Benefits and Compensation

Pay for Performance May Not Support Labor Cost Control

In recent years a growing number of companies have invested a lot of time and effort creating a performance-based compensation system. If yours falls into that category, then sales personnel and managers likely feel a strong link between the company’s overall perfor-mance, their departmental performance, their own individual performance, and their paychecks. Good job!

But before you grab your coat and head out to celebrate, consider this—you may have missed something. According to Eugene C. Epps, managing partner of EP2S Compensation Solutions, LLC (www.ep2s.net), paying people based on performance is only part of the solution.

In short, Epps describes the problem this way: You may be promoting the wrong people and granting raises for the wrong reasons. Promotions often bring with them salary increases. And those increases don’t depend on whether the company is performing well.

“Whether the company’s performance is good or poor doesn’t make much difference in labor costs,” says Epps. “Your labor costs continue to go through the roof because you’re promoting and rewarding people for the wrong reasons. Sometimes, you’re giving general wage increases, or cost-of-living adjustments. Often, you’re promoting—and therefore increasing pay—based on acquired knowledge, skills, degrees, and experience.

“Those things look good on a résumé and may deserve credit in an academic environment, but they add little or no value to an organization and are not the best reason to grant promotions in the real world.”

Historically, Epps says, companies have used one of a small number of methods to determine pay ranges and promotability. “Traditional job evaluation methods, such as job point factors, market pricing, skills-based analysis, and broadbanding, are designed to structure, rank, and evaluate jobs based on acquired levels of knowledge, skills, experience, degrees, and certifications, as well as project size, budget size, staff size, and other job-related factors. Employees are promoted, and their pay increases based on their ability to acquire these job factors,” Epps explains.

Basing important promotion and compensation decisions on these methods is old school, Epps says, and is costing American companies significant amounts of money they can ill afford— especially now.

Looking for Ways to Trim Costs

At the same time employees (and their pay) are rising within the organization, management is seeking ways to reduce the cost of labor.

One way to do that is by cutting staff. The best and brightest employees (the ones you’ll need in place as the economy turns around) are not necessarily protected from these cuts.

“Management spends many thousands of dollars recruiting and training their best people,” Epps says. “And in order to cut costs, they have to kick them out the back door? That’s not prudent use of human resources.”

“Whether you’re talking about pay or benefits, management wants programs that meet four goals,” Epps says.

1.  ‑‑They want programs that support their strategic business objectives.

2.  ‑They want the programs to have a positive impact on the company’s bottom line.

3.  ‑They want to be able to demonstrate a positive return on any HR investments, in terms of money or efficiency.

4.  ‑They want to provide quality service to their HR customers.

“How do the traditional systems stack up against these goals? They tend to have a negative impact on the company’s growth and bottom line because the costs continue to rise even if employees don’t demonstrate abilities for their next promotion,” Epps continues.

“The increases in labor costs result in companies paying more for labor—sometimes a lot more—than is competitively necessary. 

“They experience increased labor costs with little or no return on the HR investment. All in all, these outdated methods of setting pay structure can force companies into layoffs, pay cuts, and other undesirable cost-saving measures.”

New Basis for Promotions

Rather than basing promotions and their associated salary increases on acquired knowledge and certifications, Epps recommends basing them on performance.

A competency-based job evaluation system is a method of structuring and evaluating broadly defined jobs based on a demonstrated level of job complexity and job accountability, he explains.

Such a system also serves to enhance the company’s ability to manage employee career growth and administer pay.

Epps’s competency-based job evaluation system requires that employees demonstrate a grasp of the next level of job complexity and job accountability before they are promoted.

Using this kind of system, he believes, meets the four goals mentioned earlier. And it contributes to a perception of HR as a strategic business partner, rather than merely administrative support.

Contrast these two examples. Sara received a promotion last year, based on the fact that she had been in her job for 8 years. An 8% pay increase accompanied the promotion. This year, Sara is anticipating another promotion, because she will have earned a certification in her field.

According to the pay system the company uses, the promotion will bring with it an additional 8% pay increase.

When combined with the automatic 2% cost-of-living adjustment granted during each of the last 2 years, Sara will soon be earning 20% more than she was earning 2 years ago. Can she do the job two levels up from the one she held for so long? No one really knows.

On the other hand, John’s company bases promotions on performance rather than time, degrees, certifications, and other qualities that often look good on a résumé. His promotion comes when, recognizing his potential, his manager assigns him some higher-level work over a period of 2 months.

Having performed well at these senior-level tasks, John receives the promotion and the accompanying 8% salary increase. He and his management are confident he will perform well in his new position.

Using his competency-based pay system, Epps says companies can save significant amounts of money, which they can then use to increase pay-for-performance rewards. As an example, he cites a 2,600-employee company with a $135 million payroll.

They expect promotions to increase their payroll by $2.7 million for the year. After analyzing their jobs, Epps found that increases based on competency would cost the company $700,000 for the year, saving them $2 million.

The CEO agreed to use $400,000 of the savings to fund spot bonuses and outstanding achievement awards, driving desired behavior and thereby benefiting the company’s bottom line.

Invest the Time; Reap the Rewards

In order to move to a competency-based pay system, each job needs to be evaluated to specify how competencies would be determined. For example, a competency for a senior-level employee might be making independent recommendations about how to fix problems that arise, rather than just identifying the problems.

“A senior person should research issues and problems that crop up,” Epps says. “He or she needs to recommend how to resolve them. As a manager, I’m going to give the person a few of these projects to address.

“Then I can look at it and see that over the last couple of months, the person has come up with some nice recommendations. Some were a little shaky, but some were really good. I’m not concerned with perfection, just that the person is making recommendations; that’s a senior-level responsibility.

While reevaluating all the company’s jobs is no small task, Epps believes the return on investment to be well worth the effort. That’s the kind of thinking that pleases the CFO and CEO, he says.

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