No More MBOs

I am so very tired of MBO-based bonuses in startups. I knew the concept of MBOs pre-dated my time in business school, but I couldn’t remember where they came from. Wikipedia reminded me – it’s another Peter Drucker creation from The Practice of Management.

I’ve only worked in what could be considered a “big” company for 18 months (1993 – 1995) and that was the company (AmeriData) that bought my first company (Feld Technologies). When they acquired us, they weren’t  big (probably 200 people) and when I left they still weren’t really big (2,000 people) but were “big enough.” So the joy, and experience, of working in a 50,000 or even 100,000 person company eludes me.

As we enter Q4, I’m starting to see discussions about annual performance – often in the context of gearing up for 2014 plans. This often comes in the form of long emails or tedious board discussions about compensation and bonus programs. And inevitably, discussions of MBOs and qualitative performance bonuses quickly enter the discussion.

Now, I’m not a huge fan of programatic bonuses. I spend way to much time reviewing comp plans and trying to help CEOs get a decent alignment between an elusive and inaccurate “plan” (which – especially in a rapidly growing company is never anywhere close to correct), bonuses driven off of company performance, and then bonuses driven off of individual performance. It’s just really hard to get right and feels like an enormous misallocation of time for a young company.

The ostensible goal is to motivate certain behavior and reward certain outcomes. The quantitative, performance-based bonuses are about rewarding outcomes. The qualitative MBO based bonuses are often included to motivate behavior.

Therein is the conflict for me. I have a deeply held belief that a manager cannot “motivate behavior.” She can only create a context in which a person is motivated. It’s up to the individual to motivate himself. Theoretically MBOs help create this context, but it’s often an artificial construct linked to arbitrary behaviors that have nothing to do with motivational structure. Toss money in, and you put focus on the behavior, not on the motivation.

This is totally messed up in a startup. Things are changing daily. Annual performance plans are often irrelevant by February. Quantitative metrics are either too easy to hit, or completely impossible. So the MBOs becomes the achievable bonus, and behavior shifts to achieving them, even when they are even more irrelevant because of the needs of the business.

At Feld Technologies, we had a very simple bonus program. Each quarter, we paid out 10% of pre-tax profits as a bonus. We did this on an accrual basis. My partner Dave and I took the number, made a list of all employees, and figured out how much we were going to give each of them. We then printed out checks and gave them to each person. When we had our act together, which was several quarters each year, we delivered feedback – good and bad – with the checks. If I had realized how powerful this was, I would have done a better job of figuring out and delivering the feedback, in the goal of creating a context for motivation for each person, and realigning goals each quarter.

I’m considering encouraging all the CEOs I work with to get rid of MBOs in 2014. If you insist of having a bonus plan, use a financial bonus for the entire company based on top down performance. This will be a calculation across the entire company and built into the budget at an EBITDA level (e.g. it has to be funded by the performance of the company, which could include a negative EBITDA number, but the bonus pool is linked to that.) Then, the CEO and the leadership get to allocate the bonus to each person on a direct performance basis at the end of the year.

Even better, consider using equity compensation as the bonus. Figure out an equation for converting the bonus amount (in current cash terms) to stock option awards. Then let’s set aside that pool, at the beginning of the year, to award at the end of the year based on the bonus achieved. Be transparent with everyone in the company about the size and determined value of the pool, how their behavior will increase the value, and then work like hell to achieve it.

I’m looking for feedback on this approach. A programatic bonus amount driven by company performance. Individual bonuses based on the discretion of the leadership team that add up across the company to the company bonus pool. No MBOs.

  • How does MBO-based bonuses (which I’ve seen everywhere) really differ from the ‘[x]% pre-tax shared by everyone’ approach, if that’s tied to performance as well?

    Other than the obvious individual behavior vs company behavior being rewarded…

    • MBOs are explicitly defined up front, artificially constructed to seem more rigorous than they are, and often obsolete as a measurement tool the day after they are agreed to.

      % pre-tax is a absolute amount that then gets allocated subjectively based on the manager’s view of performance, not against a scorecard of artificially defined MBOs.

      • Yep, I see your point. The ‘up front’ nature is disadvantageous for a startup that is growing / changing rapidly.

  • I’ve written countless MBOs for employees.

    They work only when the objectives were right and moreso, when the employee was the right hire for the company and the job.

