Is Performance Related Pay a Plus for Businesses? - XCD
Performance related pay can be a divisive topic among HR leaders. On the one hand, some employers consider it to be a powerful tool in the performance management toolkit, boosting productivity, increasing employee loyalty, and saving your bottom line. On the other hand, other people call it an ineffective and inequitable approach that is detrimental to team spirit or company culture. Who is correct?
Like many things in life, there’s no black-and-white answer to the question of whether performance-based pay is an effective part of your performance management efforts. Indeed, whether this strategy is right for your organisation will depend on many things: the type of business, the existing company culture, current levels of employee engagement, the budget assigned to performance-based compensation, and how exactly the system is implemented.
In the current challenging economic climate, boosting performance in a cost-effective manner while keeping an eye on retention is a priority for all types of businesses. Could compensation based on performance be the solution to these problems? Let’s take a look at the advantages and disadvantages of linking pay to performance.
Performance related pay explained
Performance related pay, or PRP, is a system of paying employees where the remuneration they receive is dependent on their performance. This performance is measured based on clear targets that the employees can work towards.
With this strategy, individuals may receive a basic salary but can earn higher amounts on top of this if they meet performance goals. Or, in some cases, individuals may not receive a basic salary and receive all their money based on the work they do.
There are a few different ways to link performance with pay. Here are some examples.
Individual PRP or merit pay
By linking salary progression to performance, merit pay, also known as individual PRP, is one way of implementing PRP. This means that individuals who reach their targets are rewarded by receiving higher wages.
Bonuses
One of the most common types of pay for performance, bonuses are offered to employees on top of their base salary as a reward for meeting targets. These incentives may be offered to individuals or teams.
Sales commissions
PRP is common in sales environments to motivate and reward employees. In general, salespeople will receive a basic salary and earn commission – for example, a percentage of the sales they make – on top of this. In some cases, employees may work in 100% commission roles, being guaranteed no basic salary entitlement and instead receiving all their compensation based on their good performance.
Piecework
Another type of performance related pay is piecework, a strategy where employees are paid by the amount of work they do and have no set hourly rate. This is common in farming and manufacturing settings. For example, an individual may be paid a set rate per kilogram of vegetables picked. However, this type of compensation system does not transfer well to an office work scenario where it’s harder to quantify work completed.
Now that we’ve discussed how PRP works, let’s look at some of the benefits and pitfalls of this type of pay policy.
Advantages of performance related pay
Motivates employees to work harder
The biggest advantage of performance related pay is that it provides an incentive for employees to work harder to achieve goals and improve performance. The top performers in any organisation will be rewarded for their work, while middle and lower performers are motivated to step up, be more productive, and achieve the targets set for them by the promise of compensation.
Increases engagement in organisational goals
When individual performance goals are tied to wider organisational goals, it’s a great way to boost employee engagement in the wider targets of the business. Rewarding employees for meeting targets as part of your performance management strategy is key for keeping their work closely aligned with organisational success.
Improves teamwork
When pay is team performance based, employees are encouraged to work more effectively and closely within a team. This is a great way to encourage improvement in teamwork and create stronger, more motivated teams.
Boosts retention among highest performers
Employees who receive great compensation for their work are more likely to stick around. With effective performance-based compensation and salary progression, the employer rewards top performers and ensures that they remain motivated to remain within the company rather than looking for jobs elsewhere.
Reduces micromanagement
With clear goals and expectations set out for each employee as part of the performance management process, individuals know exactly what they need to do to achieve their goals and receive the reward they deserve. By increasing employee motivation and initiative, this can have the knock-on effect of reducing micromanagement. As a result, morale and efficiency can improve throughout the organisation.
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Disadvantages of performance related pay
Reduces motivation for middle or low performers
While it’s true that performance related pay can be a great way to motivate and reward high performing employees, this compensation system also runs the risk of de-motivating less high performing team members. If employees feel that they are unlikely to meet their targets in the first place this can lead to them giving up and causing productivity to stagnate. For this reason, it’s important to ensure that the goals and expectations set are achievable for all.
Encourages a culture of competition
PRP can also lead to a culture of unhealthy competition within the organisation. Instead of team members being willing to help their colleagues and share tasks, PRP can lead to individuals becoming increasingly competitive. As a result, team spirit and morale can be damaged, reducing the effectiveness of teamwork.
Reduces employee interest in non-quantifiable aspects of work
Another disadvantage of PRP is that it can reduce employees’ motivation for parts of their work that are not specifically related to their targets. When employees are working towards a fixed financial reward for specific outcomes, they may become more focused on meeting these metrics and less motivated to engage in activities that are not tied to a financial incentive. This can lead to a reduction in motivation for tasks that may be important for overall job satisfaction and growth, such as teamwork, creativity, and problem-solving, and instead a focus only on tangible outcomes and performance metrics.
