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Nationwide, a greater share of all employees' total rewards will come from pay for performance.
Many HR executives have long espoused a strong link between pay and performance. But now the definition of performance is changing, notes Mark Del Vecchio, vice president of human resources for MDU Resources Group Inc., a Bismarck, N.D.-based Fortune 500 corporation with energy and natural resources businesses, including a regulated utility.
More compensation specialists are moving away from revenue as a performance measure following the painful impacts of the 2008-09 recession. Revenue can soar at the expense of profits when companies slash prices to goose sales. Conversely, when revenue plummets, profits can still be eked out or at least managed in a way that staves off bankruptcy. In both cases, revenue falls short as an effective performance measure.
As a result, more business leaders “are selecting more shareholder-friendly performance measures,” explains Del Vecchio. His company, which has long used such performance measures, links its incentive compensation plans to return on invested capital for more than 8,000 workers.
To Del Vecchio’s point, compensation specialists in many organizations are now redefining performance measures, reworking performance management systems and introducing broad-based bonus incentive compensation. These changes stem from the strategic overhauls, executive turnover and newfound frugality sparked by the Great Recession.
For HR professionals, the compensation undertakings range from major organizational initiatives to redesigns to less intensive but ongoing calibration.
The Tie That Binds
The relationship between pay and performance is undergoing change in most, if not all, industry sectors and levels of the workforce. The intent is to tighten the link between pay and performance results, reports New York-based Laura Sejen, Towers Watson’s global head of rewards consulting.
Designers of total rewards packages want to ensure that individual performance and behaviors support organizational goals. The pay-for-performance relationship must make sense “from multiple perspectives, including shareholder value; competitiveness, including attracting and retaining key talent; and public relations, including employee relations,” notes Thomas V. Burke, Buck Consultants’ Pittsburgh-based director of compensation consulting.
Mark Davis, managing principal of the Tustin, Calif., consulting firm Valitus Group Inc., sees a shift toward results-based measures such as profitability and away from activity-based measures such as the number of calls made or response times in call centers. And consultant Robert Greene, chief executive officer of Reward $ystems in Glenview, Ill., expects that appraisals will start containing more-qualitative measures such as “contributes to the effectiveness of others and the organization.”
Incentives for All
While the nature of pay for performance is changing, so, too, is its application to the entire workforce.
For more than a decade, U.S. companies in most industries have been increasing eligibility for incentives and proportions of incentive compensation relative to fixed base pay, according to Sejen. This shift tends to accelerate during economic downturns when lower fixed costs and higher variable costs represent a potential competitive advantage.
Advances in performance management software have driven wide use of incentives. Technology gives senior management tools to align cascading goals with companywide strategies, notes Timothy Tanis, manager of “compbearsation” and human resource information systems for Build-A-Bear Workshop Inc. in St. Louis. This leads to “better alignment of rewards for individual, departmental and corporate performance.”
The fact that many U.S. companies currently are relatively cash-rich—as a result of reining in expenses during the recession—may further fuel the expansion of incentives, notes Richard Oyen, SPHR, senior director of human resources for SumTotal Systems Inc. in Mountain View, Calif. While some business leaders may funnel cash into stock buybacks or higher dividend payments, others may invest the money in incentives to drive productivity gains in the coming year.
The following accounts of recent incentive compensation overhauls and updates should provide object lessons.
Michigan-based brake pad and lining manufacturer Nisshinbo Automotive Manufacturing Inc., part of Japanese-based parent Nisshinbo Holdings, was challenged by the global economic downturn. In 2009, the company closed its Sterling Heights, Mich., production operations, laying off about 50 employees. It continued to manufacture at a facility in Covington, Ga., with about 250 employees.
Since the restructuring, Human Resources Manager Amy Merlo Drongowski, SPHR, and her team have been leading a redesign of the compensation and performance management program for both locations, as the Michigan office still employs 16 people. The overhaul includes incentive compensation. This undertaking represents a major change in an operation where the merit system was based on longevity and attendance.
