HBR: Don't Give Cash Performance Bonuses in a Loss-Making Company

Bonuses, particularly performance bonuses, negotiated up-front, are standard and reasonable fare in established businesses. Some smart people think they're a good idea in start-ups, too. The basic argument is the same for start-ups as it is for other companies: incentives focus and motivate managers and individual contributors alike; tying compensation to goals stimulates performance. It's not a crazy notion in the abstract, even though some research shows that cash rewards can actually diminish performance in cognitive tasks. I'm all for profit-sharing, but only when there's a handsome-enough profit to share. Until your company is generating a bonanza, you shouldn't consider doing anything other than reinvesting the cream in your growth. And I think cash bonuses are a particularly bad idea when your start-up is losing money.

Performance bonuses send the wrong message at a loss-making. The chief economic reason your team should be at the start-up is the long-term upside, the equity, the Shangri-La over the mountain. Rewarding people with cash payouts dilutes the mission. It reinforces the traditional primacy of upfront dollars over creating appreciated stock value and shared gain. At a start-up, unlike at a large company, every team member can have a material impact on the value of the stock. Connecting individual performance to that stock value — with initial and even additional "bonus" grants, for example — is a terrific motivator consistent with your message. Cash bonuses do nothing for esprit de corps (have you ever met two mid-level people at Goldman Sachs who actually like each other?). An emphasis on equity, by contrast, reinforces the understanding that we are all in this together, that our successes and failures have mutually felt impact.

I am especially opposed to cash bonuses for senior management in loss-making start-ups. Even among top, high-integrity professionals, upcoming cash bonuses become short-term focuses for executives and their families. They come to plan on the anticipated income. They tend to work hard toward their individual measured objectives so that can get the cash. Drucker-style management by objectives — what economists would call a "non-cooperative game" — works reasonably well in large corporations.

But giving incentives for self-interested behavior kills small companies. Much more often than large ones, small companies experience all-hands moments: account disasters, product changes, personnel shifts, outages, and unexpected good and bad news that affect the entire organization. Every change in a start-up has much bigger potential immediate and downstream consequences than at a large company. When a colleague calls in sick at a 20-person company, 5% of your workforce is out. When the marketing guy gets married and moves across the country, you have lost your entire marketing team. You need your executives to be ready, willing, and excited to step into the breach. They can't be privately or openly reluctant to step away from their short-term, cash-rewarded objectives in order to focus on a new or different problem that might be in "someone else's wheelhouse". You need your executives to benefit from a "cooperative game" that focuses them both on themselves and on the good of their tribe. Individual executive performance cash bonuses directly undermine this cooperation objective.

While periodic performance cash bonuses can be bad in start-ups, other forms of bonuses can be useful. These include:

Sales commissions. Sales teams should always be motivated by performance; most of the best salespeople are highly focused on quarterly commission checks.

Spot bonuses for killer team members who have excelled at their jobs or overcome huge hurdles. These should generally be small, on the order of $1,000 to $3,000.

Mini "gifts" for team members who have worked especially long hours. Think of an Amazon gift card of $50 to $100 to send the message that their efforts are appreciated.

Goal-related bonuses for engineering only. If you absolutely, positively want to ship the product by the designated date, offer a bounty for the engineers on the case. The best way to do this is to set up an all-or-nothing objective. Zero bonus will be paid unless the goal is met 100%. 3% to 6% of annual salary is a solid incentive for key objectives. Don't make this a habit, or it will become an expectation. Do it only when there is a key deadline.

Referral bonuses for good hires. Excellent people are always hard to find, but hiring is especially difficult during tough economies for loss-making start-ups, because candidates are more averse to risk than usual. Offer your employees bounties for bringing in great additional hires. It's a huge savings over recruiter fees.

Signing bonuses. Great candidates will often be leaving higher cash compensation packages — including better salaries and regularly scheduled performance bonuses — to join your company. Offering a one-time signing bonus can help take the edge off the transition. Signing bonuses also have a mitigated impact on your fixed cost structure. Signing bonuses should be paid after 90 days, just in case one of you decides you made a mistake.

Company-wide focusing bonuses. In start-ups, a lot of different useful metrics tend to circulate around the cubicles. Conversion rate, productivity, activity-based costing, CAC, customer growth, revenue per account, same store sales, sales per channel, margin per channel, etc. Often all of these data points are material, but a large number of numbers can distract your team. In these cases, consider posting a company-wide bonus that focuses on one number. The best company-wide target is one that every team member can help meet. Revenue is a good example, or customer acquisition. Company-wide bounties do carry some risks: inevitably, some team members will have more impact than others, and group bonuses always carry the downside of creating free-rider incentive problems. That's why company-wide bonuses aren't optimal drivers of business success; they are chiefly good tools for creating focus and esprit de corps.

