Share the Wealth

One of the things I do for my advisor clients in my consulting practice is to take over the management of their employees: Not only does that take a time-consuming headache off their plates, but the presence of an objective third party often reduces any tensions that crop up. Over the years, I’ve become pretty good at hiring the right people, anticipating problems, and motivating them to be happy and productive members of their firms.

But out of the nearly 200 employees I’ve managed in recent years, there is one employee that I just have not been able to get through to. He’s certainly talented enough, but doesn’t seem to have his head or his heart in his job. So, the other day, I was thinking about what I can do to work with this guy when an interesting thought hit me: I wondered how much of employee motivation is really the result of compensation structure?

So I took an afternoon and conducted an analytical survey of my past and current clients and their employees: comparing employee motivation with how their bonuses are structured, and then comparing firm bonus structure against revenue growth. No, this isn’t really a statistically significant analysis: I’m only looking at a couple of hundred employees at a few dozen firms. But the results were so clear, and so striking, that even I was amazed—and I’ll bet you will be, too.

Now, I’ve always been a big fan of revenue-based bonuses, where you simply pay out each employee a percentage of the firm’s revenues. Usually, my more entrepreneurial advisor clients are good with that: They like sharing a bit of the risk and the fact that their employees have a direct stake in the success of the firm. To really have the desired impact, it’s important that employees are told the firm’s total revenue upon which their bonus was based. This enables employees to understand the firm’s current financial situation and how it impacts them. My more technical, analytical advisors, on the other hand, don’t like the uncertainty, variability, and often the disclosure involved in a revenue basis, preferring instead to pay more predictable, and controllable, bonuses based on profits or on merit.

I strongly recommend against arbitrary bonuses for reasons which I hope are obvious, so my merit-based clients pay fixed bonuses based on completion of specific projects or tasks, or upon reaching predetermined goals. I’d suspected these bonuses weren’t as motivational, but until I did my analysis, I hadn’t quantified my theory or had any idea how big the effect was. And as it turns out, the impact of bonus structure has radically changed the way I manage employees.

To get to the bottom of the effects of different bonuses, I first listed 162 of the employees I’ve managed in recent years (including professional employees, those in operations and client service, but excluding lower-level employees such as receptionists and admin assistants), and scored each one on their motivation level: 5 for highly motivated down to 1 for low motivation. Next to each employee’s name I wrote down their firm’s bonus structure: Revenue-based, profit-sharing, merit-based, and in one case, an arbitrary Christmas bonus. Then I set the sort function on high to low motivation and hit enter.

And there it was, staring me in the face: Virtually all of the 5- and 4-level motivated employees were paid revenue-based bonuses. In fact, motivation level correlated very neatly into groupings based on bonus structure—with revenue at the top, profit sharing in the middle, and merit-bonuses at the low-motivated bottom. The evidence, at least in my small sampling, is very clear: Revenue-based bonuses are a much better motivator of employees than the other structures.

Then I wondered how much of an effect those more highly motivated employees had on the success of their firms? So, I compared the revenues of each at the lowest point following the 2008 meltdown with their projected revenues at year-end 2010. Again, the results were, at least to my mind, boggling. When I ranked percentage annual revenue growth from their low points to this year-end, they broke down into three neat groupings. At the top, with between 29.1% and 44.3% growth were the revenue-based firms; in the middle, ranging from 16.4% to 24.7% growth were the profit sharing firms; and at the bottom, with between 12.7% to 10.8% increases were the merit bonus firms.