Use Variable Pay to Retain Top Performers

Performance management and rewards systems need to be aligned

Stephen Miller, CEBS By Stephen Miller, CEBS September 12, 2021
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Use Variable Pay to Retain Top Performers

LAS VEGAS — "If you do nothing else this year, shore up your performance management system and train your middle managers to use it effectively," advised compensation specialist John Rubino, president of Rubino Consulting Services in Pound Ridge, N.Y.

Effectively evaluating and rewarding employee performance is the cornerstone of everything HR professionals and managers are expected to accomplish. However, many organizations are not doing it right, according to Rubino, who presented a concurrent session at the SHRM Annual Conference & Expo 2021.

The problems are twofold, he said:

  • Lack of consistency in management thought and application throughout the organization.
  • A disconnect between employee performance assessment and compensation rewards.

Rubino urged HR to structure financial rewards as incentive-based variable pay linked to employees' goals, which should reflect the organization's goals and direction.

"Link goals from the top of the organization all the way down," he advised. "Link department goals to corporate goals, then link these to individual goals."

Explain to employees that goals are cascading downward from the top and ask employees to write their own goals that reflect department and corporate objectives, he suggested. Those goals may be altered when employees discuss them with managers, but they should help employees internalize the organization's goals and objectives and understand how their own jobs fit into that mission.

Fallacy of Merit-Based Salary Raises

"Stop saying you pay for performance when what you mean is that you divide a 3 percent salary merit increase budget among your employees," Rubino said. "These programs are demotivating, pitting co-workers against each other for a small merit increase doled out on a zero-sum basis."

Worse, merit-based salary increases often devolve into an entitlement within organizations, Rubino said. Instead, variable-based incentive compensation—in the form of bonus payouts—"reward the top performers you want to keep and allow mediocre workers to leave because they aren't receiving a guaranteed salary 'merit' increase." It produces big rewards distinctions between those who produce and those who don't, he explained.

To counter entitlement perceptions around pay, managers should ask, "What have you done for me lately? I already paid you for what you did last year," Rubino said.

He believes that salaries, or base pay, ideally should be tied to labor rates set by the local market, with performance rewarded through variable pay. To get to that point, companies can take the initial step of granting profit-sharing awards "so employees get used to receiving lump-sum payments large enough to provide a true incentive," he said. The pay structure can then evolve toward individual goal-based variable pay.

Variable Pay Programs

All employees can be included in a broad-based variable pay program, with performance payouts often weighted by employee level. For most organizations, variable payouts can range from 8 percent to 19 percent of base pay, determined by meeting individual, team and organization goals, but often these are paid only if the company achieves or overachieves its goals, Rubino explained.

When all employees are fully part of a variable pay structure, "expect incentive payouts to amount to 9 percent to 12 percent of base compensation cost," Rubino said. While that can seem expensive, the reward of improved performance can more than offset the costs of variable pay programs, he noted.

In terms of retention, variable pay can "keep top performers who are truly adding value from leaving the company for a competitor who is offering an extra 10 percent base pay."

Sample Variable Payout Template

Tier

Target Opportunity
(% of salary)

Payout Range:
0 to 150% of Target

Corporate Goal Weighting

Department Goal Weighting

Individual/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%

0 – 15.0%

20%

20%

60%

Support staff

8%

0 – 12.0%

10%

20%

70%

Source: Rubino Consulting Services.

Employee Evaluation Forms

Employees' performance evaluation forms should not consist of a lot of check boxes, Rubino said. The forms should be kept "as simple and straightforward as possible, while still capturing the essence of performance."

Keep evaluation levels to a minimum of three or four gradations of performance (e.g., goals not met, goals met, goals exceeded, star performer).

Fewer check boxes also allow room for flexible, narrative performance descriptions.

"My favorite evaluation form is a narrative of the story of the performance of the employee," Rubino said. "The story is continuing and evolving, as corrections are made during the course of the year."

Train Your Managers

"Your middle managers will make or break everything we do in HR," Rubino said. "Spend time on training managers." If they're not effective in their jobs, which should primarily be motivating and evaluating the performance of their direct reports, then make them individual contributors again, as long as they are effective in that role.

"There is no permanent right to be a people manager," he pointed out.

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Salary Increase Projections for 2022

Pay raises in the U.S. are returning to pre-pandemic levels but rising prices mean higher salaries aren't likely to keep pace with inflation.

Pay raises in the U.S. are returning to pre-pandemic levels but rising prices mean higher salaries aren't likely to keep pace with inflation.

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