Integrating pay-for-performance in not-for-profit organisations
Snapshot
- As more not-for-profit organisations consider how to attract and retain high performing teams, they are asking Aon how to create a closer link between rewards and performance.
- With limited funding, not-for-profit organisations (NFPs) are expected to deliver on their mission in an efficient and effective way. Executing on this requires a high performing team, however most NFPs don’t link pay decisions with performance.
- There are various reasons for this including affordability, culture, stakeholder perception and lack of supporting processes, but these are challenges some organisations can navigate successfully with a best-practice approach.
Linking pay to performance
The phrase ‘performance-based pay’ is usually associated with incentive payments. But pay-for-performance can also be achieved through differentiation of fixed-remuneration pay increases based on individual employee performance.
Our research has shown that adoption of a pay-for-performance approach in NFPs is mixed, but we are having more conversations with organisations in the sector about how it could work in their environment. These conversations centre around the practicalities of introducing a pay-for-performance approach, including fit with organisational culture, consistent performance measurement and ensuring the added cost to the organisation is worthwhile and actually drives the desired outcomes. Those outcomes include improved retention of high performers, or raising the level of individual and/or organisational performance.
From what we’ve seen in the for-profit sector, it would be unusual for an organisation not to take some form of pay-for-performance approach for non-award/EA employees. While there has been a trend in the past few years for organisations to discard formal performance rating processes – in favour of more frequent and robust employee/manager discussions – in our experience these organisations will still have some form of employee rating system in place to facilitate remuneration reviews and minimum performance standards.
Market trends in performance-based remuneration
Most of our data from the Community, Advocacy & Social Services (CASS) sector does not include performance ratings, suggesting that performance is not even measured in a formal way by these organisations.
The information below shows Median Base Salary Same Incumbent Movement (SIM)[1] salary increases from both our ‘General Industry[2]’ and CASS remuneration reports. It was only in 2022 that we saw some correlation between performance rating and median SIM in the CASS workforce. Prior to this an individual’s performance rating did not seem to impact on their annual increase.
Then in 2023 the trend reversed. Anecdotally, the pressure to give high increases to all staff to compensate for cost of living has left little in the budget to differentiate increases for high performers. It will be interesting to see if a pay-for-performance trend returns once inflation settles.
| Performance Rating | General Industry Remuneration Report | Community, Advocacy & Social Services Remuneration Report* | |
|---|---|---|---|
| 2022 | 2022 | 2023 | |
| Substantially exceeds expectations | 3.3% | 4.0% | 5.5% |
| Exceeds expectations | 3.0% | 4.0% | 5.1% |
| Meets expectations | 2.2% | 2.6% | 5.1% |
| Needs Improvement | 2.0% | 2.0% | 5.1% |
| Unsatisfactory | n/a | 1.0% | 0.5% |
*SIM data from the CASS survey excludes Award/EA staff, where salary increases are generally not based on performance.
We can see that generally organisations do differentiate salary increases based on performance: the higher the employees’ performance ratings, the higher the median salary increases. However, the size of this difference is not meaningful based on the overall group surveyed.
For example, a 1.4% difference in pay increase between one employee who meets expectations and another who exceeds expectations equates to $1,120 per annum on an $80,000 salary, or $21 per week before tax. There is also generally very little difference in reward for people who substantially exceed expectations, compared to peers who exceed expectations.
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Is pay-for-performance right for your organisation?
Measuring individual performance is easier and more appropriate in some sectors compared to others. Linking pay with performance may not be the best approach in organisations where:
- Success is determined more by the collective actions of the team.
- Measurable outcomes are not entirely in the control of the individual.
- Individuals are more motivated by other career milestones than their remuneration package.
Despite beliefs that higher pay has a positive impact on employee engagement, Aon’s research shows it is more important that the organisation can show employees are paid fairly for the contribution they’re making to the organisation’s success, and that their manager can articulate this well. Put simply, people like to be recognised for doing good work and feel more engaged when their manager can explain their pay to them.
A well-designed pay-for-performance program can also incentivise behaviours and outcomes aligned with the organisation’s overall mission and strategy. Organisations who reward behaviours at odds with the organisation’s mission and/or customers’ best interest often make front page news, which can deter many organisations from linking pay with performance. This is particularly the case in the for-purpose sector where spending is under greater scrutiny . While concerns like these are valid, they should act as a driver for good governance in a pay program, rather than a barrier.
