Bonus vs. Raise: What’s the Best Way to Reward Employees?

Effectively rewarding employees is key to keeping them around for longer — as well as improving morale, engagement and productivity. But what’s the best way to do this? In this article, we’ll discuss the merits of offering employees a long-term pay increase vs. an annual bonus. 

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The importance of effectively rewarding employees

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It may seem obvious, but it’s worth exploring why rewarding employees for their work is so important. First, it’s the right thing to do. Employees spend a significant amount of their time at work, and it’s only fair that they’re rewarded with generous and competitive compensation. 

Properly rewarding employees can also increase their motivation, which can lead to improved performance and productivity. And of course, if you’re not effectively rewarding your employees, it probably won’t take them long to find another company that will. That means you could face problems with high voluntary turnover and increased recruitment costs.

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Bonus vs. raise: which one is best? 

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Let’s get one thing straight: in most organisations, offering employees a raise or a bonus is not a binary choice. Compensation structures often include multiple components, including base pay, various types of bonuses, benefits, and equity. Getting the right balance between these elements is key to incentivising the right behaviours and using compensation to help your company achieve its objectives. 

Whether a bonus or a pay rise is the ‘best’ way to reward employees depends largely on your company’s financial health and compensation philosophy, and the preferences of your employees. This might be different depending on their career stage and short-term and long-term goals. 

For example, pay rises give employees long-term financial stability by providing a predictable source of income. This can help them with their financial planning, including saving for retirement, securing loans and managing day-to-day expenses. On the other hand, a bonus is typically a larger immediate reward compared to the incremental increase of a raise. This can be particularly appealing for employees with short-term financial goals, like paying off debt or making a big purchase. 

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Understanding pay rises

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Giving an employee a pay rise means permanently increasing their salary. This is usually done as a percentage increase, which means that pay rises compound year on year. For example, giving an employee a 5% increase three years in a row represents an increase of 15.76% on their initial salary. 

There are many different ways that raises can be structured.  For example, you might offer a general increase to the entire organisation to account for inflation. Or, you might adjust employees’ salaries to bring them in line with the market, which may have shifted since their pay was set. 

However, we’re here to talk about rewarding employees, which means we’re primarily talking about merit-based increases. These are given to employees to reward good performance and may be linked to specific targets set by the employer’s manager. Alternatively, increases might be tied to company-wide achievements, and awarded to everyone as long as the company meets certain targets.

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The benefits of offering employees a pay rise 

Here are some of the benefits of regularly increasing employees’ pay:

• Improved retention: Giving an employee a pay rise is an investment in your long-term partnership. Employees are more likely to stay with your company for longer if their compensation is growing consistently. 

• Talent attraction: Regularly increasing salaries helps you to keep up with market rates. This reduces your risk of losing talent to competitors who offer better pay.

• Boost in morale and productivity: Raising an employee’s pay shows them that their contributions are valued. This can lead to an increase in morale and satisfaction, boosting productivity and engagement.  

• Contributes to employer branding: Offering regular pay increases to ensure your compensation remains competitive can help to enhance your reputation as an employer. Over time, you’ll see results in terms of talent attraction and company culture. 

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What about bonuses? 

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A bonus is another important element of an employee’s compensation package. It’s generally awarded as a percentage of the employee’s total compensation. Bonuses may be awarded to the entire organisation, or just to certain employees. 

Bonuses can be structured to reward individual performance or collective success, depending on what you want to achieve through your bonus scheme. Some companies award bonuses to everyone as long as the business meets certain key objectives. For example, they may be tied to sales or production numbers. 

In others, bonuses are awarded on an individual level based on employees meeting targets set by their manager. Bonuses can also be used as a short-term incentive to drive progress on a specific project. 

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The benefits of bonuses for employers

Here are some of the benefits of awarding bonuses to employees: 

• Cost flexibility: Bonuses are usually one-time payments, which don’t involve a long-term financial commitment. This allows for greater flexibility, enabling companies to better manage expenses to account for financial performance or cash flow. 

• Incentivises performance: Bonuses can be directly tied to performance metrics, which motivate employees to meet their goals. This can help to align employees’ incentives with company objectives, driving productivity and performance. 

• Rewards short-term goals: Bonuses are a useful tool for incentivising employees to achieve short-term goals, such as hitting sales targets or completing projects. This encourages employees to focus on what’s most important.

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Key considerations when structuring raises and bonuses 

There are many different ways of structuring both bonuses and permanent pay increases. Here are a few things to keep in mind as you build your compensation structure: 

• Short-term vs. long-term incentives: Pay rises tend to signal a long-term investment in employees, while bonuses are more suited to incentivising short-term milestones. It’s important to carefully consider how your pay structure will impact employee motivations. For example, favouring bonuses over increases could encourage employees to focus on short-term wins at the expense of long-term performance. 

• Company vs. individual goals: Both bonuses and pay increases can be structured to reward either individual achievements or company successes — and this can have a big impact on a company. Too much focus on individual goals could create an unhealthy environment where employees are competing with each other instead of working together towards a common objective. 

• Company’s financial performance: Before offering employees a pay rise, employers must ensure they’ll be able to sustain the increased cost in the long term. Otherwise, those employees may be at risk of redundancy. If a company is experiencing financial difficulties, bonuses can be an effective way of rewarding employees without committing to a long-term cost increase. 

• Market competitiveness: Employers should regularly review market data to ensure they’re not underpaying employees. It’s also a good idea to explore market practices when it comes to bonuses, particularly in industries where they’re common. Ensuring both salaries and bonuses remain competitive can help you attract and retain talent, even in competitive markets.  

• Employee needs and preferences: Every employee is different, and it’s important to consider their preferences when putting your pay structure together. While you may not be able to please everyone, understanding whether your employees are mostly looking for long-term stability or short-term financial gains can help ensure you’re rewarding them as effectively as possible. 

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So, which one is best? 

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There’s no one right answer — it all depends on your company’s unique situation and objectives. As a general rule of thumb, raises are a better long-term strategy for employee retention. They provide employees with stability, encouraging them to stick around for longer and fostering loyalty to your organisation. However, they come with permanent costs and reduced financial flexibility. 

On the other hand, a well-designed bonus plan offers flexibility for your business and allows you to effectively reward short-term performance and motivate employees towards specific goals. But they don’t provide the same sense of security as permanent pay rises, which could potentially impact retention. 

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Taking a holistic approach to compensation 

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In our opinion, thinking about bonuses vs. raises as a binary choice is asking the wrong question. Both bonuses and base salary are core parts of an employee’s total compensation package, but they don’t tell the whole story. Effectively using compensation to help your company achieve its objectives means looking at the whole package, not considering each element on its own. 

Exactly how you structure your compensation depends on your company’s compensation philosophy and what you’re trying to achieve through compensation. It’s important to take into account both your long-term and short-term goals and your employees’ preferences. You should also explore other compensation components, including benefits, paid time off, career development opportunities, pensions, equity and more. Striking the right balance between all of these elements is key to motivating your employees and driving your company forward. 

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