example at Christmas or for attendance.

It’s sometimes argued that cash may not be the most effective means of motivating employees because it doesn’t necessarily encourage them to ‘go the extra mile’ in their current role. Non-cash incentive schemes, based on the receipt of a gift or prize, can be more memorable and exciting, and therefore have a greater impact.

Typically found in customer-facing industries, non-cash incentive schemes may be based on the use of a single prize to be won by the highest-performing employee or team, and encompass a range of awards recognising different levels of achievement.

The benefits of non-cash incentives include:

• Affordability - such programmes may be more cost-effective than alternatives such as cash bonuses.
• Simplicity - it's easy for a sales employee to understand that, say, selling so many phones will result in them receiving whatever the latest prize is.
• Psychological impact - it's acceptable for employees to speak openly with pride about the winning of gifts in a way that may be considered by many to be socially unacceptable it they were seen to be ‘bragging’ about their cash bonuses.

Drawbacks can include:

• Lack of credibility - such prizes may not be taken as seriously as cash.
• Lack of employee awareness - employees may be less conscious of the value of non-cash incentives over ‘hard cash’, especially when living standards have fallen significantly.
• Lack of value - people value the same non-financial reward, such as a trip to a sporting event, differently, so what might be an incentive to one person may have no impact on another.

Types of non-cash incentives

The main types of non-cash incentives may be broadly divided into:

• merchandise such as tablets, mobile phones or watches
• activities/special events such as meals out, hotel spa accommodation/treatments or a trip to a sporting event.
• travel, for example, an all-expenses-paid trip
• retail vouchers which are often obtainable at a discount to ‘face value’
• awarding points that may be converted into a range of awards.

It’s worth noting that the last two of these categories might not be strictly regarded as ‘non-cash’ items.