It's difficult, of course, for any company to shift gears when it comes to compensation after an employee has been hired at a set salary, but it can be done. Already some companies have concluded that compensation based on knowledge, performance, and overall contribution makes more sense than the present system. These forward-looking companies do not represent the majority of American business, but their efforts are being observed and analyzed by many other companies.
Judging from a recent Robert Half International survey, conducted among top executives at a cross-section of America's largest corporations, this compensation system practice will only increase. We asked them, "Do you believe that variable, performance-based pay for most employees is a compensation approach that will increase, decrease, or stay the same in the next five years?" In response, 32 percent said it would increase significantly, and 47 percent said it would increase to some extent.
Converting to a Performance-Based Pay System
To transition from a system of set compensation, in which pay is determined by title, to a more flexible, performance-based approach, a company must:
- Be completely certain that the new system is the result of the best available thinking
- Be satisfied that the new structure allows for equal and fair opportunity for all employees affected by the plan.
- Be prepared to sell the new concept to those whose compensation will be altered. The plan must be explained in sufficient detail,both its tangible factors and the less tangible goals it hopes to achieve. Ideally, employees will come to understand how the new system of compensation is good for them, and good for the company.
- Be committed to a sufficient amount of time for the new plan to be implemented and to prove itself.
- Create a system through which the new compensation approach can be closely monitored. At the same time, establish channels through which employees can communicate their reactions, favorable and unfavorable.
- Establish other nonfinancial means through which affected employees can gain authority. Instituting a variable, performance-based system of pay should be pointed to as but one example of the company's commitment to forging a partnership between employee and management. "We rise and fall together" is the message.
- Understand that converting from the traditional title-driven pay scale to a variable system based on knowledge and performance is a long-term approach to improving company fortunes, and that one of many benefits will be the retention of the company's best people.
Variable pay also gives employers greater control over employee compensation costs. Further, it negates the need to use promotions, raises, and bonuses as devices to sustain morale.
Identify Performance Levels that Merit Salary Increases
Naturally, any company policy, particularly one that is innovative and relatively untested, will raise questions and pose problems. With performance-based pay, the obvious question is what specific levels of performance will be considered worthy of merit increases in salary or the awarding of bonuses.
To use the analogy of professional sports, will one home run justify a raise, or will it take two, three, or four? In a service company that does not pay commissions, will bringing in six new customers be considered meritorious enough to warrant an increase in compensation, or should acquiring a dozen new accounts represent the required level of productivity?
In baseball, if hitting a home run were to be considered the most important achievement and carries with it the biggest reward, that is clearly prejudicial to pitchers, who hit few home runs.
The same problem exists in companies that have instituted performance-based pay. All participating employees must have the opportunity to reach for the stars. If those people who bring in new business receive the lion's share of increased compensation, others in positions that are less sales- and marketing-oriented will soon lose interest; the program's purpose will have been compromised.
Rewarding Team Performance
An approach some companies are taking to alleviate this fairness problem is to create teams. Instead of individuals benefitting from increased pay, the team is the recipient. This makes sense. A hot-shot salesperson might sell new accounts, but it takes back-up to service them. Everyone on a successful team-- salesperson, marketing professional, secretaries, shipping personnel, mailroom employee--shares in the nurturing of new accounts and should share in the spoils as well. An important aspect of this approach is that peer pressure encourages those employees who are not productive to pick up the pace in order to be able to participate in the rewards.
Rewarding Skills or Job Knowledge
Another approach to compensating employees by a participatory system is known as "pay-for-skills," "skill-based pay," or "knowledge-based compensation." The core of this concept is that employees are paid for how much knowledge they bring to a company, and how much additional knowledge they develop while employed (provided, of course, that they put it to good use). This isn't an entirely new concept; some factories have experimented with it for years.
Advocates of this form of pay system insist it allows for more objectivity in determining pay scales and places the emphasis on learning. The result, they say, is a well-rounded employee who comes to know every part of the business, and who can make a greater, all-encompassing contribution. In a nutshell, the more you learn, the more you earn.
An article in The New York Times pointed to several companies that have implemented pay-for-skills. Quaker Oats was one of the first companies to adopt a skill-based pay scale. The participating employees were non-union factory workers at the company's pet food plant. The result reported by the company was that overall wages rose, but labor costs as a unit of output fell.
Inland Steel Bar was another company that adopted a pay-for-skills program, applying it to its unionized steel workers. It enjoyed a 15 percent gain in productivity, along with an increase in new business.
Problems with Performance-Based Pay Systems
Performance-based pay hasn't worked for every company, however. The Times article reported that I.D.S. Financial Services instituted such a plan to include its back-office, mutual fund processing employees. The company said the program resulted in a division between employees who had acquired new skills and those who hadn't. As a result, I.D.S. abandoned the experiment.
Another company, which initiated a modified form of performance-based pay, established a reward system for cutting costs. The problem was that overzealous employees eliminated certain vital services and functions which, instead of cutting costs, ended up costing more.
Problems arising from new approaches to employee compensation should not be used as a rationale to dismiss the idea. Older, more entrenched systems of compensation have always had their own problems. If they hadn't, there wouldn't be the need to seek new approaches.