“We are essentially changing the paradigm,” Drongowski says.
Starting in 2012, performance appraisals will be based on assessments of core job competencies and on contributions to achievement of company objectives. For example, employees can help increase profits by reducing costs. “We are working on rewarding employees to reduce waste,” Drongowski notes. “Eliminating waste means reducing expenses, reducing customer complaints, reducing workplace injuries, reducing our absenteeism and increasing our productivity.” Executives plan to use savings to reward employees with bonuses for achieving department performance targets.
The move to pay for performance requires a massive amount of work within the organization and from Drongowski and her team. The work began with a companywide communication effort, followed by job analysis surveys, redesign of some job grades, and more communication and training. Because the U.S. business is part of a global corporation based in Japan, Drongowski needs to keep upper management informed of progress on the multifaceted project, which features complexities such as fluctuations in local market pay rates.
“We have invested a lot of time trying to anticipate the questions upper management and on-site management and employees might ask about this change to be as proactive as possible in reducing uncertainty,” says Drongowski. The effort requires expertise in organizational communications and change management, she adds.
Add project management to that list: This initiative will have taken one year when finished.
It has “felt overwhelming at times,” Drongowski admits. She advises other companies taking on such a project to allow 18 months or two years.
The clarity of Sprint’s compensation strategy was dialed up a notch when Chief Executive Officer Dan Hesse took the reins of the Overland Park, Kan.-based wireless provider in late 2007. “He did not want any question in our employees’ minds about what’s important and what we are focused on as a company,” explains Stan Sword, vice president of total rewards.
Hesse laid out three pillars for Sprint’s strategy:
These pillars have remained constant for three years; so has Sprint’s incentive compensation program. Everyone has some pay at risk, ranging from 5 percent for entry-level employees to roughly 50 percent and higher at the vice president level and above. “We have a very strong pay-for-performance philosophy,” Sword asserts. “That is not new.”
The new twist is the way executives support the incentive program with performance management. In the past year, HR staff have streamlined performance management, freeing managers to invest more time in coaching employees. “Coaching is what truly moves the performance needle,” says Ann Rhoads, vice president of talent management. Her team works closely with Sword’s team “to ensure that our philosophies of performance management and pay for performance really connect.”
The teams reduced bureaucracy from performance management processes by replacing ratings measured on a scale of 1 to 5. Managers now assess employees on a pass-fail basis, using three to five criteria, each of which links to a strategic objective.
The shift was supported by simplified documentation within a performance management tool. Sprint uses the tool to track metrics such as what percentage of employees receive coaching as part of their ongoing performance appraisals; the target is 100 percent. In Sprint’s call centers and retail stores—where the majority of roughly 40,000 employees work—performance management technology allows employees to go online and see continual updates on their individual performance objectives and their progress toward those goals.
“The previous rating system sometimes created a barrier to substantive conversations about job performance between managers and employees,” Rhoads explains. “The move also helped drive home the point that managers need to supply employees with frequent and meaningful feedback on performance through daily interaction and ongoing coaching.”
While Sprint’s strategic objectives remained constant during the recession, its financial forecasts and targets fluctuated in response to the volatile economy. To ensure that bonus links to performance remained viable and fair, Sprint abbreviated the performance period used to measure individual objectives linked to corporate performance from 12 months to six. Employees still receive bonus payouts once a year, but the bonus is determined based on their achievements during two distinct six-month periods. “The change allows us to be more agile,” Sword notes. “If our forecast changes dramatically, as it did during 2008, we can adjust our performance targets during the second half of the year.”
Sprint executives calibrate performance objectives based on changing internal and market conditions. As the first wireless company to introduce a nationwide 4G network, the company tied 10 percent of bonus pay to 4G subscriber growth in the first half of 2010, before manufacturers of 4G-compatible cell phones had released most of their products. Once 4G cell phones hit the market in June, Sprint increased the 4G subscriber growth objective weighting in the bonus program to 20 percent for the second half of last year.
