Bonus funding and allocation in a pay for performance plan

Funding and allocation are the two issues employees care about in a pay for performance plan

So how do we make sure that we have the right amount of money in the pay for performance plan bonuses pool? And once we’ve identified that bonus pool, how do we properly allocate that within the organization?

It’s important when budgeting to budget the full amount of individual awards. You can always look at prior year’s results as a proxy for what will happen this year. And the same thing can be true of merit increases as well not just for incentives but when looking at salary increases as well.

Historical analysis can be helpful with pay for performance plan decisions
You may say, “Well, I don’t know what employee’s level of performance is going to be much less do I know what the average performance is going to be or what every employee’s performance is going to be.”

But if I have historical data, I can look at well, what was the average performance, what was this particular employee’s performance last year and use that as a proxy for this year. Some of the results maybe higher, some maybe lower but that can assist you in budgeting.

Corporate performance in a pay for performance plan
When you’re talking about corporate performance, generally speaking within the confines of budgets will be target performance bonus level. So that would be included in the budget. Any performance level above that target level – and if you recall, we identified four different points — the threshold, the target, the stretch and our maximum, we’re going to budget that target. Any performance above that would be funded directly based on that performance above target.

In other words, if our target is profitability growth and our target is 10%, if our stretch is 12% well that difference in profitability, that 2% difference should be more than enough to fund the additional dollars in the budget pool but also should be enough that there’s still more money going to the bottom line of the business.

So above target performance, there’s essentially shared results between the employees that drove those results and the bottom line of the company, which would translate to ownership.

Edited remarks from the Rapid Learning Institute webinar: “Incentive Pay Plan Blunders That Can Cost You a Fortune” byEd Rataj