In many companies, raises are given across the board--a certain percentage granted to all employees each year. Although that formula leaves no one out, it reinforces the philosophy that everyone deserves a raise, even when everyone doesn't. (Of course, such raises might simply reflect cost-of-living increases. Excluding certain employees from receiving them is tantamount to a salary decrease.)
Rewarding employees whose performance has been substandard sends a clear, negative message to those who've given it their all: "It doesn't matter how much I've contributed to the company's success. We all receive a raise simply by virtue of having been there all year. Why give extra effort? The reward will be the same whether I work harder or not."
That approach to employee compensation is destined to change. Currently, companies must weather shifting economic climates, including heated-up global competition, and cannot afford to reward marginal employees, much less "carry" them for very long.
The academic world has long had a saying, "Publish or perish," which has always been viewed as a fault in the academic system. The message to today's corporate workforce must be, "Produce or perish."
Ironically, it was the former Soviet Union's Nikita Khrushchev who once nicely summed up the philosophy behind variable production-based pay. When discussing the merits of incentive programs, he said, "Call it what you will, incentives are the only way to make people work harder."
Rewarding outstanding performance, whether individual or team, with tangible increases in compensation has always been a potent incentive. However, it should be considered only one of an arsenal of ways to motivate employees.
Giving Employee Bonuses
Bonuses have always been a popular means of motivating employees, and undoubtedly will continue to be. Generally, they're dispensed at predetermined times of year, year's end being the most prevalent. In some cases they're based on company performance. In other cases they're not. The most popular means of determining the amount given to each employee is to base it on a percentage of salary. The bigger the salary, the bigger the bonus.
This is good. Extra cash can do wonders for employee morale, at least during the period of time it's being spent. Whether a yearly bonus carries with it lasting allegiance is conjecture.
Nonetheless, my observations of the use of employee bonuses over the years has led me to conclude that although the issuance of them is well meaning on the part of employers, they aren't always used to their best advantage. In too many instances, employees expect their yearly bonuses once the tradition has been established. This goes against the growing emphasis on variable, performance-based compensation. A bonus should not be expected each year. What should be expected is that individuals who've done a good job, singularly or as part of a team, might expect to share in the company's success in some tangible way.
Spot bonuses (as opposed to those that are regularly scheduled) can have a particularly positive impact on employees. To maximize their effectiveness, give them while deserving employees are in the midst of an especially demanding and important project, rather than waiting until it's done. Providing a second wind when the hours are long and the demands seem overwhelming is always good timing.
Another concept is to base the award on customer satisfaction. The determination is based on independent surveys of customers' attitudes towards the company. When those attitudes are positive, especially if the company ranks first, the appropriate employees are rewarded.
The Xerox Corporation uses elements of this approach in its formula for awarding bonuses. Top management decided to stop rewarding only those executives who met traditional sales and profit quotas, but also managers who rarely dealt directly with customers. Bonuses under this plan increased pay levels as much as 40 percent for those who met customer-satisfaction goals. Conversely, some lost as much as 20 percent of their total compensation if service problems plagued their areas of responsibility and were not corrected.
The bonuses awarded by Xerox are based on responses to the company's customer-satisfaction measurement survey, which is sent monthly to 40,000 customers worldwide.
Awarding Employee Stock Options
Employee stock options have always been a popular tool for motivating employees. Under most plans, all eligible employees are given the option of purchasing shares of a company's stock at a future date, but at a price fixed at the time the options are granted. Having the opportunity to invest directly in a company means employees are able to invest in themselves and the fruits of their labor; the feeling of being in "partnership" with management is reinforced.
Certain groups of employees are deemed eligible to participate and are granted options to buy the stock, its value determined by the rise and fall of the market. Naturally, it behooves every employee holding shares to work hard to ensure that the company's fortunes and, by extension, their own, are enhanced. This is the motivating factor, even though few such plans have been linked to individual or team performance.
In a sense, traditional employee stock option plans are another fixed method of compensation--that is, they are not influenced by individual performance. As long as a person is in the group that is eligible to purchase stock and remains employed by the company, the option is generally available. That's why some companies are beginning to link stock option plans with performance. Like variable pay, eligibility to purchase stock is determined by individual or team achievement. The motivation is enhanced. Each employee benefits when colleagues urge them to increase productivity. Peer pressure works.
Stock option plans will undoubtedly be subject to experimentation and modification in the future, but they will remain a staple of employee motivation. A Robert Half International survey on performance-based pay asked, "How important are stock options in attracting and retaining American workers at all levels of a company?" The response: 23 percent said they are very important; 57 percent said they are somewhat important,
The major change in the way stock option plans are implemented will be, I believe, in how they are woven into a broader and more all-encompassing package of employee incentives. Performance not only will be more closely keyed to employee compensation, but also the "softer" motivations--participation in decision making, cross-discipline training, and other empowering concepts--will play an increasing role. The desired result will be empowerment programs that cover all the bases. Companies that achieve this will have developed what might be called a "victorious circle:" their employees will be motivated and loyal; the company will be known as a very good place to work; and because it is, the best available talent will seek employment there.