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Maximize Return on Compensation by Avoiding 7 Common Mistakes
 

By Jason Adwin, Sibson Consulting  11/18/2011
 

An organization’s compensation expense is an investment in talent, which requires a return, just like any other investment. Even though return on compensation (ROC) is harder to measure than the return on traditional capital investments, our experience has shown that prioritized investments in talent produce better returns than homogenous or "entitlement" approaches.

Despite their best intentions, organizations can make mistakes that sabotage their plans to improve their ROC on rewards for top-performing employees. These include seven common mistakes, each of which is discussed below.

Mistake #1.
Neglecting to Benchmark Pay Practices

Organizations that have been giving only limited-to-modest raises in this difficult economy might not be diligently measuring where their pay stands relative to the market. As a result, they might be overpaying some employees, even though they are not giving large raises, or they might be underpaying some employees, which could cause valuable talent to leave.

Charting each employee on an ROC Matrix that compares employee performance to the market rate or benchmark for the employee’s salary (see Figure 1) will help determine how the organization is compensating its employees relative to the market. It will show whether each employee’s compensation could be considered a discounted investment, an at-market investment or a premium investment. The organization can then use this information to make individual investment decisions regarding employee compensation. 

Figure 1. ROC Matrix

Source: Sibson Consulting.

Although most employees should fall in the green squares of the matrix, where their performance roughly equals the market rate of their salary, this is not always the case. For example, although Employee A in Figure 1 would be considered a discounted investment and Employee B would be considered a premium investment, neither position is necessarily wrong. The organization needs to take into account the employee’s compensation history, rate of advancement, leadership potential and other factors to determine if the person’s compensation investment is acceptable.

Also helpful is a compensation scorecard that tracks key metrics. It provides intelligence the organization can use to assess pay program effectiveness and improvement over time. A business that creates a compensation scorecard is making a commitment to improve its pay programs continually. (See the SHRM Online article, “The Compensation Scorecard: What Gets Measured Gets Done.”)

Mistake #2.
Failing to Align All the Organization’s Goals

An organization’s goals must be aligned so its units, managers and employees are working individually and together to achieve results that have been established by the CEO and the executive team. If an organization’s goals are not aligned, its various units, managers and employees will work to achieve goals that are probably not optimally focused on achieving the organization’s objectives.

As shown in Figure 2, the CEO and the executive team set goals for the organization and its executives. It is up to each unit to determine what it must do to achieve those goals. The organization’s units need to coordinate their goals to determine what must be done collectively. For example, if one of the organization’s goals is to improve its talent management initiatives, HR, finance and other affected departments need to determine what role each must play in achieving that goal. After unit goals have been aligned, the next step is to set the goals for the organization’s managers and, finally, each individual employee.

Figure 2. Goal Alignment

Source: Sibson Consulting.

Mistake #3.
Rewarding Employees with Limited Pay-for-Performance Differentiation

When it comes to rewarding performance, many organizations fall into a trap that we call the “peanut butter spread,” where the rewards are spread thinly but evenly among everyone in the organization. If the organization’s annual salary increase budget is 3 percent, everybody gets 3 percent.

Although it is easy to administer and defend, the peanut butter spread does nothing to improve the organization’s ROC. In order to make an investment, the organization has to prioritize who should get what and make difficult choices rather than taking the path of least resistance.

Although it might be difficult to differentiate when the salary increase budget is small, it is not impossible. One effective strategy, carving out dollars from salary increase budgets and incentive pools explicitly to reward high performers, leads to more effective investments in talent. (See the SHRM Online article, “How to Use Carve-Outs to Truly Pay for Performance.”)

Even with a modest salary budget, say 2.5 percent, if 0.5 percent is carved out for high performers, average performers get 2 percent, and if 25 percent of the employees are high performers, they can get as much as 4.5 percent increases. The same concept holds true for funded bonus pools. When communicating reward decisions, allocations from the high-performer pools can be used to recognize top talent while managing the expectations of the broader workforce.

Mistake #4.
Accepting Performance Management Data Without Calibrating It

Calibration—the sharing and adjusting of decisions across a group, rather than allowing each manager to make decisions on his or her own—guarantees the integrity of the data used to make reward decisions based on employees’ contributions (that is, "pay for performance"). In an organization without calibrated performance data, managers’ individual standards of performance might lead to inequitable ratings and pay investments, which lowers motivation.

In some organizations, calibration is handled by HR. It is more effective, however, to have the organization’s leaders meet and calibrate the data. Often, the prospect of a leader trying to justify the position that there are “no poor performers” in his or her group is enough to encourage employee differentiation. Formal performance management calibration sessions, within and between functions, can ensure that performance standards and ratings are applied consistently.

Mistake #5.
Avoiding Transparency in the Organization’s Pay System

Organizations that communicate a pay philosophy and the rationale for pay decisions—and place appropriate context on how they arrive at individual decisions—are more likely to have employees motivated by compensation than those that manage compensation in a “black box.” Sibson Consulting’s Rewards of Work Study shows that employees who are satisfied with their understanding of the compensation process, and believe that decisions are fair, are substantially more satisfied with their compensation outcomes.

Employees are more accepting of pay decisions when they understand how they are made and believe that everyone in the organization is subject to the same system. Without transparency, employees tend to feel that their compensation is being controlled by their manager rather than by an organizationwide system. Employees are much more likely to accept an unfavorable outcome if they understand the process that determined that outcome, even if they disagree with it.

Mistake #6.
Moving Too Quickly

Organizations that want to enhance their ROC by improving how compensation drives employee motivation should recognize that change does not occur overnight. For best results, businesses need to transition slowly from legacy approaches. It is better to execute a few changes well than to implement broad changes poorly.

Implementing a series of prioritized changes over several compensation cycles will give the business time to properly absorb change into the culture. Any mistakes will be easier to correct before they become entrenched. Moreover, it will improve employee buy-in for the compensation system.

Too often, organizations with a vision for the future have an aggressive desire to implement change swiftly and with a heavy hand. When this occurs, program results often fail to match the rhetoric, further demotivating employees and challenging the organization’s credibility.

Mistake #7.
Failing to Empower the Organization’s Managers

Organizations that hold managers accountable for pay decisions need to give them the training and tools they need to do the job effectively. In many cases, managers have only a pool of dollars and loose allocation guidelines, which can be confusing. The best compensation investments are made when managers can leverage all of the appropriate pay, performance and business planning data available.

Giving managers more sophisticated information will help them allocate salary and incentive pools effectively. This includes external market competitive benchmarks, internal average salary benchmarks, time in role/role history, performance rating history and compensation history. Other useful analytics include the employee's depth of responsibility and "role criticality" (identifying those key roles that most influence organizational success), and talent scarcity assessments (identifying those roles where talent is difficult and costly to replace).

In addition, managers need interpersonal and relationship skills training to have meaningful compensation conversations with employees and not just read a script. The goal is to blend a business conversation with a performance management conversation to create a developmental conversation that demonstrates clearly what the employee needs to do to improve his or her compensation.

Conclusion

Organizations that want to improve their return on compensation to foster employee engagement and motivation can benefit from reviewing their compensation practices regularly. Moreover, organizations need to be aware of the many possible mistakes that can sabotage the effective measurement of their ROC so they can take steps to avoid them.

Jason Adwin is a vice president in the New York office of Sibson Consulting. He offers specialized expertise in compensation strategy, design and performance management, creating programs targeted at all levels of the organization.

This article originally appeared in the October 2011 issue of Sibson Consulting's online publication Perspectives, and is reposted with permission.

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