The New Pay Reform: Pay for Performance

Compensation and Benefit Structure is the backbone of any organization. Researchers have found out that it is imperative for all organizations to adopt an innovative salary structure as it directly affects the company’s growth. The last decade witnessed a sea change in the compensation structure of employees in India Inc., which is now in a transition phase. It is adopting some of the best practices in C&B from its counterparts in the west. This is in light of:

'When an employee's extra efforts are not reflected in rewards and recognition, it erodes performance and commitment to the organization, said Tom McMullen, reward practice leader at Hay Group, a pay consultancy. At the same time, managers often confront a general notion of fairness among workers that goes back to childhood, which he summed up as "If he gets that, then I should get that, too."

But treating everyone "equally," despite their varying contributions to the organization, is not always fair. So managers can find themselves in a bind. "Don't confuse equitable treatment with equal treatment. A one-size-fits-all approach won't work," said Mark Royal, reward practice leader at Hay Group.

"There is a strong possibility for sour grapes if there is a lack of confidence in the process of allocating rewards. As rewards professionals, we impact perceptions of fairness," McMullen added.

Traditional compensation methods may hold a company back from adequately rewarding its best workers. When compensation is tied to a base salary and a position, there is little flexibility in the reward system. Some new compensation systems, on the other hand, focus on reward for skills and performance, with the work force sharing in company profit or loss. One core belief of new compensation policies is that as employees become employee owners, they are likely to work harder to ensure the success of the company. Indeed, programs that promote employee ownership—and thus employee responsibility and emotional investment—are becoming increasingly popular.

The term “pay for performance” refers to a pay strategy where evaluations of individual and/or organizational performance have significant influence on the amount of pay increases or bonuses given to each employee.  These programs, sometimes referred to as variable pay programs, generally offer compensation incentives based on employee performance or on the performance of a team. Pay for performance rewards high performance and does not reward mediocre or low performance, and is the definition of the "merit" system.

In a true merit based system, there are a few conditions which must be satisfied for it to be meaningful:

• Employees must have control over their performance. If employees are overly dependent on the actions and output of other employees or processes, they may have little control over their own performance.
• Differences in performance must mean something to the business. If there is little difference between a high performer and a mediocre one, merit pay won't work.
• Performance must be measured regularly and reliably. A clear system of performance appraisal, with defined criteria that are understood by the employee and regularly scheduled meetings must be in place.

“Pay for performance can be a powerful driver of organizational change and success, with one condition: You don’t confuse it with traditional merit pay systems,” said MacLean, who urged attendees to “drop the use of merit increases and merit matrixes altogether.”

However, merely adopting practices from the West would not help as they need to be adapted well. The organizations in India need to formulate the remuneration mix keeping in mind that an employee has varied aspirations.  For instance, in India a person’s family holds a lot of importance for him as compared to US or UK, where people usually lead an independent life. Therefore, companies in India have started giving medical insurance to employees and their dependents.

Another important point to remember is that the dynamics in the industry are changing and changing fast. Hence there arises a need to constantly upgrade the C&B plans. Also people programs and policies need to be aligned to the business strategy with a focus on talent management.   

The effectiveness of pay for performance in facilitating recruitment, retention, and motivation (and the resulting improvements in individual and organizational performance) depends heavily upon matching the approach to the situation.