“Pay-for-Performance” Alternatives
By James T. Stodd, SPHR
In our previous article entitled Pay-for-Performance: Look Before You Leap, we exposed some of the problems and pitfalls commonly associated with pay-for-performance (P4P) programs. We also made suggestions about what employers need to do if they want to successfully drive P4P objectives through their standard performance management and salary administration practices. It was concluded that trying to effectively link financial rewards to performance strictly through base pay (or salary) can be a formidable task and not an appropriate strategy for many organizations.
Those making this decision will generally return to less complex approaches for determining base pay and salary increases including cost of living adjustments, across-the-board general increases and structure adjustments. That does not mean, however, that they must altogether abandon efforts to link financial rewards to performance…not at all! Pay-for-performance can be achieved in some other, perhaps creative, and possibly more effective ways.
Options for Supporting Your “Pay-for-Performance” Objectives
There are a variety of compensation strategies available to help employers link financial rewards to performance other than “merit increases” applied to base pay. Among the available options are the following:
- Incidental Pay/Salary Increases
- Step Systems & Career Progression Ladders
- Individual “Spot” Bonuses
- MBO Programs
- Individual Commission, Piece-Rate or Production Incentive Plans
- Group/Team Incentive Plans
- Organization-wide Gain-Sharing and Profit-Sharing Plans
- Stock Options, ESOP’s, Phantom Stock & Stock Appreciation Rights (SAR’s)
A number of these strategies can be used to supplement existing salary administration practices by rewarding individual productivity, competency development and career growth, while others support collective and team accomplishment. Most can provide potentially large rewards without contributing to recurring salary expense and provide powerful tools to organizations that want to provide ample rewards while simultaneously restricting the growth of fixed costs. In addition, provisions can be made with most of these reward strategies for ensuring that the employer meets certain operating and performance objectives before divvying-out payments to employees. As such, these programs can be used to create “win/win” scenarios with minimal “down-side risk” to either the employer or to its employees. And of course, those listed above are merely a sample of the options available.
Selecting the Right Approach
In selecting the best approach for tying pay-to-performance, an organization should first determine the behaviors that it wants to encourage, reinforce and reward. Once the desired behaviors have been isolated, the next step is to select the program, or a combination of programs, that would best reward those behaviors. In making these selections, consider the following:
a) The approach selected should “supplement” your base pay and salary administration strategy and not “replicate” rewarding the same behavior or addressing the same factors.
b) Be sure your approach does not undermine the behavior or culture you want to achieve!
c) Select an approach that is “affordable”! After all, you don’t want to create expectations that you’re not likely to fulfill. When in doubt…modesty works best.
d) Consider using a “multi-level” approach to spread the wealth across numerous desired behaviors, and then ensure the behaviors targeted by each program component do not overlap. There is no sense in rewarding the same thing multiple times and in multiple ways, while letting other desired behaviors go unaddressed.
Example of a Multi-level Compensation Strategy
As a means of illustrating the above suggestions, please consider the case of BigTime Builders, a fictitious design/build general contractor specializing in large scale commercial construction. Let’s assume that BigTime is a private company closely held by the founder and a couple of key investors, and has approximately 400 employees. Let’s also assume that a handful of these employees perform administrative and overall management functions for the corporation as a whole, but the vast majority consists of construction managers, architects, engineers, skilled technicians and some skilled crafts assigned to various projects. Finally, let’s assume BigTime is a growing organization seeking to expand at a rate of approximately 15{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7} per year, and has five major building projects going on that must be completed on time and relatively close to budget in order for the organization to meet its revenue and profit targets.
To help the organization meet customer expectations and achieve its strategic goals, BigTime has adopted a multi-level compensation strategy which includes the following components:
1. Base Salary: BigTime has concluded that the purpose of its base pay/salary program is to attract and retain the level of talent needed to fulfill the company’s business purpose. As such, BigTime maintains a “competitive” base pay and salary structure sufficient to ensure consistency with market norms, but not so aggressive as to contribute to any unnecessary salary expense. Salary expenses are closely monitored since they constitute “fixed cost” in an industry that can be rather turbulent.