    You can do away with them but it pushes the focus on making great hires which it honestly is regardless.

    Biggest issue with a broader stroke idea like you pose is when you hire people to build channels, sales types who need to spend a few quarters building what they will farm later. This personality needs to accomplish and be compensated. MBOs work great for them.

    • I should have been clearer that I always separate sales comp from this. I’ve never been able to come up with a non-variable / performance based sales comp plan. It is so ingrained in our society that pay-for-performance is what matters in a sales organization and how salespeople are “motivated.”

      • Jeffrey Hartmann

        I’ve been thinking about this a bit lately (reading the compensation chapters in Startup CEO right now.) I think pay for performance isn’t all bad, but getting the right objectives is so key. I think using EBITDA, overall company performance and overall judging things with a simple profitability lens (improvement of profitability of a deal, work that saves money, thinking like an owner, etc. is better for your comp.) is the best idea. I am not completely convinced objective based bonus compensation is completely BS, I just think it needs to be very simple, not build an artificial incentives, and not become a beast of its own. I think a set aside pool that gets distributed when the company does well, and the senior management will judge you on what you did that made us believe you were focusing on increasing our bottom line and thinking like an owner might be the right objective here. For some people it will be a little squishy, but for your sales and operations people it can usually be measured. Once you get a culture of reward based on deals closed, upsell %, or some other metric you get bad behavior creep in. But if you just judge on what did your input do to affect our bottom line, people start to have to think how to maximize profit. That is only a good thing. I worked at a private company that had a bonus structure sort of like this for most employees (it was allocated equally to all employees as percentage of salary though, I don’t think thats exactly right but it was good), and it worked really well. We had lots of people take on initiatives to save money, since we knew it would have a direct impact on our take home pay. If you get that right, it really breeds a culture of success.

      • Bill Adkins

        I think there’s plenty more to the sales-comp story as well, along the same lines as this MBO discussion. Too often the plans are absurdly simplistic or absurdly complex, but often generated for fiscal, not (corporate) cultural goals. Same for the cultural view of the salesperson. As Brad stated, oftentimes annual goals in a startup have dramatically changed by February, yet the work/investment and alignment of the sales goal to those changes is often an afterthought. I think many would find the salesperson in a startup working there for many different reasons (and often higher-ranked ones) than pure cash-for-closes. With that person generally being the “front line” to a very new/emergent company, the value of that “front line” is often squandered with coin-operated comp plans, IMO.

  • JamesHRH

    Wanted to check that MBO meant what I thought and, in doing so, also learned it is a language spoken in Cameroon. Symbolic maybe?

    You were right when you had a mgmt discussion and split up the pool.

    It is, basically, how IPFs (Indiv Perf Factors) are accomplished @ my wife’s Fortune 5 energy company,

  • Kev

    I got halfway through this before I realised you weren’t talking about Management Buy Outs!

    • Hah! Oops.

    • pjpronger

      Hell, I thought it was “Merit Based Options”.

  • John Fein

    I like the % of net profit distribution, though I would caution against giving it all as stock options. For some, a 4-year vesting option award won’t have the immediate and tangible reward effect of cash, especially around the holidays. A mix of options and cash may strike a good balance.

  • bnme

    I think that current research supports your argument against MBO based bonuses. Daniel Pink covers this really well in his book on motivation called Drive: The Suprising Truth About What Motivates Us, but essentially, for creative or complex tasks and jobs, tying bonuses to achieving them not only does not increase performance, but has been shown to decrease performance. Not only does MBO based bonuses not “motivate behavior”, but it can warp what was intrinsic motivation towards a task into extrinsic motivation (inferior) to completing that task. He also has a TED talk on this.

    • Bruce Greig

      + 1 for Daniel Pink’s book. Excellent summary of academic research showing that, broadly speaking, linking pay to performance leads to worse performance.

      • +2 for Daniel’s book!

  • Krishna R

    I agree with the main point you are making that MBOs don’t work all that well. The one place where I have found MBOs to come in handy is in attracting good talent to join the company as they can see how performance can lead to a higher take home pay. This is a good tool for convincing someone to take a lower pay than market especially if they come from a larger company where MBOs are understood well. I feel this in some ways also mitigates the risk of bringing on a very expensive hire as you get a quarter or so to evaluate the performance of the individual.

