Crash Course: Performance-related pay

Your junior team is complaining that only the higher-ups get pay incentives and nobody has any idea what they're given for. Time to have a closer look at rewards for performance.

by Alexander Garrett
Last Updated: 09 Oct 2013

Understand what it's for. 'Organisations say performance-related pay plays a part in achieving their business strategy by making clear what is important and getting people behind it,' says Jori Wonders, head of the Reward practice at Towers Watson. 'The metrics you choose send strong signals about what the organisation is about.' Increasingly, performance-related pay is a must-have for attracting talent.

Get your definitions straight. 'A bonus is not an incentive, it's usually a one-time payment made after you have done something exceptional,' says Monica Franco-Santos, senior research fellow at Cranfield School of Management. 'Incentive payments are compensation that's paid when you achieve a set of objectives, measures and targets.'

What do you mean by performance? Charles Cotton, reward adviser at the Chartered Institute for Personnel and Development, says: 'Often the focus is on outputs such as sales or profits, but that can be harder to evaluate and it may be better to focus on inputs such as competencies, skills acquired and behaviours.'

Choose your criteria. Ideally, all staff should have measures relating to the whole organisation, their function and their own contribution. But keep it simple - people can only bear in mind between three and seven objectives - and relevant. 'Individuals have to see that the action they take has an effect on the measures chosen,' she explains.

Be open - up to a point. 'If you're going to dangle a carrot, you have to explain how big and tasty it is,' says Cotton. But publishing how much others receive may cause resentment - especially if it's not clear why they've been given what they have. 'The most important thing is that people understand how their reward is worked out,' says Wonders.

Be fair. 'Perceived fairness is just as important as the quantum value of someone's reward,' says Wonders. 'We are seeing a greater emphasis on the review and calibration of the assessment process so that it is seen as more objective than subjective.'

Exceptional or normal? Performance-related pay used to be for exceptional achievements. But it has morphed into 'variable pay', says Cotton.

Keep it in proportion. Some research recommends offering at least 7% of base pay to motivate people; other studies say that performance-related pay should be at least 15%. 'If you go too high, you encourage too much risk,' says Franco-Santos.

Do say: 'This document explains how your reward will be affected by your contribution and the company's performance.'

Don't say: 'Let's have lunch today and divvy up the bonuses.'

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