Every year, business owners face the decision of what to do about year-end bonuses. Some have an incentive compensation formula they attempt to calculate. Others use simple bonus plans. And many just don’t know what to do to keep their employees happy and reward those who contributed to the overall company success.
Surveys show that as many as 50% of all construction and manufacturing companies offer some form of bonus plan and another 33% have some sort of pay for performance incentive program. It seems that wherever I speak, company owners always want to know which program works the best and how should they be implemented to get the biggest bang for their buck.
Following the professional sports analogy for example, many professional football and baseball teams use financial incentives with their players. If a player achieves certain milestones or targeted results, a financial bonus amount kicks in and the player is rewarded. Some baseball player bonus milestones include: playing in a set number of games, batting 300, making the all-star team, pitching a certain number of innings, or achieving a specified earned run average. In addition, when teams reach or win the playoffs, every player participates in the extra compensation pool awarded these winning teams. Note, these incentives are for achieving specific results versus doing a good job.
What kind of bonus program works?
I received this question from a reader of my column: “What kind of year-end bonus should my general manager and my sheet metal workers get as they already make top wages for our area?”
There are four basic kinds of employee recognition, bonus and incentive compensation programs that can be offered to your employees. They include thank-you awards, gifts, incentive compensation and profit sharing. The one you choose for your company is dependent on your overall goals. Most business owners are overly generous, feel they have to pass out bonus checks at year-end, and want to give their employees extra money whether the company does well or not. But without an incentive compensation program that everyone understands, does handing out bonus checks motivate employees to work harder, build teamwork and result in the extra bottom-line profit it is supposed to achieve?
You can give everyone an annual bonus because you are a nice guy, based on whatever you want to give out. You can set targets and goals for each project or key employee, and if they hit them, you can attach an extra cash reward for hitting the goals. Or you can attach bonuses to a percentage of the net profit your company makes. This requires you to show all profit sharing participants your financials. Giving out money based on an arbitrary formula that employees don’t fully comprehend is nothing more than a gift.
For example, if you arbitrarily decide to give all of your project managers $5,000, foreman $2,500, field workers $1,000, and office workers $500 as their year-end bonuses, will you get them to work harder next year? No! Will they appreciate the bonus? Some might, while others will think it isn’t enough and complain to their peers they deserve more. And to make matters worse, they’ll expect the same or more next year, whether or not your company makes any money or achieved better results than the previous year.
Bonuses without a required performance level are nothing more than gifts which deliver goodwill and/or frustration. Profit sharing tied to performance gets everyone in your company focused on hitting the targets you want to achieve: customers, productivity, profit, referrals, customer service, on-time delivery, or safety.
Consider these situations when deciding which bonus program to implement. What happens if your company has a great year? What about a bad year? What if all of your employees worked hard to achieve spectacular results but one of your customers went broke, didn’t pay and caused your company to lose money for the year? What if some foremen always finish their jobs under budget, while others continually go over budget?
How do you reward your best foremen and project managers who are assigned the most difficult projects, and do an incredible job that only breaks-even? What about a field superintendent who can get a project going fast but takes forever to get the punch-list completed? Or what about a field operator who does a good overall job but has an accident and destroys a large piece of company equipment?
The number one motivator of employees is recognition and praise. People want to know they are doing a good job, and, therefore, need to be appreciated on a regular basis. I recommend you set up an ongoing company program where everyone gets recognized on a regular basis for doing a good job. Many companies use a “Do It Right” awards program where managers and supervisors are encouraged to give out weekly awards when their employees are caught doing something right, going the extra mile or going beyond the call of duty.
This program works well when a supervisor recognize a few of his or her team players at weekly meetings. During the meetings, the supervisor acknowledges and recognizes people on the team who did something commendable, helped the team achieve their weekly goals, or accomplished tasks ahead of schedule or under budget. After the person is recognized, the supervisor gives them a ‘Do It Right” award and everyone claps and cheers for the winners. These small recognition opportunities or ‘Do It Right’ awards can include gift certificates to restaurants or hardware stores, $20 bills, company hats or shirts, tools, lunch dates with the boss, or even an hour off with pay. The key is to make these awards fun and a part of your exceptional work environment to get everyone feeling part of a winning team.
Creating a comprehensive incentive compensation program takes a lot of work and is hard to implement. The easiest bonus program to implement is a gift program where the award is arbitrary based on simple formulas or no formulas at all. Many companies successfully use this system until they grow to the size where they can properly administer an incentive program that creates rewards based on performance and results.
Some gift bonus programs can be totally arbitrary. At the end of the year, the owners decide how much money they want to distribute to employees as year-end bonuses and split it up based on how they feel about each employee’s contribution to the overall company results. Some companies pay out amounts such as one, two or three weeks pay per employee based on how well the employee does and/or the company performed. This system is simple and easy to manage. You can reward some or all of your employees under this program. As these bonuses are arbitrary gifts, they are not expected and the amount should not be anticipated by employees. However, if this system is used over many years, employees get used to the extra money and count it as a part of their entitled compensation.
