Pay-for-Performance Programs: Are We Expecting Too Much?
By James T. Stodd, SPHR, SHRM-SCP
September 22, 2015
Decades ago many organizations jumped on the “pay-for-performance” bandwagon. In short, these organizations abandoned giving COLA’s, general increases, step increases and other traditional forms of pay increases, in favor of lumping all increases into one performance-based category called “merit.” However, recent studies, as well as those extending over the last decade, continue to indicate that dissatisfaction with “pay” tops the list of factors contributing to employee turnover. Moreover, SHRM’s 2015 report on employee job satisfaction and engagement indicates that 96{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7} of all employees say compensation is either “important” or “very important,” while only 62{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7} indicate being satisfied.(1) That’s a pretty big gap, particularly when satisfaction with pay has been shown to be so highly related to employee engagement, productivity and retention. (2)
So, why are these “pay-for-performance” programs failing? After all, the concept seems to make sense and have appeal to both employers and high performing employees. Perhaps it’s because there are some fairly nasty problems and pitfalls associated with the design and administration of many traditional pay-for-performance programs. Consider the following:
1. Erosion of Reward Value: In one of my prior posts we provided figures that show that the “real gains” employees have made over the last decade, largely administered through traditional merit increase programs, have been significantly negated when normal inflation, the increased cost of benefits (health insurance), and other costs are considered.
2. Failure to Differentiate: Salary budget survey reports continue to show that the difference between merit increases generally granted to “top performers” versus “average performers” is pretty small. In fact, WorldatWork’s 2015 forecast projects that top performers will receive only an average merit increase of 4.1{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7} compared to 2.8{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7} for average performers. Given that small difference, top performers will be making a mere 13{56cd7e6aa1a9e8b37b474966a37e40db52ca317c7a8b7c79ab3d6ff71decf1c7} above average performers after a ten year period. That’s not much of a difference for 10 years of sustained commitment and superior performance. And how many job changes would a person need to make to achieve that same outcome? Not many!
3. Inherent Zero Sum Game: If for no other reason than for budgeting purposes, most merit programs include some form of “forced distribution” or control on the number of employees who can receive a superior rating and superlative merit increase. As such, the norm is for these merit programs to result in internal competition and some form of “robbing Peter to pay Paul.”
4. Subjectivity: Since performance evaluations are such broad, unfocused and subjective processes, employees often feel they have more influence over the size of their bonus (or incentive payment) than they do their merit increase. For this and other reasons, we are seeing a growing trend amongst employers to significantly modify, or even do away with, the traditional annual evaluation.
5. Equal is Not Equal: Since increases are typically awarded as a percent of current pay, wellcompensated “average performers” often receive larger merit increases (in absolute dollars) than lesser-paid “top performers”.
6. Compounding Costs: Merit increases always add to “fixed cost” that compounds year over year.
7. Merit = Loyalty: Wages and salaries do not reward for tangible outcomes, achieving goals, or measured results. Rather, they compensate employees for committing their time, talents and continued loyalty to a particular employer. Merit increases merely compound that reward, nothing else!
Given the compounding fixed costs, poor results achieved in attracting, retaining and engaging top talent, and the restraints competitive norms are placing on salary increases, it appears that many employers may be trying to accomplish too much through a singular “pay-for-performance” strategy. It is understandable that progressive employers would seek alternative or supplemental reward strategies that are much more narrowly focused, outcomes oriented, and truly differentiate rewards for “top performers” from those of others. Here are some options:
1. Replace “forced distribution” rating systems with programs where employees are evaluated against objective, job-related standards and criteria. This improves the linkage of outcomes to the desired performance as well as the prospects that each employee can receive top rewards in exchange for exemplary performance.
2. Ensure that top performers receive some “real gain” in exchange for their contributions over and above inflation and other employee costs. Doing so may require performance bonuses, retention bonuses, lump sum awards, perquisites or privileges reserved only for those who achieve superior performance. This is a strategy that is often used with sales compensation programs (e.g., the “president’s club”), but can be used with other employee groups as well.
3. Adopt a performance management matrix which dispenses rewards based not only upon the person’s performance, but also considers the employee’s current base salary in determining the size of the merit increase. Such matrices often result in a more equitable distribution of merit increases (when expressed in absolute dollars) because differences in “current pay” are taken into consideration.
4. Supplement merit increases with a diverse set of variable pay programs that focus on very discrete outcomes that are strategically relevant. Recent surveys show that variable pay plans are increasing both in frequency as well as amount, perhaps because variable pay does not add to fixed cost.(3) Of course, well designed plans will require that rewards a) be earned each year (or performance period), b) are affordable, c) meet the organization’s strategic and ROI objectives each plan year, and d) reinforce the organization’s intended culture.
1 Society for Human Resource Management, Employee Job Satisfaction and Engagement: Optimizing Organizational Culture for Success, 2015. (http://store.shrm.org/2015-job-satisfaction-and-engagement-report-optimizingorganizational-culture-for-success.html)
2 Stephen Miller, Employee Engagement Linked to Rewards Perceptions; Alexandria VA: Society for Human Resource Management, June 1, 2015. (http://www.shrm.org/hrdisciplines/benefits/articles/pages/rewardsperceptions-engagement.aspx)
3 Jack Craver, Companies Putting Money Into Bonuses Over Salaries, BenefitsPro; August 27,2015 (http://www.benefitspro.com/2015/08/27/companies-putting-money-into-bonuses-over-salaries)