Unless you have been living on a different planet for the past couple of years, you know that performance management has undergone a transformation. Flexible, agile, forward- looking approaches have replaced old, structured, rearward- facing assessments and reviews. If you are one who has joined this trend, I do not have to tell you that the new methods are no panacea. And they are ever evolving. As a result, in the midst of this change you are likely trying to figure out what to do about your rewards approach—and not finding adequate solutions. And so you are left wondering where your pay strategy fits in this less rigid environment and what role should it should play in helping your performance management system succeed.
Well, here is one way of looking at it. In many respects, your compensation plan’s performance should be evaluated in much the same way you assess your employees. You have “hired” your pay strategy to do a job and you need a means of determining whether or not it is meeting expectations. If it is not, you need to either improve or replace your approach.
So how do that? What principles should you be following to ensure that the way you pay your people is compatible with the system you are using to manage and evaluate their performance? I’ll offer three.
1. Tie Pay to a Philosophy. You need to know what you believe about the outcomes for which your people should be paid. And you need to put what you believe in writing. If you follow this blog, you know I have talked ad nauseam about this—and you are probably tired of reading about it. But I do so because it is that important. As things in business change and evolve more and more quickly, I will likely be talking about it more, not less.
Your compensation philosophy should clearly articulate at least these things:
- How you define value creation in your business; the profit, revenue or other threshold that must be met before you will start paying incentives to your people.
- Where your company wants to be relative to market pay. (This may vary according to position categories or salary tiers.)
- The balance between guaranteed income and incentive compensation you want to maintain.
- The percentage of incentive pay that should reward short-term versus long-term performance.
- For long-term incentives, what you believe about tying the value to business growth versus other financial metrics.
- Under what circumstances equity will be shared.
- How merit increases will be determined.
There may be more things you want to address but this gives you some idea of what your statement should include. Consider your philosophy to be a kind of pay “constitution.” You will want to reference it regularly as you map out your pay strategy, speak with employees about their value proposition or begin the design of any new compensation offering.
2. Hold Pay Accountable. The subject of accountability is usually tied to people. So what does it mean to hold pay accountable? It means you make an effort to isolate your company's profits that are attributable to the productivity and performance of your human assets as opposed to other capital resources and assets already at work in the business. At VisionLink, we call this "productivity profit." You calculate it by subtracting a reasonable shareholder capital “charge” from our net operating income. The capital charge is the percentage of profits the company feels should be returned to owners before value is shared with anyone else. This measure is one way of defining value creation in a business.
The concept of a productivity profit helps employees understand where their contribution to value creation actually begins. All incentive payments should be made out of productivity profit. If a productivity profit is not produced, then incentives should not be paid.
When you commit to holding pay accountable in this way you will find that it drives employee accountability to greater levels simultaneously. This is because in order to maximize their earnings, they have to learn how to become stewards of the company’s profits. The more value is created (productivity profit), the higher their incomes can climb. This is one of the ways that sustained success takes root and is perpetuated. When this occurs, a lot of performance management issues take care of themselves.
3. Keep Pay Agile. Business is all about agility these days, which is why performance appraisal systems are being transformed. Organizations want their employees to be able to adapt to change and move quickly to alter their focus and priorities. As a result, compensation systems and programs need to be able to flex and adapt within this kind of environment.
So, does this mean you should plan to come up with a new pay strategy at the start of every quarter? No, that would obviously create a whole new set of problems. What you want is a pay approach that is agile but enduring.
Let’s start with the enduring part. You make your compensation strategy sustainable by creating a structure in which to manage it. Usually, this requires the creation of a system that allows you to view all of your rewards offerings in one place by tier or salary grade. Such a perspective allows you to quickly determine how balanced your approach to pay is and where any gaps might exist. When you set up this kind of structure and system, you can easily and frequently evaluate where changes need to be made in your comprehensive strategy.
A structure also enables agility. Because you always have a full view of your complete value proposition, you can move quickly to make changes in the “weight” each component is given. Here is what I mean. Think about your compensation structure as you would an investment portfolio. Each pay component is like an asset class. In an investment portfolio, you wouldn’t typically make radical changes from quarter to quarter in the core assets you hold. What you would do is just rebalance the portfolio. Similarly, with a compensation structure you are able to quickly decide whether a given pay “asset class” should receive more or less emphasis. This way, you can respond to current enterprise conditions without reinventing your value proposition every three to six months.
Business systems are going to continue to change and adapt. Performance management will go through new metamorphoses in the future just as they have in recent years. Focusing on these three principles will ensure that your pay strategy helps and doesn’t hinder the performance environment you are trying to manage and improve.