by Performance-based pay systems provide financial compensation based on either focus on individual or group performance. Below introduces this common HR concept and the associated advantages and disadvantages.
Performance Pay Systems
There are different types of payment schemes that apply to performance pay systems, which are designed to distribute financial rewards to employees. In contrast with set salaries, performance pay is based on compensating the employee per their individual contribution, not the value of the position itself. There is individual performance pay, which is often associated with sales personnel who depend on commissions, and skill-based pay, in which compensation is connected to competency. Some companies engage in profit-sharing, which means that employees will receive a certain percentage of the company’s financial gains.
Skill-Based Overview
Many manual labor and manufacturing companies favor skill-based pay systems that link aptitude and expertise to pay grades. This promotes productivity, better workforce skills and product quality. There are two types of skill-based payment systems. First, there are general skill systems that increase the employee’s ability to perform more tasks and positions. Second, there are specialized skill systems that compensate employees for master’s highly difficult tasks. An employee who learns how to operate similar machinery would be rewarded through the general skill system; an employee who learns an entirely new machine would be incentivized through a specialized skill system.
The Benefits
Performance pay offers a variety of benefits. Management enjoys better employee performance and employee engagement. As long as there is a fair and effective performance review system that is accurately aligned with local salary levels, employees will strive to work hard. Executives will enjoy increased revenue and working capital. Management can use performance pay systems to transition model employees into supervisors. HR administrators can use performance pay to attract potential job applicants and improve employee retention. In the beginning, turnover rates may be slightly higher as low performers leave, but qualified and motivated employees will remain.
The Disadvantages
Some companies struggle to implement performance pay systems because it is hard to define performance levels and objectively evaluate employees. The performance criteria and measurements may be vague and inadequate. As a result, supervisors favor certain employees over others, which increase collective employee dissatisfaction. When employees cannot understand the performance measures, they may still blame management when they fail to receive wage increases. Sometimes, the objective of performance appraisal systems is to merely identify training needs or promotion suitability. The biggest challenge of performance pay systems is that management must continually observe and document employee performance while also providing feedback, which is very time consuming.
The Performance Criteria
The actual pay scheme will determine the performance criteria, which may be based on individuals, groups, the organization or a customized mixture. Some individual-based criteria focus on the achievement of personal goals and the supervisor’s feedback. Individual training goals may be based on specific skills and knowledge needed to perform work duties. Individual performance systems are not recommended when the company’s objective is to increase teamwork performance and information sharing. Other systems utilize peer reviews, which are often considered to be highly subjective.
Variable Pay Programs
Variable pay programs encompass a variety of discretionary and non-discretionary bonuses that can vary according to the payout period, the employees who are eligible, and the metrics that employees are measured against. Unlike merit pay increases, variable pay programs are increasingly administered not just annually but multiple times a year (e.g., once a quarter) and a mix of different variable pay programs are often used in combination to achieve the desired results.
Discretionary bonuses are awarded on an ad-hoc basis to employees who demonstrate exceptional performance, often without consideration of pre-defined goals and objectives. Some common discretionary bonus types are:
- Spot bonuses: Reward employees “on the spot” for achievements that deserve special recognition.
- Project bonuses: Reward employees for completion or superior completion of a specific project.
- Retention bonuses: Typically awarded to long-tenured employees, or employees in hot jobs, to decrease their flight risk.
Nondiscretionary bonuses are awarded when employees, teams, or the entire organization meets specific, pre-defined goals and objectives. Based on the duration of the assessment period (the amount of time over which performance is measured), they are considered either short-term incentives (STI) or long-term incentives (LTI). Some common nondiscretionary bonus types include:
- Company-wide bonuses: these focus around specific improvement goals for the organization, and reward employees based on how much improvement is made on these goals within a certain period of time.
- Team-incentive bonuses: these focus around specific improvement goals for one team (e.g., marketing or sales) and are rewarded based on performance for that team.
- Individual incentive bonuses: these plans are often based on predetermined, measurable business objectives (MBOs) that are evaluated periodically (e.g., each quarter) based on one person’s performance
