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 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.