Weighing up the pros and cons
The table below details some of the key pros and cons in taking a pay-for-performance approach:
| Why pay-for-performance? | Why not pay-for-performance? |
|---|---|
| Better alignment with market rates | Increased administrative cost and time (including setting and measuring performance goals) |
| Increased employee engagement (when done well) | May not align with the organisation’s philosophy (e.g. unionised workforce – specific principles to pay employees equally regardless of performance/capability in the role) |
| More effective use of budget i.e. targeting higher increases at higher performing employees | If implementing a pay-for-performance approach is unlikely to result in increased employee engagement, performance and/or a positive return on investment compared to current outcomes. |
| If accompanied by a good performance feedback approach, employees have more clarity on what is required of them which facilitates good conversations about developing their capabilities. | If performance goals cannot be measured consistently in a way that accurately reflects performance. |
Ongoing administration of a pay-for-performance program can be another obstacle. Good policy design and initial implementation is important, but equally important is a commitment to not ‘set and forget’ in the future.
As pay transparency and gender pay gap reporting become the norm, it’s important to ensure increases linked to performance are not subject to any unconscious bias. A good pay-for-performance program can strengthen governance on pay equity policy and practice.
Conditions for a successful pay-for-performance program
Understanding common market practice or trends is a good place to start when deciding whether to implement pay-for-performance. It is just as important to look at the organisation’s own unique circumstances, strategies and principles.
Establishing principles is a priority. Integrating market practices is easier when viewed through the lens of an organisation’s principles. If practices are out of step with the market, it will be clear if a principle needs revision, or the practice is simply not viable.
We often guide our clients, in agreement with their key stakeholders, to be clear about remuneration principles and employee value propositions. Are these set in stone or are under review as part of this process? Many organisations can easily articulate how they manage pay, but not all can link those decisions back to values and principles.
Understanding the ‘why’ is important from a pay-for-performance perspective because goal setting in isolation of the overall organisation strategy can encourage behaviours that don’t align with the values of the organisation.
For example, at the Financial Services Royal Commission, we saw individuals were motivated to achieve goals at odds with community expectations to act in the best interest of customers. Clear expectations set from the top about what is and is not expected and accepted in pursuit of a performance goal, is key.
Steps to successfully integrate a pay-for-performance approach include:
- Establish the why: Have a clear philosophy about how much difference there can be between the best and worst performers. Also consider if there is enough differentiation in pay to be meaningful to employees and drive improved performance.
- Ensure performance can be measured: Have a proven performance rating system in place (or at least some method of identifying high vs low performing employees).
- Establish governance procedures: Ensure unconscious bias or inconsistency in awarding performance scores doesn’t drive unfair differences in pay increases.
- Develop manager capability: Managers need to be able to consistently apply this method and communicate the process to employees (and have the confidence to make hard decisions so everyone doesn’t end up rated as “meets expectations”).
- Make it meaningful: Budget to allow meaningful differentiation, especially if you have a philosophy of providing a minimum increase to all employees (e.g. based on CPI). If you do provide a minimum increase to all employees, then you will need either a larger review budget, or an appetite to provide some zero increases to lower performers to fund the increases for higher performers. The salary budgeting process in a pay-for-performance approach is likely to be more complex than applying uniform increases for all employees.
- Good market data: If you are using a merit matrix ensure that you have well aligned market data for each role (or level).
- Allow time: Schedule sessions to properly plan, implement, monitor and review this approach.
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Success relies on a holistic approach
An organisation’s leadership team includes individuals with varying experiences and points of view about how pay should be determined. While welcoming diverse points of view, when it comes to setting pay strategy across an organisation it is important for the leadership team to be in agreement on policy and practice.
An uplift in employee engagement is not only linked to the manager’s ability to explain how pay is determined, but also to robust support from a leadership team. This will foster clarity and consistency in how the strategy is applied.
Setting the right foundations
We know increased engagement from a pay-for-performance approach relies on the approach being perceived as fair, delivering meaningful differentiation, and being well communicated by managers. That’s why it’s important to dedicate enough time and resources to get the design, goal setting and training right and make it an ongoing commitment.
The right pre-requisites need to be in place, and this could mean the practicalities of implementing and maintaining a pay-for-performance program outweigh the expected return. Other methods of rewarding high performance might have better outcomes.
Ultimately a pay-for-performance policy needs to align with the organisation’s principles, philosophy and strategy and support the messages promoted in their EVP. Done well, it will attract and retain the best people and teams, providing the set up for success with well-considered policy, alignment with mission and supporting processes.
Also see:
Explore Three Steps to a Pay Transparency Strategy
Are you ready for Pay Transparency? Try our pay equity readiness assessment tool
[1] SIM measures the salary increase of an individual employee who was matched to the same position in the salary survey this year and last year. It measures employee salary increases, without other factors such as promotions or role changes.
[2] The Aon General Industry remuneration report includes salary data from over 1,000 organisations in Australia from all industries, and the data is effective November 2019.