By Paul Loucks, President and CEO of Halogen Software
Pay-for-performance systems establish an explicit link between compensation and the realization of specific goals that are mutually agreed upon by the organization and the employee. Pay-for-performance is based on the theory that rewards, bonuses and recognition motivate employees to do their jobs better and that high-performance talent seeks out employers that recognize their achievements.
The Role of Pay for Performance
Over the years, organizations have designed unique ways to achieve a pay-for-performance culture based on their specific organizational goals. Pay-for-performance programs can reward employees in a number of ways, including merit-based salary increases, variable pay, bonuses and stock options for reaching established performance levels. The potential for increased compensation drives performance and potentially helps attract employees, and organizations embracing a pay-for-performance culture benefit from the combined efforts of all employees working toward set goals that support overall strategic business objectives.
Ultimately, an effective pay-for-performance compensation system enables organizations to gain a competitive edge by ensuring corporate goals are being executed on a day-to-day basis and that all employees are directly invested in the organization's success. While the many advantages of a pay-for-performance system are clear, some compensation and human resources (HR) professionals view these programs as being ineffective, complicated and labor-intensive. In some ways, pay for performance has received a bad reputation due to many companies' bad experiences early on as they failed to gain employee or management buy-in, did not have the right supporting information or had other organizational problems that needed to be addressed. However, with the light practices in place, pay for performance can become a highly effective talent management tool working as part of an overall benefits and compensation strategy.
Organizations are increasingly moving away from annual bonuses and/or salary increases and toward performance-based incentives that allow for significantly greater compensation for those employees who are the highest performers. A key factor for any organization examining pay for performance is to ensure there is a significant difference in the compensation received by those who deliver exceptional results. As a result, any compensation program of this sort must be closely aligned with the proper and consistent appraisal of employees. This way, high performers can be clearly and objectively identified within the parameters of a consistent organization wide appraisal process that accurately and objectively assesses all employees. Appraisals form the building blocks of all talent management-related programs as they examine and assess employees using common criteria and provide valuable information on which to base other programs, from compensation to training to succession planning. Without a tight link between appraisals and compensation, pay for performance is not a realistic or achievable program.
Historically, pay-for-performance programs have faced a number of stumbling blocks that need to be understood when considering rolling out a program of this type. The majority of these issues stem from a lack of information or intelligence from the appraisal process. This may include inconsistencies on how employee performance is measured across the company, business units or managers who regularly do not participate in the appraisal process, or a lack of data on which to structure the levels and details of a pay-for-performance program. As the saying goes, knowledge is power; in the past, compensation professionals have not had the information required to make pay for performance work.
Organizations that rely on paper-based appraisals need to manually track and assess performance. It can be difficult to accurately quantify, let alone compare, performance. Tracking where appraisals are in the process is a major challenge— Appraisals are sometimes skipped or handed in late, impacting the organization's overall completion rate, which is a factor in some industries such as health care. Unless the organization has a massive HR department, there is probably no one who has time to perform in-depth analysis of hundreds or thousands of appraisals each year to come up with the information required to establish and maintain a pay-for-performance program.
With this in mind, compensation professionals looking to include pay for performance as part of their benefits and compensation strategy need to ensure that the organization's appraisal process will provide the information required to effectively support the program. By establishing tight links between the pay-for-performance program and appraisals, the process of identifying how individuals perform and rewarding them accordingly becomes much simpler.
Making Pay for Performance a Reality
Once the role of pay-for-performance programs is clear, the next step is to fully understand how to make pay for performance a reality within an organization.
To get started, there are a few important questions that must be asked during the planning stages of the program:
Another key step in the process is ensuring buy-in from the executive team for pay for performance. Achievement benchmarks for the program must be set or approved at this level and appropriately matched with compensation adjustments. Having the boardroom visibly behind any new pay-for-performance system is vital to making sure the process is based on appropriate goals and helps drive acceptance throughout the organization.
Increasingly, executives are becoming more involved in employee performance management as they recognize the value these systems can have in assessing the organization's overall performance. Employee performance- and talent-management systems, including compensation and pay for performance, are really additional management controls that offer executives a whole new level of insight into an organization and its employees. For example, once a pay-for-performance program is rolled out, if only a low percentage of employees are meeting their objectives, executives can quickly identify a larger issue in the organization that needs to be addressed. Perhaps managers aren't communicating clearly with employees, there's low employee morale or the program itself is unrealistic.
