What do top performers get paid in your organization? And how much more money do they earn than a peer who barely contributes? If the difference is less than 50% of the top performer's pay, you may be driving away your best people.
Many companies believe they're paying their employees for performance. According to a recent Â鶹´«Ã½AV Poll (See "How Did Employee Compensation Fare in 2002?" in See Also), more than 4 in 10 employees (43%) say that part of their total compensation includes some type of incentive pay. This may take the form of a commission, an incentive tied to performance, or a bonus.
In many companies, however, an employee's "performance" is defined by a manager's year-end rating and opinion. Elaborately conceived performance appraisals guide the manager through the process, making the rating system quite specific in an effort to accurately reflect desired behaviors. While this process may look valid on the surface, reality tells another story.
For several companies, Â鶹´«Ã½AV Organization researchers have attempted to statistically link performance ratings to important outcome measures, such as customer scores or sales. In most cases, the correlations were either zero or negative. In effect, the analyses suggest that manager ratings don't reflect actual performance or economic contribution as well as most companies assume. And if performance doesn't equal an employee's economic contribution to the company's goals, then on what basis is that employee getting paid? The answers sometimes differ, but they often include an employee's relationship with his or her manager, good citizenship, and other intangibles that have little to do with productivity or economic contribution.
That leaves companies with a problem. There's almost always a wide range of true performance, which usually doesn't translate into a wide range of paychecks. This is great for mediocre and poor performers; some companies are a paradise for them. But it is devastating for top performers, who are usually well aware of their true contribution and that of others.
Fewer paid more
A great compensation plan is grounded in a great performance-measurement system. That system starts with objective, balanced, performance-outcome metrics that measure each employee's impact on the company. And those metrics link directly to company goals and strategies and the way the company drives its returns.
Once your company has developed performance-outcome metrics, ask yourself: How seriously do you want employees to take those metrics? If you want employees to build healthy, sustainable relationships with customers, are you willing to make it real and very personal for those who serve your customers? In too many organizations, performance-based variable pay is only 5% or 10% of total compensation. This is adequate at best and not very meaningful. Imagine what would happen if the variable or performance-based portion was increased to 50% -- or even 100%.
Some companies have very aggressive pay-for-performance plans. Many sales organizations, for example, are adept at designing performance-based pay systems (though many lack balance in their scorecards). Employees become quite serious about demonstrating value when up to 100% of their pay varies according to their performance.
A few companies have successfully created change across almost all roles in their organization by establishing performance metrics and significantly linking them to pay. If your company wants to motivate performance as effectively as these businesses, try these strategies:
- Make 25% to 50% of a person's total compensation variable based on a balanced set of performance metrics.
- Ensure that top performers earn three to five times as much as bottom performers. For example, if your worst performer makes $30,000 a year, your very best, world-class performer should be able to earn up to $150,000.
- Make sure that bottom performers earn salaries that are clearly below the industry average. For example, if the average industry salary is $50,000 a year, a bottom performer should earn $30,000.
If designed and managed well, this is the perfect free-market system. It would yield a decrease in total payroll and an increase in per-person compensation because fewer employees will produce more. Top performers will get paid the most. And they will continue to grow because the company gives them the chance to increase their pay. They'll become your new heroes, and they'll think twice about working for a competitor. Your company is truly rewarding excellence.
In contrast, employees who consistently underperform will have no choice but to face the fact that they are in the wrong role -- a good opportunity to see if there is a different role in which they can excel.
In the end, your company will have more superior performers and fewer poor ones. This will enable you to accomplish more with fewer people and increase overall productivity.
Consider this case: In one company, annual per-person productivity for project managers increased from $5 million to $10 million; the top-performing employee now manages a record $20 million in business each year. During a three-year period, the total number of employees in this position decreased from 22 to 14, while employee engagement as measured by Â鶹´«Ã½AV's Q12 (See "Discovering the Elements of Great Managing" in the "See Also" area on this page) actually increased from 4.4 to 4.8 on a 5-point scale. These employees' pay was based on performance metrics that were derived from important organizational and client outcomes (volume, gross margin, and internal and external customer engagement). Their managers continuously worked toward perfecting performance, increasing expectations, and recognizing excellence. And it worked.
In another case, a business with several call centers adopted a pay-for-performance plan based 100% on the number and quality of employees' calls. During a five-year period, the total number of full-time and part-time employees decreased from 1,800 to 700. Within that time frame, managed volume increased 58% (from $40 million to $63 million), while the total annual hours needed to staff the centers dropped from 1.4 million to 800,000. Managers were held accountable for engaging and developing each employee and for increasing team scores on Â鶹´«Ã½AV's Q12 metric. Again, compensation played a major role in driving a significant increase in productivity.
Is it clear enough?
Even when a company implements a more aggressive variable pay plan, beware: Many compensation systems are confusing to employees. Pay-for-performance plans are often based on complex formulas with many variables. And as a result, they contribute little to focusing the employee and setting clear expectations. In systems that aren't performance based -- those in which managers determine their employees' pay levels -- a raise isn't any more predictable either. Too often, employee expectations are left to the job description and aren't clarified or reinforced with outcome-based metrics.
What a missed opportunity! According to Â鶹´«Ã½AV research, about half of U.S. employees don't clearly know what is expected of them at work. A number of organizations have resolved this problem perfectly:
- Their performance-measurement systems consist of a limited number of metrics -- usually between three and six.
- Associated compensation is clear and straightforward: For every perfect box an employee assembles, he gets $1; for every project he leads, he gets $1,000; for engaging his clients, he gets $500. Made simple and communicated effectively, plans like this clarify what is expected from each employee in each role.
Good performance-measurement and compensation systems focus and align the organization. And over time, they help to continuously increase performance expectations.
An aggressive pay-for-performance system may not work for every company. These systems tend to attract and retain the kind of employees many CEOs want -- employees who like a healthy degree of measurement and competition and want to perform. Many organizations, however, may not be ready. Just remember that in the end, you get what you pay for.