    • After trying almost every approach here, I’d rather pay the person the higher market salary and not bullshit them with the fantasy of variable comp that they might or might not get, but as a way to hedge against what they want to get paid. If they don’t work out, they should lose their job. Making that deal clear is very aligning. In the variable comp case, if the person underperforms, you know have an underperforming person who feels like they are being underpaid. Not good.

      • This is the core of the issue. I believe that with the exception of the founding team, you cannot underpay and hope to promise it up on MBO’s or options.

        I’m not saying you have to pay the huge BigCo salary. No you are are looking for people that can punch above their weight as Mark Suster says.

        I have seen both and been ridiculed about we pay discretionary bonuses, but when I have seen the results of the “quantified” method, I know which one works better.

  • Jonathan Soares

    I feel this thread holds a lot of merit especially in a growing company, which should divert their focus to core operating and growth objectives. As owners we invest heavily in our teams, infrastructure and culture providing an environment that is rewarding, engaging and full of opportunity. From my experience if you don’t adopt a bonus structure it typically doesn’t come into discussion. The moment you do it sets a level of expectation that can become troublesome during business cycles that might not be so favorable on an organization. A semi annual performance review followed by an annual comp review sets a reasonable expectation level. There are plenty of other perks along they way.. equipment, software, bar nights, beer, team events, outings, beer, contests, meals, snacks and beer which I feel are very motivating and rewarding. It’s the thought that counts not the expectation.

    • Yup! There is endless theory about “hygiene factors” in compensation – specifically you need them to meet a minimum threshold of happiness. And – once they are there – you can’t take them away.

  • Kris Tuttle

    First of all Amen! Second I would make one critical observation which is the division of the quarterly bonus checks. Employees often dislike what they see as “subjective” allocations because it feels uncertain and can breed a level of politics, brown nosing and boot licking that is counterproductive. For several years I was a partner in a firm that had these subjective bonuses *but* a percentage of profits were distributed to all employees each quarter based on their equity in the firm. The more contributions they made and the longer they stayed the more equity they would be given. The combination of both short-term cash and long term equity with cash distribution tied to it was super powerful and didn’t lead to endless conversations and negotiation.

    • Powerful point. At Feld Technologies we made subjective decisions about it and used it to deliver feedback. And – no one other than Dave, me, and my dad had equity so that allocation approach wasn’t available to us. But in lots of cases, figuring out how to make the allocation less subjective, especially if there is a unifying metric like equity ownership, can be highly effective.

  • laurayecies

    We struggled with this at SugarSync and after 4 years and trying a couple of approaches I must say I agree with the post. They are problematic, time consuming and not, in the end, positively motivating. There is simply too much change in a startup for this to work as desired. I could see, however, once a company gets big that some sort of profit sharing could work.

    • Yup – different bonus approached work at different stages. I’m focused on the < 1000 person stage with this post.

  • Mike Smith

    You complete me. I’ve been on both sides quarterly MBO’s and quarterly profit based goals for everyone. The latter was much more unifying, imo.

  • secureccloud

    Brad overall I agree with you. However, I think you miss a critical point. Often times especially with new employees the MBO is used as the carrot to make up for a below the line salary/comp package. I have seen (and I know you have too) many times a startup trying to bring in a valuable addition to the team and instead of paying “fair market value”, instead give a under market salary tied to a sometimes unrealistic MBO structure. Consistently this only winds up blowing up in everyone’s face.

    • Yup. And I don’t like to do this anymore. If the new employee doesn’t buy into the value of the equity upside, then they probably aren’t a good culture fit for the company.

  • Great topic Brad, completely agree with clarity and simplicity of the package. Interested to know how you establish realistic expectations of performance in startups specially in management ranks.

    • It varies by company and I’ve got a long list of suggestions, some which I’ve blogged in the past and some which I’ll likely blog in the future. I’ve found that it’s very linked to the cultural norms / dynamics of the company, so there is no magic approach.

  • You write a lot about intrinsic motivation, Brad. Wanted to make sure you’re aware of Csíkszentmihályi’s work on this back in the `70s. While the “Flow state” shown in the top right of his diagram is what we’re all after for our teams, it turns out the “zone of optimal engagement” on that diagram can be drawn as a stripe from the bottom left corner up to the top right: This is where intrinsic motivation is at its highest — learning and performance are maximized there.

