Pay and Benefits

The recession and a now faltering economic recovery, alongside the Government’s austerity drive, do not, on the face of it, appear to have provided a favourable context for executive and employee bonus plans. The Financial Services Authority played a contributory role to inappropriate incentive plans in bringing about the original financial crisis. In addition, surveys in both London and Wall Street suggest that significant numbers of bank staff post-recession are still not satisfied with their bonuses (66 per cent in London according to Hays Financial Markets), and so are looking to leave their current employer (50 per cent).

 

Research from the Guardian purported to show that bonuses only work for simple, low-skilled jobs such as fruit pickers, rather than high value-added and complex, knowledge-based work such as financial and business services, that is now the driver of our national economic growth. At executive levels in the private sector, the economic uncertainty in many sectors is making target-setting for annual bonus plans a difficult task for remuneration committees. As in banking, some are questioning if the focus on short-term results is desirable in the longer term.

In the public sector we have seen bonuses removed and restricted for senior Government employees, with the Cabinet Office apparently advising that the word “bonus” is no longer appropriate in these austere times, as well as the effectiveness of the bonus system for GPs being seriously questioned.

So was American commentator Alfie Kohn right in his famous Harvard Business Review article to say that financial incentives don’t motivate? At least, not at a time when payouts are down or non-existent. Should bonuses be consigned, along with manual piecework, to the scrapheap of outdated Victorian management practices?

 

Motivational guru Dan Pink cites recent research on the effects of a large pay-for-performance programme for schools in New York, offering teachers an annual bonus of $3,000 (approximately £1,830) for reaching performance targets. The study found that “providing incentives to teachers did not increase student achievement in any way”.

 

Aon Hewitt’s latest Variable Compensation Survey demonstrates conclusively that bonuses should not be scrapped. The UK data reveals that a quarter of firms have increased the number of their employees covered by bonus plans in the past 12 months, which a further third had done in the previous two years. Fewer than 10 per cent have removed any bonus plans over that timeframe, though of course payments on average fell during the recession. However, despite the continuingly choppy economic environment, companies are still spending, on average, 14 per cent of their current payroll on bonuses.

A clue for the reasons for this continuing expansion is in the title of our survey: variable compensation. This reflects not just the adoption of common American terminology on this side of the Atlantic. Variability is proving critical in the current climate for two reasons. First, it reduces the fixed cost base of an employer, so that if performance dips costs will fall without the need to cut jobs. Indeed, from a national perspective it can be argued that bonuses “worked” during the recession, as the falls in payments and total national bonus costs, from £28 billion to £18 billion in 2008/9, helped to ensure that unemployment did not rise to anywhere near the levels forecast by the gloomier economists at the start of the recession.

As the economy starts to pick up, as we have already seen recently, for example at John Lewis and Sainsbury’s, those included in all-employee bonus plans can share in the financial gains achieved, which in both these cases were multi-million-pound bonus pools. The research on performance-related pay and particularly bonus schemes is more evenly divided than the generally negative press coverage might lead you to believe.

A wide variety of research studies show associations between employees having a financial stake in business success and high firm performance. Wallace Bell for example, found that firms with profit sharing plans, like these two examples, outperformed a matched sample of firms by more than 50 per cent in terms of their levels of profitability. In addition, the large national Workplace Employee Relations Survey found that firms with some form of performance-related pay and employee shareholding had, on average, 17 per cent higher productivity and half the labour turnover of those without.

Second, when pay budgets are still tight, most employers are particularly concerned about retaining their best employees. So, as the Chartered Institute of Personnel and Development’s Reward Management Survey also confirms, they are diverting more of their pay and bonus budgets to ensure these staff are properly recognised and remunerated. Individual performance matters in almost all environments, with top performers adding proportionately more value than the average employee for the higher skill level of the work. So after two or three years of falling or zero bonus payments and pay freezes, companies are understandably worried about hanging onto their best staff.