Without the right systems in place to support pay for performance, compensation professionals may find properly rewarding top producers and allocating pay increases across an organization to be a complex, laborious and error-prone task. In looking to roll out a pay-for-performance program, compensation professionals need to take the time to look not only at the why and what of the program but also the "how" or practical execution of the program. Questions should include:
Streamlining Pay for Performance
Successful pay-for-performance programs are built on the foundation of a strong talent-management strategy and the right tools to ensure consistent management across the organization.
A performance-management system that includes an automated, online employee- appraisal component can track employee performance over the course of the year using such tools as performance journals, in which employees and managers can record relevant achievements. These systems give managers the ability to actively track performance against goals and check training and development plans, past appraisals and other pertinent information—all through a Web portal. This can be a more efficient way for managers to put together a thorough, accurate and meaningful employee review and for compensation to line up with a complete picture of the employee's performance throughout the year.
Appraisal systems are also key to the overall success of pay-for-performance programs, as they can be used to link specific individual goals with overall strategic goals. Providing pay-for-performance incentives for employees to achieve individual goals mapped to organizational goals is a powerful and strategic way to cultivate a high-performance workforce.
Employee-performance and talent-management systems enable organizations to ensure they have the information required to execute pay for performance, and some systems provide a compensation component to tightly link appraisals and compensation. Ideally, any sort of talent-management system should include a number of modules, in addition to appraisal systems that support key talent-management functions such as compensation.
While with the appraisal system all individuals involved in the process have the information they require to effectively manage pay for performance, the process can be further streamlined by adopting a Web-based compensation system. A compensation system takes the information from the appraisal system one step further by providing all levels of management with secure, simple-to-use tools to help allocate merit-based compensation, including base salary, variable pay, bonus pay, stock options and more.
Pay for Performance: A Case Study
One of America's largest nonprofit investment management firms used a paper- based compensation process that included a two-part compensation system made up of relatively modest merit-based salary increases, which were determined using employee appraisals, and a separate, more substantial incentive bonus process. The company decided to look for a new solution that would automate processes and store all of this sensitive information securely while providing the flexibility required to facilitate existing compensation programs.
The organization selected a Web-based system that covered both appraisal and compensation processes for the company. The new system was based on the seamless and strategic integration of these two key talent management processes. The appraisal portion of the system streamlined the appraisal process and fostered better interaction between managers and employees while providing accurate data for use in the compensation process. The compensation portion enabled the organization to allocate merit-based compensation based on facts from the appraisal portion, establishing a consistent framework for pay for performance across the organization.
HR and compensation professionals at that organization have been able to better manage and track the compensation process. Employees are now evaluated using a common appraisal form, creating a level playing field for the administration of pay for performance.
The best employees want to know that their focus and productivity will be appropriately compensated. A well-implemented pay-for-performance system will attract the best people in a given industry and ensure that employees and potential employees are compensated for their achievements.
In a highly competitive talent market, attracting and keeping high performers can be significantly enhanced with a well executed pay-for-performance program. However, the successful rollout of a pay-for-performance system requires careful planning. Compensation professionals need to ensure that they have both the information required on employee performance and the systems in place to avoid creating an administrative headache. Pay-for-performance methods offer organizations the opportunity to create a culture of performance where employees know what is expected of them and are invested in achieving both personal and organizational goals. By driving performance to a new level and fostering employee engagement, organizations achieve better results overall, giving them an advantage in today's competitive global market.
About the Author
Paul Loucks is president and chief executive officer of Ottawa-based Halogen Software. Loucks has been recognized for his leadership and accomplishments, winning aTop Forty Under 40 Award from Ottawa Business Journal in 2001. Prior to joining Halogen, he was founder and president of NeoDyne Consulting, which was named one of Canada's 100 fastest-growing companies by Profit Magazine, and was recognized as an "up and comer" by the Globe and Mail. Loucks holds a bachelor's degree in computer science from the Technical University of Nova Scotia.
Reproduced with permission from the Benefits & Compensation Digest Volume 44 Number 7, July, 2007, Pages 36-39 published by the International Foundation of Employee Benefit Plans (www.ifebp.org), Brookfield, Wisconsin. All rights reserved. Statements or opinions expressed in this article are those of the author and do not necessarily represent the views or positions of the International Foundation, its officers, directors or staff. No further transmission or electronic distribution of this material is permitted.
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