Perfect Bonus Systems and Other Fairy Tales

July 10, 2009
How management employees can receive huge bonuses when their companies have not turned a profit seems incredulous. It happens because bonuses and company profitability  are tied to short-term goals rather than long-term business vitality. The lesson to be learned when it comes to bonus systems — tread very carefully!

Why Most Bonus Systems Don't Work: Lessons from Wall Street

by Douglas A. Kellogg, DDS

Today’s financial problems on Wall Street have been highlighted by the large bonuses given to the management of some Fortune 500 companies. How these employees can receive huge bonuses when their companies have not turned a profit and have in fact lost billions of dollars seems incredulous. This separation between bonuses and company profitability is allowed by bonus systems that are tied to short-term goals rather than long-term business vitality.

The lesson to be learned from these incredibly high payments is, when it comes to bonus systems, tread very carefully. The Wall Street managers receiving millions of dollars in bonuses are excellent examples of bonus systems gone awry. If Fortune 500 companies, with their business expertise and legions of consultants, can create such misguided systems, can you imagine how easy it would be for naive dentists to install systems with unexpected results? Though bonuses can be tied to practice parameters to mitigate the untoward results seen on Wall Street, this surprising outcome is only one of many pitfalls that must be avoided in order to install the “perfect bonus system.” Bonus systems similar to Wall Street plans may not be something the dental service industry wants to emulate.

Many doctors create bonus systems as employee incentives and to attract and retain staff. The psychology of the bonus system is deceivingly appealing. By adding this benefit, doctors hope employees will work harder for the practice in exchange for extra money. They also hope the bonus system will attract prospective employees and help retain staff by increasing practice appeal.

Though bonuses may enhance practice attractiveness somewhat, in reality employees will not remain employed or accept employment based on a bonus system. They may see it as a potential benefit but will not make their decision to join or remain with a practice based on a bonus.

Whether a bonus actually acts as an incentive greatly depends on the system. Structured properly it may indeed serve as an incentive, however, the incentive it creates may be entirely different than what the doctor has in mind. In other words, be careful what you wish for.

Though great in theory, bonus systems can actually create disincentives and disharmony among staff and doctor. They may even create disgruntled employees, leading to staff loss rather than retention.

At least six pitfalls can contribute to the failure of a bonus system. Some are failures from the perspective of the employee, and some are failures from the perspective of the employer. There are also pitfalls associated with specific types of bonus systems. First, let’s address three issues considered failures by the employer.

Bonus system failures from the employer’s perspective

1. Employees viewing the bonus as pay rather than an actual bonus.

If the bonus system becomes so automatic that every time a bonus can be earned it is paid, then employees expect it. As time passes, though staff may be doing no more work to earn the bonus, they expect to receive a bonus. They view it as part of their regular pay. Eventually the dentist realizes he or she has increased employee pay, yet is seeing minimal benefit for the payroll increase. It is easy for the dentist to become resentful of this situation, even though he or she created the situation.

2. Employees manipulating the system to achieve the bonus goal, not necessarily the doctor’s or practice’s goal.

It’s human nature to manipulate the bonus system within its boundaries so that employees actually make the or increase the bonus. Employees will influence the schedule, patients, production, and more so that, for example, income will fall into one bonus period rather than another, which allows them to reach their goal.

If the bonus is based on a month’s production and there is no chance a bonus will be made for the current month, employees may avoid scheduling in the current month. It is tempting for staff to delay scheduling any big cases until the next month in order to achieve the bonus for that month. Obviously, putting off treatment until the next month is not an objective of the bonus system or the doctor, yet this is one example of behavior the bonus system may encourage.

3. Employees becoming disgruntled and ending employment if the bonus system is reduced or terminated.

If the doctor eliminates the bonus system due to inequities or unexpected results, the result may be a decline in staff morale or even employees quitting. If there’s a downturn in the economy and a resulting decrease in production and collections, bonuses may also decrease. If the downturn is extended, employees may face a long-term discontinuation of the bonuses. Either of these can cause low employee morale and possible staff loss, especially if they have come to expect a bonus.

If the doctor stops or reduces the bonus after the staff has continually achieved a high level of production, employees will view the doctor and bonus system as arbitrary. If the staff works hard to reach a high bonus pay level, then sees the doctor reduce the reward or increase the goal, any incentive is eliminated since the staff will assume that every time they reach goal the doctor will capriciously raise the bar.

Bonus system failures from the employee’s perspective

1. Bonus calculations being too complicated or information being unavailable for employees.

In order to arrive at a fair and effective bonus system, the calculations to determine bonuses must be easily understood and transparent enough that employees can calculate bonus amounts and project bonus payments. Often bonus systems are complicated, making it difficult for the average staff member to understand just how a bonus is determined. This will lead staff to believe that bonuses are capricious and based on something other than their efforts. Remember, though the staff may be highly trained and educated in all things dental, they may not be business savvy or mathematically astute.

Also, the information used to determine bonuses may include production, collections, or other information that the dentist wants to keep confidential, and may therefore be reluctant to reveal to staff. This reduces the transparency necessary in bonus calculations to mitigate staff perceptions of capriciousness. For a bonus to be effective, calculations should be easy for staff to figure in order to determine or verify bonuses on their own.

