Five Keys to implementing an effective pay-for-performance program.

1) Leadership articulates pay program priorities

The first key is to outline the real priorities for your pay program. It’s important for the leadership to be aligned around the real issues at hand. Pay program priorities typically include things like:
•Attracting and retaining most people
•Attracting and retaining the key people or groups
•Motivating effort
•Aligning effort with goals
•Keeping costs competitive
•Ensuring overall fairness and equity
•Ensuring that cost of living increases are given if appropriate (assuming this is the goal of the company)
•Ensuring that there are no surprises in the way the program is run (this year should be similar to last so the employees get what they expect)

When establishing a pay-for-performance system in your organization, first ensure employer and employee expectations are explicit. When goals compete (as some of the examples above do), this can be discovered by clearly articulating the goals up front and determining how to proceed. If employees expect rewards without clarity about the employer’s business-based expectations, rewards become an entitlement instead of a motivator.

2) The pay structure should define the opportunity

The second key to creating an effective pay-for-performance system is ensuring that the pay structure defines the employee’s pay opportunity. Employees should understand what pay is available for their role. This means that the appropriate pay structure needs to provide (for each person and job) both market equity and internal equity. The pay opportunity should outline the base amount and the amount available if goals are met.

3) The goals should be set at the top and aligned throughout the organization

Individual goal and priority setting must be done in light of company and unit goals and priorities, and with cross unit alignment. In other words, the CEO and executive team set the company and executive goals. They should also review unit goals.

Then the business units cascade the corporate goals to middle managers and to the overall business unit objectives. They also align goals across functional units. Finally, individuals and their managers ensure employee goals and priorities are linked to the unit goals. Expectations should be clear. The overall goals and objectives should be visible to others.

4) Ratings should be differentiated

The fourth key to effective pay-for-performance systems is to ensure that ratings are differentiated. “The trend is away from a forced distribution or away from a forced ranking.” Jim Kochanski explained in a recent BLR webinar. In other words, ensure that the distribution of ratings is not forced into a pre-defined set. Instead, successful companies are creating a target distribution that is linked to organizational performance and making the actual distribution – which may differ from the target – visible to company leaders.

5) Managers should meet to discuss compensation decisions

Calibration of goals and ratings across managers improves rating differentiation because it reduces the subjectivity of ratings and encourages similar standards across groups. “What we mean by calibration is saying that before those ratings and rewards and sometimes goals are finalized, that peer managers compare their recommendations with each other and their boss.” Kochanski explained. This allows them to develop performance norms and calibrate ratings.

This must be done before the ratings are finalized. Having peer managers meet to calibrate ratings and compensation decisions creates and reinforces performance norms and creates positive tension to differentiate appropriately. Senior management should approve decisions in a final calibration meeting.