Though there is scant evidence for the theory that money motivates, or that more money motivates more, companies continue to put their faith in performance-related pay.
No one can prove performance-related pay (PRP) improves performance.
But then no one has proved that it doesn't, either.
So UK companies continue to put their faith in paying for performance and tweak, tinker with or transform their PRP systems in pursuit of the perfect reward structure. But perfection, insists Cliff Weight, director of remuneration experts Hay Management Consultants, does not exist. 'There is no Holy Grail where PRP is concerned,' he argues. 'Everyone is searching for it but it doesn't exist.
Nor could it. The business environment is constantly changing - from recession to growth, for example - and pay systems must adjust to those changes.'
A growing number of UK companies, however, view PRP as a vital step on the path to perfection. More than two-thirds of UK organisations now provide a non-salary reward for at least some of their employees which is linked directly to individual, group or organisational performance, or to any combination of the three. Incentive pay now assumes a complicated variety of guises including payment by results, individual and team incentive bonus schemes, share ownership schemes and, more recently, team-based or competency-based pay. (The introduction of Inland Revenue-approved profit-related pay schemes does little to clarify matters as here the issue is generally one of tax efficiency more than tailored employee reward.)
The proportion of PRP within an income package can vary widely according to industry or even company division. At one extreme, a salesman may be paid entirely according to performance. Board directors too may find their income boosted by a massive performance-related element. Lower down the corporate ladder, the element of PRP within a pay packet is often small - typically between 1% and 4% of annual salary.
While the impact of PRP on an individual's overall reward package may be small, organisational faith in PRP is great. Perhaps too great, argues Professor Laurence Handy, director of research at Ashridge Management College. 'Our recent opinion survey of 563 general managers has identified a clear mismatch between organisational and individual belief in the value of PRP,' he says. Ashridge asked managers to rank the factors which were important in their own motivational psyche and those which they thought their organisation relied on to motivate staff. The majority of respondents stated that the challenge and interest of the job provided their greatest motivation. Next in order of importance came the authority and freedom to get on with the task. A high basic salary ranked the third most important motivating factor. Only 3% of respondents considered PRP important, ranking it ninth in importance below factors such as formal recognition of success, job security and the opportunity to learn continually and develop skills and knowledge.
However, when asked to rank those factors which managers felt their organisations relied upon to motivate staff, over half of respondents nominated PRP which jumped from ninth to second place in the ranking behind challenging and interesting work. PRP, concludes Handy, represents 'the biggest mismatch between what organisations are seen to be relying on to motivate managers and what actually motivates them'.
Researchers in the UK and US have consistently failed to produce any supporting evidence for the theory either that money motivates or that more money motivates more. With the exception perhaps of salespeople who work solely on commission, the Institute of Manpower Studies insists that 'the benefits most often claimed for PRP are not met in practice'. Alfie Kohn reviewing PRP research in the Harvard Business Review three years ago noted that no relationship has yet been discovered between fat cat executive bonus or incentive schemes and superior corporate performance.
On the shop floor too, evidence that productivity improves in tandem with the introduction of incentives is scant.
Even if such schemes have some sway, it is worth remembering, says Oonagh Ryden, policy adviser on pay and employment conditions at the Institute of Personnel and Development (IPD), 'that extrinsic motivators in the form of pay have, if anything, an immediate but short-term impact and that incentive schemes have a tendency to degenerate over time, often within five years'.
Organisations are full of good intentions and PRP schemes are generally well received at first, expands Peter McGrath, head of human resources at Clydesdale Bank, which has recently revamped the PRP scheme it introduced five years ago. 'But PRP tends to lose credibility either because the schemes don't actually pay out because the targets are too high or the schemes are not sufficiently transparent or predictable and staff don't understand the measurement criteria. Also PRP schemes need a fair amount of reinforcement and maintenance over time. They don't just happen but require managers to work hard to keep the system running. Without maintenance you find that the business has moved on and PRP is no longer aligned to the organisation's new objectives.'
Add to those problems the difficulty of measuring individual performance effectively, the expense of running a PRP system and the strong tendency for PRP, once introduced, to drift upwards and performance-related pay may lose some of its appeal. If you want people to do a good job, give them a good job to do, opined Frederick Herzberg, with fairly compelling logic.
But what if you want them to do their good job slightly differently?
