Variable Pay Aligns Performance with Rewards

Use base pay to reflect job value, and variable pay to reward performance

By Stephen Miller, CEBS Jun 21, 2016
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“Performance management should be at the core of everything we do as an organization,” and that’s not hyperbole, said variable pay guru John A. Rubino, president of Rubino Consulting Services in Pound Ridge, N.Y.

Speaking June 20 at the Society for Human Resource Management 2016 Annual Conference & Exposition in Washington, D.C., Rubino shared insights on how linking performance measurement and management with total rewards can help organizations engage and retain high-value employees—and perhaps persuade average and underachieving employees to consider moving on.

Rubino is an advocate for shifting compensation away from annual salary raises that purport to be merit-based but seldom actually are. Instead, he advocates rewarding all employees organizationwide through variable pay linked to goal achievement, at least in part.

“When performance management”—a formal process for planning, managing, appraising and rewarding performance—“cascades throughout the organization, articulating performance goals for every employee, it improves service, efficiency, competence and quality. And that has a direct relationship on the bottom line,” he said.

De-Emphasize Base Pay

“I’m on a worldwide crusade to abolish merit-based salary,” Rubino said. “With a 3.5 percent base pay budget, how much can you give top performers to differentiate them from average employees? Not much.”

While his ideal may not work for all organizations, Rubino said, he believes the optimal way to structure compensation is to have base pay reflect each position’s market value (determined by competitive position analyses) and the organization’s pay philosophy, such as whether salaries are set at the market average or a higher or lower percentile. Base pay would only adjust to changes in a position’s market value. This avoids the exponential curve of base pay compounding every year.

When making the shift, Rubino doesn’t recommend cutting anyone’s base pay, “but if a position is being paid above the market rate, consider putting in place a freeze,” he said.

Performance would be rewarded through lump-sum variable compensation based on accomplishing performance goals. This results in “employees who are focused on adding value to the business by meeting and exceeding performance expectations.” It creates a “direct line of sight between results and rewards” and “an environment that discourages the entitlement mentality” while providing “a good ‘sell’ to top candidates, and a compelling reason to join the company.”

Variable compensation should be paid out along a range, determined by whether target goals were exceeded or fully or partially met (typically stated as maximum, target and threshold), Rubino explained. For most organizations, he noted, potential payouts would range from 8 percent to 19 percent of total base salaries.

Payout calculations under a variable plan can look complex, but “an Excel spreadsheet makes it extremely simple,” Rubino said.

Often, officers and managers will receive more of their total compensation based on goal achievement than will professionals and support staff, but all employees should have at least a portion of their pay “at risk,” he advised.

Typically, payout distributions are on an annual basis. However, a plan may pay semi-annually, quarterly or even monthly, but “only if all performance measures can be accurately evaluated within those time frames,” he cautioned.

Funding the Plan

“Funding comes from gains calculated in the achievement of the performance measures,” Rubino said. Also, the savings between the former base salary “merit” budget and the new market-adjustment approach can be used to partially fund the variable pay program.

In his experience, a positive return on variable pay investments is achieved within a three- to five-year period.

Another source of funding for a variable pay program is to let base pay slide below market rates, “at least in a nonunion environment,” Rubino said.

If providing variable pay organizationwide represents too much of an initial investment, “start with a subset of employees,” such as officers, directors and managers, “with the goal of including everyone within a specific time frame,” he suggested.

Once in place, variable pay programs create a more efficient workforce that can even reduce the need for excessive overtime, Rubino remarked.

Managers’ Critical Role

An effective variable pay/performance program requires that managers work together to define excellence in all jobs, that they be properly trained to evaluate performance fairly and consistently, and that they continually coach and mentor all employees to reach their full potential. “If managers aren’t up to that task, they shouldn’t remain managers and can be embedded back into the organization” in other roles, Rubino said.

“I’m a big fan of white space on employee evaluation forms,” he added. “Encourage managers to write a narrative” when evaluating employees, because “a number or score is essentially meaningless.”

The evaluation should be as simple and straightforward as possible while capturing the essence of an individual’s performance. If evaluation levels are used, keep them to a minimum of no more than three or four graduations—such as “exceeded goals,” “met goals” and “didn’t meet goals”—to force managers to make definitive performance decisions without relying on “fudge factors.”

Organizational goals (business and operational objectives for the upcoming performance period) should cascade down to departmental and individual/team goals, for which the criteria should be valid, discernible and measurable—and “within the realm of feasibility; otherwise, employees will just opt out,” Rubino said.

Ask employees to make the first attempt at writing their performance goals, he advised. These can later be streamlined, but when employees first try to articulate their goals themselves, this serves as “a basis for critical conversations between managers and employees.”

Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow him on Twitter @SHRMsmiller.

Related SHRM Articles:

Bonus Binge: Variable Pay Outpaces Salary, SHRM Online Compensation, August 2016

Variable Pay: Ready to Make the Leap?, SHRM Online Compensation, June 2016

Private Companies Typically Award an Incentive Pay Mix, SHRM Online Compensation, March 2016

Keep Incentive Pay Plans Simple but Challenging, SHRM Online Compensation, June 2015

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