Are Bonuses the Best Reward? The Answer May Surprise You. One management expert weighs in on whether bonuses work and how you can establish an effective bonus system.

In his book No B.S. Ruthless Management of People & Profits, business coach and consultant Dan S. Kennedy presents a straightforward assessment of the real relationship between employers and their employees, and dares you to take action. In this edited excerpt, the author reviews the pros and cons of paying bonuses for a job well done.

I was waiting around in a client's office one Friday, right before lunch, and heard his staff talking about "pizza Friday." For hitting the office's sales quota for the week, he sprang for pizza, sub sandwiches and soft drinks for everybody. Apparently this happened frequently. One staff person told the others, "And the cheap bastard orders from whatever place he has coupons for!"

I made this kind of mistake myself years back, when I had a lot of employees—confusing "bonuses" with "being nice." But if bonuses become routine, then they become expected, then they become a valueless expense.

Many people view bonuses as rewards for jobs generally done well or, in my opinion, worse—a requisite sharing of the wealth from the business's prosperity. Just throwing money around without securing measurable return on investment is in violation of your chief responsibility as CEO: to maximize profits for invested shareholders (even if you're the sole shareholder).

As my "cheap bastard" anecdote illustrates, you can't buy morale or compliance this way. Bonuses should buy something of value that you can clearly and definitively measure. Bonuses may be used to correct unprofitable behavior, encourage profitable behavior, encourage education and self-improvement, or encourage doing difficult or uncomfortable things. They are not gifts or obligations; they are tools.

Let's also clarify the difference between "bonuses" and "recognition." Getting the employee-of-the-month parking space, for example, is recognition—it's not a bonus. A bonus is money, extra time off, or things money buys, like vacations or merchandise. Recognition is pins, plaques, newsletter articles, parking spaces.

Bonuses are very troublesome things, and team or group bonuses are the most difficult. Frankly, I'm not convinced there are any good answers to this conundrum. I've had many business owners show me their plans for bonus compensation, and I've found them all flawed, one way or another. I'm especially not a fan of group bonuses tied to sales, because far too much of that outcome is outside the control of the employees, and the reward is almost always overly generous to some and miserly to others.

The best results seem to come from very targeted, behavior-based, individual bonus plans. These are usually engineered to get an employee to do something he tends to avoid, neglect or find uncomfortable or difficult, often connected to making that employee and his job function more profitable for the company. Such bonuses do, however, become obligations. If you take away the bonus compensation, the bought-and-paid-for compliance also goes away. Such institutionalized bonuses can be perfectly OK and profitable, but you need to realize what you're getting into before you start. Undoing any is ugly.

Even on a group level, it's best to narrow the focus of the result rewarded by bonuses to what's very much in the control of the people in that employee group. Consider an office or showroom where prospects come by appointment to meet with a salesperson. The three people fielding the phone calls from prospects responding to advertising have near total control over how many such calls convert to kept appointments, but they have little if any control over how many convert to customers or how much they buy. Tying their bonuses to sales can be "demotivating," especially if the sales reps are having a slump.

Or consider a service business like a restaurant or a dry cleaner. The counter clerk, cleaning folks in the back room, chef and cooks, concierge and car valets have little or no control over total sales, as that depends a lot on the effectiveness of the business's advertising and marketing, pricing, and possibly even physical location. But they all have considerable impact on customer retention and repeat business.

In developing bonus opportunities for individual employees or groups of employees, you have to think about what "extra effort" behavior you want to try and buy, what it's worth to you, and what you're willing to pay for it.

Next, you have to figure out what will be most motivating to the person or people you're trying to buy extra effort behavior from with your bonuses. Money may or may not be the right answer all or part of the time. For example, in a marketing test I conducted for a client, offering $100 cash or a choice of a $100 Walmart, Olive Garden restaurant, or Bed, Bath & Beyond gift card, three times as many people opted for the gift card. Why? Given cash, they'd feel compelled to pay bills with it. Given a gift card, they'd feel free to splurge and buy themselves something they want. If given $750 cash, they might feel compelled to pay off a big credit card balance—and certainly not run off to Atlantic City for the weekend. But being given a weekend at an Atlantic City hotel, room, meals, a show and $100 cash to gamble with might be much more inspiring. You also have to decide whether to rotate different incentives and bonuses during the year, tied to the same behavior being purchased and rewarded or to lock in the same bonus every month. You should also consider the frequency of your bonuses or at least the frequency of measuring progress toward them.

Finally, you have to decide whether to institutionalize the bonus plan or set it up as temporary and short term, then have it go away to be replaced with a different one.

Bonus plans shouldn't be considered out of context for your entire compensation scheme. Most employers act as if they're paying people to show up. In reality, you're attempting to purchase certain behaviors and results connected to those behaviors, including cooperative and even enthusiastic compliance with your program. So all compensation should be tied as clearly and directly as possible to those objectives. Woody Allen was probably right when he said that one-third of success is just showing up. But in managing people, it's the other two-thirds we really have to worry about!