As the end of the year approaches, it’s time to begin calculating the bonuses that you’ll be distributing to your employees. Many companies simply take a percentage of each employee’s salary or one or two weeks’ salary and earmark that amount as the employee’s bonus. Employees who work harder than others and put more effort into their jobs are disappointed that they’ve received the same percentage as everyone else.

An increasing number of companies are choosing another route. They pay a competitive salary as a fixed amount and then distribute the company’s profits as a variable amount based on a formula for each type of job. Jack Stack highlighted this compensation methodology in his book, The Great Game of Business, in which he profiles a company plagued by problems. Stack and the employees purchased the company and when the employees learned how their jobs affected the bottom-line, profits soared.

Another type of bonus distribution is based on an employee’s contribution to profits. This type of system works particularly well with law, accounting and other firms where employees bill their time and/or bring in business. Firms pay a competitive fixed salary or slightly less and then reward employees with a variable bonus based on several factors, including the number of hours billed over a minimum number, the expenses incurred by the employee, or the amount of new business generated by the employee. 

Take for example an associate in firm A, who is asked to bill 1,800 hours per year. For one reason or another, the employee is short on hours each month. Yet no matter how many hours worked or not worked, the employee will still receive the agreed- upon salary. Because the employee is not sharing in the profits, there is little regard for expenses, which the employee does not hold to a minimum. Frequent overnight messenger deliveries for work that could have been completed in time for less- expensive regular delivery by the U.S. postal service are commonplace. Meanwhile, the associate is jockeying for a larger window office that just became available after a partner moved to a new firm. The employee receives a bonus at the end of the year equivalent to one week’s salary.

Now contrast firm B. Employees are asked to bill a minimum of 1,500 hours at a fixed salary that is competitive with other law firms requiring 1,500 hours. For each hour billed in excess of 1,500, the employee receives a percentage of the hour's revenue as a bonus. To discourage padding the hours billed, the employee and the partner in charge of the work agree on the number of hours that it should take to complete the project. For example, an employee is preparing an estate plan or a tax return. The partner has told the client that the fee will be $2,500. The partner allocates two hours of his or her time to review the work. At a partner fee of $250 per hour with $500 total for two hours, the remaining fee is $2,000. If the employee's billable rate is $100 per hour, then the partner allocates 20 hours for the employee to complete the project. Or if the employee's billable rate is $125 per hour, then the allocated time is 16 hours for the employee to complete the work. 

The employee receives credit only for the specific number of agreed-upon hours, no matter how long the work takes to complete. Prior to the awarding of the bonus, expenses, either for the individual or the firm, are deducted first. For example, if the employee uses overnight messenger service instead of regular mail delivery, that expense is deducted from the bonus. If the employee wants a large window office, that extra overhead expense is also deducted from the bonus. Meanwhile, the employee who works in a small inside office is credited with the amount saved from the allocated office expense given to each employee. If the employee brings in new business from current clients or new clients, then a percentage of that revenue is added to the bonus.

Businesses that follow firm B’s method, find that employees work longer hours and work smarter, while constantly seeking ways to drive down expenses. The result is that the partners’ income can increase dramatically, because the rule of thumb is that approximately one-third of the billed revenue is profit for the partners.

For non-billing or non-revenue-generating employees, performance-based job descriptions are critical since bonuses are based on whether the employee meets or exceeds the performance criteria in the job description. For example, if the job description for a receptionist is to answer the telephone, the performance-based job description would be for the receptionist to answer the telephone within two rings.

Because January is one of the biggest months for employees to switch jobs, make sure that your salaries are in line with other companies. Many trade organizations conduct compensation surveys and provide reports to their members. Several Web sites provide salary data to help executives set appropriate compensation for their employees.

In an age when excellent or even good service is sometimes rare, the companies that tie their employees’ bonuses to performance and bottom-line results are finding that workers treat their customers or clients as if they were their own and the company was theirs. At firms where service is already outstanding, employees realize that their bonuses ride on the success of the company and work hard to improve income and limit expenses.