How to Get Pay-for-Performance Right

Image: matdesign24/iStock

A popular management philosophy in Asia today, pay-for-performance uses the “carrot and stick” approach to reward high-performing employees through mechanisms such as increases in base pay, bonuses, profit-sharing, and equity awards. But does it actually work?

Traditionally, we’ve seen that pay-for-performance models work well for low-to-mid level employees, where work is transactional, and quality is easily discernible. Examples include tradespersons, assembly line workers, or a product salesforce.

For the vast majority of employees though, pay-for-performance models may not be as effective because employees are not confident that their actions are accurately assessed, or directly linked back to sometimes high-level and vague performance outcomes.

The high risk-high reward outcomes inherent in pay-for-performance models are intended to motivate employees to perform better and work harder. However, analysis conducted by Willis Towers Watson suggests that the majority of employees would prefer relatively guaranteed, or low-risk options, even if they yield lower reward.

In other words, current performance management systems may not be effective.

The love-hate relationship with performance ratings
Traditionally, performance is measured through a system of ratings, usually one that gives employees a score along a five- or seven-point scale using a normal distribution curve. That is, most employees will be rated as average performers, with a few outstanding and a few lagging behind.

But does this allow for correct evaluation of performance? Companies trying to manage distribution curves ultimately have to force rank on employees, and that is where the fundamental problem lies.

Two managers in the same team view performance very differently, let alone the entire organization. So how can we expect a system that rates all employees on a distribution curve to be fair?

In recent years, recognizing these drawbacks, several companies have tried to tweak or completely redesign this system. But have these changes been sufficient to drive right behavior and build a performance culture?

If target setting, process and methods of evaluation and calibration remain the same, then changing the rating system will not make any difference. 

What’s going wrong?

Instead, what we need to do first is understand whether the core issue is around evaluation of performance, or its impact on reward.

As discussed above, we believe the main problem lies with the performance evaluation process.

As an employee, my bigger concern is whether my performance is being correctly evaluated, and less around how it impacts my reward.

This is not to say the reward is less important, but once I know that my performance was assessed fairly, I am more likely to trust my managers to make the right reward decision. When all employees are forced to fit a pre-arranged ratings curve, they are less likely to believe that evaluations are fair.

However, the impact on reward can be problematic as well.

Employers often use the ratings to explain and justify bonus outcomes and salary increases. In the model where performance is based on individual contributions, reward outcomes would also be individually differentiated. This would be particularly relevant for executive populations, where achievement against individual scorecards would determine bonus outcomes.

Yet, many organisations in the region are also missing the opportunities to differentiate incentive payouts for top performers. In the 2018 Getting Compensation Right survey conducted recently by Willis Towers Watson, 35% of employers said that they pay incentives to employees who do not meet expectations. And when funding is below target, 4 out of 5 organizations cut payouts to top performers as much or more than they do for other employees.

Getting pay-for-performance right today

What does effective pay-for-performance look like today? When ratings just don’t work, what alternatives can employers consider? We believe it’s a system that:

  • Moves away from forced distributions or bell-curves for the general employee population, and places emphasis on absolute performance instead. Business unit results and associated bonus pools should then have a strong correlation with top performers within the business unit (if not, then the bonus attributable to the absolute ratings become even lower than corresponding levels under a forced-distribution model).
  • Provides continuous feedback and visibility on employee performance. Through this approach, rather than reviews once a year or twice a year, managers and other stakeholders are more tuned in to an employee’s performance, their challenges, and their achievements. Employees also have more line-of-sight to how their contribution impacts the team and the bigger picture, allowing them to link their day-to-day work to the company’s overall vision.
  • Provides flexibility, where the system works like a continuous loop and managers and employees are able to tweak and change targets and objectives more real-time. This will likely inspire employees as well. Not to mention, the system encourages the escalation and resolution of things faster, in turn enabling greater efficiency.

From here, employers can design more effective links to pay outcomes, using a number of mechanisms to differentiate pay such as annual incentive plans and new types of recognition programs.

As we enter the new economy of the Fourth Industrial Revolution, companies need to move away from the traditional ‘pay-for-performance’ approach. Instead, they must look at new methodologies and approaches to improve employee performance and engagement, or risk productivity losses and missed business goals.

About the Author

Shai Ganu is Managing Director, Talent & Rewards business, South Asia, Willis Towers Watson. He heads the Rewards business in Asia Pacific for Willis Towers Watson. He also oversees the Talent & Rewards business segment across ASEAN and South Asia – covering Board Advisory, Management Consulting, and Data Services portfolios.

He leads a team of 450 consultants providing human capital advisory, data, and software solutions to organizations across the region. This includes advising companies on their executive compensation, board effectiveness, performance management, talent management, sales effectiveness, and Diversity & Inclusion strategies.

Shai is also a member and faculty at Malaysian Institute of Directors (MINDA) and Singapore Institute of Directors (SID), and sits on SID's Professional Development and Corporate Governance committees. In addition, he lectures at the Singapore Management University (SMU) and conducts training courses for Directors on Remuneration and Talent Management matters for the SID-SMU diploma.