Making Bonus Plans Work For You

Designing and implementing bonus programs is not as easy as it may seem. If you have ever designed a bonus program and then abandoned it due to undesired results, you are not alone. You would probably be surprised by the number of construction companies which have done just that. And of course, when this happens it is very demoralizing to the employees. And, it is just this type of experience that has caused so many construction companies to not have a defined bonus plan.

Clearly Define Your Objectives
Any bonus program should be designed around a set of objectives that you hope to accomplish. My belief is that the bonus program should encourage employees to be more productive, thereby making the company more profitable and competitive. Consequently, the bonus plan should be based on what they have most control over, which are direct and indirect job costs. Consequently, the bonus plan should be based on the attainment of a calculated annual gross margin contribution goal that will enable the company to pay for the overhead and have enough profits left over to fund the bonus plan, owner distributions, tax liabilities, and equity growth of the company. Gross margin contribution is defined as:

Sales – Direct Job Costs – Indirect Job Costs = Gross Margin Contribution
Gross Margin Contribution – Overhead Costs = Net Profits

Don’t Base the Results on Net Profits
Since most employees do not have any control of the overhead, what is the benefit of designing a plan on the bottom line? From the field employees’ point of view, none. They often don’t trust the overhead numbers and most always believe that there is too much office overhead anyway. For this reason, the bonus plan should focus the employees on what they most control and influence—their productivity. Of course, through a budgeting process, you have to ensure that the gross margin goal is high enough to protect the company’s profitability and the owner’s needs.

Here are the Pros and Cons of this type of bonus plan.

CONS
1. It represents a change from the norm. Some employees and owners naturally resist any change.
2. The time frame is usually annual which could result in a longer payout period than what has been customary.
3. It requires an annual forecast for sales, gross margin contribution, and overhead expenses—a fundamental business practice that is often ignored by contractors. This is really a PRO from a business standpoint, but is listed here because it represents a change from the norm.
4. The owner has to overcome the fear factor. It requires the company to share information (sales, job cost info, and gross margin contribution) on a consistent basis—information that the owner may not have shared in the past.
5. It emphasizes team goals ahead of personal goals, which some employees may not like if they are used to the per job bonus plan. (A PRO from an employer standpoint)
6. Employees become responsible for all the job costs—not just labor costs. (Another PRO from an employer standpoint.)

PROS
1. It requires an annual forecast for sales, gross margin contribution, and overhead expenses—a fundamental business practice that is often ignored by contractors.
2. It protects the profitability of the company. The company will have the ability to pay the bonuses without jeopardizing its long-term financial stability. If the gross margin goal is not met, there is no bonus distribution.
3. This bonus program requires an open environment by sharing information that the employees influence and appeals to the human motivators of recognition, sense of achievement, sense of belonging to a group, peer approval, and financial security.
4. Performance numbers are routinely and openly shared so that there is a connection between personal and job performance to the attainment of the goals.

“When performance is measured, performance improves. When performance is measured, reported, and shared, the rate of improvement accelerates.”

5. All employees share in the same team goal. Teamwork and team spirit are encouraged. There is a better opportunity for all to be on the same page.
6. The potential rewards are defined and known ahead of time. “What’s in it for me?” is answered ahead of time.
7. The customized distribution methods recognize both team and personal contributions toward reaching the goals.
8. It minimizes many of the unfairness issues that crop up from job-by-job plans as it is team-based.
9. All eligible participants have an opportunity to earn a bonus if the team reaches its goal.
10. Conditions of the plan discourage unsafe work practices and poor quality. Other conditions are customized per client preferences.
11. It is by far most fair to both the employees and the company.

More Than Just a Bonus Plan
1. From a business standpoint, it adds discipline and causes better business planning.

• a. It is driven by an annual forecast for new orders, sales, gross margin contribution, overhead budgets, and net profits.
• b. The annual forecast is broken down into monthly targets.
• c. The forecast enables the company to determine the true recovery rates for indirect costs and overhead expenses so that the true break-even point is established for each bid.
• d. Creates a more forward-looking environment as departments strive to meet or exceed the planned goals.

2. From a project management standpoint, it adds discipline and accountability.

• a. Requires monthly margin reviews to project the estimated final costs of all non-closed jobs.
• b. Active job costing creates a more forward-thinking environment, which reinforces the value of pre-planning.
• c. Margin reviews provide accounting with more accurate information for WIP statements and income statements.

3. From a financial standpoint, income statements become an operating tool and reflect the methods of forecasting.

• a. Direct and indirect costs may be redefined.
• b. It lends itself to more accurate financial statements, which must be generated timely each month.
• c. Variances to planned goals are identified.
• d. A monthly financial planning meeting will show the results of the last month along with a 3 month look ahead by projecting out existing sales and gross margin backlogs and updating the new orders forecast by sales/estimating. This information will enhance a proactive decision making environment.

4. From an estimating/selling standpoint, accountability is strengthened, as each Estimator/Salesperson will have monthly goals for the amount of new gross margin from contract awards he/she is to bring into the company.

• a. It will become quite apparent that shortfalls in new orders will affect future sales and future gross margin contribution.
• b. Shortfalls or over-capacity situations will be recognized early enough to take corrective action.

More than just a bonus program? Absolutely. With proper commitment from the management team, this type of bonus program will create a more goal-oriented environment. Business won’t just happen. It will be created and driven by those who can most affect it by establishing those benchmarks from which to measure performance and with a predefined reward for reaching or exceeding the team’s potential. The company will only pay out a bonus if the company’s profitability improves. This type of bonus plan is a WIN-WIN bonus program for both the employees and the company.