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

In work relationships, miscommunications between employers and employees often lead to issues like decreased employee engagement, low retention, and poor performance.

Compensation is one topic that is miscommunicated all too often in the workplace. When it comes to compensation, employers and employees aren’t always on the same page. According to Robert Half’s 2023 Salary Guide, there is a gulf between employer and employee perceptions on pay. Of the employees surveyed, 48% will ask for a raise this year. And 4 in 10 employees said they would leave a job for a 10% increase in salary.

This gap in perception is a problem. However, understanding that compensation is a matter of perception is the first step to addressing the problem. One critical step in addressing perception is having all your payroll data in one place so you can be transparent about value with your employees. Read on to understand how compensation and performance management work hand in hand.

How Do Performance Management and Compensation Management Work Together?

Since one of the goals of an organization’s compensation strategy is to encourage high employee performance (and thus meet key business goals), compensation should be a natural piece of your overall performance management strategy. Performance and compensation management unite under one umbrella, so an employee’s job-related performance can be directly tied to their compensation.

What Are the Four Types of Compensation?

Compensation can mean different things in 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. Positions that require more education or specific skills generally pay a salary.
• Commission: Commission-based compensation is designed to incentivize employees to produce at a high level and may be used in certain industries where the employer can’t guarantee a consistent workload.
• Bonuses: Bonuses give businesses a flexible option to reward employees additionally for great performance.

What Is Pay-for-Performance Compensation?

As the job market grows more competitive, performance compensation (also called pay-for-performance compensation) is gaining traction. According to one recent survey, 77% of organizations have incorporated pay-for-performance compensation into their overall compensation plan.

Performance compensation encourages employees to do their best work and rewards them for achieving goals or objectives. It is 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 performance and compensation management efforts, employers provide clear compensation guidelines for themselves and can help employees understand their value and work to increase it.

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

As you create your strategy, consider these three things your pay-for-performance compensation strategy 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 levels of performance from all employees.

Obviously, there are many ways to reward performance beyond a mere money payment. And depending on your situation (e.g., industry, company size, growth stage, etc.), you will want to mix base pay with a variety of other 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 performance metrics, and are prepared to pay up consistently.

Get Creative With Your Pay-for-Performance Initiatives

Since rewards don’t have to be monetary or scheduled, you can get creative with them. If you know a particular high performer loves the orchestra, get them tickets to an upcoming concert. Maybe you want to reward an entire team for putting on a successful event. Provide them with a catered lunch. And, of course, traditional bonuses go a long way when you tie them to specific work accomplishments.

If you have a smaller budget, you can provide employees with other rewards that still show you value their performance. A one-on-one lunch with the CEO or another senior leader will go a long way with ambitious employees. You can offer high performers a paid day off after a crucial deadline. Or maybe give employees who have shown the ability to be self-starters the ability to work remotely. The list of ways you can reward performance goes on and on.

Improve Pay Transparency

But don’t run too fast. There is some alignment that needs to take place before you discuss your pay-for-performance strategies with your people. More than half of employees (55%) feel they’re underpaid, though 83% of managers say they've raised starting salaries and adjusted the pay of existing employees.

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 so important to be transparent with employees about their compensation and align their perceptions with reality.

Managers should be prepared 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 industry, experience in discipline, product and competitor knowledge, etc.).

Develop a Compensation Communication Toolkit

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

After HR and senior leadership create a strategic compensation plan, they need to train managers to communicate the plan with individual employees. HR should provide managers with the following “communication toolkit”:

• 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 SMART (Specific, Measurable, Achievable, Relevant, and Time-Bound) goals with specific employees to both show their value and offer paths for increased compensation.

Use Compensation Management Software to Improve Communication and Get On the Same Page

This may sound like a lot of work to simply “talk about pay.” But as managers help employees connect the dots on why they’re 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 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.