How to Structure Merit Raises and Bonuses for Employees

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Employee pay may not be a pressing concern for your business. If you think you have more urgent items on your agenda, then you may need to stop and reconsider.

But if you can project where your business is headed, how you'll know when you've arrived, and how you'll get there, then the task of leading your employees and rewarding them for their efforts should be natural.

Start with the basics

• Create a job description for every position and each employee. Describe the scope of the employee's accountabilities and record tasks that the employee handles on a daily, weekly, monthly, quarterly, and yearly basis. If you're not sure what each employee does (and such a scenario is not uncommon in a fast-moving, decentralized company), then make observations or ask the employee to document duties.
   
• Evaluate and plot your company's market position as an employer. As a business, you'll likely have a market niche; similarly, whether you like it or not, your company has a reputation as an employer. Decide how you'll excel: salaries, bonuses, health care coverage, lifestyle benefits, work/life balance, or some combination.

Consider how your employer niche will attract (or repel) certain types of people, and make decisions about salaries, wages, raises, and bonuses accordingly.

Develop goals and budgets

1. Decide what you want to accomplish as a company. Set overall goals. Then charge your leadership team with setting departmental and individual goals so that every group and each employee is working toward shared objectives.
    
2. Create a road map that specifies the paths that the company will take to reach its goals. Ask your managers to develop, present, get feedback on, and finalize annual performance plans for themselves and their employees. Start the goal-setting and planning process at least a couple of months before the start of a new year so that everyone is equipped to meet and exceed objectives.
    
3. Develop a compensation budget and set aside money for categories such as salaries, wages, benefits (health care, lifestyle, contributions to retirement plans, etc.) along with merit raises and bonuses. Establish a ceiling for merit raises (4 percent, for example) and budget that percentage increase of your current payroll expenses.
    
4. Determine the minimum level of financial performance that the company needs to reach before distributing bonuses. Figure out how much of the profits you're willing to give to employees. Devise a plan to set aside money throughout the year to fund bonuses.

Structure Merit Raises

1. Establish competency levels for each position. Define performance levels that meet expectations as well as those that fall short of and exceed expectations.
    
2. Set stretch goals that are measurable, observable, or both. Identify methods and timeframes for measuring or observing results. Make sure that these objectives cover more than just day-to-day duties at an average level of performance.
    
3. Structure individual goals so that the company's goals are being realized or can be achieved through collective effort.
    
4. Tell employees how they'll be evaluated. Show them the reports you'll use or the information that you'll pull from your business enterprise system to measure performance. Let them know the specific milestones they should reach by a certain time frame (a project completion or number of customer contacts by the end of the first quarter, for example).
    
5. Conduct annual performance reviews to discuss performance, but don't wait until the end of the year to bring up any problems. Check in periodically with employees or ask your managers to give feedback that corrects errant ways and encourages desired behaviors.
    
6. Give merit raises aligned with performance ratings. Be specific about the reasons that each employee earned an increase, linking improvements and results with growth in annual salaries or hourly wages. Let employees know that percentage increases are specific to each position, its accountabilities, and performance.

Create Bonus Program

1. Determine which positions are eligible for bonuses. These positions should be able to influence overall company profitability.
    
2. Set goals that directly link increased sales and profits to bonus structure. Consider creating tiers of bonus opportunities for greater and greater performance levels.
    
3. Communicate levels of performance that will qualify for bonuses if the company meets its financial goals.
    
4. Award bonuses at intervals appropriate for recognizing successes without jeopardizing the company's financial standing.

Stay the Course

Set an official policy that salary, wage, merit-raise, and bonus information is confidential. However, realize that employees may talk anyway, so be clear and specific about reasons that employees earned raises and bonuses. The more you link performance with pay increases and bonus opportunities, the more your highest performers will be motivated to excel.

Keeping the right people is critical to your success. Even more important is steering your business in the right direction, communicating plans to employees, and rewarding the employees who contribute to your success.