Since incentive pay does focus people on the things which matter to an organisation, it can thereby help either to reinforce existing culture or change cultures which need to become more performance and results-orientated.
Allied Carpets, for example, as part of its drive to become a more customer-focused organisation, has linked a proportion of employee bonus not solely to carpet sold but also to customer satisfaction ratings.
By focusing attention on key performance issues, PRP can encourage employees to identify with the organisation's mission, values, strategies and objectives.
The link which PRP appears to provide between pay and the achievement of organisational and human resource objectives accounts for its continuing high corporate profile. According to research by the Confederation of British Industry and Hay, the desire of employers to strengthen the link between pay and business performance has been the key factor driving change in reward policy over the past two years. Based on responses from nearly 400 private and public sector organisations with a total workforce of 1.3 million, the survey suggests that companies continue to overhaul their pay and benefits practices. Almost half of those surveyed had revised their reward arrangements in the previous two years.
Organisations are increasingly aware that a focus on individual performance bonuses may militate against the team and competency-based culture which many are currently anxious to engender. 'Individual PRP tends to make people focus on short-term or narrow issues,' explains remuneration consultant Barry Cushway. 'In a sales environment, this may mean the salesman works hard to achieve his own targets but ignores the rest of the team. Or concentrates on sales but ignores back-up or the longer-term customer relationship.' Rewarding team spirit is, therefore, the new slant on PRP. Use of team pay (rewards provided to members of a formally established team which are linked to the performance of the team) is on the increase, says the IPD. Almost half of the public and private sector organisations covered by the IPD 1996 Guide on Team Reward survey said they were thinking of introducing a form of team pay within the next 12 months and nearly one quarter had already established formal systems.
The most common method of providing team pay for managerial, professional, technical and office staff is to distribute a cash sum related to team performance among team members. No typical bonus formula exists for allocating team bonus to individual team members although proponents of team pay as diverse as Lloyds Bank, Norwich Union, Rank Xerox and Portsmouth Hospital NHS Trust tend to use one of three methods. The first, adopted by Pearl Assurance among others, is performance related to defined criteria. Pearl Assurance has three measures: speed of processing, accuracy and customer service or satisfaction. The second approach ties the bonus to achieving one overall criterion while the third relates the bonus to the achievement of predetermined, organisational and team objectives.
Tony Strike, head of human resources at Portsmouth Hospitals NHS Trust (PHT), believes that the introduction of team PRP for senior management 'has fostered a corporate spirit towards the achievement of the Trust's objectives'. The PHT was restructured in 1993 into six new clinical directorates, consisting of cross-functional teams, each of some 850 employees. 'These directorates were set up as semi-autonomous units and we felt there was a danger that the goals each unit adopted might contradict those of the Trust as a whole,' Strike explains. 'Where resources are short, for example, each directorate may have become competitive rather than consider the best interests of the hospital.' To avoid counter-productive competition, the board decided to replace individual PRP for the 70 senior managers across the directorates by introducing team-based PRP in the form of a non-recurring annual bonus. The team payment is determined by the chairman and non-executive directors and is dependent on how they view the Trust's success in meeting its objectives. While Strike is happy with the overall results of this pay initiative, he admits there are drawbacks. 'Individual PRP was a much better way of picking out and rewarding individual good performers,' he says. 'We are currently exploring other, perhaps non-financial, ways of continuing to recognise individual excellence.'
Meanwhile Rank Xerox (UK) Ltd operates team bonuses for around 2,000 sales, management and engineering staff and calculates the payout according to three measures: customer satisfaction, sales revenue and market share.
'We thought it vital to link employee objectives to company goals and thereby ensure that everyone understands how they contribute to company success,' explains Marika Szalanczi, compensation manager for Rank Xerox (UK). The team bonus is based on the regional business plan and is determined by the team's performance against both the team revenue target and market share with a multiplier for customer satisfaction performance.
The bonus is paid quarterly but not to poor performers. Sales managers and team leaders have the authority not to pay the team bonus to any individual whom they believe has not contributed to the team's performance. One of the major advantages of this system, says Szalanczi, is that it encourages staff to work together and share best practice. 'If any member of the team is not performing well, then they are encouraged by the rest of the team through coaching and counselling.'
