Pay for performance: Retaining the crown jewels

While companies are focusing on looking at their cost structures and thinning down their employee bases, they should not forget that loosing the good employees in this process will account for major replacement costs in the future.

Many studies show that the skills valuable for any business are mostly concentrated within 20 percent of the organization’s workforce. HEAR THIS: 20 percent of people hold more than 60 percent of the required knowledge for YOUR organization to function effectively. Hence, while companies are focusing on looking at their cost structures and thinning down their employee bases, they should not forget that losing the good employees in this process will account for major replacement costs in the future. These are troubled times, but one cannot afford to be short-sighted. Skilled resources are limited and even in the worst of times one cannot take them for granted.

Why to implement a Pay-for-Performance Plan?

How will designing and implementing a Pay-for-Performance plan help in retaining these employees? Why should companies spend more money in compensating them during a period of recession and layoffs? Here are 3 reasons:

CEOs and HR professionals in most companies would claim to have some sort of Pay-for-Performance plan already in place, but very often such plans fail to achieve their intended objectives. The reason for such ineffectiveness lies in the fact that in most cases, the differences in salaries and benefits are either not consistently based on performance, or are not relevant enough to derive the benefits of a Pay-for-Performance plan.

In this section we aim to bring some clarity on the key steps in building a Pay-for-Performance plan. The details of the plan will differ from company to company and from industry to industry, but the broad steps involved in building a plan are common across companies and industries.

How to implement a Pay-for Performance Plan?

• What quantum of base pay will create a meaningful differential for the employees? In some cases a 10 percent differential could be relevant enough as a differential for high performers, but in industries where the wages are low, a 12 or 14 percent differential is more appropriate.
• What do employees value? Young employees would prefer to receive the differential in cash (base pay or bonus) while middle-aged employees might prefer a more tax-efficient form of differential pay (like, greater contribution to pension plan)
• A good understanding of the industry, the organization and the diversity & drivers of the employees will help in determining the quantum of differential and the manner in which this differential needs to be paid out.

• For example, a mobile telephony company which is entering a new market and wants rapid penetration should reward sales force purely on the basis of number of customers acquired, as opposed to an established existing player which might want to reward its employees on the basis of customer profitability.

• Job Descriptions are a must. The content of these job descriptions must be updated and relevant. The importance of this document lies in the fact that employees should understand what they are getting paid for. A good job description explains clearly the value of the role and the contribution of that role to the organization.
• Need for a strong appraisal process in place. In order to create a differential pay, companies require ways to fairly assess the contribution of each employee. An organization must have a solid process that is capable of capturing goals and evaluating performance regularly.
• Get your base pay in order. Companies need to look at their base pay structures, look at market survey and internal equity to assess the readiness of their individual pay structures for a pay-for-performance plan. Many companies that grow rapidly are not able to create a coherent compensation policy. The results could be that new joinees are getting paid the same amount as, or in certain cases, more than, experienced people within the organization. In other cases, there is clear disconnect in compensation for a set of roles, as compared to the rest of the market. HR professionals need to solve these problems concerning internal and external equity before going for a more sophisticated pay plan.

• Account for inflation. This means that the total compensation increases by a certain amount. But, that does not mean that the entire workforce will be entitled to the increase - some will get more, and some will get less.
• Adjust pool for market changes. An organization needs to create a buffer to be able to react to market changes in the middle of the financial year.
• Budget for incentives. The amount that will be paid as incentives and bonuses needs to be budgeted based on expected performance of the employees, using scientific models and scenarios.
• Budget for appreciations. A dedicated budget for appreciations must be part of the overall salary budget, as it will give companies an opportunity to award ‘spot’ bonuses, completion bonuses etc.

What are the Challenges in Implementing a Pay-for-Performance Plan?

Now, is it that simple? Compensation is a very complicated field; you get it right and it can be the most cost effective initiative in the organization but if you get it wrong it can lead to other behavioural problems.

What can go wrong? These are the factors that companies need to consider while implementing a Pay-for-Performance scheme:

CEOs and HR professionals should transform the concept of compensation from being viewed as a cost, to being viewed as an investment in resources. This shift will help organizations to identify what compensation philosophy works best and how this can motivate employees to work towards the organizational objectives.