I have always been fascinated by companies that reject conventional wisdom not because they want to be contrarian, but because they actually found something better. When I started researching Netflix’s compensation philosophy — specifically, why they pay no bonuses at all — I expected a clever cost-cutting trick. What I found instead was one of the most well-reasoned talent strategies I have come across in years of studying tech companies.

It starts with a basement experiment in 1968. It ends with a CMO interrupting her own CEO to tell him his bonus metric was irrelevant. And in between, there is a principle that has reshaped how the best companies in the world think about paying people.

Netflix headquarters in Los Gatos, California Photo: Wikimedia Commons, CC BY-SA 3.0.

The Rock-Star Principle: One Programmer Worth Twenty

In 1968, a group of researchers ran an experiment in a basement in Santa Monica. They gave nine trainee programmers a series of coding, debugging, and execution tasks, each with a two-hour time limit. The researchers expected some variation in performance. What they found was staggering.

The best programmer was 20 times faster at coding than the worst. 25 times faster at debugging. 10 times faster at program execution. Not 20% better — 20 times better.

“The fact that one of these programmers would so dramatically outperform another has caused ripples across the software industry ever since.”

— Reed Hastings and Erin Meyer, No Rules Rules

This became known as the rock-star principle, and it forced Reed Hastings to confront a fundamental choice when building Netflix. With a fixed amount of money for salaries and a project he needed to complete, he could hire ten to twenty-five average engineers — or he could hire one exceptional person and pay significantly more.

Hastings chose the one exceptional person. And he was not alone in this thinking.

“A great lathe operator commands several times the wages of an average lathe operator, but a great writer of software code is worth ten thousand times the price of an average software writer.”

— Bill Gates

The distinction Hastings drew was between operational roles and creative roles. For operational work — an ice-cream scooper, a delivery driver — performance differences between employees are bounded. A great scooper might be 10% or 20% better than an average one. Pay middle of market. But for creative and inventive roles, where the best performers can be orders of magnitude more productive, the math changes completely. One incredible person, paid at the top of their personal market, will outperform a team of average performers paid collectively the same amount.

Reed Hastings speaking at the MCB15 conference Photo: Wikimedia Commons, CC BY 2.0.

Leslie Kilgore and the Bonus That Never Happened

This brings us to the story that, for me, captures the entire problem with bonuses in a single scene.

Leslie Kilgore was Netflix’s Chief Marketing Officer. Before Netflix, she had worked at Booz Allen Hamilton, Amazon, and Procter & Gamble — a resume that screamed traditional corporate excellence. Reed Hastings was about to announce her enormous bonus, tied to the number of new customer signups her team had driven. The numbers were remarkable, and the bonus was well-earned by any conventional standard.

Then Leslie interrupted him.

“Yes, Reed, it’s remarkable. My team has done an incredible job. But the number of customers we sign on is no longer what we should be measuring. In fact, it’s irrelevant.”

She went on to explain that customer retention rate — how many subscribers stayed — had become the metric that actually mattered for Netflix’s future. The company had reached a point where growth from new signups meant nothing if subscribers kept churning out.

Hastings later reflected on the moment with relief: “Thankfully, I hadn’t already tied Leslie’s bonus to the wrong measure of success.”

This is the core problem with performance bonuses. The entire system is built on the premise that you can predict the future. You set targets in January and hope they are still the right targets in December. At Netflix, where the company had to adapt direction quickly in response to rapid changes in the market, the last thing they wanted was employees being rewarded for hitting a goal that had become meaningless — or worse, actively harmful to the business.

The Science Against Bonuses

It is not just Netflix’s intuition that bonuses hurt creative work. In 2008, behavioral economist Dan Ariely ran a study with 87 participants that tested the effect of bonus size on task performance. The results were counterintuitive and devastating for the traditional bonus model: higher bonuses led to worse performance on creative tasks.

“Creative work requires a level of freedom. If part of what you focus on is whether or not your performance will get you that big check, you are not in that open cognitive space.”

— Dan Ariely

The mental bandwidth consumed by thinking about the bonus — will I hit the target? am I on track? what if the goalposts shift? — actively interferes with the kind of open, exploratory thinking that creative and technical work demands. You are optimizing for the metric instead of optimizing for the best possible outcome.

Netflix’s solution was radical in its simplicity. No bonuses at all. Every dollar goes into base salary. Big salaries, not merit bonuses, are good for innovation. Employees do not have to worry about hitting arbitrary targets. They can focus entirely on doing the best work of their careers, knowing their compensation is not contingent on a prediction made months ago.

Top of Personal Market: No Salary Bands

Netflix does not use salary bands. Instead, they pay top-of-personal-market — they scour the market for what competitors would pay a specific individual, then pay just above that number. Every employee’s salary is calibrated to their unique value, not slotted into a range based on title and years of experience.

The stories from people who encountered this system for the first time are remarkable.

Mike Hastings (no relation to Reed) was working at Allmovie.com in Ann Arbor, Michigan, when a Netflix recruiter called. Mike had done his homework. He had read salary negotiation books. He had prepared his counteroffer. Netflix came back with thirty percent more than the hundred-percent salary increase he had asked for. He must have gasped audibly, because his future boss clarified: “That’s top of market for your job and skill set here.”

Then there is Joao, a PR Director from Sao Paulo who had worked at an American advertising agency. He had poured himself into the job — long nights, sleeping on the copy room floor, delivering massive results. His reward? A five percent raise. He was devastated. He left. At Netflix, his talent would have been priced at what the market actually valued it at, not what an annual raise cycle deemed appropriate.

Netflix even encourages employees to take calls from recruiters. Not because they want people to leave, but because those conversations are the best way for employees to know their own market value — and for Netflix to make sure they are paying above it.

Why This Works

The genius of Netflix’s approach is that it aligns incentives perfectly. When you eliminate bonuses and pay top of market, you remove the anxiety of chasing targets. You remove the temptation to game metrics. You remove the resentment of watching a colleague get a bigger bonus for hitting a number that was easier to hit. What you are left with is a workforce of exceptional people, paid what they are worth, free to focus on the work itself.

It takes confidence to run a compensation system with no safety net of salary bands, no variable pay to adjust for uncertainty, and no bonus structure to motivate performance. But Netflix’s bet is that if you hire the right people and pay them what they deserve, motivation takes care of itself.

Having studied this model for a while now, I believe it holds an important lesson for any company that employs creative and technical talent. The old model — moderate base salary plus performance bonus — was designed for a world where work was predictable and output was measurable in widgets. In a world where the most valuable work is creative, adaptive, and impossible to reduce to a January target, paying people well and getting out of their way might just be the smartest strategy there is.

I hope this piece gave you something to think about the next time bonus season rolls around. Fellow techies, feel free to come back for more.

Sources

  • Hastings, Reed and Erin Meyer. No Rules Rules: Netflix and the Culture of Reinvention. Penguin Press, 2020. Chapter 4: “Pay Top of Personal Market.”
  • The 1968 programmer study referenced by Hastings is documented in: Sackman, H., Erikson, W.J., and Grant, E.E. “Exploratory Experimental Studies Comparing Online and Offline Programming Performance.” Communications of the ACM, 11(1), January 1968.
  • Ariely, Dan et al. “Large Stakes and Big Mistakes.” Federal Reserve Bank of Boston Working Paper, 2008.
  • Bill Gates quote widely attributed, referenced in Hastings and Meyer, No Rules Rules.