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Avoiding ‘Pain for Performance’; How to Design and Implement a Pay-for-Performance System Effectively
 

By Lisa Gabel, Kate Harker, and Ethan Sanders, ICF International  9/23/2009
 

There are many motivations for shifting to a pay-for-performance system, including the desires to reward the highest performers, to eliminate the lowest performers, to attract and retain talent and to offer competitive salaries within tight labor markets. Regardless of the reason, migrating to such a system can be difficult and complicated. In 2008, ICF International assembled a consortium of consultants who have extensive experience assisting federal and private organizations with the implementation of pay-for-performance systems. Over six months, the team captured, cataloged and analyzed hundreds of lessons learned. Five primary categories of issues were identified:

Culture and leadership.

Resources.

Policies and procedures.

Performance objectives.

Evaluation plans.

The result of not adequately addressing key issues before a performance pay system is implemented can be costly, can be disruptive to the organization’s mission and can undermine trust in the organization. The core challenges associated with each of these categories are briefly described below; the full white paper can be requested from the authors at esanders@icfi.com.

Culture and Leadership

Regardless of how well the technical elements of a pay-for-performance system are put together, without clear and continuous advocacy for the system by top leadership, there is little chance of the system taking hold. Similarly, leadership must provide avenues for addressing concerns and for promoting transparency in the system.

While the topics of pay and performance are typically treated as confidential information when attributed to individuals, in the aggregate there must be an open sharing of what is and is not working in the system, where the average scores and payouts fell, and what steps management is taking to improve the system continuously. If leadership is functioning in this manner, the overarching culture of the organization will support the new system and the focus of employees will migrate toward performance rather than just pay.

Resources

Cynical opponents of pay for performance will claim that it is a thinly veiled attempt to drive down labor costs. In our experience, a pay-for-performance system never achieves lower payroll costs, and when the additional administrative time to implement these systems is considered, they often represent much higher costs when compared to traditional pay scale systems. However, these higher costs are justifiable if higher levels of performance are achieved.

The monetary infrastructure must exist to support the change, including a plan for a fiscally sustainable compensation system. In a private organization, additional gains in performance typically lead to additional profits, which can be used to fund the pay system.

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Gains in performance typically lead to
additional profits, which can be used
to fund the pay system.
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Public institutions, however, typically have a fixed financial resource pool that is calculated based on historical spending on salaries, bonuses and forecasted pay increases such as locality pay and adjustments for inflation. Few federal agencies obtain financial returns from their work. Most agencies are funded through appropriations, and the relationship between performance and appropriations is nebulous at best.

Therefore, most government agencies must allocate funding for performance-based salary increases and bonuses from their existing salary budgets (funds that might otherwise be used for scheduled step increases, “on the spot” awards, quality step increases (QSIs) and cost-of-living adjustments). This typically limits pay increases to a relatively small amount even for exceptional performance (e.g., in the Department of Defense National Security Personnel System—NSPS—program, a perfect performance score of 5 would typically provide a pay increase or bonus of no more than 10 percent).

Policies and Procedures

For a pay-for-performance system to work effectively, policies and procedures must be defined and documented accurately. Effective policies ensure that the system functions as intended and that employees and supervisors know how to use the system.

Policies are particularly important during the implementation of a pay-for-performance system. For example, most organizations focus initially on what steps will be necessary to close out the performance period (such as writing the final assessments) rather than on what steps can be taken during setup to ensure that the final review is efficient and effective. This initial focus on the end of the performance year leads to a misconception that there is time to develop the policy and guidance. Several organizations ICF has worked with rushed headlong into implementation of the system because they believed that guidance was not needed until the actual work began at the end of the year. This led to a tumultuous and painful closeout of the first performance cycle.

Performance Objectives

Because performance objectives are the ultimate means for determining an employee’s level of compensation, determining clear, relevant and measurable performance objectives is the cornerstone of an effective pay-for-performance system. If performance objectives are not written effectively, the pay system will not be successful. If an organization is measuring the wrong things or does not measure employees’ performance accurately, in most instances the goals behind implementing a pay-for-performance system will be lost (to attract, award and retain the highest performing individuals, and to precipitate high levels of performance for the organization as a whole).

There are several primary issues that organizations encounter when developing performance objectives:

The organization does not have clear and measurable goals, thereby eliminating the necessary context for deriving individual performance objectives.

Individual performance objectives are not aligned with the organization’s goals.

Individual performance objectives are not written clearly and objectively.

If the bar for performance achievement is not determined at the beginning of the performance period, making meaningful measurement of progress will be impossible.

Evaluation

Several distinct components pertaining to design and implementation of the pay-for-performance system were isolated:

The quality of the supervisor and employee written evaluations.

The process used to adjudicate the final assessments and to prevent bias.

The process of determining if the pay-for-performance program is working.

In the first topic, it was often the case where there was inconsistency between the written performance objective and the supervisors/employees descriptive prose that should justify the level of accomplishment. This inconsistency makes it difficult to rate performance of the individual fairly against the objectives. Once this issue is resolved, the next step is to ensure that there is an adjudication process in place (and being followed) to ensure there is an over-arching assessment of how fairly the collection of performance plans are being judged.

Even if each individual performance assessment is high-quality, the issue of easy vs. hard grading supervisors exists. There must be a process that allows senior management to assess if there is bias in the system and to determine if the overall level of employee performance matches their understanding of overall organizational performance (i.e., they should expect the overall scores to trend high if the organization has had a very successful year and should trend low if the organization has failed to meet its annual goals).

Finally, the pay-for-performance system must be evaluated to determine whether the programmatic goals are being met. There must be clear evidence that the system is promoting high performance, rewarding the right employees, providing constructive feedback for improvement and allowing the organization to reach its mission.

Conclusion

Building a pay-for-performance system is an evolutionary process that must begin with the basics. While ideally all five of the primary issue categories should be addressed before a performance system is instituted, most implementations are not afforded the time. Those overseeing the shift to pay for performance must focus on the essentials through a careful assessment of the most relevant issues to the particular organization.

Many pay-for-performance efforts fail because the focus eventually becomes about pay and has little to do with performance. The focus should remain on performance and providing lasting results for organizations.

Ethan S. Sanders, a fellow at ICF International, has provided human performance consulting services to clients in the public, nonprofit, military and private sectors for nearly 20 years. Kate Harker, an organizational effectiveness consultant at ICF, is an expert in measurement and evaluation. She has provided consulting services to numerous government entities transitioning to pay-for-performance systems. Lisa Gabel, an organizational effectiveness consultant at ICF, has extensive experience in performance and change management. Through work conducted for the federal and state governments, she has first-hand knowledge of the design of performance objectives, evaluation plans, and policy related to pay-for-performance systems.

The views expressed in this paper and any errors are those of the authors and not necessarily those of ICF International.

Related Articles:

Pay for Performance: No Merit in Merit Pay, SHRM Online Compensation Discipline, June 2007

The Problems with Pay-for-Performance Plans—and What to Do About Them, SHRM Online Compensation Discipline, January 2007

How Kimberly-Clark Ties Pay to Performance, HR Magazine, November 2006

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