Evolving Company Culture from Base Pay to Variable Rewards

Ending the base pay increase 'entitlement' rewards goal achievement

By Stephen Miller, CEBS Jun 20, 2017
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​Comprehensive variable reward programs emphasize incentive-reward payouts for meeting individual, team and organizationwide goals, and de-emphasize—or eliminate—raising salaries annually to reward performance. And variable pay programs are a growing trend, said John A. Rubino, president of Rubino Consulting Services in Pound Ridge, N.Y.

"Management is finding out that merit-based salary increase programs simply do not work," Rubino said during his concurrent session at the SHRM 2017 Annual Conference & Exposition.

Current salary increase budgets of 3 percent to 3.5 percent are "an amazingly small pot of money at managers' disposal to differentiate annual raises for top performance vs. average performers," Rubino said. The result is that salary-based rewards "aren't motivational; they're demotivating. Employees know that they're not being paid for performance, and their managers know it."

If salary increase programs aren't getting the job done, traditional annual bonus programs have their own drawbacks, Rubino explained. "Annual bonuses often devolve into beauty contests" to reward managers' favorite workers, "with no underpinning of specific performance measures to rationalize incentive payments."

Rubino advised that for a true variable rewards program to be successful:

  • An organization's culture and values must support a variable rewards framework.

  • Senior management must allow the variable pay program to work and not impede it with exceptions.

  • Performance measures must be internally equitable and externally competitive.

  • Performance criteria must be discernible, valid and understandable.

  • The program must deliver what is promised on time and fairly.

Variable rewards based on clearly defined target goals at the individual, departmental and organizational level can change employees' mindsets from "this is what I need to do to please my boss so I can get a big raise or bonus" to "this is what I need to do to add value to the company," Rubino said.

For incentive metrics to work, "there must be a performance threshold beneath which no payments are made," he added. "That's why the program is called 'variable.' "

"Take performance out of base pay decisions entirely," he advocated. Changes in salary should be tied solely to market adjustments in the value of the position, with variable pay used to reward performance.

 

Sample Variable Payout Template

Tier

Target Opportunity
(% of salary)

Payout Range:
0 to 150% of Target

Corporate Goal Weighting

Department Goal Weighting

Team Goal Weighting

Officers

35%

0 – 52.5%

70%

20%

10%

Directors

25%

0 – 37.5%

40%

50%

10%

Managers

15%

0 – 22.5%

30%

50%

20%

Professionals

10%

1 – 15.0%

20%

20%

60%

Support staff

8%

0 – 12.0%

10%

10%

70%

Source: Rubino Consulting Services.


Line-of-Sight Metrics

Variable rewards should be directly tied to performance-criteria achievement, with a direct line of sight between the target goal and the payout, typically calculated as a percentage of base pay.

Variable reward opportunities must be perceived as substantial enough to motivate performance. "A $5,000 lump sum to a secretary earning $30,000 is substantial. To the CEO, it's not," Rubino pointed out.

Timing of variable reward payments also should be as close as possible to the qualifying event.

Performance criteria in a successful program, he explained, are:

  • A combination of quantitative and qualitative measures.
  • Simple to understand.
  • Supported by valid competitive data.
  • Monitored through strong controls.

"Redesign reward elements, and introduce new ones that encourage job ownership and engagement and discourage entitlement," Rubino said.

[SHRM members-only toolkit Designing and Managing Incentive Compensation Programs]

Self-Funded Programs

A successful variable reward program should work toward self-funding, Rubino explained. It pays for itself by sharing a portion of company profits based on the achievement of success factors. "No success, no payouts," he noted.

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Nonprofits and government entities can also use variable rewards, basing target goals, for instance, on achieved efficiencies.

Organizations should be relatively profitable when the program is initiated, and new plans should be designed to guard against windfall payments, he advised. Companies can do this by putting a cap on plan payouts in case, it turns out, target metrics were set too low.

If designed and administered properly, payouts to employees will yield "slices from an expanding financial pie," Rubino said.

Manager and Employee Buy-In

"Middle managers will make or break the variable reward program," Rubino noted. Also, the program must be communicated effectively to employees, emphasizing the opportunities.

"By definition, the program will appeal to top performers who will see a way to reap higher rewards," he pointed out. Average and subaverage employees might resent the loss of an annual raise entitlement and seek to leave. "That's not a bad outcome," Rubino noted.

Variable rewards also are "a good 'sell' to top job candidates, providing a compelling reason to join the company."

Employees and managers should be involved in the plan design, he advised, including identification of performance criteria.

"Even the most elegantly designed variable reward program will not achieve the desired results unless employees and managers understand and, ultimately, buy into the program," Rubino said. When communicating about the program, point out the visible benefits to the employees and to the organization.

Success also depends on regular formal and informal performance feedback so employees understand where they stand on achieving their goals.

Easing In

Organizations may not want to shift from base pay merit increases to a variable pay rewards program all at once. "Start initially by putting more of the employees' annual pay increase at risk and slowing down the growth of base pay, then move forward with a comprehensive variable pay program that replaces merit-based salary raises," he recommended.

He recommended taking these steps:

  • Remove performance considerations from base salary increase decisions. Re-define base salary increases as across-the-board market adjustments only, determined by competitive position analyses.

  • Partially fund the variable program with the difference between the base salary "merit" budget and the market adjustment factor. An initial investment by the organization is usually required to fully fund the program the first year. Over time, ongoing fixed salary expenses can be considerably reduced due to the compounding effect of base pay increases, and performance improvements generate higher revenues and increased profitability.

  • Pay for performance within the variable pay plan framework. Incentive payments are distributed in lump sums only when performance warrants (i.e., "pay at risk").

"Start with the critical foundation of an effective performance management system and sound management training, and communicate, communicate, communicate," he advised.

No Forced Ranking

Rubino clarified that variable rewards programs are not the same as "forced ranking," a controversial process by which employees are graded against each other instead of judged against performance standards.

"I'm totally opposed to forced ranking," he said. Under that system, for instance, management has the view that "only 15 percent of my employees can be excellent, not 16 percent, because that would be too much excellence for us," Rubino quipped.

"Companies that have forced ranking have no confidence in their managers' ability and in their performance management system," he noted. "It's entirely the wrong message to give your employees."


Related SHRM Article:

Employers Try Better Ways to Measure and Reward Performance, SHRM Online Compensation, August 2017



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