Pay for Performance, Not for Showing Up, Expert Advises

By Stephen Miller Jun 29, 2009
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NEW ORLEANS—Variable pay can help control compensation costs by allowing companies to trim back their annual merit-pay increases, but these programs aren’t without challenges, explained Sharon Koss, SPHR, during her June 28, 2009 workshop on “Compensation Basics” held here in conjunction with the SHRM Annual Conference.

All employees aren’t above average, a fact that performance-based merit pay (reflected in annual raises) and variable pay schemes (bonuses and incentive awards) must take into account, advised Koss, a pay consultant and author of Solving the Compensation Puzzle (SHRM, 2007).

Reward Your Stars

Koss provided a series of tips for rewarding performance better. For instance, “the difference between high performers’ annual merit increases and low performers’ merit increases should be at least 3 percent to be motivating,” she noted, citing psychological studies. “If an average performer receives a 3 percent raise, your all-stars should get at least 6 percent.”

On a standard 5-point scale, “some have to get ‘0’ to fund your stars,” Koss said. “That’s OK.” When managers fret that if they give out low ratings with no increase those employees will quit, she advises: “Offer to drive them to the bus stop. Poor performers can poison your workplace culture,” she added. If someone is receiving ratings of 1 or 2 on a 5-point scale, “determine if they’re problem employees or employees with a problem.” If the former, work to move them out, she said, “and then they’ll become your competitor’s problem.”

In these litigious times, be sure to document the record of achievement that differentiates your well-rewarded stars from their less-stellar colleagues.

Another tip: Jettison anniversary-date merit-increase reviews in favor of doing performance appraisals for everyone at one time. One drawback with using anniversary dates is that “you’re constantly tracking which managers are ‘late’ and prodding them to turn their appraisals in.” Or not tracking and prodding, which is even worse.

Reviewing everyone together allows managers to look at the whole bell curve of employee performance at one time, and it avoids the temptation to make everyone at least “average.” Also, it circumvents problems that crop up, for example, when comparing Fred’s performance in February against Jane’s performance in June—when deteriorating economic considerations might weigh on Jane’s rating unfairly. “It’s just fairer to rate everyone at the same time” under the same market conditions, she said.

The ‘Variable’ Shift

The number of organizations with variable pay has doubled since 1990—now 80 percent have a plan, Koss said. “Nonprofits and government are adopting plans, and variable pay is now part of the compensation package for lower-level employees.”

Variable pay includes bonuses, delivered after the fact and not part of a predetermined formula, and incentive awards, usually a written plan that has a formula for rewards paid. But unlike base pay, “it doesn’t become a permanent part of an employee’s paycheck.” Like respect, it must be earned.

“Good variable pay plans can pay for themselves in decreased cost and increased revenue,” Koss said. In other words, incentives work.

Another advantage of variable pay is that it speaks to young workers’ desire for individual recognition and addresses the so-called “What’s in it for me” (WIIFM) issue.

Steps for successful plans, Koss said, achieve top management support, mesh organizational and individual goals, and communicate clearly why the shift is being made (again, WIIFM) and the criteria for earning bonuses and other incentive pay.

And how do you measure the link between employee behavior and payout? Start with a pilot group, Koss recommended. Run financial modeling to provide a sense of what payouts will cost. And have a written plan that spells out variable pay criteria.

“Educate your managers,” Koss emphasized. Make sure that they’re onboard and comfortable with new variable pay approaches.

Stephen Miller is an online editor/manager for SHRM.

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