MBOs Demystified

MBO bonus plan

“Show me the incentive and I’ll show you the outcome” is a quote from Charlie Munger often used to describe the direct relationship between special compensation and behavior. Certain roles in a company include a bonus as part of the total compensation plan. If Charlie’s quote is true, setting the elements of that bonus plan will have a direct impact on the employee’s outcomes and, therefore, company results.

What criteria should be used for determining a bonus payout? Common choices include company-level goals, department-level goals, individual projects or some combination.  The bonus plans I’m describing here are different from sales commission plans (see related article titled “5 Golden Rules for Setting Sales Compensation Plans“) and are commonly called Management By Objectives (MBOs) bonus plans.

The original concept of the MBO was introduced by famous strategist Peter Drucker decades ago. And although the way MBO bonus plans are administered has evolved over time, it is still is an important part of many management systems today. This article will explain the types of roles MBOs can be suitable for, basic components of an MBO bonus plan and some tips for administering them.  I’ve also included an MBO template for you to use.

Suitable Roles

Every employee gets some form of base salary, even if it is a hourly wage. For that base salary, the employee is expected to perform various tasks, foster the company’s core values, be positive contributor to company culture, and other foundational basics of just being an employee. Because of this, most roles don’t really need a special bonus plan in order to achieve certain outcomes.

An employee that regularly finishes a task sooner than the assigned due date is an employee that exceeds their manager’s expectations. Same for one that identifies needed process-related improvements that will benefit their whole function. There are many things employees can do to exceed their manager’s expectations, but don’t call for a special bonus compensation. Instead, they yield recognition (shout out or award), a pay raise, or maybe a promotion that also comes with a pay raise.

There are some roles that involve assignments with a certain risk-reward level that is greater than most others. Again, I’m not referring to a quota-carrying sales person that has an even greater risk-reward level associated with their role. Rather, I’m referring to a role like business development. A person in BD might be responsible for securing strategic partnerships that provide an oversized benefit to the company, if achieved. Such tasks involve customized approaches, strategic thinking, and sometimes long duration rather than transactional or highly repeatable approaches.

Successes from such a role bring enough benefit to the overall organization that extra compensation is merited, if achieved. Enter the MBO plan.

Company-Level vs Individual Targets

The spirit of an MBO is to reward for individual performance and sometimes also team performance.  It’s true that the company-level targets are (hopefully) highly scrutinized and well thought out by the management team.  They’ve already been well vetted before you find yourself considering them for incorporation into bonus plans. But how much does any one individual contribute to the overall company’s performance?  You might find that you’re offering them a bonus just for doing what’s expected in their job description.

The closer you get to setting targets on individual performance, the more the employee can directly impact their earnings. The trade-off is that individual targets are sometimes harder to set than you might think, and the possibility for wide degrees of under/over-achievement also exists. So you’ve really got to be careful.

Golden Rules for MBO Plans

Just like my golden rules of sales compensation plans, I have a handful for MBO bonus plans. After coming up with a proposed MBO plan for an employee, review it again using this list of golden rules.


Any MBO line item that is based on individual performance should also be tied to company-level and/or function-level goals for the period.  Think of a cascading effect. In a perfect world, if individual objectives are met across a function/department, then it’s likely that function’s various objectives will be met. And if this also happens across the various functions, the company’s objectives will be met.

When deciding on the elements of an MBO plan, ask what accomplishments are necessary to achieve important functional or company-level goals. This is just sound management practice in general, but when bonus plans are in place the principle should be preserved. To better understand ways to align your employees’ actions with company goals, see Joel Trammell’s post titled Are Your Employees Misaligned?


Usually, MBO plans are set and paid each quarter. As such, you should only define 2-4 objectives that have compensation tied to them, even if the employee has more than 2-4 quarterly goals. I personally like to stick with 2-3 objectives. Compensating on more objectives than that causes a couple of problems.  First, the amount of money tied to any given objective isn’t enough to cause the desired motivation. Second, a key reason for having a bonus plan in the first place is to promote extra focus and prioritization.


