Is Performance Based Pay Practical for Your Company?

employees competingOver the years, many companies have attempted to implement performance based pay for employees. Some have been successful with the programs, while others have experienced utter failure. So what makes a performance based pay program work in some situations and not others?

Research and real-world trial and error suggest that the success of a performance based pay system can vary greatly depending on many factors, including:

  • Employees’ level of commitment to the company
  • Length of the program
  • Manager expectations vs. employee expectations
  • Realistic balance of company cost and employee reward

These are not the only factors that can impact the success of a performance based pay system, of course, but they are all extremely important influences on how the performance based pay system will operate. Consider the following discussion of the points above to determine whether a performance based pay system would be appropriate for your company:

Employee Commitment

Believe it or not, research indicates that the most successful performance based pay systems are those that are implemented at low-commitment companies. In businesses where employees are highly committed to the company, performance based pay initiatives are often not as well-received by employees as they are at low commitment companies.

In low commitment companies, employees view the opportunity to receive additional pay based on increased performance as a great way to make extra money, and their productivity increases as a result.

In high commitment companies, however, performance based pay systems are rarely worth the effort. Often, because they are loyal to their companies, employees are willing to work harder to meet deadlines anyway, making performance based pay incentives an unnecessary expense. Research shows that in some instances, highly committed employees may even become offended by the company’s introduction of performance based pay, viewing the program as a form of bribery.

desiring to winLength of the Program

The length of your performance based pay program will be a huge determining factor of its success. Research indicates that some of the most successful performance based pay systems tend to be those that are implemented only temporarily.

The reason behind this is that when faced with an ongoing performance based pay system, many employees adjust to it very quickly. After a time, employees become accustomed to receiving increased pay, and in the event that that pay is lowered (when performance objectives are not met), employees feel as if they have been cheated. This causes morale to drop, which can cause performance to decrease even more. As business researchers Michael Beer and Mark Cannon remarked in their performance based pay research, “A workforce that always expects additional pay for additional progress can become a liability.”

When performance based pay systems are implemented only as temporary solutions, though (for rushed projects, important client deadlines, etc.), employees tend to view the increased pay as a bonus, rather than as a guarantee.

Manager Expectations vs. Employee Expectations

One of the main reasons performance based pay systems fail is a lack of communication between management and employees. In order for a performance pay program to be successful at your company, you must ensure that employees and managers have similar expectations for the program. Some common points that must be discussed with employees include:

  • How long will the program be in place?
  • What are the reasons behind the program? (Are you attempting to meet a client deadline, beat the competition to market, temporarily push to fill a productivity gap, etc.?)
  • How difficult will it be to see a pay increase based on the requirements of the program?
  • How will outside factors affect evaluation? (For example, if an outside manufacturer is late with a delivery that one of your departments needs to continue with production, will the affected department suffer under the performance pay program’s deadlines despite the fact that the delay was no fault of their own? If not, how will the rules be adjusted?)

If management does not discuss the ins and outs of the program with employees, then they are bound to encounter problems. For a performance based pay program to be effective, it must also be fair, and in order for it to be considered fair, it must be completely understood by each and every employee who takes part in it.

Costs vs. Benefits

winning the contestThe most important component of your company’s performance based pay program is the balance of costs and benefits. Studies have shown that a huge number of companies overestimate the benefits of performance pay systems and severely underestimate the costs. In order for your performance pay program to be successful, you must be realistic about the costs and benefits. Consider the following questions when evaluating costs:

  • What estimated percentage of employees will receive increased pay under the program?
  • How much of a pay increase will employees have to receive in order to sustain increased performance? Can the company afford that increase?
  • Realistically, how much will the company benefit from the increased employee performance?
  • How long can the company sustain the program?
  • How much time will management have to spend implementing, tweaking, and/or redesigning the program? How much will those adjustments cost the company?
  • Could the predicted benefits of the performance based pay system also be achieved through more conventional and less costly managerial methods like coaching, training, etc.?

Performance based pay systems are not as straightforward as many companies think, so before implementing one at your business, it’s important that you try to learn from the mistakes of those who came before you. While performance pay programs can be extremely effective, they are unlikely to be successful if you do not perform thorough research before implementing them.

If a performance based pay program is to succeed at your company, you must ensure that managers and employees communicate their expectations clearly, that you carefully research the best length of time for your program, and that you find the perfect balance between employee reward and company profit.

If you don’t, then like so many before you, you will likely watch helplessly as your performance pay program transforms from a promising productivity booster into a terrible failure and a large drain on company resources.

Photo credits: © pressmaster / Fotolia.

About Andrew Jensen

Andrew Jensen, a business growth, efficiency & marketing consultant, provides business advisory services for clients in the Baltimore; Washington, D.C.; York, Hanover, Lancaster & Harrisburg, PA regions. Andrew advises regarding business growth, productivity, efficiency, business startups, customer service, and online/offline marketing. Follow Andrew on Google+

Comments

  1. The question of whether performance based pay is practical for your company is really a matter of motivating employees through the use a financial based incentive. Although the four points you have illustrated are great and in my mind correct above all lies the question of what type of work the employee is engaged in. If it is creative work, pay-based incentives have been shown to reduce performance, however in autonomous roles performance may increase. You may find this article interesting. http://www.ted.com/talks/dan_pink_on_motivation.html

  2. Abi Shaan says:

    We at batteryrevival.org being a startup are also facing a tough time trying to figure out a performance based pay structure for our team to get them motivated.

    The problems we face is that we can’t afford to increase their salary as we are having a tough time in acquiring funding for growth and at the same time, our team has been working for over a year now.

    Stagnated is not enough to describe the situation. :(

  3. Patrick Mphaphuli says:

    The company that I work for is also implementing what they call ‘Performance Pays’, meaning employees will get any increase based on their performance. I would like to do my MBA research on whether this has increase the performance and motivation of the employees. Can you please refer me to some articles that I can read to do this research. Your assistance will be very much appreciated.

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