Pay-for-Performance? Three Questions to Ask First

Green, who is a principal at consultant Hay Group, offered her tips at a recent webinar sponsored by HRHero/BLR.

What Pay-for-Performance Is (And Isn’t)

First, says Green, it’s important to clarify what is pay for performance and what isn’t. Pay for performance, she says is:

• Any type of compensation or reward that is provided only when certain specified performance results occur. (Or, a program under which, if performance targets are not achieved, a certain amount of pay is withheld.)
• Compensation that is contingent upon company, group, or individual performance (or a combination).
• Merit increase, but only if you have to earn it. If your increase is the same as everyone else’s, that’s not pay for performance, Green says.
• Incentive plans, again assuming that there’s the possibility of not getting the incentive
• Profit sharing, but note that many profit-sharing plans turn into entitlements, and that’s not pay for performance. The best pay for performance has links to individual performance, Green says.
• Company ownership. For example, Green says, many companies in Silicon Valley give all employees stock. In other companies, only top performers get stock or only a certain level of management gets it. Remember, says Green, that these rewards are usually only meaningful if the stock rises.

What Isn’t Pay-for-Performance?

Green points out that some things that mask as pay for performance aren’t:

• Any type of “guaranteed” compensation an employee receives regardless of how he or she performs (ex: salary, guaranteed bonus)
• Uniform salary increases that are given across the board to all employees, such as cost-of-living adjustments
• Salary increases and bonuses that do not vary much from year to year and end up becoming an entitlement
• Bonuses that have out at target for five years—Is that really pay for performance? Green asks.
• Giving a title increase in lieu of a pay increase. This is an interesting phenomenon, Green says. But when you make your coordinator or analyst a “manager” you create a whole host of problems with your pay system.

Is Your Company Ready for Pay-for-Performance? Three Questions

To assess whether your company is ready for pay for performance, Green suggests asking three questions.

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Question 1. Is Your Existing Performance Management System Meaningful?

It’s unfair (and ineffective) to put a pay-for-performance program in place if the performance management system and infrastructure aren’t ready, says Green.

Most organizations have a formal performance management program in place (74% according to a Hay Group poll). However, she says:

• A majority of organizations (76%) believe that individual employee performance is not managed very well.
• A majority of organizations (66%) believe it is not considered a normal way of doing business, and
• A significant number of managers (40%) view the process as burdensome and labor intensive

In addition, while most organizations (72%) have clear strategic objectives, the survey suggests, only 30% believe that there is a clear linkage between strategic objectives and individual performance criteria.

For many, says Green, the performance management process:

• Is completely unrelated to other key business processes
• Is dreaded by managers and employees alike
• Does not result in meaningful feedback
• Is a focus for only one or two days—or hours—per year
• Does not differentiate performance or pay

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Distribution of Ratings

The final piece to look at is the distribution of performance ratings in your company. Are they relatively normalized?

Green typically hears, “We have few poor performers, we operate lean, everyone has been pitching in.” That’s nice, says Green, but these artificially high performance ratings distort the pool. And top employees are not incented to excel, because putting in extraordinary effort won’t mean anything salary-wise

If your performance management system isn’t ready, you have work to do before can effectively implement pay-for-performance.

In tomorrow’s Advisor, Questions 2 and 3, plus an introduction to the all-in-one HR site, HR.BLR.com.