In 1993 BP Exploration (BPX) adopted a team-based pay system, which it calls gainsharing, as one of the three elements of its reward strategy for 2,500 employees at offshore and onshore installations in the North Sea and Norway. Designing the main part of employees' variable pay around a team bonus for performance beyond the BPX business plan is proving highly effective, says BPX's senior human resource adviser for pay and policies Kevin Higgins. BPX's endorsement is made all the more significant by the fact that BPX had already explored its reward structure in great detail in 1990 and concluded that the existing system (which included a generic performance bonus paid to the entire workforce at the end of each year on the performance of the BP group as a whole) had little positive impact on employee behaviour.
The BPX gainsharing schemes are tailored at the asset level to meet local targets and are supported by broader company-wide performance measures.
The asset targets are team-based and constructed around production, cost and safety measures. A minimum stretch standard (for stretch performance beyond the business plan) is identified for each performance target and where team performance exceeds this minimum target figure, employees receive a gainshare or team bonus. Gainshare bonuses are currently capped at 15% of median pay, with an average payout of 8%-10%. 'We can afford to be relatively generous,' says Higgins, 'because targets would not be met without extra effort and so productivity is increased. As the company gains, the staff share. We have seen the benefits of paying out for specific achievements rather than generalised wishlists.'
The current drive towards team rather than individual PRP is matched by a growing interest in ways to link pay with skills or competencies.
Almost 15% of employers participating in the 1995 IRS Employment Review annual survey of pay prospects stated that they were considering restructuring their reward systems along skill-based lines over the next 12 months and a quarter of respondents to the CBI/Hay survey currently use a skill/competency-based approach to managing pay.
According to the IRS skills-based pay survey, no single definition of skills-based pay exists and the term can describe anything from awarding a supplement for operating a particular piece of machinery to arrangements where a formal assessment of skills is used to locate an individual employee on a skills-based pay structure. With competency-based arrangements, organisations identify and assess the functional and behavioural competencies which are key to their success. Competency-based reward systems are designed to reinforce the drive to develop these key skills and behaviours among the workforce.
James Richards, senior personnel officer at National Power, believes that the transformation of National Power's pre-privatisation PRP system into a competency-based approach has helped engender a 'performance culture' within the organisation. Richards joined National Power 10 years ago when, he says, 'PRP had become an increment which was only stopped when an employee did something really outrageous'. The new competency system emphasises individual contribution through a combination of behavioural competencies, skills and targets. National Power has defined a number of competencies required throughout the organisation including communication, organisational contribution, supervision and leadership. Managers together with staff select those competencies most useful for the employee's task, and performance is assessed against those competencies. 'It provides a consistent process for rewarding and reviewing performance,' says Richards.
While the team and competency-based approaches to PRP may address some of the defects of traditional incentive pay systems, formidable problems remain. The effectiveness of team pay depends on the existence of well-defined and mature teams and on the ability to develop performance measures and methods of rating team performance which are seen to be fair. In addition, failing to distinguish the contribution of individual team members may demotivate individual contributors while organisational flexibility may be prejudiced if people in cohesive, high-performing teams are unwilling to move teams.
Moreover, for some occupations including salespeople, team pay may simply not work. Salespeople at the Prudential, for instance, are paid a basic salary plus commission based on the product they sell, its term and premium size.
'We don't favour team pay for salespeople as it doesn't suit their method of working,' explains Howard Naughton, compensation and benefits manager at the Pru. 'Selling tends to be a solitary pursuit and so rewards are geared towards individual performance.' Skill-based pay, too, has potential drawbacks which include creating training aspirations that are difficult for the employer to fulfil and the expense of paying for skills which are not used or which quickly become obsolete.
Badly designed and poorly implemented PRP schemes will demotivate staff more successfully than well-designed and implemented schemes will motivate them, says Cushway. Research suggests that some schemes appear to have demotivated 10 people to every one they motivated. Hampshire chief constable John Hoddinott, for example, recently declined a Home Office appointment because it included an element of PRP. 'The notion that I will work harder or more effectively because of PRP is absurd and objectionable, if not insulting,' he said.
Incentive pay is beautiful in theory but very difficult in practice, concludes the IPD's Oonagh Ryden. 'I can't see it disappearing but it continues to create dissatisfaction and a groundswell of resentment. While it can be used to advantage, doing that extra bit for your employer is unlikely ever to come down just to PRP.'.