    Conditions for Flow include:

    (1) “One must be involved in an activity with a clear set of goals and progress.”
    (2) “The task at hand must have clear and immediate feedback.” And,
    (3) “One must have a good balance between the perceived challenges of the task at hand and his or her own perceived skills.”

    How does this impact the MBOs-are-bad point you make in your post?

    (1) The clear goals MBOs ostensibly provide individuals are nearly impossible to define well in a startup: things are too fluid. Perhaps this is why MBOs work at large companies — roles and conditions are relatively static. That said, “coin-operated” sales people’s commissions seem to be an important exception for startups.

    (2) The feedback from MBOs lags the performances of the team member, so MBOs don’t provide the immediacy that fosters optimal motivation. (Sales team: again an exception since they know exactly what each deal will be worth to them when it closes.)

    (3) Hiring the right people, as other commenters have pointed out, is key.

    Given the above, what are folks’ thoughts about the alternative of “you will all get fraction of the x% of EBITDA / y% stock option pool we’ve set aside for this year / quarter”? This seems to address the clarity problem for goal-setting, but I’m not sure it helps in any other areas. Does an opaque and subjective CEO decision about allocating the portions of the team’s aggregate bonus introduce other potential problems?

  • Brad, your post could not have been more timely. I probably have a dozen things I’d like to ask/talk about on this topic, but then you’d have to charge me a consulting fee. 🙂 I’ll stick to one point. Should it be a % of Profit or a % of Revenue? The problem with a % of Profit is that fast-growing startups should have no profit. We should be re-investing the money. It would be counter-productive for the team to be trying to be preserve growth cash — or even challenging management why they are hiring more people — so they can increase their bonus. Thoughts?

  • Vic Bel

    A bit confused. I don’t think the way most companies do MBOs is necessarily the best, but rewarding all employees the same way on the performance of the entire company seems odd. Maybe it’s just the paranoia of someone who grew up in the USSR but it really smacks of “from everyone according to their abilities – to everyone according to their needs”. 🙂
    Just don’t see why engineers who worked 18 hour days to meet the release date should get the same bonus as the QA who missed a critical bug and fucked up the entire release.

    Also, assuming that the startup does not make a profit, bonus payout would have to be triggered by some other KPI (revenue, revenue velocity, some other proxy like user acquisition or engagement or retention) – which s basically an arbitrary MBO for the entire company. Not sure how that’s any better than setting individual goals for employees.

    At RingCentral, we always did MBOs based on the customer life cycle model int he following way: most employee’s MBOs are based on 2-3 KPIs – first 1 or 2 are the ones the employee is responsible for, the 3rd one is “downstream”. A simple example:
    A lead gen guy might have 2 KPIs:
    1. His own: Number of generated leads – this allows him to focus on the key deliverable of his job
    2. Downstream: Conversion to trial – this KPI is the core KPI for the “downstream” gal, but it’s important for our lead gen guy because it keeps the quality of leads high.

    The trial gal will then have 2 KPIs
    1. Her own: Conversion to trial
    2. Downstream: Conversion to paid

    and so on and so forth….
    V –

  • MBO’s practice was popularized by Hewlett-Packard. Drucker wrote about it. MBO’s essence was to avoid micro-management, so the idea was to come up with broad objectives with the employee, and then let the employee decide how to achieve them.

    I worked for HP for 14 years and it was part of the lifeblood. It worked really well, because when you’re a large company, MBO gives you a planning discipline that you need to have, and it enables a degree of co-ordination and relationships between all the various objectives which you couldn’t get otherwise. There was this cascading effect of MBO’s, where your manager’s objectives became your strategy for delivering results, and you in turn cascaded that to others in your group, so that everybody was always working towards the same goals, as varied and broad they may have been.

    And I’ve been part of another large organization that gave proportional bonuses that were a mix of departmental performance and individual performance. First, the company had to do well as a whole. Suppose they blew their numbers and reached 140% of objectives, then the bonus pool is distributed accordingly to each department on a proportional basis. For e.g. if Marketing did well, they receive say 140% of that pro-rated amount. The CMO then decides how to allocate within the marketing employees. Some will get 100% of that, some will get 160%, or all might get the same %. It was a % uptick of your salary.

