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Control and Customization

A Towers Perrin global survey of performance management and compensation practices indicates that variable pay programs often fail to produce performance improvements.

November 13, 2007
Related Topics: Performance Management, Plan, Compensation Design and Communication, Variable Pay
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In the five years since Towers Perrin concluded performance reviews and pay weren't effectively tied to business goals and companies put too much focus on compensation to keep employees from leaving, much has changed. Companies are moving away from one-size-fits-all performance measures prevalent before the recession toward more nuanced programs tailored to specific business issues and the job responsibilities and goals of different employee segments, says Ravin Jesuthasan. The longtime workforce compensation analyst and managing director of the now merged Towers Watson & Co. says recent hard times forced companies to pare back incentives and re-examine their manpower investments.

It became "an issue of where does good enough suffice and where does it make a difference to go from good to great?" he says. Many companies opted to focus incentives solely on performance that elevated the bottom line—and it worked. As recent corporate earnings have shown, "Company performance improved pretty dramatically, without the benefit of a lot of incentives." he says. At the same time, employee engagement has plateaued. Says Jesuthasan: "It's no surprise when you look at some of the issues we have to deal with, with the economy and unemployment rates being what they are."

Companies still focus on pay as a primary lever in talent management, but its impact on retention and engagement is limited. Variable pay remains ineffective as a tool for driving behavior change. Performance management systems are not effectively linked to business needs.

These harsh conclusions come from Towers Perrin's latest global survey of performance management and compensation practices. Worse yet, findings from the 2007 survey show little change from the company's earlier surveys on the same issues.

The results indicate variable pay programs often fail to produce performance improvements.

"Many organizations installed variable pay as a way to reduce and share costs with employees and shift the risk to them. But then for both the organization and employees, they overlay this with the expectation of improved performance," says Ravin Jesuthasan, managing principal and practice leader at Towers Perrin. "But there is no common definition, for example, of engagement, and no agreement about what drives it."

The survey also found that few companies attempt to measure the return on investment for their variable pay programs. "The absence of metrics is a symptom of the absence of a decision science for HR, not a driver," Jesuthasan says. "There is no consensus about models."

For many companies, variable pay has been successful in controlling costs and shifting risk to employees. "But over the long haul, you can't keep transferring risk to employees without also transferring control," Jesuthasan says. The needed transfer of control is not reflected in the survey data, which show a growing number of companies now rely on companywide metrics to determine variable pay.

"Companywide measures give strong assurance that any additional costs will only come with stronger financial performance," Jesuthasan notes. "These measures are a safeguard. But it's better to keep the measures at the individual, team or functional level so that employees have greater control. The company can still determine the incremental increase in cash created and can still carefully calibrate the relationship between higher pay and higher performance."

"With all of these variable pay programs, there is a tipping point," Jesuthasan says. "If you keep taking costs out and put too much risk in the system, employees will eventually balk."

Companies can customize pay programs for specific groups of employees to provide the right balance of risks and rewards. "This is especially important as globalization and other forces increase the diversity of the workforce," Jesuthasan notes. Companies are increasingly designing rewards for mission-critical employees with pay plans that look different from plans for the general population.

"A typical organization may need three or four distinct deals," Jesuthasan says. "But it requires the right metrics and you have to manage the change."

The entire pay plan for each group may need to be customized, including base pay and merit increases, salary scales, variable pay, career paths and promotion opportunities—or it may be enough to simply customize the variable pay plan.

Jesuthasan advises workforce management executives to be mindful of the critical job families in the workforce and understand what engages employees in these positions. "Then they can determine where to invest and what returns they can expect," he says.

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Workforce Management, November 5, 2007, p. 42 -- Subscribe Now!

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