There’s a school of thought that says businesses exist to take care of their employees, employees will, in turn, take care of customers. Whether you subscribe or not there’s certainly merit in the methodology. Paying your employees is, therefore, one of the most important things you will ever do, perhaps more so if you are one of those employees on the payroll. Working out the right sort of pay scale that balances the goals of the employee and the organisation is a fascinating subject which we will look at just one part of; performance-related pay (PRP).
Performance-related pay is a system that rewards workers based on the outcomes of their work. This should not be confused with performance-related pay increase which awards increments based on the achievement of a certain target. In PRP the degree to which an employee is based on an output level that may be combined with a fixed amount.
Advantages of Performance Related Pay
A PRP system automatically incentives work for the employee. A PRP system also creates a built-in recognition system for performing employees. PRP also helps in fostering a culture of performance and assists in implementing systems such as results-based management. Goal setting and goal orientation are automatically built into organisations that use a PRP system. Self-improvement and personal development responsibility can be shifted to employees as they take charge of their performance. PRP systems also reward high performers while not rewarding low or non-performers. Finally, a PRP system helps in keeping the best and most productive staff in an organisation.
Disadvantages of Performance Related Pay
PRP may reduce pay equity in organisations, especially when not administered properly. Performance-related systems may also create a bias towards results and rewards while playing down the developmental needs of employees in an organisation. If the goals are set to low or too high they can equally act as demotivators to staff. In some cases, short-termism can creep in with employees squarely focussed on remuneration now.
Types of Performance Related Pay
Piecework arrangements pay a defined specific amount for a specific unit of work. Imagine a person paid to pack boxes or perform a certain number of the same task. In this case, an employee would be paid say $10 for every box they successfully pack.
Results based work is similar to piecework however it uses an output standard to determine the rate of pay. Let’s continue with our box packing example. An employee is paid on a per hour basis however they are paid the percentage of the standard number of boxes they manage. If the standard is 80 boxes and the employee only manages 60 they will be paid 75% of the hourly wage.
Incentive schemes work much better on an organisational or divisional basis. In this case, the entire box packing team would be paid if they as a team reach a desired target of output.
Merit pay offers bonuses where a certain known target is reached or surpassed. This mirrors the aforementioned performance-related pay increase. Using the box example again, workers packing over 100 boxes per hour on average would be entitled bonus pay of 25%. Merit systems can also be applied to entire teams through profit share.
Profit share rewards employees by giving them a share of company profits for a period. This is usually in addition to existing payment arrangements. While our box packing employees may not be directly responsible for sales and therefore company profit, they may contribute through experience or reduced breakage and damage. It incentivises the entire organisation when done right.
Commission structures are best applied to employees such as salespeople who operate in revenue centres (more on this later). This rewards them on a per-sale basis, usually paying a known percentage of the total revenue they bring in.
It is important to consider where employees are in an organisation before attaching performance-related pay systems to their remuneration. Using our box case study, for example, an administrative clerk in the company has no bearing on the sales or boxes nor the reduction of costs.
This is a unit in an organisation that is responsible for the creation of income such as salespeople. They may be responsible for how much money comes in. but not for what goes out and therefore a profit-related agreement would not be in.their favour.
Cost centres such as administration and human resources are not responsible for any income in the organisation (at least directly). It would be very unfair to put members of such departments of PRP arrangements based on the income of the company.
Profit centres are responsible for both income and costs and as such have a direct bearing on the profitability of the company in some types of businesses. These are found higher up the hierarchy of an organisation.
Elements of Good PRP systems
Good PRP systems have 3 essential elements present in them. They offer clear guidelines, consistent application of principles and transparency.
A good system has clear guidelines on how it works and shouldn’t leave employees or any users of the information in a quandary as to how the system works. Employees and management should be able to rely on the guidelines to determine how much is due to an employee. Complexity is not always a bad thing but it is a warning of a system that may not be good.
Consistency across employees and across time.should also be present in a good PRP system. Shifting goalposts are a very bad signal to employees when dealing with a PRP system.
Calculations for remuneration should be made available to all concerned and it should be abundantly clear how the remuneration figure was arrived at. A system that lacks transparency especially where it seems to conflict with a guideline will leave employees feeling uncertain at best and shortchanged at worst.
The most important thing is to apply the right type of system for the given organisation or employee. Think through the type of PRP as well as the responsibility centre that the employee is in. PRP systems are not meant to reduce the earnings of individuals but rather to better match output with earnings.