When circumstances require that you simply must meet a certain cash compensation objective in order to get or retain a key employee at a loss-making start-up, a salary raise is a better bet than a scheduled performance bonus. Often the cash requirement for the company is the same on an annual basis, even though the pinch of regular, higher fixed cost is sometimes a touch harder to bear. But giving a higher salary doesn't sacrifice the long-term thinking, shared upside and risk, and team cooperation that are critical in your company's early stages.

Michael Fertik is a repeat Internet entrepreneur and CEO with experience in technology and law. He founded ReputationDefender in 2006 with the belief that citizens have the right to control and protect their online reputation and privacy. Michael recently co-authored Wild West 2.0 which quickly gained acclaim as an Amazon.com Number 1 Bestselling Internet book. He has been named a World Economic Forum Technology Pioneer for 2011

China Is Here

Is China really taking over as the global manufacturing hub? In the past few months the alarm bells over the country's rapid penetration of industrial markets have grown louder. The main arguments are familiar: first, there is a significant migration of global manufacturing capacity to the mainland; and second, China is rapidly moving into capital-intensive and high-technology industries, threatening to erode the competitiveness of producers in developed countries. Both are based on a misinterpretation of China's astonishing growth.


First, take the question of manufacturing migration. This is not a complicated analytical issue but is nonetheless misunderstood by a surprising number of analysts. For China to be a global manufacturing hub, it has to be a net exporter of manufactured goods. And the best measure of the rate at which industrial capacity is migrating to the mainland is exactly the rate of increase of China's net manufacturing balance with the rest of the world.

Between 1993 and 2002, China's gross industrial output rose from $480bn to $1,300bn. This represents an impressive increase from 2.4 per cent of estimated global industrial production at the beginning of the period to more than 4.7 per cent last year. However, at the same time China's gross purchases of industrial products rose from $490bn to $1,250bn, or 4.6 per cent of world industrial production.

The difference represents China's net manufacturing exports to the rest of the world, which were $50bn in 2002, or a meagre 0.18 per cent of global manufacturing capacity. Moreover, that figure has not been increasing noticeably over time; the net balance reached $45bn in 1997 and has been broadly stable ever since. In other words, the mainland may account for an ever-greater share of the world's industrial output but this is almost completely offset by its growing industrial market. Far from sucking in capacity, China has had virtually no overall effect on manufacturing outside its borders.

The astute reader will argue that in lumping all manufacturing industries into one overall category, the above argument misses the point, which is that China has a much more devastating impact on those markets in which it competes directly. And the reader would be right. This brings us to the second argument, that China is rapidly moving up the manufacturing food chain. When we break down overall manufacturing by industrial category, we find that the mainland records a rapidly growing net surplus in textiles and light consumer goods (roughly $80bn last year) and an expanding deficit in machinery and capital equipment. Despite headline electronics exports of more than $100bn in 2002, the net balance was only $11bn, as China's information technology export sector is still predominantly made up of processing and assembly of imported components for re-export.

The bottom line is that China is becoming a manufacturing hub for the rest of the world in low-end, labour- intensive goods. Contrary to current fears, the rest of the world is becoming a manufacturing hub for China in high-end, capital-intensive goods. This is exactly how international trade should work.

So far, so good. But could all this change tomorrow? Is not China importing capital equipment today so that it can turn round in a few years' time and flood the world with cheap high-end products? Of course, there is no guarantee this will not happen - but the chances are remote. For China to jump multiple rungs on the global value-added chain, we would need to see a rapid build-up in capital-intensive sectors with both a high domestic value-added component and a significant export orientation. There are plenty of industries where one or the other is true but few examples of both.

A final worry is that China's economy could collapse, or at least slow sharply, resulting in a flood of excess manufacturing capacity on to world markets. After all, this is what happened in 1997 and 1998, when a post-bubble decline in domestic demand caused the trade surplus to rocket to nearly 5 per cent of gross domestic product. Again, however, the chances are remote. Goldman Sachs' index of activity in China points to rapid growth over the past two years and, despite objective macroeconomic risks in the future, the outlook is far more stable and manageable than it was six years ago. Chinese manufacturing is a force to be reckoned with but not one to fear.