    At HP, profit sharing was equally allocated to all, twice per year, but your salary increases were tied to the MBO achievement. Later, after I left when they took away profit sharing, but they introduced individual bonuses, but it got messy that way.

    Reading between your lines, it seems to me that MBO has since been distorted. I have never heard of “Qualitative MBO”. MBO’s are Quantitative, even if they include a personal objective. MBO works if it’s done properly. I agree that if the startup is dynamically changing, then annual MBO’s don’t make sense. So you fix that by having quarterly ones that are reviewed monthly.

    Another approach that I’m hearing about are OKRs, which are “Objectives and Key Results”, and it consists of setting an objective, and also a series of measurable results aligned with that objective. It’s MBO by another name, because we like to re-invent things. The essence is that it helps you to align strategy with objectives to deliver results.

    The sensitive point you’re touching on is that when it’s tied to a motivational behavior that starts to torpedo other things.

    Here’s my recommendations, and I’m going to write a post now that you’ve sparked this.

    1. Fold personal/qualitative MBOs inside the Quantitative MBOs. Don’t have a multitude of personal MBOs.
    2. Don’t use the MBO on its own as a direct bonus kicker. Use it to qualify the employee for the bonus. The final number is at the discretion of the manager (excluding sales which are a different beast for compensation). That way, torpedo behaviors will get a discounted bonus.
    3. If you want to motivate someone in a startup, give them an independent, time-sensitive goal. For e.g. if you do this in 60 days, I will give you xyz extra options right away. I have done this and it works. (it has to be above and beyond their job)

  • Hey Brad – We’re $865M (ttm) revenue and about 700 employees. The leadership eliminated MBO’s about five years ago and we couldn’t be healthier. Our corporate wide bonus program is an incentive for collaboration and communication. Communicate corporate objectives (long term growth as a %, profitability, etc.) and work together to achieve the goals. Our culture is not old school command and control…..we would be dead by now.

    • “Communicate corporate objectives (long term growth as a %, profitability, etc.) and work together to achieve the goals.”

      That sounds like management by objectives and results to me. I’m curious- how did you manage or track the progress towards the goals?

      • We don’t track and report progress towards bonus objectives. We score and payout bonuses every 6 months. The metrics are few and focused of the long term health of the company. They are not a factor in the daily decision making. Bonus driven MBOs in my industry are indeed micromanagement; product schedules, staffing, yields, etc…..and they don’t work.

        • I agree that MBOs tied to bonus doesn’t work. But MBO works. In its original form, MBOs had nothing to do with bonuses, and I know that from my long experience at Hewlett-Packard where MBOs originated and thrived.

          I think someone started to slap programmatic bonuses on MBOs about a decade ago, and that’s when things got derailed.

  • No idea what MBO’s are, but I’ve often thought about this compensation device. Allow all employees three votes for the most valuable employees, most helpful, best culture fit, or whatever you are optimizing for. Then calculate all those votes and recalculate them while weighting the previous top vote getters. Take the new calculations and pay out the allotted bonus money (10% pre-tax) based on this distribution. Of course you have some caps in place so that a select few don’t get the whole pie, but I think you will end up with a pretty good, even, merit based, and employee driven system that is not easily gamed. Basically, employee-sourced performance reviews, with algorithmic controls. … just a thought.

    • pjpronger

      So that’s interesting. What is the formula for weighting the previous top vote getters? Do you happen to have a complete example?

      • I don’t have en exact formula, as it would need to be customized to the size of the org. The concept is that if its a simple 1 to 1 vote, it can be a popularity contest. But if you then weight the top vote getters, and ideally you can presume the person voted “most critical” actually has an insight into who the critical people are, you can offset the popularity effect. Obviously the top vote getters cannot vote for themselves so it redistributes the vote. It’s a pretty objective system, as I can’t imagine looking at a name and then trying to subjectively figure out what they are worth based on my limited experience with them.

        • pjpronger

          OK, so you’re giving more weight to the votes of the top vote getters. Got it. Have you done this in practice?
          (Note to Brad: sorry to hijack your blog because my application for this has nothing to do with startups, you guys carry on.)

