Headstart: Management - Managing bonuses in a downturn.

We are facing low inflation, low interest rates, low unemployment and a nervous stock market. Investment decisions and discretionary spend are under review. Targets are being stretched, budgets revised and forecasts re-forecast. Annual base pay rises will be limited. As downward pressure on base pay continues, bonus schemes will drive performance, sending clear messages about goals and targets.

Bonus schemes have different structures and purposes depending on the sector. In the City, bonuses have traditionally been discretionary management tools, focused on individual performance. Risks are heavily weighted in favour of the individual. The bonus award remains the key to retention and motivation for many in the City.

The financial sector often finds it easier to cut costs and re-shape through ‘downsizing’ than to manage the employment spend. The last month has seen the first signs of re-shaping. Bonus awards will be down in areas where activity has dropped, such as corporate finance and M&A, but across the board we can expect some 10-20% reduction in bonus budgets. Overall, bonus pay-outs may not change much, as reduced bonus pools are distributed across reduced head counts.

In other sectors, bonus schemes play a different role. Many major UK companies have ‘high base, high benefits’ reward structures. Significant changes to these structures are needed, as they face increasing competition from new market entrants and their customer base comes under threat. Many of these companies have limited bonus schemes based on company or group financial results, with little focus on individual or team achievement.

Reward risks are heavily weighted in the company’s favour. As companies’ profitability falls, bonus outcomes will fall. For these companies to become more competitive, major shifts in the reward risk profile are needed.

In the professional service sector, the approach to bonus design is different again. The emphasis on employee recruitment, development and retention and difficulties with performance measurement often means that a certain amount of fuzziness creeps into the bonus structures. Bonus schemes are broadly based and involve a balanced approach to measurement. Employee involvement and retention tends to be achieved through employee share schemes and deferred bonus schemes. To facilitate this, consultancies migrate from partnership structures to corporate models.

Good bonus design involves balancing company and people performance and reward risks. There is no such thing as ‘best practice’, only ‘best fit’.

At times like this, companies need to review their bonus and reward frameworks, to ensure that their structures underpin and reinforce the new direction and shape they are taking.

– Mark Edelsten is European partner at William M Mercer.