Why (and How) More Employers Are Linking Performance to Pay

A pay-for-performance compensation strategy isn't just for high-powered executives. It's a time-tested strategy that when applied to all employees can result in greater contributions to business success. Why are more and more companies implementing pay-for-performance? Let's look at its advantages and some suggestions on how to implement it.

How It Works

An employee's total compensation may include two elements:

1. A base component established by what the competitive market pays for a comparable position, factoring in skills and experience, and
2. A component that varies, determined by how well an individual or group of employees does in meeting specific goals.

The variable pay an employee receives is based on her or his performance or contribution. This is determined by measuring the worker's results against individual targets that are set and clearly communicated in the beginning of each performance period. If an employee meets the minimum threshold established, he or she earns more. If another employee surpasses that same expectation, he or she earns even more. Hence, those who contribute the most get paid the most.

For instance, if a company wide goal is to retain key clients by providing quality service, the variable pay part of an employee's total compensation could be linked to measurable indicators of delivering quality client service. The logic is that, if you set specific goals, employees can earn more by reaching or surpassing those goals, which in turn will lead to heightened client service quality.

Why Companies Are Drawn to It

When designed correctly, pay-for-performance programs focus employees on what's most important to your company's success. It can create accountability in employees around key aspects of what you're trying to accomplish. When they have this kind of clarity about how you define success, employees should be better able to focus on the tasks that will generate desired results.

Top performers tend to respond well to these kinds of programs. They're motivated by the clear link between their work and the achievement of company goals, and they enjoy seeing their hard work rewarded - not to mention receiving a larger paycheck.

Those employees whose performance doesn't earn them more get a clear message about how their performance measures up. But don't give up too quickly on these employees. It is a manager's responsibility to help guide these workers to better results by making sure they understand their goals and pointing out ways to better meet them. Remember to stay flexible so that you don't push seemingly mediocre performers out the door for the wrong reasons. Some individuals simply require more attention in order to contribute more.

Keys to Success

At the heart of a successful pay-for-performance plan is a company's ability to clearly communicate its goals to employees and to link its objectives to jobs. But doing so can be challenging for some companies.

For instance, a small ad agency's goal to solicit new business may be difficult to make applicable to all teams, such as the accounting and administrative staff. A pay-for-performance plan won't be successful unless performance goals are made specific to different work groups, with expectations and measurements that are appropriate for the different roles that ultimately contribute to landing new business.

Also, managers must be able to objectively evaluate employees' performance. If employees feel their tangible results are being overshadowed by inaccurate metrics or favoritism, your pay-for-performance plan will lose its credibility and effectiveness to shape behavior.

Keep in mind that there may be barriers to meeting specific goals that workers have no influence over, such as goals that are unrealistic or that rely too heavily on other employees or departments.

A Long-Term Investment

Pay-for-performance shouldn't be thought of as a quick fix for all compensation-related issues. Instead, you should view it as a long-term strategy and investment in your company's ability to reach its most important goals. Rewarding employees according to their contribution toward reaching those goals can be a cost-effective way to help your organization be more innovative and stay focused on goals.