A pay for performance program can be instrumental to a company’s talent strategy.
An effective compensation strategy is integral in attracting new talent and retaining and motivating the best performers. Yet, if not done appropriately, the way in which a company compensates its employees can lead to a number of negative effects.
Compensation should never be a guessing game or one based on gut feel, but rather should be based on a solid foundation of actual data. Data that needs to be assessed include items such as the company’s position against the market as it relates to wage rates, the company’s desired market position on wages, the company’s overall compensation philosophy, and available resources that the organization has to reward employees. It is with this data-informed foundation that more companies today are using a pay for performance program to guide their compensation decisions.
A pay for performance program can be instrumental to a company’s talent strategy; when employees are recognized for their work through increased compensation, they will be more likely to be engaged and continue working at their best.
Read: Salary Compression and Pay for Performance
The challenge for many employers, however, lies in determining which positions should be eligible for performance-based salary increases and how much they should receive.
Many would contend that pay for performance is where two employees holding the same job and performing at the same performance level should get the same increase regardless of where they are paid in their respective salary range, such as all employees rated a “3” would receive a 2 percent increase and all employees rated a “1” would receive a 4 percent increase. However, this is not pay for performance, but rather increase for performance. By basing pay for performance on additional data — not just performance data but also company budgets and competitive market position — companies can make compensation a critical competitive differentiator.
Now let’s define what a true pay for performance system is. A pay for performance system looks not only at your performance level but also at your compensation level as well. For companies seeking to utilize data to create an effective pay for performance program, there are three main steps to get it right.
Three Steps to Implementing a Pay for Performance System
- Measure employee performance. Most companies rely on a performance management system offering quantifiable metrics to determine how employees are performing. Key to doing this successfully is to calibrate performance criteria with managers, allowing them the ability to subjectively identify those who are exceeding expectations, those who are meeting expectations and those under-performing. Calibration can be a time-consuming exercise but is critical in ensuring that performance is managed consistently across the company.
- Appropriately allocate the compensation budget. Once the company has calibrated performance criteria and assessed their employees against the same criteria, the next step is to determine which employees will receive an increase and by how much, based on market position and desired market position. For instance, you may decide to increase the salary for some job families that are further behind the market, or job families you deem more critical to the success of the organization.
In addition to looking at current market position for specific jobs or job families, you should also be assessing trends in the markets as some job families may be moving faster than others. We have found that technical positions tend to move at a faster rate than non-technical positions. As an example, we looked at our CompAnalyst Market Data rates for software engineers and accountants and compared the movement of the rates for those jobs between July 2015 and July 2016.
While software engineers levels 1-3 went up by approximately 2.3 percent, we found the market rates for accountants levels 1-3 dropped by 1.7 percent. Since the market rate for software engineers is moving faster, a company should seek to increase compensation for these job families. Certainly, we can see that we should be allocating more to software engineers than accountants in order to keep pace with the market movement.
Understanding where you stand and what the market is doing allows you to allocate precious compensation dollars appropriately, such that you are not overpaying the slower moving positions and underpaying the faster moving ones.
- Connect compensation to performance. Use technology to measure and analyze internal compensation practices against market rates by creating a salary increase matrix — a function of how much an individual is paid and their performance level. Doing so will ensure that an employee’s pay is moved toward the appropriate position in their salary range based on their individual performance and the movement of their position in the market as a whole.
Utilizing a pay for performance system, you may find instances where an individual might receive what I would refer to as a “0 percent merit” increase, even if they are meeting performance expectations. This would be appropriate when an individual’s performance level is eclipsed by their pay.
As an example, an employee who is meeting the expectations of their job but is paid in the upper part of a salary range would be a situation where a “0 percent merit” may be appropriate. While it may be difficult to tell an employee they’re not getting a salary increase, I would submit the more difficult discussion would be explaining to company leadership why top performers in the most business-critical positions are leaving the company.
What to Keep in Mind When Implementing Pay for Performance
The ability to use relevant data to tie compensation to performance management is crucial to developing and retaining a high-performing workforce, while ensuring compensation is aligned with company budgets.
Key to success is underscoring the focus on pay for performance rather than increase for performance. Giving all employees extra compensation for doing their job isn’t as effective as basing their increase on both their current pay and performance levels. By leveraging real-time performance data, the company has a defensible way to determine how much each employee should receive. This will help to differentially reward top performers, while ensuring appropriate allocation of increased dollars to all other employees. It will also help to spur performance improvements; when employees understand that any increase will be based on their performance, they are likely to strive to work at their best to receive the maximum increase.
Just as important is understanding the market. To utilize pay for performance most effectively, the company must remain aware of how the market is moving for its job families, and ensuring the compensation strategy reflects such movements. Being able to track which roles are increasing in value and adjusting compensation accordingly will ensure crucial decisions around compensation are based on actual data.
Getting Pay for Performance Right
As compensation is often a company’s biggest expense, it is critical that companies get it right. Leveraging data on compensation rates and performance alike and ensuring alignment with the company budget is key to striking that balance. With the insight into what employees are currently making, the market rates of their positions and their individual performance, the company can make informed decisions on how best to allocate its compensation dollars. As a result, the company can ensure it pays its employees based on the value they bring to their organization.
Mark A. Szypko is vice president, compensation strategy, at Salary.com. He holds expertise in international benefits, mergers and acquisitions and HR systems selection and implementation.