Compensation that is tied to performance should also be connected to corporate goals.

Pay-for-performance has powerful advantages for companies that consider shifting to this compensation model. What are those advantages? Here are a few factors to ponder.

Potential Advantages of Pay-for-Performance Models

What is pay for performance? It is a model where employees are paid based on productivity as opposed to a set salary or wages paid based on hours worked. Pay-for-performance is common in sales, where commissions and bonuses are based on sales closed or dollars secured via those sales.

While some employees and companies do not feel comfortable with the uncertainty and potential loss of financial security, there are advantages to both employees and companies. Here are a few:

  • Motivating Drive. Pay-for-performance plans are ideal for self-starters who are motivated by the opportunity to do more to drive income levels. With more motivated employees working harder, the company also benefits.
  • Flexibility. Some employees and employers enjoy the flexibility that pay-for-performance plans provide. Many companies with such plans have a chance to set their own hours that leverage their lifestyles. This can result in less use of office space and resources for companies.
  • Increased Productivity. With a high desire for more income, employees often become more productive, able to deliver more in less time.
  • Retention. High-paying pay-for-performance jobs are attractive and often result in employees who stay longer, comfortable with the relationships, commissions, and paychecks that result from long-standing stints.

A 2011 study showed that the top drivers for putting in place such compensation systems were:

  • Recognition and reward for high performers (46 percent)
  • Increased likelihood of achieving corporate goals (32.5 percent)
  • Improved productivity (7.8 percent)
  • Shifting away from an entitlement culture (7.8 percent)

Pay-for-performance structures are a popular way to recognize and reward top achievers.

Potential Drawbacks

While there are advantages to pay-for-performance, there can be drawbacks. Here are a few:

  • Contention, Part 1. If there are certain groups of employees that are on a pay-for-performance plan and others that are paid wages or salaries, it can create animosity within the organization. Workers not offered the option may wonder why others need such as a system to work hard and may be discouraged.
  • Contention, Part 2. When you have a pay-for-performance model, managers need to be fair in the application of their work. If managers spend more time and effort helping one or more employees reach their higher compensation levels, it can breed animosity and distrust. Companies should consider structures that encourage collaboration, not competition, among those on pay-for-performance plans.
  • Less Input. Some pay-for-performance models come under criticism because they dissuade employees from speaking up about making changes. Change brings with it uncertainty that compensation patterns may change, meaning employees who are well compensated may choose to remain quiet.
  • Less Change. With less input from employees and resistance to change from well-compensated employees, companies with these models may be less likely to change models that are outdated or unproductive. Those that do change, and see a reduction in compensation, may experience reduced motivation and productivity throughout the organization as a result.

Considerations for Companies

For companies mulling whether pay-for-performance is the right choice, here are some other factors to consider:

  • Clear Guidelines. Companies need to establish, document, and communicate clear guidelines about their compensation policies. These guidelines need to cover questions about wage increases, commissions, bonuses, and requirements. Without documentation and regular communication about the plans, companies expose themselves to distrust and litigation.
  • Focus on Goals. Successful pay-for-performance plans are those that clearly tie that performance and compensation to broader company goals and priorities. When incentives are tied to better customer relations, increased profits, or more retained business, companies are less prone to competitiveness and low morale.
  • Consistency. Once in place, systems must be applied consistently and fairly. Managers and supervisors need to apply policies regarding the pay-for-performance structure fairly and accurately. Companies should have checks and balances in place to review assessments and measures of progress to ensure consistent application, not only by a manager regarding his subordinates but also by different managers across the organization.
  • Incentives. Companies need to develop and maintain incentives that encourage employees to work harder, more productively, and smarter. These incentives need to drive profitability while also inspiring better performance.

At The Lindenberger Group, we help companies develop the right compensation models to achieve organizational goals. Our HR consultants bring years of expertise in compensation analysis and best human resources practices to our clients in New York, New Jersey, Philadelphia, and nationwide.

With The Lindenberger Group HR consulting firm, you gain access to top insights and skills that can extend the scope of your HR operations. Contact us to learn more about how we help small and midsized companies develop the right policies and practices to spur growth.