The terms "Bonus" and "Incentive" are often used interchangeably, but in fact they are quite different. Let's begin with basic definitions:
BONUS -- A single payment made at the end of the performance period (typically a year) to reward extraordinary effort or achievement.
INCENTIVE -- 1) A tangible or intangible reward that is designed to motivate a person or group to behave in a certain way. 2) A single payment made at the end of the performance period (typically a year) to reward specific measurable or observable achievements that have been defined in advance.
Although bonuses may or may not be not tied to a specific predefined outcome the employee does not know in advance how much she will earn if this outcome is achieved. As a result bonuses have limited behavioral or motivational impact. Bonuses are often viewed by employees as gifts and it is not uncommon for them to be paid around holiday season.
Incentives differ from bonuses in that incentives define BOTH what needs to be accomplished AND what the employee will receive in return for accomplishing it. As a result incentives have greater behavioral and motivational impact.
Incentives function much like a contract. Both parties pledge something at the outset -- the company pledges a certain payout if certain results are achieved. The employee pledges to exert the effort and attention necessary to achieve these results. In this way, both parties understand clearly what is expected of them.
Structuring incentives in this way obligates the company to a payout when/if the results are achieved. Sometimes this makes owners nervous. After all, what if one person hits their goals and has qualified for a payout in a year where the company loses money or otherwise has a bad year? Should the incentive be paid? Absolutely. The rationale is that if the measures and goals were designed properly at the beginning, the one person who hit their goals has helped avoid the company from having an even worse year. That said, it is prudent to build into incentive plans certain qualifiers (such as minimum revenue, profit, or quality levels) below which NO payouts will occur, regardless of any one persons results. This is made tolerable by communicating it in advance, but such thresholds should be set just above survival levels and should only trigger very rarely or else you risk alienating your best and most successful employees.
Without the clear connection between results and rewards, much of the motivational value is lost. Since employee cannot predict with any certainly what they might earn in the way of a bonus, there are certain very predictable outcomes:
- Employees don't change their behavior or increase their effort to earn a bonus. They just wait around and hope to get something.
- The satisfaction of receiving a bonus is short-lived and usually after a few days it is gone.
- Bonuses tend to become an entitlement making employees frustrated or angry when they go down or disappear.
- Employee tend to blame others (usually management) when bonuses aren't paid.
Conversely, the results of well-designed incentives are quite different:
- Incentives will motivate employees to try hard because the results are something they can control and influence.
- The satisfaction or receiving and incentive payout is much higher because it is accompanied by a sense of achievement.
- Incentives are not viewed as entitlements because they are a direct result of employees own effort.
- When and incentive is not earned, the employee has no one to blame but themself.
I am a huge advocate of well designed incentives and I have seen them work extraordinarily well on numerous occasions. I consider them to be an integral part of The Perfect Pay Plan.
For more information on designing effective incentives, visit http://www.incentiveplanbuilder.com