“Weightings may change, and we may calibrate in other ways to increase effectiveness,” Sword adds, “but we always work to consistently tie incentive pay to the key pillars of corporate strategy.”
WD-40 Co.’s incentive compensation overhaul has played out, gradually and deliberately, for more than a decade. Recently, the San Diego-based global consumer product company redesigned the bonus formula. This change, which was largely driven by employee comments, played a key role in stellar fiscal 2010 financial results, notes Vice President of Human Resources Nancy Ely.
WD-40 has operations in the United States, Asia, Canada, Europe and Latin America, and it derives the majority of its revenue from outside the United States. Executives introduced an incentive compensation plan 10 years ago for all employees in more than a dozen countries in North America, Europe and Asia. At the time, about 80 percent of bonus payouts were determined by overall financial performance and 20 percent by financial performance within the employee’s country.
In 2008, the results of an employee survey indicated that employees wanted more of their incentive compensation to be linked to country-specific performance; they wanted greater focus on measures within their control. At that time, the mix of global and country bonus criteria had shifted to roughly 50-50.
In response, WD-40’s HR professionals transformed the bonus plan into the Double Vision Program. To launch the new program, they designed a global education, communication and awareness campaign with focus groups that were facilitated by bilingual consultants.
The program is “competitive, supports our business strategies and is motivational to a global workforce,” Ely notes. “We redesigned the plan with a stronger focus on local areas while still rewarding global business results.” She emphasizes the word “global” to clarify that the company has a single total rewards program, including compensation and benefits, that employees in every region, country and location participate in.
“Double” in the program name signifies two performance metrics: net invoiced sales, and earnings before interest, taxes, depreciation and amortization. The latter is a useful measure of an organization’s operating cash flow.
“Vision” refers to the clarity employees now have when looking at how their activities influence the company’s performance in their country and overall. Eighty percent of the bonus is now based on local performance, according to the achievement of sales and profit targets the CEO and board establish for the entire company. Of that 80 percent, 50 percent is determined by the achievement of sales targets and 30 percent is determined by achievement of the profit targets. The remaining 20 percent is determined by global, or corporate, earnings results.
This transformation took about 18 months to implement. Ely says holding the focus groups was crucial: It “showed employees that the company is reaching out to them and investing time, talent and treasure for this program.”
Ely’s team works with members of the finance department to distribute quarterly reports on earnings and sales performance to every employee. They “know where they stand toward their incentive compensation for the year, and that all of the numbers in the program add up,” she says.
The program, which was in place before the start of the 2010 fiscal year ending in August, got off to an impressive start. “We had the best year in the 57-year history of the company,” Ely notes. “Every single employee in the company earned a bonus for 2010, and we believe our redesigned incentive plan was a major factor.”
Incentives remain only part of compensation. An effective broad-based compensation system, Sprint’s Sword points out, should focus employees on what really matters to the organization while helping employees reach their full potential.
“We are going to have to be very creative and innovative when we are identifying what is going to motivate employees in the future,” says David Twitchell, PHR, director of human resources at Rutland Regional Medical Center in Vermont, and a member of the Society for Human Resource Management’s Total Rewards/Compensation and Benefits Special Expertise Panel. “Providing incentives to employees goes beyond the financial piece. … It will have to be something that gets people engaged and excited about the work that they do.”
The author is a business writer based in Austin, Texas, who covers human resource and finance issues.
Incentive Compensation Eligibility
Eligibility for incentive compensation is increasing, according to a 2010 Buck Consultants survey of more than 200 U.S. companies in all industries. Most of these companies are large; only 13 percent of respondents work for companies with fewer than 500 employees. Bonus participation is also on the rise as more employees are expected to receive bonuses for 2010 performance than for 2009. Organizational performance must continue to improve and employee performance needs to remain strong for these expectations to be achieved, according to the researchers.
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