Learn how to implement a reward strategy that supports organisational objectives
Whether used proactively to influence behaviour or retrospectively as part of a reward package, bonuses and incentives can have various benefits for organisations and employees. The success of any bonus or incentive scheme, however, is based on an understanding of the context in which they operate and an appreciation of how individuals may respond differently to the same stimulus.
This factsheet explores the various types of bonuses and incentives, the trends in their use, and the potential benefits and drawbacks of these reward arrangements. It provides an insight into how bonuses and cash or non-cash incentives suit a variety of contexts, and what to consider when designing and operating such schemes.
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What are bonuses, cash incentives and non-cash incentives?
Bonuses and cash incentives are a form of variable pay based on the use of cash lump-sum payments linked to individual, collective or organisational performance (or some combination of these). They are not consolidated into base pay, though in certain situations (such as due to cost constraints) they can be given as part of, or instead of, a pay rise.
It's important to draw a distinction between the cash incentives and bonuses, although the two terms are interlinked and often used interchangeably.
Incentives aim to influence future employee behaviour or performance, usually using targets: if a specific target is met, the employee will receive a cash payment.
Bonuses cover a wider range of purposes and can be discretionary or non-discretionary. Like incentives, they may be used to influence employee performance or behaviour to meet pre-set objectives, but they could also be used to reward past achievements.
It's also helpful to differentiate between:
Non-cash incentives, sometimes known performance improvement plans, are forward-looking, formal schemes. They aim to affect directly employees’ future performance by awarding prizes or ‘gifts’, such as merchandise, travel or retail vouchers, associated with some performance measure, such as sales volume.
Employee recognition schemes are retrospective as they recognise past performance rather than incentivising future efforts. They may be informal and discretionary. Such schemes may be linked with non-cash incentives.
Our report Show me the money! The behavioural science of reward examines recent thinking on how individuals respond to various kinds of incentives.
The purpose of bonuses and cash incentives
The desire to incorporate bonus and incentive plans into reward packages has been partly driven in part by the influence of the ‘new pay’ philosophy. This advocates that ‘guaranteed’ basic pay should comprise a smaller element of the overall reward package, with a shift towards strategic reward linking employee performance and pay to the wider business strategy.
There's also been a move in certain sectors towards market-based pay, whereby an employee might only receive a pay rise if the market rate for the role had increased: in this scenario, individual contribution could be recognised via a bonus instead of a pay rise.
For the employer, the advantages of bonuses/cash incentives over consolidated salary increases include:
- ongoing motivation as bonuses must be re-earned
- lack of impact on certain employer on-costs that are linked to basic salary levels, such as overtime rates.
- capacity for maintaining market pay competitiveness without necessarily inflating the annual pay bill
- flexibility through, for example, the ability to reduce or even halt payments during economic downturns.
For the employee, the main benefits are:
- greater control over their own level of remuneration
- higher payments are potentially possible.
But the downside for employees includes that:
- non-consolidated payments must be re-earned and may not count towards pensionable pay
- payments may be unpredictable or lower than expected if targets cannot be met.
Types and coverage of bonuses and cash incentives
The payment of bonuses and cash incentives is generally linked either to the quality and/or quantity of work, on an individual or collective basis, or to some measure of company performance such as profit levels (or both).
Schemes may be broadly divided into the following categories although definitions vary, may overlap or be linked.
Individual-based - payment of the bonus/incentive is calculated by some measure of individual performance, hence there should be a considerable incentivisation effect. Sales commission could be included within this category (although this may be regarded as a distinct form of remuneration in its own right).
Schemes driven by business results - company profit levels or customer satisfaction may be used as measures to help determine bonuses.
Team-based - links the bonus with some measure of collective performance, often with the aim of fostering effective teamworking.
Project-based - might be used when a deadline is important, for example to reward construction workers for completing a building project on time, although such schemes may be open to manipulation.
Department/site-based - payments that could be used to reward, for example, workers who attain productivity improvements in one factory.
Gainsharing - the idea that employees should be able to share in financial gains achieved through improved performance (particularly enhanced productivity).
Combination - based on two or more of the above schemes.
There're also more specialised bonuses, for example at Christmas or for attendance.
According to our 2019 Reward management survey, many employers operate some form of cash-based bonus or incentive plans. However, such schemes are far more common in private sector than in the public or voluntary sectors. The most popular arrangements include individually based plans (for example, personal performance or commission), plans driven by business results (such as profit) and combination schemes.
Payment levels and recent developments in the use of bonuses
Levels of payments
If they are to impact on employee behaviour or performance, bonus or incentive payments need to be ‘worth having’. That means they must be set at a high enough level to have an effect, and consider (though not be driven by) market practice. By contrast, setting bonuses at very high levels need caution to avoid encouraging undesired behaviours or outcomes, such as the ‘crowding out’ of non-financial motivation.
An important factor in calculating any incentive is that it's kept simple. Ideally, employees in the plan should be able to measure progress against targets and carry out the calculation themselves so they know how they're progressing and what payment level they might achieve.
Employers need to decide the way they'll set bonus payments, including whether to make use of a formula and how to express payments (for example as a salary percentage or a flat-rate payment).
Information tracking specific breakdowns of UK bonus payments over time (by gender, for instance) can be found in the Office for National Statistics' Annual Survey of Hours and Earnings.
Following the 2008 recession, bonuses have become a contentious issue with their whole nature and operation questioned. The Financial Services Authority (FSA) considered that remuneration practices were a ‘contributory factor to the market crisis’. Practices in investment banking in particular tended ‘to reward short term revenue and profit targets’ and, in so doing, ‘gave staff incentives to pursue unduly risky practices’.