  • DJ

    In the early days at SurveyGizmo we had a very simple but effective bonus policy. It was tied to the number of active customers, not profits. We wanted employees’ #1 focus to be getting and retaining customers – even programmers. All employees got an equal share of the bonus, so they were motivated to keep headcount low as well.

    • Well done – simple and clear.

  • This inspired me to respond with this post – Don’t Abolish MBOs

    • Good post – I interpreted it as “Abolish MBO-based bonuses” which I agree with. And one way to do this, even if it’s thin in substance, is to call them something else. OKR and KPI is a shot at it. That’s fine – everyone wants their own methodology. But fundamentally the notion is to decouple comp as the “motivator.”

      • Exactly. It’s called “Management” by Objectives. It’s a Management tool, not an incentive program.

        Tying a bonus directly to the MBO is lazy incentive management.

  • We are implementing a Win-Win Performance Agreement between every team member and their mentor/team leader. The template we are setting up is based on broad objectives, goals and aspirations of our team members, we have some overall objectives and if we achieve those objectives then everyone in the team is compensated. The weights we give to individual KPI vs Team KPI is the important indicator 80% weight for overall team kpi, 20% weight for individual KPI. Don’t know if it will work or effective but the dialogue we are having is making everyone in the team very excited so maybe we are doing something right.

  • JLM


    A poor craftsman always blames his tools.

    As a guy who has been a CEO for 33 years and who got sheep dipped in the MBO notion with 5 years of military service I can say enthusiastically that the MBO approach works — it is only a tool and it requires a craftsman to employ it correctly.

    This generation did not invent sex nor did Drucker but he wrote about it a long, long time ago.

    The entrepreneur is responsible for creating a world changing Vision and the converting that into a Mission, Strategy, Tactics, Objectives operated under a set of prescribed Values and which will determine the Culture. This is the “story” of every successful company.

    VCs are primarily investing in the entrepreneur himself and the Vision. Both the entrepreneur and the VC are pretty clueless on the balance of these things. Not a “knock” but how would one expect someone to know how to fly an airplane if they have never flown one successfully. Worse still, how about if they have had a “bad experience”?

    We are all lazy as Hell when it comes to planning. This is, in part, the Internet in our brains. VCs today are telling entrepreneurs they don’t even need a semblance of a business plan, just some Vision mojo and a slap with a checkbook. This is intellectual laziness at its extreme.

    In the planning matrix of Vision, Mission, Strategy, Tactics, Objectives — you don’t really get to Objectives until you have done a lot of very powerful and detailed planning. This is a reality that may be very uncomfortable for startups and VCs. Understandably so.

    Read about this here:

    The reason Special Forces is “special” is because of their planning. Going on a one hour raid? Expect to spend about two months planning. These Alpha Male warriors are nebbishes when it comes to planning. Want to be “special” in business? Might want to increase the quality of your planning.

    Nonetheless, until you have completed and documented this planning it is almost impossible to fashion objectives which are Specific, Measurable, Attainable, Realistic and Temporal — SMART objectives. Your lament is in great fashion about the quality of the Objectives and the quality of how they are created. On this I agree completely. It is hard to do right.

    It is damn hard work to do this and like any tool in an entrepreneur’s or CEO’s toolbox, some CEOs are better at it than others. Slapping paint on to a wall with a roller is pretty damn easy stuff but painting intricate trim around a window is not. Objectives are in great measure the window into the soul of the company’s management.

    There is no question that refining the matrix of Vision, Mission, Strategy, Tactics, Objectives, Values, Culture is hard, hard, hard work — particularly for startup CEOs who are visionaries, leaders and for whom management is a new experience; or, for VCs who are parachuting in 6-12 times per month and thinking that Objectives is a subject for a few Compensation Committee meetings.

    The notion that you cannot motivate behavior with a carefully crafted program of compensation which includes performance bonuses based on the attainment of specific objectives is nonsense.

    A great compensation program is a balance of salary, benefits, short term performance based comp (Objectives), long term incentive comp and “something special. The attainment of objectives drives only a portion of the compensation in an “adult” well designed program. The error that many startups and VCs make is that they put all of their chips on the attainment of objectives rather than using it as one ingredient in a well crafted plan.

    I could write on this forever as I did it for a long, long time. I have written on these subjects extensively at The Musings of the Big Red Car. It is only a tool but done right can be a very, very effective tool.

    A poor craftsman blames his tools.