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Effective Pay-for-Performance Strategies

Regardless of the diverse composition of your workforce today, a solid understanding of what triggers top-flight individual contributions is essential to developing an effective pay-for-performance strategy

Tuesday, January 3, 2012
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Despite its familiarity in the workplace, the phrase "pay for performance" likely means different things to different people. This lack of clarity and understanding can keep employers from meeting short- and long-term goals and employees from deriving satisfaction in their roles and careers.

For top management, performance has most often been defined by metrics commonly reported to public-company shareholders or otherwise easily calculated, such as earnings per share or total shareholder return. This has afforded top management and shareholders a clear view of the linkage between pay and the final measure of performance.

But unfortunately, the means to achieving that end measure of performance were not typically included as performance measures. As for other employees, the metrics used for linking pay to performance were not always considered from a business-performance perspective.

In some companies, middle management and lower-level employees might have been incentivized based on overall company goals, without knowledge of how their role impacted the company as a whole.

In other cases, they were incentivized based on individual-performance measures that had no direct linkage to company performance, and during years of poor company performance, incentive pay was reduced or eliminated -- even for high performers.

Balancing your organization's use of pay and other rewards with meaningful measures of individual performance helps create a talented, engaged workforce and an organization capable of creating long-term value. This applies to the entire organization, including top management.

A properly managed pay-for-performance program should reflect:

* What fuels individual performance;

* What links individual performance and organizational performance; and

* How to effectively use performance goals to achieve short-term successes and long-term objectives while managing risk.

Fueling Individual Performance

With talent management identified as the No. 1 focus of CEOs around the globe, according to PwC's 14th Annual Global CEO Survey in 2011, it's critical that employers weighing workforce strategies understand and apply the behaviors that enable them to attract, reward and retain pivotal talent.

The retirement-savings hit inflicted by the economic downturn, combined with longer life expectancies, have kept many baby boomers in the workforce beyond traditional norms. These more deeply experienced workers now contribute side-by-side with recent college graduates and Generation X, which is establishing itself as the predominant workforce population.

Amid this diversity, no single approach is likely to enable your organization to achieve its talent-management objectives. Baby boomers may be more highly motivated by financial rewards, while millennials (also known as Generation Y) -- who entered the workforce during the 21st century -- are more likely to respond to career-advancement incentives.

In Managing Tomorrow's People: Millennials at Work, our 2009 survey finds that this latter group chose training and development as its first choice among benefits three-to-one over those who opted for cash bonuses.

When considering the most effective reward package for sparking individual performance, your organization should take into account the typical components of most reward programs: salary, short-term incentives, long-term incentives, benefits (including health insurance, retirement savings, and vacation pay); training and development, and recognition.

Many organizations have also been focusing on work/life balance and offering new benefits, such as flexible work schedules, telecommuting opportunities and sabbaticals.

Although the "pay" in "pay for performance" can refer to any of the more traditional components of reward programs, your organization should look beyond its current forms of remuneration and consider whether additional approaches might work best in the long term.

Regardless of the diverse composition of your workforce today -- in experience levels, gender, location, work style, or any number of variables -- a solid understanding of what launches top-flight individual contributions will be essential to developing an effective pay-for-performance strategy.

Rewards that Resonate

Compensating an employee with the same amount of monetary value as that created by the employee for the organization is viewed by some as the "holy grail" of compensation strategies.

But it's rare that such value can be measured. And value can be tough to grasp, particularly when its creation is not a direct, easily quantified objective, as is the case, for example, with employees whose roles are to preserve the organization's value through public relations or customer service.

For top management, responsible as it is for the overall success of the organization, individual success can and should be measured by organizational success. Even so, determining the value created by top management is no easy task.

Because total shareholder return and other measures based on share price don't fully take into account the effect of the market in those measures, high-level managers can wind up under- or overcompensated. And, while measures of performance that can be controlled, such as reducing operating expenses, provide far superior linkage between individual and organizational success, they're still not perfect.

With the lines between individual-performance measures and organizational performance often dotted, the term "pay for performance," while hardly alien, isn't always thoroughly understood or effectively applied.

To strike the right balance, leaders need to understand the behaviors of each employee group responsible for creating or preserving organizational value and use that knowledge to develop reward programs that encourage those behaviors.

Consider, for example, a payroll manager who's responsible for timely and accurate payroll submissions to ensure that employees are paid as expected. This manager's contribution prevents loss of productivity if employees discontinue work to determine why they weren't paid on time.

High performers in this role might, as a rule, effectively manage their time, use proper planning and efficiently apply technologies. As such, the payroll manager can be rewarded based on having achieved measurable objectives in these categories. If the payroll manager is a millennial, a company-sponsored trip to an annual payroll conference, which sweetens the package with millennial-minded training and recognition, can be a crucial ingredient in rendering a reward that resonates.

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Your organization can fully assess its linkage between individual and organizational performance by conducting competency assessments and interviews with critical stakeholders, with the approval and support from appropriate organizational leaders.

Enhancing Performance while Reducing Risk

Once you have an organizational understanding of individual-performance boosters and the linkage between individual and organizational performance, individual goals should be established with consideration as to how they'll support organizational goals.

Choosing the right short-term and long-term goals without creating excessive risk for the organization presents the final challenge in the mission to balance the pay-for-performance equation.

Most organizations set short- and long-term goals as part of their business plan, providing the basis for individual goals and incentive-pay programs. Organizational goals, which often pertain strictly to financial performance, are used to set similar financial goals for the workforce.

But armed with the knowledge of how employee behaviors fuel organizational performance, you can determine individual goals that will encourage positive behaviors that will propel the enterprise toward its strategic objectives.

When setting short-term goals for employees, the focus should be trained on what's tangible and achievable. A goal of increasing earnings per share by a specific percentage for the year will be more effective and better support a high-performing culture when rewards reflect achievements that fall within their span of control.

Long-term employee goals should parallel and contribute to the organization's vision for sustainable financial success.

For example, since CEOs place talent management at the top of the corporate agenda, the successful implementation of a strategy to attract, reward and retain pivotal talent should be viewed as a long-term goal of top management.

Although this strategy might not provide staggering return in the short-term, it can position the right workforce and the enterprise to deliver on long-term goals. The success of this goal can be measured statistically using workforce metrics such as the turnover rate of priority talent and employee-engagement-survey feedback.

The goal-setting process should also take into account the importance of risks and rewards. On the one hand, risk management can help keep the process consistent with the company's risk profile and contain and reduce behaviors that might be deemed excessively risky. On the other hand, performance goals that languish without achievement-based rewards can quickly lose impact and relevance.

A performance-funded plan is an effective way to make sure that monies will be available to recognize employee achievement. This kind of funding mechanism can serve as an operational self-fulfilling prophecy by setting performance goals and payout levels based on formulas that depend on corporate success.

Keep it Simple

Many factors contribute to establishing and maintaining a meaningful and effective pay-for-performance program. But program management needn't be overly complicated. A successfully designed plan should be meaningful and simple.

It won't always be feasible or cost effective to set specific goals for every employee, or even every employee group. But if your organization understands and communicates the linkage between individual performance and organizational performance, you can create a sense of concrete continuity for employees, management and investors alike.

Brandon Yerre is a director in the compensation practice of PricewaterhouseCoopers Human Resource Services. He is based in Dallas.

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