8 Guidelines for a Successful Pay-for-Performance System

Top performers need to be rewarded based on their productivity and results. Organizations that have successfully implemented a well-defined pay-for-performance system understand that it’s almost impossible to have an engaged workforce that’s committed with both their heads and their hearts without having a performance management system in place that recognizes outstanding performance.

We’re often asked to help organizations looking for a boost in productivity, engagement and morale. What we find are employees who frequently express this thought: “It doesn’t matter how hard I work or how much value I add to the organization, I get the same recognition and reward as my co-workers who contribute substantially less.” In these organizations, performance management centers on unclear business objective statements, and feedback is reduced to uncomfortable discussions of personality traits. Even worse, rewards are seen as either whimsical, bearing no relation to performance, or as ironclad entitlements that follow cycles as predictable as the seasons. In either case, there’s no motivation for employees to improve their performance.

A CEO we recently interviewed had another great perspective when talking about his new pay-for-performance system. He stated, “With our previous system, or lack of a system, we had no idea whom to give a bonus to and whom we should fire.” He went on to add, “It was a system that only had the satisfaction of the poorest performers.”

Because most organizations have been running lean, and haven’t allocated significant budget increases to wages, for the first time in over 20 years, raises are no longer keeping up with inflation for the average employee. What is exciting is that, according to the Hay Group, the companies who do have an effective pay-for-performance system in place have been raising their top performers 1.5 to 2 times faster than an average employee.

For years, pay-for-performance programs have been given a negative rap by both the press and large numbers of people. For example, unions are fond of telling you that they truly believe that all their employees are excellent or that it’s impossible to accurately measure and hold their employees accountable. Our research tells us that about half of a company’s employees don’t like the current performance evaluation system in use…regardless of what the system accomplishes. Jack Welch, the CEO of GE in the 80’s, was famous for his rank and yank program where, each year, the bottom 10 percent of the employees were let go. Although this system has been widely talked about in the press, most companies, including GE, have modified this program after a year or two and focused on other behaviors such as collaboration and teamwork.

Below are 8 practices used by our clients who have successfully implemented an effective merit pay or pay-for-performance system.

1. Develop a clear vision and goals for the program:
   A successful merit pay program will:
   • Reward staff members for achieving performance results and exhibiting behaviors aligned with management’s philosophy and the strategic objectives of the organization. For example, you may want to pay salespeople on the profitability of their deals versus measuring total revenue.
   • Provide rewards commensurate with contributions, i.e., bigger pay increases for stronger performances
   • Motivate team members to meet goals and produce even better results
2. Measure key results and competencies:
   Key results define the job’s end result; for example, the number of parts to be manufactured or the amount of sales. Key results must be repeatable and reproducible. Meaning, multiple people may all become high performers receiving large bonuses.

   Competencies reflect the organization’s values and describe what the organization feels is important in regards to how the work is to be accomplished, e.g., teamwork, initiative, communication. Measuring both key results and competencies is critical to an effective performance appraisal process.

3. Promote transparency:
   People in the organization need to know who are the highest performers. Leaders should be transparent because when you use metrics to measure performance, it’s very clear who is performing and who isn’t. Organizations are willing to pay more for top performance so, most likely, we will continue to see pay differentials of the highest performing employees.
4. Make the program simple:
   The metrics used to measure and reward performance need to be easy for team members to understand. I’ve worked for several organizations where the system was so complex that one person was anointed to figure out who was a high performer and who was not, ruining the program’s objectivity.
5. Involve team members in establishing metrics:
   If team members are involved in setting the goals, there will be a higher level of commitment to achieving the goals. The downside of this involvement is that the leader may not get the bar as high as s/he wants to on year one, but each year the goals are met, the bar can be raised soon after.
6. Encourage employees to conduct a self-appraisal:
   Employees who participate in the appraisal are more familiar with their standards of performance, work harder to exceed the standards, and come to the appraisal meeting prepared to identify ways to improve rather than passively wait for their supervisor to “pass judgment” on them. The best part of a merit pay system is objectivity. Both the employee and the supervisor can compare the employee’s performance to the metrics.
7. Provide opportunities to learn and grow:
   Top talent are high performers for a reason. They outlearn and outgrow the average worker. Providing them with opportunities to learn and grow will help to fuel their fire to continue to be one of the best.
8. Re-recruit the top performers:
   Every employee has a need to be valued and appreciated. Top performers have an even higher need for people in power to acknowledge their significant contributions. Listening to them, involving them in decisions, acknowledging their contributions and providing rewards commensurate with their level of success all help top performers feel that they are valued and appreciated.

In today’s environment, the Best-of-the Best Organizations have learned that in order to retain top talent, out-innovate their competitors, make customers loyal advocates, and bring better results and bigger profits to the bottom line, top performers need to be rewarded differently. These organizations know that a merit based pay system will produce these results far better than a socialistic pay system where everyone in the organization gets the exact same pay increase.