How will designing and implementing a Pay-for-Performance plan help in retaining these employees?
The differences in salaries and benefits are either not consistently based on performance
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:
- Employees are resources not costs. Companies are willing to spend crores in maintaining equipment and updating software, but when it comes to employees, motivation & retention initiatives are seen as ‘costs’ and not as opportunities to enhance employees’ motivation and skills.
- Money drives behaviour. REMEMBER: ‘You get what you pay for’. Companies need to understand very clearly what they are paying their employees to do. If the emphasis is on attendance, then organizations will have people coming and leaving ‘on time’, but if pay is based on results then there will be greater alignment between the employees’ actions and the organization’s objectives.
- A plan should pay for itself. A well-designed & implemented Pay-for-Performance plan should help companies re-distribute their compensation budgets more effectively. Any potential increase in compensation should be offset by a corresponding increase in revenue.
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?
- Need to have Financial Commitment from the top. The CEO needs to commit to create a differential pay even if that means a temporary increase in the wage costs. The top management team needs to buy into the concept of Pay-for-Performance and should champion the initiative from the top.
- Understand what works in your organization. Understanding the diversity and culture of the workforce will help HR Professionals answer some key questions to determine the details of the plan. For example:
- 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.
- Understand what the organization wants to achieve. Organizations should reward behaviour that is aligned to its objectives. This will enable management to reinforce the message within the organization and get closer to achieving them. Hence the entire performance management program and the compensation philosophy should be constructed around a core set of organizational objectives.
- 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.
- Get your house in order. These are the essentials that companies should have in place internally to implement any Pay-for-Performance plan:
- 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.
- Bring all managers on board. The commitment of the managers is essential for the success of a Pay-for Performance plan. Their contribution in the performance appraisal process is key for an objective and fair implementation of such initiatives. It will not be of any use if after implementing a Pay-for-Performance plan, when it is time for the yearly review, the managers in an organization rate everybody within their team as ‘5’ or as ‘role models’. This situation means that the managers are not able to take ownership of their responsibility and fear that those employees rated below ‘5’ might resign. The truth is that an organization does not want the real ‘5’ to be the ones that leave.
- The most important part: Budgeting & Financial Modelling! This is the part that by nature scares most HR professionals. Arriving at a Pay-for-Performance budget would mean analyzing various hypothetical scenarios. The components of the budget include:
- 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.
- Document. The entire exercise must be well documented and must contain guidelines for managers and employees to understand in advance what is expected from the plan and what will result out of it.
- Track and Monitor. Organizations must create a detailed mechanism to track the effectiveness of the plan. Standard metrics of performance improvement include increase in revenue, increased customer satisfaction, decrease in attrition of best performers, and increase in employee satisfaction.
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:
- Cultural resistance to change. Managers and employees saying “We have always done it that way in the past and it has worked, so why should we change it now?”
- Entitlement mentality. Employees may expect salary revisions to be based on anniversary dates (i.e. every year) and not based on achievement of results.
- Supervisor ‘chickens out’ when it comes to appraisals. Managers need to own performance reviews and be fair to the individuals in the team, by creating differentials based on performance
- Need for strong financial commitment. Top management needs to be committed from the beginning to the end of the process.
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.