I remember clearly the first time I received an annual bonus. I was grateful for the extra money, but it was also mysterious. No one mentioned the bonus when I was hired. Why had I received one? And more importantly, how could I earn it again? What could I do to earn even more?
Throughout my tenure at the company those questions remain unanswered. Of course, we all assumed bonus payouts had something to do with individual and company performance, but no one explained details.
In hindsight, my employer missed a great opportunity. The annual bonus created plenty of goodwill, but did nothing to give employees incentives to achieve specific goals. All that money could have had a big impact on employee behavior, but it didn’t.
How then should an annual bonus be set up? There are almost infinite options, and which you choose depends on the specific circumstances of your business. But at a high-level, an effective bonus program should answer the following basic questions:
A well-defined bonus program helps employees understand exactly what they need to do. It empowers them and gives them a strong incentive to achieve.
Leave room for discretion. While it's important to have clearly defined objectives, sometimes unexpected events force a change of plan. Give yourself room to push the bonus up or down, or adjust the goals, when it makes sense.
One word of caution — take time and be thoughtful when setting objectives. It's important to get them right, because you will get exactly the behavior you ask for. Giving employees incentives to do the wrong thing is a recipe for disaster