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Winter 1979: There was a time when owners begrudgingly only gave pay raises to employees brave enough to repeatedly ask for one. A bonus, on the other hand, was something that usually came at the holidays; an entitlement handed out at a lively and energetic holiday party, whose atmosphere and open bar would make today's HR directors dizzy from the slate of policies being broken. The bonus of that time rarely had any connection to individual performance. Often, the sealed envelope at the festivities contained a sobering reality when it was exposed to the morning light. A slow year might get each employee a gift coupon for the same "skinny chicken" at each family's holiday table. A good year might produce a bonus check that precisely matched the ones given to Frank, Harriet and Stanley — so much for individual recognition!

This scenario demonstrates the extremes of a by gone era with what is now a nearly unrecognizable pattern. Paradigm is a fancy word that means "the prevailing concept, example or philosophy" at the time — in this case pay and compensation issues. Clearly, the pay choices and attitudes of today are far different from those of the late 1970s. Empowered workers, smarter managers, complicated tax rules and tectonic shifts from seniority-based to merit-based compensation are just some of the compelling reasons behind the massive changes to the paradigm of pay. Without promoting any one position, this article explores the three more common approaches to employee pay: traditional merit raises, the more edgy variable pay gambit and the one-off bonus tied to an organization's performance objectives.

Employers Increasingly Favor Bonuses

The Wall Street Journal recently featured a well-researched article titled "Employers Increasingly Favor Bonuses to Raises." While bonuses have become more of an everyday management tool, the feature still created a buzz in the HR community.

According to the article, 80 percent of companies will offer some form of performance-linked bonus program this year; up from 78 percent last year and just 67 percent in 1997 (that's a strong 20 percent increase!). Once again, predicted raises for 2007 will average a modest 3.7 percent, just slightly ahead of the 3.6 percent increases seen this year and last. Other points in the article included the more common, and more inclusive, pay-for-performance initiatives, which today make more employees than ever eligible for bonuses.

Promises Unwelcome in the Pause Economy

While the economy and labor market is, at the time of this writing, relatively strong, employers remain reluctant to reward employees with broad salary increases. Remember, a salary increase is essentially a promise, and promises aren't too welcome in The Pause Economy of 2006 (The Pause Economy is a frustrating time governed more by lingering financial fears than by relevant financial fact). Instead, the well-timed, well-targeted merit bonus is becoming the compensatory weapon of choice on today's business battlefield.

Employers have moved giving merit-based bonuses front and center by deepening the pool of workers eligible for this more exciting, but less secure, world of variable pay. We'll discuss the risks and rewards associated with the word "variable" later. Additionally, bonuses are increasingly used by owners to recruit, retain and further motivate employees to squeeze every last drop of productivity out of the system. With sales and profit margins in a relatively steady state, productivity gains often become the final frontier for increasing corporate profits.

Raises and Bonuses — What's The Difference?

Readers of the WSJ article wasted no time in registering their passionate comments online. Your employees will feel the same way, too, if you roll out a variable pay plan. The shift from routine annual pay increases to merit bonuses generates emotional and financial gray areas. All of those commenting saw the distinct corporate advantage to be found in the "no promise of a repeat" aspect of intermittent bonuses vs. the immediate security found in a weekly cost-of-living adjustment (COLA) and/or merit pay raise.

Why would employers increasingly favor bonuses to raises?

• A bonus is not permanent like a raise, so fixed costs remain lower.
• A bonus can motivate employees to achieve goals and work harder.
• A bonus is rarely promised, so an entitlement culture can be avoided.
• A bonus that is tied to a business objective can create a surge of focused teamwork.
• Raises and bonuses are often based upon percentages of an employee's base pay. Keeping the base small will also keep future bonuses small.

Click here to view the PDF version of Whip-Smart Premium Pay Chart.

Shared Risk and Tipping Points

As the days of the 5 percent annual raise began to wane, companies began sizing up alternate ways to satisfy and effectively quiet employees who had languished on waiting lists for rate increases. "The Pay for Performance Model" was wheeled out to soothe the impatient crowd, a complicated gift for the newly empowered 21st century worker. With workers in the unfamiliar position of bearing risk, the model was suspiciously viewed as management's Trojan horse; heaving with hidden bean counters, attacking optimistic projections with swords forged of flattened sales and defending coveted cash reserves with shields of downbeat forecasts. Too many pay battles ended with workers bitter, discouraged and defeated by fine print and their own rookie mistakes.