When judgment beats formula: Why your salary and bonus structure should have gray area

In my last post, I talked about how early in my leadership tenure, I set up a formulaic way of paying salaries and bonuses and discussed why I did that and the benefits and challenges with that type of system. In this post, I want to talk about having flexibility in pay bands and why having guidelines you can break, rather than rigid rules about what people are paid, is a better way of managing employee pay and bonuses.

A quick disclaimer: any financial figures or names are fabricated, and I’m only speaking for myself, not anyone else who was part of the leadership teams at the companies I worked at. I’m also going to magic away things like Overhead, General & Administrative, Fringe, etc. costs. It’s my post and I can do that J and it makes things simpler and easier to get through.

Pay Band Setup

In case there are people reading this that don’t know what pay bands are, they are simply the range of pay an employee could make based on the level that employee is at within the company. Below, I’ve taken the three levels I used in the last post but made them bands where the salaries have a $30K range.

Level 1 Engineer Base: $80,000 - $110,000

Level 2 Engineer Base: $100,000 - $130,000

Level 3 Engineer Base: $120,000 - $150,000

It is critical that the pay bands overlap. That doesn’t make sense, you say? Let’s go back to the AWS example I used in the formulaic post. Alice is a solid L2 engineer but maybe would typically fall into the middle of the band making $120K. But Alice happens to be amazing at AWS, and she is experienced with the exact work the customer needs support on. Because of her skills and experience, the customer is willing to pay us $120/hr instead of $100/hr. Using a standard 1920 work hours per year, that would mean the company would increase revenue by $38.4K.

1920 Hours * $100/hr = $192,000

1920 Hours * $120/hr = $230,400

Alice is going to help us win this contract with higher rates, she knows she is going to help us and wants more from us because of it. Paying her the maximum amount for an L2 engineer, the company will make $28K more profit on the contract than if we paid her $120K and only billed at $100/hr.

$192,000 - $120,000 = $72,000

$230,000 - $130,000 = $100,000

And that might mean that she makes more than Bob, who is a solid engineer, but just barely meets the L3 requirements and is making the base salary of $120,000. This isn’t a knock against Bob; this is the company understanding the value of a person in the marketplace, leveraging that value, and rewarding them for that value. Welcome to capitalism.

Having this flexibility provides benefits beyond being able to pay someone more because they have skills that a customer needs. It can also be used to reward employees who work harder or perform better. Maybe I’ve got an L1 engineer who recently graduated college but is working extra hours all year, the customer and team love him, and he has the skill of a mid L2 engineer. In the government contracting world, this is the type of person you’re worried is going to go to one of the FAANG companies (Facebook Amazon Apple Netflix Google). If I don’t have some range in my salaries that allow me pay more for this person, there is a higher chance I could lose them.

Bonus Flexibility

This flexibility is the same for bonuses, but it can provide a more instantaneous benefit. In my example in the last post, we gave out 40% of $30K, or $12K of the profit as a bonus. At QSI, where we had strict formulas and bonuses were based on tenure and we didn’t have flexibility, Alice would make more than Bob because she had been with the company longer. Maybe in Q1 Bob worked late and worked every weekend to help us get a key deliverable in on time. As opposed to QSI, in this system I have the flexibility to say, you know what, Bob, I’m going to give you $5K instead of $3K. That makes Bob feel more appreciated for his work and effort. That hopefully encourages him to want to stay with the company.

Giving extra to Bob from a bonus pool does come with its own complexities. If Bob is going to get $5K instead of $3K, I can either A) reduce the bonuses that other people receive or B) increase the bonus pool. Both options have drawbacks but should be considered. I’ve found that typically you end up adjusting the bonuses for others. And if people have questions, you have to be open with them and explain that while they did good work, there were other people that did more and deserved to get a larger bonus.

Guidelines, Not Rules

Level definitions should be guidelines and not rules. While it doesn’t happen often, sometimes you have that one employee that is just far better than their degree and experience would say they are. You need to be willing to put rock stars in a band that might not make sense on the outside but will help the company.

Maybe they are just naturally talented or maybe even though their “experience” is one year, they’ve been programming since they were 5. Whatever the reason, sometimes you need to be able to put someone at a level that might, based on their degree and experience, seem higher than that person is qualified for. But I believe you should pay someone what they are worth, and if someone can perform the work required at a level, even if they don’t have the degree or experience, you should give them what they deserve.

Downsides

Now let’s talk about the side of things that isn’t all sunshine and rainbows. Maybe we have an employee that is underperforming. They have a good degree, they have experience, and they should have the skills, but this past quarter, they have just been subpar. With pay bands, and non-formulaic salaries and bonuses, I have options. When bonuses come out, maybe I only give this person $1K instead of $2K. If they consistently underperformed for the year, maybe their raise amount is below the average percentage or maybe if they are severely underperforming, you don’t give them one at all.

If this is below the type of bonus or raise, they have received in the past, they are most likely going to have some questions about what has happened. If that happens, you sit down with them and explain the reasons and what improvements you’d like to see in the next cycle.

And lastly, this applies when it is time to give out raises. At QSI, we gave out raises based on COLA inflation determined by the Social Security Administration (SSA). Everyone got the same raise. Sounds fair except that, just like I’ve been pointing out, sometimes people perform better than others and you want to reward them for it. So, when I’ve got someone that is performing at an extremely high level, I’m going to give them extra when raises happen because I want them to feel rewarded for their work. That hopefully encourages them to keep working hard and makes them want to stay with us longer.

Communication 

Communication might just be the most important part of leadership and not shockingly communication about performance and the compensation impacts of performance are extremely critical. When you are not using a simple formula to decide raises and bonuses, you need to be communicating with your team about their performance. No one should ever be surprised that they got a small raise or bonus. A good leader talks with the members of their team about their performance regularly and ensures that they are aware of how they are doing.

I’ve failed at communicating with employees about challenges. You can get caught up in the day to day and, even if you meet regularly with employees, it’s easy to put off uncomfortable conversations. But you aren’t doing the employee, yourself, or the company any good by putting it off. And having conversations as small problems arise will be much easier to tackle than having a conversation about why a bonus or salary increase was lower than expected.

TL; DR 

You should design your pay bands to overlap to give you flexibility for top and bottom performers. You should treat the rules around who goes in what pay band like guidelines and being willing to break them for the right person. Pay and bonuses are ways to incentivize everyone in your company, and you should wield them like the sword they are to get the most out of people. And finally, you need to communicate if a person’s performance is going to have a positive or a negative impact on their compensation.  

Postscript

One thing that I couldn’t get to was talking about was balancing employee pay i.e. expenses and employee bill rates i.e. revenue. There is a lot of nuance to that and hopefully I can get into it in a later post.