Aon Hewitt’s databank of employee attitudes shows that pay has risen to being the fourth highest driver of employee engagement in Europe, and in the top three drivers in four out of 10 companies. In higher performing companies bonus payments are more differentiated and employees also have much higher perceptions of the strength of the links between pay and performance. Around 56 per cent of employees at those companies on our database rated as the best to work for agree that their performance has a significant impact on their total pay, compared to the European all-company average of just 35 per cent. They also think that their pay is fairer than those in other companies. Other research studies confirm that knowledge workers and high potential staff are generally strong advocates of individually driven variable pay systems.

The issue, therefore, is not whether bonuses are a universally “good” or “bad” thing, but in what conditions are they likely to be successful, and what types of design and what methods of operation maximise the chances of their success?

The Aon Hewitt study again gives us some clear indicators. Common problems reported by the participants in our survey and at our associated client seminars were that:
•    payouts had become viewed as an entitlement rather than genuinely variable pay
•    employees felt disenfranchised and unable to impact on the plan measures
•    plan designs were too complex.

 

Correspondingly, higher performing and best employer companies scored well for their plans on levels of staff involvement and communications, alignment with business goals and support from the top managers, and had bonus awards and opportunities that were big enough to make a difference to people.

Therefore, it appears that two factors, along with robust and well-tested designs and performance measures, seem to be critical to leveraging the potentially positive effects of bonus plans on your firm’s performance.

 

A variety of research studies confirm that those companies without clearly stated reward objectives are far less likely to have successful bonus plans. Where bonuses work, they support clearly stated and communicated goals and act as part of a comprehensive total reward strategy, involving explicit senior management support and a wide variety of other performance management and communications initiatives. For example, a major retailer had launched a campaign to promote its exceptional customer service to the public. At the same time it switched its bonus plans from being totally based on store operating profit to being 50 per cent based on customer service ratings and 50 per cent on profit. The plan was very popular with staff as it demonstrated that the company really was “putting its money where its mouth was” and was genuinely prioritising customer service as a key business goal, something they could directly impact on. Firm performance has continued to improve, rewarding shareholders and employees.

 

If staff don’t understand or trust the performance measures and targets that you are using in a bonus plan then it is never going to succeed. Involving staff early and extensively in the design and operation of a bonus plan improves the quality of its design, generates suggestions and improvements to help to power the achievement of the plan’s performance goals and may generate its own “Hawthorne effect” of staff simply liking to be consulted and feel they can make a difference.

The focus groups I ran recently with a company in the aviation sector highlighted problems with the current incentive plans and particularly an excessive emphasis on individual performance in some areas, when the company brand and team working were seen as key to their success. Staff themselves came up with many suggestions for modifications and improvements.

Performance management is also critical to successful bonus and incentive plan operation. If staff aren’t clear about the performance measures used in the bonus and don’t feel they can influence them then, however well designed, the plan will not support highly engaged and high-performing staff.

Recent research confirms that this is a major problem area at the moment. E-reward found that 74 per cent of organisations had changed their performance management processes in the past three years. Yet the majority remained dissatisfied and had further changes planned. As one HR director told me, “it’s expected to be part business planning, part employee development, part performance pay and part communications process. No wonder it is often seen to fail”.

The trend is therefore, as another told me, to recognise “we’ve gone back to basics, cut back on everything else and said, first and foremost, it’s about communications and having good one-on-one conversations”. With this type of effective, regular two-way discussion around performance and improvement, you then have an excellent basis for pay and bonus schemes to reinforce and reward the achievement of key and agreed business goals. Academic research confirms that bonus plans can help to motivate behaviour by focusing attention on a few key performance goals.

According to management guru Peter Drucker “only performance is reality” and every organisation needs to have some sort of relationship between its performance and its pay costs. In conclusion, renamed or otherwise, bonuses aren’t a “magic bullet”, universal solution to performance improvement, as the financial crash has illustrated. However, our research and client work demonstrates conclusively that variable pay is here to stay. With a clear strategy, effective design and well managed communications and involvement, these plans can work for, rather than against, the success of your organisation.

 

Duncan Brown is Principal of Reward and Engagement at Aon Hewitt