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Day 20: Using Pay for Performance to Drive Results

Carl Kleimann

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Over the past several decades, America has migrated from a manufacturing economy to a knowledge economy. The relatively low cost of foreign labor has rendered us largely uncompetitive in labor intensive industries. As a result, the strength of the U.S. workforce is no longer its muscle but rather its brains. And while this transformation is still in progress, the average pay for a U.S. worker has already risen considerably, improving our overall standard of living. It has also created tremendous opportunities for emerging economies which ultimately increases the global market for many of our goods and services.

So what does all of this have to do with how you compensate your employees? While America’s workforce has been forced to evolve, our strategies for motivating employees have not kept pace. Incenting someone to perform repetitive tasks on an assembly line is much different than motivating someone to use their creative skills and to be intellectually engaged. Adding to this challenge is the fact that we now have four distinct generations in the workforce; more than ever before. You need an incentive compensation strategy that appeals to baby-boomers as well as generation X’ers.

Incentive pay, also known as “Pay for Performance” has gained widespread acceptance among organizations of all sizes and types. It is generally used to reward someone for achieving specific results as opposed to the amount of time they work. And while incentives are not the answer to every personnel challenge, they can be very effective at improving worker performance, employee retention, and engagement.

There are two general types of incentive pay and although each rewards specific employee behaviors, they differ substantially. In structured incentives, workers understand ahead of time the precise relationship between performance and the incentive reward. In a casual approach, workers never know when a reward will be given. The focus of today’s lesson is on structured incentives.

Structured incentives help direct employee efforts in order to improve productivity and/or quality. Other benefits include cost certainty and in many cases, cost reductions. Benefits to employees include the opportunity to earn higher pay for a job well-done and achieve greater job satisfaction.

A structured incentive (1) must be capable of fluctuating (variable pay) as performance changes, and (2) is based on a specific accomplishment-reward connection that is understood by both management and workers.

Examples of typical Structured Incentives:

  1. Production or Quality Incentive – pay that is based on the amount of product and/or service production and/or the quality of the product or service produced by an employee.
  2. Cost Containment/Reduction Incentive – pay that is based on the overall efficiency that an employee or group of employees achieves.
  3. Profit Sharing Incentive – pay that is based on the overall profitability of the organization. This is typically a team based incentive that rewards all employees equally based on team performance rather than individual performance.

Conclusion:

Even though most employees recognize that increased productivity and attention to detail will likely result in indirect rewards such as continued employment, and raises and promotions, structured incentives are characterized by the exact and expected timing and amount of the reward. In other words, if you achieve this, you will receive that. Employers and employees alike benefit from this more direct link between performance and pay. A good structured incentive plan draws a clear roadmap for employees to achieve the results that you desire. As with any plan, it requires constant monitoring and mentoring to help employees make all the right turns.

Structured incentives are most likely to succeed if they: (1) have reasonable and accurately established standards; (2) clearly link superior performance with pay or a valued reward (such as paid time off, a company paid vacation, advancement, etc.); and (3) are effectively communicated to employees. Effective incentives are designed so that the more an employee earns, the more the employer benefits.

Action Items:

  1. In order to decide whether a Pay for Performance plan is right for your business, follow these steps:
  2. Analyze your most prevalent business challenges (cost, quality, turnaround time, etc.) and determine if incentive pay is an appropriate solution to one or more of them.
  3. If so, then find a way to link your employees’ pay with the performance necessary to address the challenge(s).
  4. Establish standards and determine pay.
  5. Anticipate loopholes in your plan. Employees can get very creative when it comes to their wages.
  6. Protect workers from negative consequences that are beyond their control.
  7. Communicate with employees about the plan. Make certain that they understand your underlying objectives (i.e. the big picture).
  8. Periodically review the plan with your employees and be open with them about any changes to the plan, including why you are making them.

The purpose of any incentive program needs to be clear and specific. Once your employees truly understand what they must do in order to grow their income, they will be more candid about training and other resources they need to be successful. No amount of incentive will help an unskilled manager improve production. It is management’s job to make sure that they have the tools and resources necessary to take full advantage of your plan.

This is not something that occurs overnight so don’t get discouraged. Once you have a nucleus of employees on-board, others will follow. Over time, your best performers will also become your most highly paid employees and your worst performers will be more likely to move on to “greener pastures.” You will marvel one day at how harmonious and effective your organization has become.

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