Performance and Compensation

One of the most complicated and frustrating issues that most senior leaders face is how to use pay practices as a way to improve company performance. The first comment that I will make is that there is no perfect system—if there was, then everyone would be using the same system and thousands of employee compensation consultants and experts would be out of work.

As I researched this article, one common thread came through in all my reading. A company must have a compensation strategy that is in alignment with the company’s strategic direction and goals.

The compensation strategy is the philosophy that guides specific compensation decisions. The components considered when developing a compensation strategy include base pay, incentives, benefits, working conditions, and opportunities for growth. Pay practices should be considered within the context of the overall compensation strategy.

There are a number of factors to be considered when determining base pay for jobs. One commonly used method is to use market information about pay ranges for similar jobs and to establish a company position relative to the market range. Another method is to use a system, like the Hay system, to establish a value for a job based on the scope, responsibilities, and impact of a position.

Many companies are including some type of performance-based pay compensation throughout the organization. Typically performance-based compensation is at risk—it is not guaranteed. The philosophy behind this is that people will be motivated to work harder and produce more if some or all of their compensation is tied to performance.

The reality is that pay for performance systems have seen mixed results. For each success story, there is also a failure. The theory is good, but the complexities of designing and implementing a system that produces the desired results is daunting.

The Washington Nationals are the worst team in baseball right now. If management of the Nationals implemented a system that gave players a significant bonus every time they won a game, we probably wouldn’t see much change in results. The issue is talent, not motivation. One reason that incentive programs fail is that the people do not have the talent to perform better.

One of the assessments that I use in my consulting practice evaluates a person’s interests and motivational factors. One factor that we evaluate is called Utilitarian which is the drive for money and practicality. We find that this is not as strong of a driver as other factors in a number of people. There is more to motivation than money in some people

Michael Beer, a professor at Harvard Business School, studied why Hewlett-Packard dropped pay-for-performance systems three years after they were initiated. Here are some of his findings:

• The systems showed a dramatic improvement in the beginning, but the gains were short-lived

• Pay became very inconsistent among groups—some benefited from factors outside their control while others were penalized. This created a lot of dissatisfaction and the need to constantly modify the program.

• The large payouts in the beginning became entitlements in the minds of employees. They built their lifestyles around the higher level of pay and became dissatisfied when bonuses decreased.

• The costs of constantly changing and evaluating the program became greater than the benefits.

When making a job decision, most people will discount the performance piece of pay in their decision making process because it is at risk. For example, with all other things being equal, a person will generally choose a job with a $50,000 base salary over one the has a $30,000 base and a potential of $30,000 bonus even though this would appear to be more money People subconsciously will put a discount or probability factor on variable compensation.

Benefits are usually of secondary importance when people make job decisions as long as they are reasonably competitive and cover the basics. Working conditions and opportunities for growth also factor into the job decision process, particularly with younger workers. Some people are willing to sacrifice some pay to work in better conditions and to have opportunities to grow.

Ultimately the effectiveness of a compensation strategy is measured by the ability to attract and retain the human resources necessary to execute the business strategy. If a company has high turnover or difficulty in filling necessary positions, then most likely the compensation strategy is either not well defined or ineffective.