UPDATED FOR 2022

Performance-based pay is a type of compensation that rewards employees for their contributions. In this blog, we look at how performance-based pay works and reasons to implement it in your organization.

Performance-related pay, or pay for performance, is a financial rewards system in which all or some of the employees’ monetary compensation is related to how their performance is assessed relative to stated criteria. The success of this type of compensation depends largely on communication. Participants must know what you’re rewarding for, what they need to do to be eligible for rewards, and whether rewards are tied to individual, group, or organizational performance. Thus, your stated criteria should reflect your company values and be consistent with the message you’re sending as an organization. Learn more about the foundations for an effective performance-based approach to pay here.

How Can Your Compensation Philosophy Support Performance-Based Pay?

Your compensation philosophy is an integral component of performance-based pay. It is a set of principles organizations use to manage their compensation plans. In publicly traded companies, the compensation philosophy should be part of the company’s proxy statement.

A compensation philosophy defines who your competitors are for talent, and encompasses the following additional components:

Why Implement Performance-Based Pay?

At the most basic level, performance-based pay aligns risk (the cost of compensation) with results delivered. For example, companies that are performing well and have a high rate of return can afford higher increases.

Performance-based pay also focuses attention on what’s most important to the organization. It drives desired behaviors and is aligned with the needs of a particular business by linking to the company strategy. This approach also allows employees to contribute to their own success, facilitating engagement in the process.

Additionally, performance-based pay is a rational way to differentiate employees. People often become discouraged with pay structure, not because of external factors, but when they look around their own department: when employees see peers in similar roles making more than they are for the same level of contribution, they become demotivated. Performance-based pay addresses this issue by recognizing and rewarding the team members who are making the greatest contributions.

At the same time, it can also enhance the communication between supervisors and their employees – given that it’s administered correctly. Finally, clear, structured, and well-executed plans can also help companies that fall under pay equity regulations defend their compensation decisions.

What Is the Role of HR in Plan Design?

It’s important to emphasize that although performance management systems are sometimes perceived as an HR function, that is not the case. Instead, the role of the HR business partner in plan design encompasses:

  • Gathering input from stakeholders
  • Aligning the performance plan to support the business strategy
  • Providing external pay data to support management decisions
  • Researching best practices in performance management
  • Providing advice and counsel based on data
  • Supporting training efforts and implementation of the plan

In short, HR business partners should provide input and expertise, and inform leadership of how the plan could work. Keep in mind that involving stakeholders is very important to successful plan design. The more people you involve, the easier it is to gain acceptance.

Conclusion

Now that you know what performance-based pay is, you can begin talks with your HR team to implement the compensation strategy in your organization. You can also look into performance management software that aligns with your goals.

HRSoft’s performance management software, PERFORMview, is proven to drive better feedback conversations, align goals and promote informed and justified reviews. See how it works by requesting a demo today.