Comp 101: How to Craft a Solid Pay-for-Performance Strategy

When it comes to compensation, employers and employees aren’t always on the same page. Only 41% of employees believe their employers have achieved pay equity, and 26% believe the companies they work for are unsuccessful in ensuring equal pay.

This gap in perception is a problem. However, understanding that corporate compensation is a matter of perception is the first step to addressing the issue.

Read on to understand how compensation and performance management work together to address pay transparency and help you be more open about value with your employees.

What Are the Four Different Types of Compensation?

Employee compensation can mean different things to different companies depending on the industry and workforce. The four most common types of direct compensation for employees are:

• Hourly pay/wage:  Hourly pay is the most common and direct form of compensation and is typically used with unskilled, semi-skilled, and part-time positions.
• Salary:  Customarily, a yearly amount is split evenly into pay periods so that workers receive the same amount every paycheck throughout the year. Generally, positions that require more education or specific skills pay a salary.
• Commission:  Commission-based compensation is designed to incentivize employees to produce at a high level and may be used in industries where the employer can’t guarantee a consistent workload.
• Bonuses:  Performance-linked bonuses give businesses a flexible option to reward employees additionally for high performance.

What Is Pay-for-Performance Compensation?

Employee performance compensation (or pay-for-performance compensation) encourages employees to do their best work and rewards them for achieving pay-for-performance goals or objectives. It’s typically an additional compensation component alongside fixed pay. Pay-for-performance compensation is variable and depends on the performance of the worker.

Let’s discuss two ways to combine compensation and performance management to help employees and management get on the same page.

Build a Pay-for-Performance Compensation Strategy

By linking pay to employee performance in compensation management efforts, HR and employers provide clear compensation guidelines for themselves and help employees understand their value and work to increase it.

HR professionals should lead these strategic compensation planning efforts by first working with senior leadership to create these HR compensation strategies (and subsequent tactics). Second, you’ll want to ensure these strategies are tied to applicable data—because your people will want proof. Data and employee performance metrics from your performance management efforts can help.

As you create your employee compensation strategy, consider these three things your pay-for-performance structure should achieve:

• Compensation should be fair and consistent with the value of an employee’s contribution.
• Compensation increases should come at an appropriate pace and reflect the employee’s ongoing performance and changes in the labor market.
• Compensation should motivate higher performance from all employees.

There are many ways to reward performance beyond a mere money payment. Depending on your situation (e.g., industry, company size, growth stage, etc.), you’ll want to mix base pay with other creative employee incentives.

What’s important is that you create a thoughtful mix of monetary and non-monetary incentives that fit your unique organization, tie them to specific employee performance metrics, and are prepared to pay up consistently.

Get Creative with Your Pay-for-Performance Initiatives

Since performance-based employee rewards don’t have to be monetary or scheduled, you can get creative with them. The key is to know what compensation your employees want by talking to their managers, conducting surveys, or simply being exceptionally observant.

There are many pay-for-performance compensation examples to inspire your thinking.

• If you know a particular high performer who loves the orchestra, get them tickets to an upcoming concert.
• You want to reward an entire team for putting on a successful event, so you provide a catered lunch.
• Traditional bonuses go a long way when you tie them to specific work accomplishments.

If you have a smaller budget, you can give other rewards to show you value their performance:

• A one-on-one lunch with the CEO or another senior leader
• A paid day off after a crucial deadline
• The option to work remotely

Improve Employee Pay Transparency

Compensation, including raises, was a top concern in 2023. Based on this, it's clear that the problem is how employees  perceive  their compensation. Compensation is an exchange of value, and value is about perception. So, even if you come up with a perfect strategy to compensate employees fairly, it only matters if they perceive the same value.

That’s why it’s important you follow pay transparency best practices and be transparent with employees about their compensation to align their perceptions with reality.

Managers should prepare to talk about compensation on an individual basis and match the value they provide (e.g., pay, benefits, experience, flexibility, etc.) with the specific value an employee provides (e.g., experience in the industry, experience in discipline, product and competitor knowledge, etc.).

Develop an Employee Compensation Communication Toolkit

Most managers don’t know how to discuss employee compensation. Before managers have these conversations with employees, organizations need to work out their employee compensation communication plan.

After HR and senior leadership create a strategic compensation plan, managers need training to communicate the plan with individual employees.

HR should provide managers with the following “compensation communication toolkit”:

• Employee compensation plan talking points
• Compensation plan information
• Details for each employee they supervise
• Tips for each type of conversation they may have

Managers should walk away from their training prepared to discuss the compensation strategy with employees, use data to show the whys of the strategy, and know how to implement goals with specific employees to both show their value and offer paths for increased compensation.

Create an Open Culture to Build Trust About Compensation

As managers help employees connect the dots on why they’re being compensated the way they are, employees will better understand their value and feel confident they are being paid fairly.

Employees will also be more receptive to direction on what they can do to increase their compensation. These two elements combined will lead to less miscommunication and misperception.

Of course, since it’s impossible to eliminate misperceptions completely, a culture of openness is imperative to succeed in these efforts. Employees should be encouraged to bring compensation questions or concerns to their managers when they’re unsure. With clear employee compensation strategies in place and managers trained on how to discuss them, the answers will be readily available.

That way, whenever a gap in value perception comes up, managers and employees can work together to bridge it quickly and get back on the same page. Our Total Compensation Calculator can help. This tool helps employees see the full value of their compensation package—including benefits, PTO, perks, and more.