Puts emphasis on money over mission
With performance-based pay there’s a risk of encouraging employees to see their work as driven by money rather than the organisation’s mission. This can lead to a lack of employee engagement where employees perform well, motivated by financial incentives, but have less ongoing commitment to the organisation’s mission because of the lack of long-term incentives. Despite the short-term performance benefits, this might lead to higher levels or employee burnout or turnover in the long run.
Risks bias and inequality
Finally, performance-based compensation runs the risk of bias and inequality. With much of the process depending on decisions from management about whether employees have met their goals, there’s a real risk of managers’ prejudice making the scheme unfair.
Moreover, unless the pay for performance model is carefully evaluated, there is a risk of it becoming inequitable. In a poorly implemented scheme, the incentives might have a detrimental impact on pay equity and may result in an increased gender pay gap or unequal opportunities for different people.
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How to implement PRP effectively
- Establish measurable and achievable targets
These targets need to be transparent and clearly communicated to all. Ideally, these targets will be objective, but if they are reliant on a manager’s evaluation there should be clear and replicable guidelines for evaluating performance. Crucially, these targets should be consistent and universal.
It’s also important that these targets are achievable – employees can be easily demotivated if these objectives are too hard for them to achieve. Therefore, the PRP system must be based on goals that are ambitious enough to push employees to higher productivity and performance, while also achievable enough to keep team members motivated.
- Ensure your criteria are fair and equitable
Because one of the potential pitfalls of performance related pay is a lack of equality, it’s essential that HR teams evaluate the criteria to ensure that the targets are equally achievable for everyone. An equality impact assessment can be used to evaluate all performance targets to make sure that these do not discriminate against certain groups. For example, can these performance objectives be achieved equally by men and women, or people of all abilities? Without an equality assessment, a performance-based compensation model is likely to become inequitable.
- Consider the plan from the perspective of different types of employee
Following on from the previous point, it’s essential that you evaluate the fairness of the targets across different groups and types of employees. For example, do the targets unintentionally put part-time staff or employees who have taken parental leave at a disadvantage? If so, it’s time to re-evaluate the system to ensure it is fair for all.
- Provide training for managers
As the gatekeepers for performance related pay, it’s essential that management staff are trained in how the plan works. With training to understand the reasoning behind and objectives of the scheme, managers are better prepared to implement it effectively. Moreover, they should be aware of the potential pitfalls of the scheme to look out for, including issues of equality, prejudice, and toxic competition in the workplace.
- Rethink performance appraisals
To ensure that your performance related pay scheme is a success, it’s essential to use performance appraisals effectively. This means providing ample time and resources for effective appraisals to ensure that employees are supported in their personal development as well as evaluating their progress towards performance targets.
Furthermore, effective performance reviews are key for quickly identifying issues with PRP plans and taking action to resolve them. Appraisals need to be frequent and detailed – a single annual appraisal is insufficient.
- Remember the importance of recognition
As HRs, we know that recognising the efforts of employees is often just as important and financial rewards. Without performance-based pay going hand in hand with recognition, it’s easy for these schemes to lead to the pitfalls of an overly competitive company culture, employees being less willing to do tasks that do not relate to targets, and a focus on quantity over quality. An effective recognition strategy allows HR teams to supplement the effectiveness of a PRP scheme and maintain a supportive company culture where employees are motivated both by financial reward and recognition.
- Record and review
Finally, it’s crucial that you keep a detailed paper trail of all records linked to your PRP plan. This is key for internal reviews of the system and whether it is meeting objectives or needs to be adapted. It’s also essential to ensure that prejudice and bias are not entering the scheme and can guard your organisation against accusations of unfair treatment from disgruntled employees.
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Performance related pay: HR’s role
It’s down to HR experts to evaluate how best to implement PRP schemes within an organisation. HR professionals are responsible for analysing the business needs to determine whether PRP aligns with the company’s goals and culture. It also falls to HR to ensure that PRP is implemented fairly and transparently, and that it does not negatively impact employee morale or motivation.
For a transparent, effective, and standardised approach to performance related pay, HR performance management software is a must-have. A powerful cloud-based tool such as XCD’s HRMS makes appraisals more accurate, effortless, and fair every time, with live performance analytics and easy-to-use discrete contributions on performance feedback forms.
Moreover, as a single solution, XCD HR software brings together performance management and payroll and reward in one comprehensive system. This means that pay and bonuses can be easily and consistently aligned with performance data.
Overall, a performance related pay strategy is tricky to pull off effectively and requires the right HR tools to ensure total fairness and consistency. Want to find out more about how XCD HR and payroll software can revolutionise performance management and compensation strategy? Book a demo of our software or get in touch today.
