How to design an effective pay-for-performance plan
Companies are now turning towards pay-for-performance schemes in a bid to reward better-performing employees. But how can HR practitioners build the foundation for such a compensation plan?
By Lisa Cheong
When budgets are tight and HR practitioners are strapped for cash, more companies are turning to pay-for- performance schemes to single out higher
performing individuals to recognise, reward and motivate them accordingly.
According to Mercer’s Asia Executive Remuneration Snapshot Survey released in 2010, more Asian companies are now factoring individual
performance into their short-term incentive plans. After surveying 233 companies across Asia, it found that approximately 30 to 40 percent of a senior
executive’s total pay package is linked to variable pay (which includes both short and long-term incentives), regardless of the type of organisation.
The survey also found that larger companies often had greater levels of variable pay in their leader’s salary package, which may be attributed to the
alignment with international practices where pay-for- performance is strongly encouraged.
So how would a HR practitioner set out designing a pay-for-performance scheme for the company?Step 1: State your objectives
The first step to developing a pay-for-performance scheme is to understand where the organisational direction is going and how a pay-for-performance
scheme will enhance these business objectives. What are your critical success areas for the company? What is the preferred outcome from implementing the pay-for-performance scheme? What is the success or failure of the pay-for-performance scheme based on?Step 2: Conduct your research
The next stage is to conduct a feasibility assessment to understand whether your company is equipped to roll out a pay-for-performance plan. Is the pay-for- performance scheme a common standard in the industry? Aside from learning what the industry benchmarks are, when collecting data, one should take into account both the benefits and problems that arise from this scheme. Collecting data should be done internally as well. Understand how receptive (or not) employees are towards the idea of a variable pay programme. What concerns do they have? And how will a variable pay programme affect their overall employee engagement in the company? For employees who have worked in other competing industries, how does a variable pay programme distinguish your company from the rest of the industry?Step 3: Build your foundation
So what are some of the more common organisation pay-for-performance plans that organisations use?Incentives:
One of the most common pay-for-performance scheme is awarding compensation incentives when an employee has achieved certain management-set goals, such as a specified sales target. This incentive can be based on team/department target or an individual target.Profit-sharing:
Employees who typically participate in profitsharing schemes often receive a stated percentage of the company’s profits, if they meet a set revenue profit.Gain-sharing:
This incentive is used when companies share any productivity or profitability improvements with the relevant employees.Goal-sharing:
Similar to gain-sharing, goal-sharing places an emphasis on employees to reach certain management-set goals.
Whichever incentive scheme you choose, a good pay-for-performance needs to be supported by a reliable, clear and transparent performance data
collection which employees feel they are fairly measured and evaluated against.Step 4: Working out the finer details
Once you have finalised which incentive scheme your company will adopt, it is time to work out the smaller details. Some of the questions which need to be addressed are:
- Who would be eligible for the pay-forperformance programme?
- What will employees be measured against? Will this be the same across the entire company? If not, how will the standards and payments differ between the various company levels?
- How many award levels should you implement? Will there be stretch targets? While it is good to have various targets to motivate employees to reach their higher goals, making the system too complicated may demotivate employees.
- How will the company issue payout? Will this be in company shares or in cash? When, and how often, would the payouts take place? How can be the payout frequency be weaved into the company’s retention scheme?
Typically, companies measure employees’ performance based on three main factors. Due to the different nature of each job, companies may opt to measure different groups of employees based on key performance indicators (KPIs).
Employees are typically evaluated based on one or a combination of the below:Revenue generation:
This is when employees’ KPIs are dependent on sales, income generated or profitability margins. These goals are typically aligned with the business
objectives. Typically, employees’ KPIs would include a financial revenue goal, in which not achieving this goal would mean that no bonus payouts would be given.Productivity:
While various companies measure productivity differently, productivity is usually seen as the relationship of a company’s input to its product output. Variable pay formulas typically depend on labour, materials, inventory and contracted services, which are factors employees can control in their
day-to-day job scope.Quality:
While productivity and working more efficiently are good gains to have, if the quality of the product diminishes, it would be detrimental to the company as well. This is why companies also have a quality KPI that aims to complement their productivity KPI.Step 5: Test your model
Once a pay-for-performance system has been designed, HR practitioners should test the feasibility of the model by testing it against its previous
business results - both in good financial times and bad. In those scenarios, how would payouts have worked? Would the model help the business achieve its goals?
Besides a financial viewpoint, companies should garner a range of views from employees across the spectrum to see how the model would affect their departments and compensation plans.Step 6: Communicate and implement
Companies should spare no effort in communicating to their employees at every step of the implementation stage. Whether it is through emails, company videos or in large town hall meetings, business leaders need to address all the concerns which employees have to gain their buy-in.
Not only should business leaders communicate the new pay-for-performance scheme and its objectives, they should address how this scheme would affect employees’ in the short and long run. How will this affect existing recognition and incentive awards?Conclusion
Ultimately, this scheme should not be seen as a way for companies to drive down the wages of employees.
Instead, employees should feel as though they would be able to earn more if they perform well at work, and that the company is doing well at recognises higher-achieving employees from the average ones.