2. Employees perceiving no control over whether they receive a bonus or over the bonus amount.

If employees feel there is little or nothing they can do to control whether or not they receive a bonus, then there is no incentive for them to work harder to achieve the systems goals. Therefore, rather than an incentive, the bonus is at best a variable and whimsical payout beyond regular pay.

For example, if the payroll clerk’s bonus depends on production or collections, the clerk has no direct input into either. No matter how strong his or her efforts are the clerk will be unable to affect his or her bonus. Therefore there is no incentive for the clerk to work harder. It will seem capricious since the clerk will either get it or not.

3. Bonus systems not compensating for poor working environments or poor staff relationships.

Studies reveal that employees who are happy in their careers say the main reason they are satisfied is that they feel needed or appreciated. Therefore, by doling out more money in bonuses, the dentist will not compensate for a poor work environment or poor staff relationships. Job satisfaction will still suffer, and unless there are extenuating financial circumstances, employees will leave when jobs with better working environments present themselves.

Team bonuses

Bonuses distributed to the entire team with no regard to individual efforts present additional problems from both the employer and employee perspectives. It is virtually inevitable that a team bonus system will overcompensate some staff members and undercompensate others.

From the employer perspective, unless each employee has equal input (not likely), unfair bonuses are distributed when every employee receives a bonus. Some may be rewarded for little effort, while others may be under rewarded for efforts above and beyond. Either way, unless the job input is pro-rated for each jobs’ impact on the practice within the bonus calculations, the system cannot be fair. Employers pay some employees a bonus for efforts no greater than average.

Some may attempt to circumvent this problem by pro-rating bonuses based on the number of hours worked or part-time or full-time designations. Just because an employee is at the office more or fewer hours does not mean that employee is more or less effective. Trust me, employees know this.

From the employee’s perspective, bonus distribution fairness is often questioned. “Mary doesn’t work as hard as I do, yet she still gets a bonus. That’s not fair.” This can create discord among staff since some staff will feel they do more while others put forth little effort in the bonus quest. Some will have a direct effect on the bonus, while others may affect it indirectly. Some staff members will be tempted to assert that others are not pulling their weight.

Outside forces affecting the system

Bonus systems based on such parameters as production and collections can be influenced by factors other than employee efforts. These may include population growth, location, marketing, and doctor efforts, all of which will affect production, collections, and other parameters. These outside influences will cloud the effects employees may have on practice parameters, resulting in parameter changes that may or may not be related to employee efforts.

For example, if bonuses are based on production increases, how does an employer know that a production increase is due to internal marketing by team members rather than a spike in local population or an enhanced marketing effort by the practice? If a major employer opens or closes its nearby business, there may be a major impact on practice production and collections, regardless of employee efforts. In these cases, any bonuses may be met from the resulting increase in patient base, not necessarily from the extraordinary efforts of employees. This may result in awarding unearned bonuses since outside forces, not employees, accomplished the objectives of the system.

Bonus Pitfalls

As seen by the Wall Street bonus payments, bonus systems often have unintended and untoward results. Many times doctors look to such systems to act as incentives for employees or to attract and retain staff. Since employees remain at a practice due mostly to job satisfaction, the bonus system is not likely to impact staff retention or attraction. Psychologically, a bonus system often seems to be an easy fix for a poor office environment or poor staff relationships.

Though bonus systems fail to attract and retain staff, they can effectively create an incentive for employees. However, they often have unforeseen or unintended consequences that can lead to their failure.

There are six major pitfalls that result in the failure of bonus systems, three from the employee’s perspective and three from the employer’s perspective. These are:

1) The employees viewing bonuses as pay

2) The employees manipulating the system

3) The employees terminating employment if a bonus is reduced or discontinued

4) Bonus calculations being too complicated or unavailable for employees

5) The employees perceiving they have no control over bonuses

6) The bonus system not compensating for a poor working environment

Team bonuses have other potential faults. It is virtually inevitable that a team bonus system will overcompensate some staff and undercompensate others. As a result, hard-working employees may resent less motivated staff, which creates morale problems among team members.

Employees are not the only forces acting on the practice, therefore, whether bonus parameters are met due to employees efforts or outside forces is sometimes impossible to calculate. This may result in employees being rewarded for results achieved by outside forces rather than for their extra effort.

Due to the numerous pitfalls that lead to bonus system failures, the likelihood of a perfect bonus system is low. Unless very carefully constructed, the unforeseen and unexpected results may cause serious consequences when they fail. Therefore, careful development of a bonus system is required in order to meet practice goals as well as doctor and employees expectations.

Dr. Douglas Kellogg is a graduate of the UNC – Chapel Hill School of Dentistry and has been practicing in Greensboro, N.C., for over 20 years. He is a principal in Kellogg Consultant Associates, LLC, a consulting group emphasizing systems, marketing, business analysis, and management skills. The principals of the company have consulted for companies in the U.S. and China. Dr. Kellogg may be reached by phone at (336) 854– 9270 or by e-mail at [email protected].

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