You can also tie this gift system to performance by creating personal, project or company targets or goals. For example, if the company achieves certain revenue or profit targets, the employee bonuses can jump from one to two or three weeks pay accordingly. Other bonus triggers for project performance can include an additional weeks pay if the project is completed on-time or under-budget. Or if the project finishes late or over-budget, the pay bonus can be deducted from the annual bonus amount for that employee. Other ways to bonus performance can include a week's pay to reward customer satisfaction, quality workmanship, safety achievements or overall company improvement.
If the economy or company performance does not warrant or allow for extra bonus gift compensation to be awarded, make sure you fully explain the situation to all of your employees in a company meeting. Open up the discussion to explore ways to improve results, increase productivity, increase profits, finish faster or enhance safety.
Over one third of companies use some form of earned incentive compensation. When employees know what is expected, participate in the achievement of these goals, and get rewarded for hitting their targets, everyone wins.
At the project level, I encourage you to create incentive compensation programs based on the area of responsibility the manager or supervisor controls. For example, the project manager of a general contractor controls the contract, customer communications, contract awards and the overall project profit. Project managers can receive a percentage of the overall project profit earned or the extra profit gained by their tight job management. Field superintendents control the schedule, workmanship quality, field manpower labor productivity and equipment usage. Therefore, their incentive compensation can be based on these factors they control. For example, if they finish a project ahead of schedule, they can receive a percentage of the costs they saved.
Many subcontractors reward foremen based on hitting their job labor manpower budget. The foreman reviews the bid estimate for labor hours and agrees to bring the project in at a targeted number of man-hours. If the foreman achieves this goal, he can receive from 1% to 5% of the total man-hours as an incentive compensation bonus for bringing the project in on-budget. If the foreman brings the project in under the man-hour goal, he can receive an incentive compensation bonus from 10% to 25% of the hours saved. These percentages vary by company, trade and project difficulty. In some programs, the foreman splits the incentive compensation with the crew members as well. The key to making these field incentive programs work is to meet with your foreman every week for an in-depth review of the man-hours expended by work task versus the project goal or target as the job progresses.
Many companies are moving towards ‘Open Book Management’ where every employee sees and understands the company financial results and participates in the overall company profits. Some companies only include upper management in this form of profit sharing and financial disclosure. For most smaller companies or family owned businesses with fewer than 50 to 100 employees, only the owner, division managers and key management team members see the financials. The management team receives a profit sharing bonus based on the overall company performance.
A simple profit-sharing program that works starts by setting an overall annual target for revenue and net profit. In a construction company for example, the management team can include the owner, president, vice presidents, business development, CFO or controller, chief estimator, and senior project managers. You can add or reduce your executive management team depending on how your company is structured. These management team members receive their incentive compensation based solely on how well the company performs. Each team member receives one equal share of the total net profit-sharing pool available for distribution. This way each person is equally responsible for the company to achieve the desired results and everyone works together as a team.
The overall company profit target is set by starting with a minimum annual net profit goal. Some companies set their minimum net profit goal at a 10% to 15% return on the company equity. Other companies set their annual net profit goal at 20% to 30% return on the annual overhead budget.
When the minimum annual net profit targets are hit, each management team member receives an equal share of the net profit incentive pool earned. For example, if the company’s equity is $1,000,000, the minimum annual net profit goal might be 15% return on equity equaling $150,000. For hitting this net profit goal, the management team will receive a percentage (like 25%) of the $150,000 net profit (or $37,500 total) to be split between the team members. If the company net profits are larger than the minimum goal, the management team can receive a larger percentage of the additional net profit earned.
As your company grows, it will need to reinvest most of the profits back into the company. This allows for expansion, increases bonding capacity and reinvestment into people, tools, equipment and technology. Be careful when setting up profit-sharing programs that they leave enough profit in your company to allow for steady growth. To get a “Performance Pay Plan’ template, email GH@HardhatPresentations.com.
Installing and maintaining a winning bonus and incentive compensation program can be the key to improving your bottom-line. Or they can be a drain on your cash-flow and employee morale. Make sure you consider all of the pros and cons before embarking on a program where you give out lots of cash and don’t improve your company profits, revenue, employee development, customer satisfaction, safety, quality, and teamwork.
George Hedley CSP CPBC is a certified professional construction BIZCOACH and popular industry speaker. He helps contractors grow, make more profit, build management teams, improve field production, and get their businesses to work for them. He is the best-selling author of “Get Your Construction Business To Always Make A Profit!” available on Amazon.com. E-mail GH@HardhatPresentations.com to sign-up for his free e-newsletter, start a personalized BIZCOACH program, attend a 2 day BIZ-BUILDER Boot Camp, or get a discount at www.HardhatBIZSCHOOL.com online university for contractors.