5 Tips for Linking Compensation with Performance

Reading Time: 6 Minutes

Contributed by Garima Sharma

Garima Sharma leads the Talent Assessments & Employee Engagement team at GreenThumbs.

GreenThumbs is a human resource consulting firm offering talent assessment, people management, talent search, and related advisory services to businesses.

Let’s first look at the very crucial role compensation plays in any business.

We all know that compensation plays a critical role in attracting & retaining talent, handling performance, and managing business affairs. Compensation is a powerful catalyst in aligning employees with an organization’s mission and for bringing about desirable changes in work behavior.

Decisions made around designing and implementing a compensation for performance system are defined business success and therefore, companies should weigh their options cautiously.

Payscale writes, “In a shrinking labor market, getting compensation right is a critical component of any strategic approach to talent acquisition and retention.”

In a competitive labor market, if you can’t match a candidate’s expectations, they will simply look for a better offer elsewhere. Even if you’re able to attract an employee, a competitive compensation plan is needed to keep your teams satisfied & motivated. To make your talent stay longer, and avoid the high costs of turnover, you need to continue to engage them by offering relevant & desirable packages.

The Society for Human Resource Management (SHRM) recommends following a process to draft and implement a strategic compensation plan: 

  • Determining the sources of external market data.
  • Conducting market analysis, develop pay structures.
  • Calculating the cost.

What Does Compensation for Performance Mean?

Compensation for performance or pay-for-performance is a framework where a portion of an employee’s compensation is related to their performance at work. This performance can be based on certain individual goals, group goals, business goals, OKRs, etc.

While the strategy might sound simple, the key is to be able to find the right balance between the two factors – compensation and performance. An imbalanced strategy, like for instance – under performers getting paid more than their work merits or star employees getting paid too little relative to their performance can make organizations lose on some real talent.

When planned and drafted properly, a compensation for performance plan proves to be a game-changer for your company, especially in today’s fiercely competitive labor market.

PayScale’s 2017 Compensation Best Practices Report found that 74% of employers offer some type of variable pay. Of these employers, 64% offer individual bonuses and 25% offer team bonuses.

Benefits of Linking Compensation with Performance

Linking compensation and performance can be beneficial both for employees and organizations. Here are some benefits that a well- designed compensation for performance program can bring:

1. Greater Employee Engagement

Nothing connects an employee with the goals of your company better than a smart compensation- performance plan. Not only do your employees see a direct relationship between their performance and positive financial results, but they also realize, in a measurable way, the benefit they bring to your company and its operations.

This makes them become more engaged towards the originations’ vision. It’s a no-brainer that engaged employees to work faster, harder and stronger.

2. Overall Productivity Boost

When employees see the correlation between compensation and performance, they consistently make efforts to do better at work. Also, when organizations pay their teams based on performance, it makes them more efficient with managing resources and deciding on where to spend, how to spend. For instance, you can refrain from investing in the wrong people/roles. It’s a win-win.

David Chaudron, Managing Partner at Organized Change says, “Compensation can be looked at as a motivator and also a feedback tool. […] Money usually lights up people’s eyes, especially if the rewards are a result of their efforts.”

3. Employees self-assess performance

With a concrete and clear compensation-performance program, managers need not be required to oversee tasks all the time. Employees themselves will be innately motivated to assess & drive performance, take up challenging tasks and succeed with flying colors.

They will aim at getting things done in time, without procrastination and regular supervision. Managers can play the role of mentors, helping and supporting employees when needed.

Anthony Babbit says, “When compensation is linked to performance, employees see the direct value of their contributions.”

4. Fall in Turnover

Research by Glassdoor states that 35% of employees are so unsatisfied with their salary that they’re willing to start a job search over it. Compensation has always been a key driver for employee engagement & retention. Therefore, the right strategy here will enable organizations to retain their talent and keep employee turnover at bay.

Employees get paid for their work and their performance gets recognized. When your employees are interested in and connected to what they are doing, they are more likely to stay committed to it.

5. Healthier Work Cultural

Lastly, an organization where – both the management and employees work towards achieving targets; teams stay motivated and aligned to the overall mission; employees are ready to innovate in order to do better, is bound to thrive on healthy and progressive work culture.

A sound compensation-performance link helps boost ownership, innovation, accountability, continuous improvement, less stress, and high morale among employees.

5 Tips for Linking Compensation with Performance

Now, let’s come to the question of how to link compensation with performance i.e. what kind of compensation for what level of performance.

1. Identify the right roles

It is important for organizations to pick the right roles & positions to link compensation and performance. There will always be some roles that can be mapped better to a compensation-based performance model, than others.

A role that has a direct connection with say revenue or overhead reduction will be a good option for this.  On the flip side, a role like IT may not be a good fit, as there may not be a direct link between performance and sales or expense reduction in this case.

The key is to make sure that when you link compensation and performance it should be viable.

2. Identify the right employees

In addition to roles, mapping the right employees to your compensation-performance plan will also make a lot of difference. Identify the High potential employees (HIPOs) in your teams. HIPOs are

individuals who have the ability, aspiration, and engagement to rise and succeed in more senior and critical tasks. What makes them stand out is their skill, talent, aspiration, and determination.

Organizations use methods such as assessments like MBTI, Psyft Personality Assessment (PPA), etc. to identify their star employees through crucial aspects like work behavior, temperament, stress tolerance levels, etc. A better understanding of your employees will give you heads-up in recognizing the true potential of employees. Identify personalities that would thrive in a compensation-performance framework.

3. Have a structured plan

Have the right mix of base pay and variable components. You cannot have people working on only a commission basis or only a base component. Think about bringing together a mix of these components. Depending on your organization’s size, roles, industry, etc. chalk out a smart compensation-performance program. A few things to recall here are:

  • Understand the difference between bonuses & incentives. Bonuses are paid based on past performance and results. Incentives are the motivation for future performance.
  • Consider linking incentives to the pace of work.
  • A goal can be an individual one or a group goal, therefore, align the compensation you offer keeping this factor in mind.

4. Draft a self-sustaining plan

Plan compensation-performance program in such a way that incentives and bonuses can come out of the revenue earned in terms of higher sales, product or service expansion, etc.

Remember the plan needs to be motivating for your employees while also being sustainable for your organization at the same time.

5. Simplicity is a virtue

The aim of linking compensation with performance is to:

  • Assess and award employee performance
  • Help your employees understand how this process works

There is no scope of ambiguity here. If your compensation plan is too complicated, your employees won’t understand it and won’t get motivated by it either. This is only going to lead to greater confusion and a fall in productivity.

Common Ways of Linking Compensation with Performance

The process of linking compensation with performance needs to be as seamless as possible, maintaining the integrity of the overall compensation system.

Some popular strategies for linking compensation with performance include:

  • Linking compensation levels directly to the employee contribution
  • Using the variable pay structure
  • Giving out bonuses and incentives to reward employees & to motivate improved performance
  • On-the-spot recognition with cash payments

Conclusion

Compensation for performance is a very powerful way to build a productive work culture in any organization. Organizations should make sure they use the best strategy – one which is beneficial for their employees and them alike.

Every organization should invest in its employees in a way that motivates performance needed to achieve a business goal. Therefore, an organization’s compensation plan should tie-up with the overall performance strategy effectively.

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