A range of measures have been introduced, with further proposals anticipated, to regulate remuneration in the finance sector, particularly for senior pay. The latest development is the EU’s Capital Requirements Directive known as CRD IV which requires that bonuses in the finance sector should be limited to 100% of base pay, or 200% with the approval of at least 66% of shareholders. The regulation covers senior banking employees irrespective of their location, so those staff working for a European firm but based in Asia would be subject to the same cap.
Many reward specialists believe there’s a need for a continuing clear link between high levels of performance and the payment of bonuses, but without rigour in applying this principle, bonuses may reward less-than-robust performance or incentivise inappropriate behaviour.
One example of inappropriate behaviour is corruption, which according to a Transparency International report Incentivising ethics: managing incentives to encourage good and deter bad behaviour, can include fraud, trading in influence, anti-competitive practices and the offering, promising or payments of bribes. They argue that for incentives to work as intended and to avoid perverse and distorted outcomes, employers should ensure they have an open and ethical culture in which staff are encouraged to do the right thing and feel able to challenge management decisions or targets they think are unethical or dysfunctional. See more in our factsheet on ethical practice and the role of HR.
There’s also the danger that if bonuses have too many checks and balances their complexity may fail to motivate.
While money influences behaviours, it may encourage the wrong types. So any financial-based bonus or incentive scheme must be designed carefully and tailored to align with an organisation’s business objectives, corporate governance and ethical standards as well as the views of key stakeholders, such as employees, donors or customers.
The success of such variable pay plans depend on how effectively performance is defined, managed and ascribed, requiring effective communication and supports for both line managers and employees.
The purpose of non-cash incentives
It’s sometimes argued that cash may not be the most effective means of motivating employees because it doesn’t necessarily encourage them to ‘go the extra mile’ in their current role. Non-cash incentive schemes, based on the receipt of a gift or prize, can be more memorable and exciting, and therefore have greater impact.
Typically found in customer-facing industries, non-cash incentive schemes may be based on the use of a single prize to be won by the highest-performing employee or team, and encompass a range of awards recognising different levels of achievement.
The benefits of non-cash incentives include:
Affordability - such programmes may be more cost-effective than alternatives such as cash bonuses.
Simplicity - it's easy for a sales employee to understand that, say, selling so many phones will result in them receiving whatever the latest prize is.
Psychological impact - it's acceptable for employees to speak openly with pride about the winning of gifts in a way that may be considered by many to be socially unacceptable it they were seen to be ‘bragging’ about their cash bonuses.
Drawbacks can include:
Lack of credibility - such prizes may not be taken as seriously as cash.
Lack of employee awareness - employees may be less conscious of the value of non-cash incentives over ‘hard cash’, especially when living standards have fallen significantly.
Lack of value - people value the same non-financial reward, such as a trip to a sporting event, differently, so what might be an incentive to one person may have no impact on another.
The incentivisation industry is more highly developed in the USA than it is in the UK where, according to our 2019 Reward management survey, only a minority of employers have non-cash incentive schemes.
Designing and operating non-cash incentive schemes
Types of non-cash incentives
The main types of non-cash incentives may be broadly divided into:
- merchandise such as tablets, mobile phones or watches
- activities/special events such as meals out, hotel spa accommodation/treatments or a trip to a sporting event.
- travel for example an all-expenses paid trip
- retail vouchers which are often obtainable at a discount to ‘face value’
- awarding points that may be converted into a range of awards.
It’s worth noting that the last two of these categories might not be strictly regarded as ‘non-cash’ items.
Selecting a supplier
Numerous suppliers of non-cash incentives exist. Such organisations often provide a wide-ranging service encompassing not only employee non-cash incentives but also other employee schemes such as recognition and team-building activities. More information on suppliers can be found in the journal Incentive and motivation.
Employers need to consider the tax implications of implementing a non-cash incentive scheme as they can be subject to income tax over a certain level. It is possible for employers to arrange payment of any tax or national insurance owing on behalf of employees. Information on the UK tax implications of non-cash awards can be found in guidance from HM Revenue and Customs.
Books and reports
ARMSTRONG, M. (2019) Armstrong's handbook of reward management practice: improving performance though reward. 6th ed. London: Kogan Page.
PERKINS, S.J. and WHITE, G. (2016) Reward management: alternatives, consequences and context. 3rd ed. London: Chartered Institute of Personnel and Development.
Visit the CIPD and Kogan Page Bookshop to see all our priced publications currently in print.
PARK, S. and STURMAN, M.C. (2012) How and what you pay matters: the relative effectiveness of merit pay, bonuses and long-term incentives on future job performance. Compensation and Benefits Review. Vol 44, No 2, March/April. pp80-85.
SHAW, J. and GUPTA, N. (2015) Let the evidence speak again! Financial incentives are more effective than we thought. Human Resource Management Journal. Vol 25 No 3, July. pp281-293.
TAYLOR, T. (2010) The challenge of project team incentives. Compensation and Benefits Review. Vol 42, No 5, September/October. pp411-419.
CIPD members can use our online journals to find articles from over 300 journal titles relevant to HR.
Members and People Management subscribers can see articles on the People Management website.
This factsheet was last updated by Charles Cotton.
Charles Cotton: Performance and Reward Adviser
Charles directs the CIPD's performance and reward research agenda. He has recently led research into: how employers can help improve their employees’ understanding of their personal finances; how front line managers make and communicate reward decisions to their employees; how employers manage the risks around reward; how private sector employers can build the business case for workplace pensions; how employees form their attitudes to pay; and how the annual pay review process can become more strategic.
He is also responsible for the CIPD’s public policy reward work and has given evidence to select committees on banking pay, redundancy awards as well as responding to various consultations, such as on pensions, retirement and MPs’ expenses.
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