What’s Behind the Move to Variable Performance Pay?

Across-the-board increases and the entitlement mentality are out, and the pay-for-performance mentality is in, says Consultant Teri Morning, MBA, MS, SPHR, SPHR-CA. Organizations are looking for less expensive, less permanent solutions, such as lump sum payments, bonuses, or just paying top performers, she adds.

Increasingly, employers are less averse to withholding merit increases for poor performers so they can afford to grant meaningful increases to better performers, says Morning, who is president of Teri Morning Enterprises in Carmel, Indiana. Morning made her suggestions during a recent webinar sponsored by BLR®.

What is Variable Performance Pay?

Variable performance pay aligns the focus of the employee with that of the enterprise. Thus, it encourages employees to support the organization’s strategic direction, and it drives the accomplishment of organizational goals. It does so by enabling companies to recognize and reward high performers and to sustain high performance, says Morning. Key factors include:

• Average performance is already compensated for in the base pay at the market rate. Average performance doesn’t necessarily require a merit increase.
• Variable pay programs should pay for themselves. (Although, says Morning, this does not negate the need to compete in the market with base pay for good employees.)
• Incentive pay isn’t always applicable to every position.
• Variable pay rewards outcomes—not good tries.

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Why use incentives? Morning says they can:

• Add to bottom line profitability.
• Help control costs.
• Reward, retain, and motivate further performance from top performers.
• Incentivize average performers to improve.
• Incentivize low performers to go elsewhere.
• Raise the bar for the entire organization.

Trends in Variable Performance Pay

Morning sees that:

• Short-term incentives are increasing as part of the rewards package.
• Promotional budgets are becoming separated from the salary budget. One in three companies from a WorldatWork survey are now, as standard practice, adopting using separate budgets for promotions.
• Employers are shifting funds to ensure that they are rewarding their top performers.

Keys to Variable Pay Program Success

• Clearly defined outcomes. Clear understanding of what the reward will be and what the criteria are.
• Efficient communications. What the employee has to do to receive the award.
• Metrics and measurements. Make it easy for employee and employer to calculate the reward or otherwise see that the reward has been earned.
• Appropriate and substantial reward. Something the employee wants and large enough to incentivize for the desired behavior.
•  Employee can effect. The employee must be able to effect the reward criteria.

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How Do You End Up with Salary Compression?

Salary compression is generally defined as a situation where there should be a difference in pay, but the difference in pay is so small as to be considered inequitable, says Morning.

The most common examples are:

• Pay of supervisors and nonexempt subordinates is very close. (This is typically due to union contracts and/or overtime.)
• New hires’ salaries are almost the same as existing employees in the same job. (Sometimes this brings out the issue of whether the existing employee has 20 years’ experience or one year’s experience 20 times over, says Morning.)

What causes salary compression? The most common causes, says Morning, are:

• Internal equity is incorrect. You may have valued the job(s) incorrectly so it is priced wrong in the market.
• No one was watching the numbers, or they were watching bad numbers.
• Midpoint differentials are too close.
• Merit system is not really a merit system.
• Unions/and or overtime.

But the basic, most common reason is that no one wanted to step up. No one wants to take it on, so it festers until it’s a real problem, Morning says. Bottom line, if it’s not a numbers problem, it’s a management communication problem.

In tomorrow’s Advisor, an increase grid that will help you avoid compression and red circle problems, plus we offer a free downloadable white paper (FREE! thanks to sponsor PayScale)—the 2014 Compensation Best Practices Report.