Recognizing and rewarding employees for their contributions is required to motivate and retain staff. But “Pay for Performance” as we know it just doesn’t work!
For the longest time, companies have used performance ratings to decide merit pay increases and sometimes, annual incentives. Typically, merit increases are determined according to a combination of performance ratings and position in range (compa-ratio) – those with a combination of higher performance ratings and lower compa-ratios are eligible for higher increases, while those with lower ratings and higher compa-ratios get less. The idea is that such an approach provides a differentiated reward to those with better performance, while ensuring that, on average, the company is paying at the market rate (compa-ratio of 100).
The level of differentiation between strong performers and good ones isn’t much with annual salary budgets of 3% or less in many countries. Employees don’t get excited about getting an increase of 3.2% instead of 2.9%. It’s not really motivating, and does little for retention, which are the two primary goals. Not to mention employees and managers probably hate your performance management system and do not trust the results are fair.
What’s Wrong with Pay for Performance?
Putting aside that last thought, and assuming your performance management approach is working well and is perceived by management and staff to be fair and effective, the problem with pay for performance is one of alignment. Pay for performance rewards a one-time achievement (as measured by the annual performance rating) with a salary increase forever. That’s a huge misalignment!
Merit increases are essentially “baked in” and will remain a part of salary until the employee leaves the organization. On the other hand, performance is variable, and usually changes from year to year. If an employee is a high performer one year, and gets a “high” merit increase, and then in the next year, their performance is lower, how much do they give back? Yeah, right. The penalty for lower performance is a smaller increase going forward.
Using annual performance assessment to determine salary increases is crazy.
Alignment is Key
To align your pay for performance strategy, the first thing you need to change is the role performance management plays in determining rewards. Birches Group believes performance management, which measures periodic, time-bound achievements, should be used to grant one-time recognition such as bonuses. When performance is higher, bonuses go up. If performance drops, bonuses go down, sometimes to zero. You should do something else for salary movement. But what?
Using Skills to Recognize Growth
In Birches Group, we believe that pay movement should reflect one’s experience. As an employee gains more experience in their job over time, they develop a deeper understanding of their role and accumulate the necessary skills that enable them to be more efficient and produce results of increasing quality. Linking an employee’s growth in skills and knowledge to the determination of their salary movement makes sense, and it’s totally aligned. The accumulation of skills and knowledge stays with your employees and can be applied continuously in the future. Skills are like an annuity that keeps paying over and over – like salary! The challenge with such an approach has always been how to measure skills and knowledge. Until now.
Birches Group Community™ Skills provides a framework for measuring experience. Skills uses five skill levels – Basic, Proficient, Skilled, Advanced, Master – anchored to our job levels. For each job level, explicit measures or milestones are defined, enabling managers to evaluate employees’ accumulated skills and knowledge. Companies can link their compensation administration to the progression of Skills in any number of ways, and provide increases based on employee growth in their jobs rather than performance.
The New Pay for Performance
Employee’s should be recognized for both the growth they demonstrate in their job and their achievement during a performance period. By structuring your pay for performance philosophy using two concepts instead of just one, you can solve the alignment issue and create a pay for performance program that works.
If an organization’s goal is to motivate and engage their staff, the approach must be clear and fair. By linking salary movement to growth in skills and knowledge, you will be paying for increased capacity, while also recognizing achievement. Contact us to learn more about our Community™ approach to recognition and reward.