2. Salary Increases: Salary increases are planned to ensure the company’s base compensation practices remain competitive and are sufficient to cover cost-of-living and other considerations which may erode the value of base pay. As such, pay increases are generally granted as market and/or COLA adjustments with all employees receiving what is necessary to meet the company’s objectives of maintaining a sound base salary platform. Increases are rarely granted in recognition of individual performance; although adjustments may be made to base pay periodically, and on a selective basis, to ensure each person is paid competitively and in a manner commensurate with the position they hold as well as competencies they bring to the company.
3. Career Progression Ladders: BigTime has adopted ladders for several groups of key professionals including architects, engineers and project managers. These ladders provide significant increases in base pay for those who “invest in themselves” and make prescribed advancements in competencies and capabilities associated with their profession. In short, moving up the ladder is treated as a promotion, even though the person’s duties and responsibilities may remain largely the same.
4. Team Incentives Plan: Managers and employees assigned to the various construction projects participate in a team incentive plan unique to their assigned building project, including the Project Manager. Therefore, all the folks working on a given project are tied to a common set of goals and rewarded AS A GROUP. Each of these team incentive plans has “trigger criteria” to ensure the project team has met basic financial and operational objectives before any rewards are paid out. Thereafter, the size of the incentive opportunity is determined for the group as a whole based upon timely completion of key milestones and project profitability. The amount of incentive opportunity available to each employee is based upon that employee’s base salary, such that higher level managers and professionals tend to get higher incentive awards than other staff. Fifty percent (50{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7}) of the incentive opportunity is awarded based upon individual performance and contributions to the collective effort as determined by the Project Manager through a project-related MBO program, the remainder is formula driven. Since BigTime’s projects often extend over multiple years, these plans are designed to have an annual reconciliation and pay-out at the close of each fiscal year.
5. Corporate Incentive Plan: Members of the corporate staff are participants in a separate incentive plan that rewards participants AS A GROUP for achieving certain revenue and profitability targets for the company as a whole. All employees (except those participating in a project-based team incentive plan) participate with incentive opportunities also indexed by base pay. Like the team incentive plans described above, this plan is also designed with “trigger criteria” to ensure that certain corporate financial and operating objectives are achieved before awards are distributed. Fifty percent (50{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7}) of the incentive opportunity is based upon attaining individual MBO objectives, the remainder formula driven. Reconciliation and pay-outs are determined at the close of each fiscal year.
6. Phantom Stock: While the company is a closely held private corporation, select executives are given the opportunity to experience the risks and rewards of ownership through a phantom stock plan. This plan pays regular dividends to participants and provides stock appreciation rights (SAR’s) upon termination subject to meeting the requirements of an established vesting schedule.
Again, BigTime is a fictitious company concocted to illustrate how a multi-level compensation program can be crafted to reward desired behaviors. Please note that each of the six components has a very specific purpose and is designed to reward specific behaviors with minimal overlap from component to component. In addition, the only programs likely to contribute to fixed expense are those designed specifically to increase base pay or salary. All the other components are designed to provide upside inducements on a “win/win” basis after meeting either project specific or overall company performance objectives. Hence, each component is sensitive to the turbulence of the industry as well as “ability to pay” issues, and does not contribute to any expectations that are not based upon true performance.
We believe a multi-level plan such as that illustrated above would work very well for a company like BigTime Builders! After all, everybody “wins” including investors, employees and customers!
So, what would work for you and your employees?
About the Author
Jim Stodd is a Principal and Managing Director of JT Stodd & Associates. Jim has helped numerous clients develop the organizational architecture and infrastructure required to achieve their strategic visions and goals. In addition, he has assisted other organizations to build strategically-focused and highly successful human resource management programs by introducing forward- thinking approaches to talent management issues. Before starting an independent consulting practice in 2001, Jim spent more than 15 years in senior management positions where he was responsible for human resources, organization development and change management. In addition, he was associated with several leading professional service firms including Ernst & Young LLP, Hay Management Consultants, and First Transitions, Inc. Jim is a specialist in Strategic and Organizational Planning, Change Management and Human Resource Management. He currently teaches classes in those subjects at Louisiana State University and the University of Louisiana-Lafayette. Prior to that he taught at the University California-Irvine where he was a recipient of UCI’s “2010 Distinguished Instructor Award”.