Compensation & Benefits

Published May 2006

Strategic Compensation: Pay for Performance

Kevin Dobbs

Pay for performance plays an essential role in achieving workforce alignment. Many leading companies practice this compensation management discipline with varying degrees of success. Typically they rate their managers on a bell curve annually, assigning an overall performance rating from "Exceeds objectives" to "Does not meet objectives."

At many companies, the "Does not meet objectives" generally have to go, while others are awarded bonuses, raises and stock-option grants commensurate with their rating.

Unfortunately, although most organizations profess to subscribe to pay-for-performance philosophies, many simply cannot execute. There is a broken link between senior executives' desire to differentiate pay based on performance and line managers' ability to do so. Relating compensation to individual performance for tens or hundreds of thousands of employees across large global companies is nearly an impossible task today. Complexity in compensation processes creates apathy among managers who do not see themselves as compensation experts and instead take the path of least resistance.

Hence, the companies use the "peanut butter" approach to compensation distribution, spreading merit increases, bonuses and stock options equally across the employee population. Top performers are not given rewards commensurate with their contributions, and under-performers are over-compensated.

Shockingly, the peanut-butter approach is used in company after company, where employee-related compensation spending consumes up to 80 percent of each operating expense dollar, according to industry research. This reality practically screams for a pay-for-performance solution that keeps compensation expenditures in line with the allocated budget — a system that makes managers compensation experts and, above all, makes them believe in the pay-for-performance process and take ownership of it.

Challenges

Today's business environment provides a stark backdrop for the ongoing disconnect between corporate performance and individual compensation. Unfortunately, in all too many companies, workforce misalignment is the norm. Despite strong commitment from senior executives to differentiate pay based on performance, managers throughout the organization have a difficult time doing so.

Meanwhile, economic pressures conspire to force organizations to do more with less. As compensation funds shrink, how are limited resources best used? Every day newspapers are filled with the latest news on lower-than-expected earnings, mergers, acquisitions and corporate restructurings, all of which beg the question: Which employees will be chosen to stay, which will go, and how shall the remaining ones be motivated?

Without a connection to compensation, performance management lacks the element of execution. How can companies ensure that employees will actually be financially rewarded for meeting performance objectives? Adding compensation to the equation brings the required element of execution to performance management, ensuring that it is a true pay-for-performance strategy that can deliver tangible business results.

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