Companies Pull Back From Performance Pay

Some employers are shifting incentives to mission-critical jobs after programs for the broader workforce fail to deliver results

November 3, 2006
Disillusionment with broad-based performance pay plans is palpable among workforce management executives and compensation managers. For decades, proponents have advised companies to push incentives further down the organization, but there is little evidence that this has happened on a meaningful scale.

    "We are seeing more U.S. companies offering mission-critical incentives only for specific jobs—for example, for R&D employees in pharmaceuticals," says Ravin Jesuthasan, managing principal and practice leader for rewards and performance management at Towers Perrin. "This change reflects the experience with incentive plans for broader groups of employees that haven’t delivered performance results. Some organizations have just given up on performance-based pay. We see constant churning with design changes and plans removed or replaced."

    Jesuthasan notes that some U.S. organizations are moving to significantly higher merit increases for high performers, basically doubling the average. But it is also true that average merit increases are barely keeping employees whole. "Companies have simply decided that there is no more money to spend," he says.

    Surveys report that the range for merit increases for low and high performers in the largest workforce segment is 2.5 percent to 4.8 percent, well below what is needed to create meaningful differences for high performers. And although some companies use short-term incentive plans for this segment, the payouts usually are small.

"Some organizations have just given up on performance-based pay. We see constant churning with design changes and plans removed or replaced."
--Ravin Jesuthasan, Towers Perrin

    "The pay approach for lower-level employees in the United States is really more about providing a sustainable living wage," Jesuthasan says. "Variable pay has a much higher impact on actual living standards for these employees and their level of risk tolerance is much lower, so there is really an artificial floor placed under pay to eliminate most of the risk and variation."

    Jesuthasan believes that the failure of many performance pay plans can be traced to three key mistakes. First, many companies create conflicting objectives for their incentive plans. "They want the plan to contain costs, but at the same time they want it to change performance," he explains. "There is a lack of clarity about what the plans can and cannot do and how they should be designed."

    Problems also arise when companies set the performance bar too low and the plan is basically a profit-sharing plan, or the company sets the bar too high and the plan pays out only once every five years. "It’s a very fine line that must be drawn," Jesuthasan notes.

    Finally, in many plans, the line of sight is missing. This is the case with profit-sharing plans and plans that use the wrong performance metrics for different groups of employees.

    "Because there’s been so much frustration, we’ve measured some plans to see if they have really changed behavior and profitability," Jesuthasan says. "And we’ve documented some very impressive results. Some companies slap these plans in, but successful companies know that the change in the compensation plan must be a flashpoint for a change in how people work."

Workforce Management, October 23, 2006, p. 26 -- Subscribe Now!