Another Option for When Employee Bonuses Don't Work

From: Entrepreneurs’ Organization | Inc.
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By Kent Lewis, an Entrepreneurs’ Organization (EO) member in Portland, Oregon, is the founder of pdxMindShare, an online career community focused on Portland professionals:

I recently shared a presentation on increasing employee engagement and retention by fostering a Culture of Caring with a group of Silicon Valley entrepreneurs. Toward the end, I asked for their thoughts about the efficacy of bonuses on employee retention. They unanimously (if not surprisingly) agreed that traditional cash bonuses simply do not work.

I thought I was the lone skeptic up to that point, based on my personal experience as a business owner.

Our passionate discussion on the topic, their shared experiences, and industry research helped determine why employee bonuses do not work, and what entrepreneurs and executives can do to increase employee retention instead.

My Bonus Journey

In 22 years of managing employees, I evaluated myriad bonus options. As a startup, my digital marketing agency team’s salaries were on the low end, so I made up the difference with annual bonuses (based on salary, tenure, and individual contribution). While it reduced my financial risk and provided an incentive for high-performers, salary discussions eventually became a distraction. I decided to pay my team above scale so they could focus on the work.

In late 2007, when the market crashed, I decided to take a left turn and inspire the team as we powered through the recession. I announced the 2-in-2 compensation plan in January 2008, which would double every employee’s compensation in two years if we hit revenue and profit targets. In December 2009, the company hit its targets, and I paid bonuses averaging 20 percent for the two-year period.

While the 2-in-2 program helped the agency navigate a rough stretch with strong financials, the negative impact that followed far outweighed the benefits. One of the largest bonuses inadvertently funded a competing agency that took my clients and employees. But the bigger issue arose a year later when the now highly paid employees were disappointed with bonuses that were only a fraction of the one-time 2-in-2 bonus program. The resulting frustration kicked off a three-year downslide in employee morale and retention.

We pivoted to “spot” bonuses for valued activities such as referring new employees or clients and rewarded collective team efforts with company-wide experiences (field trips, unique events, etc.) that were engaging, fun, and memorable. By 2018, cash bonuses had virtually disappeared, yet team morale was higher than ever because we empowered employees toward greater success and aligned recognition with our vision, mission, and core values instead of financial targets. Our decreased spending on bonuses was on-trend, according to statistics. In December 2023, bonuses paid by firms on Gusto’s platform averaged $2,145, a 21 percent decline from 2022.

My entrepreneurial and agency peers shared similar experiences with bonuses having a neutral or negative impact on employee retention, indicating that cash bonuses do not solve the problem.

According to 2023 Gusto research, 86 percent of employees said they would stay at their company for a longer time in exchange for an immediate cash bonus. This statistic does not address the fact that these employees leave shortly after, regardless of the reason.

Why Cash Bonuses Do Not Work

Cash bonuses are extrinsic motivators that fail to alter attitudes that underlie our core behaviors and beliefs. At best, bonuses only temporarily change behavior. Part of the issue is that performance bonuses are typically based on quantitative data and lack a view into qualitative metrics. For that reason, we factored customer and peer feedback into quarterly employee performance reviews.

Research by Jude Rich and John Larson indicates that even top executives are not immune to the lack of ROI that bonuses provide. This is further proof that bonuses are short-term — unlike salary increases — and thus lack the ability to influence behavior change over time.

There are a host of other issues around cash bonuses. For starters, cash bonuses rarely help workers feel more appreciated, especially if the cash is automatically deposited into a checking account without ceremony. Additionally, cash bonuses rarely address non-monetary concerns such as flexible work schedules, hybrid or remote work options, child support, or other expanded healthcare options that may be top-of-mind for employees.

Alternative Incentive Solutions

I am a major fan of non-monetary incentives such as unique experiences or gifts with individual meaning. Your company might also consider offering flexible work arrangements, additional paid time off, or enhanced professional development opportunities. For in-office employees, revisit desirable benefits like a regular massage therapist, yoga classes, or other wellness-based benefits (as opposed to the alcohol and unhealthy snacks of the 1990s).

On the “cash” side of the ledger, consider creating a formal profit-sharing plan or offering equity as compensation. With profit-sharing plans, transparency is essential, often necessitating employee education on financial literacy fundamentals. The payoff can be significant, as outlined in The Great Game of Business. I offered phantom equity to one key employee in 2013, who still benefits financially from our March 2022 exit.

As you embark on mitigating cash as a bonus incentive, consider soliciting input from key employees and stakeholders to inform a plan that will create the biggest impact for the organization while maximizing employee engagement and retention.

Regardless of which path you pursue, the fundamentals apply: Tie bonuses to behaviors you want to change over time that are consistent with your company’s core values and regularly communicate with employees regarding evaluation criteria, supporting financials, and how everyone wins when everyone on the boat is rowing the same direction.

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