If a particular objective requires a magic decoder ring to figure out if/when/how compensation will get paid, you’re in trouble.  Instead, use simple language.


This can sometimes be at odds with trying to be simple but it’s important to minimize accidental misunderstandings. One way to do this is to include definitions or examples in the description of the objective. Then, make sure to have a discussion about each objective with the employee and ask them to tell you what they think success means.

Subjective Criteria

It’s best if the bonus plan elements have quantifiable metrics that are easily measurable. If you must include subjective criteria, try to describe how the criteria will be applied.  For example, imagine a line item that says, “The bonus will be paid based on how successful the marketing campaign is.” What does “successful” mean?

Instead, try something like this: “The bonus will be paid based on the overall reach and awareness generated from the marketing campaign as evidenced by social media activity, online and print press coverage, and inbound inquiries.” Even though you haven’t set quantifiable targets, you’ve at least described the criteria that will be used to make the subjective judgement.


Be careful about setting targets without any qualifiers to ensure quality. You should assume the employee will do whatever is necessary to achieve the target. For example, imagine you set a target to “Produce a joint press release with XYZ Corporation”. Doesn’t it matter what the press release is about? Doesn’t the resulting exposure gained through online and print media matter? Include quality-based attributes with your MBO descriptions or prepare to suffer the consequences of employees cutting quality corners and gaming the system.

Underachievement or Overachievement

Each line item in the MBO plan has a compensation amount associated with it. So what happens if the target is mostly, but not fully, achieved? What if the target is exceeded? If the criteria are quantifiable, it’s easier to accommodate paying more or less than the stated bonus amount. But with subjective criteria it’s harder.

First, make it clear in the description if the bonus is “all or nothing”. If not, how will the bonus payment be determined if the target is partially achieved? What if it’s exceeded?

Even with quantifiable results, the payout doesn’t need to be linear.  In other words, 65% performance doesn’t have to yield a 65% payout. Instead, you could word the plan something like “If you reach at least 85% of the target, this bonus will pay out at 50%.” But you would only want to do this if achieving 85% of the target still brings pretty favorable things to the company. In some cases, the employee might need to reach 95% of the target to merit some partial bonus payment. You could also include extra bonus payment for overachievement, although this is a little less common with MBO plans.

MBOs aren’t the same as a sales commission plan, which means they don’t usually need a high degree of granularity in the payout scale. But it’s often appropriate to include some partial payment for under-achievement rather than have all line items be “all or nothing”.

Outcomes versus Activities

A common mistake I see is crafting MBOs around activities instead of outcomes. For example, conducting meetings with 10 new prospective distribution partners is an activity-based metric. Securing three new distribution partners with signed distribution agreements and completing their on-boarding and orientation sessions is an outcome-based metric.

There are usually lots of ways to play games or skimp on quality with activity-based metrics, but that’s much harder with outcome-based metrics. Which OUTCOMES are most important for your MBO-compensated employee to accomplish in order to meet your business goals?

Mid-Term Progress Report

We already covered the importance of not assigning bonus compensation to things that aren’t extra important. After all, the employee already gets a base salary to do their required job. But rather than wait until the end of the bonus period to assess the performance against the MBO plan, have a progress report discussion with the employee somewhere in the middle of the bonus cycle.

Hopefully your management system already calls for monthly manager-to-employee communications about goals and performance. If not, at a minimum you should have a conversation in the middle of each MBO performance period. It not only gives you a chance to measure progress against obviously important projects but it also gives a second opportunity to make sure the bonus descriptions are clear and to avoid surprises later.

MBO plan templateMBO plans can be a highly effective tool but they require more effort than most new managers think. Anytime you assign compensation to specific tasks, the affected employees will pay very close attention and won’t be tolerant of any lack of planning or foresight on your part. So please use one of my mantras when it comes to bonus compensation of any sort: “measure twice, cut once”. And please refer back to the golden rules.

Click the graphic to the right for an MBO template I’ve used in the past (scroll down to the Compensation Resources section of the page). Floating over some column titles in the spreadsheet will reveal comments I’ve embedded to provide further explanation.

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