When does the pay for performance system kick into gear?

by on June 23, 2009 · 0 Comment POSTED IN: HR Info Center

Pay for performance system eligibility and incentive targets need to have target clarity

One of the issues that come up very frequently with a pay for performance system is what exactly are the performance levels, what are the metrics. What are trying to reward, how much of a bonus do I achieve for different levels. The term we hear over and over is “black box” with the awards in the pay for performance system. We kind of do our thing for the year and at the end of the year, somebody whether that be HR, finance or my boss shows me what the bonus number is and I have absolutely no idea what the link is between my performance level and the pay for performance system bonus amount.

Eligibility in a pay for performance system can be a major question.

Employees ask I don’t know if I’m eligible for a bonus or not? Typically eligible employees would include full time exempt employees.

So, typically part-timers would not be eligible for the pay for performance system and typically nonexempt or otherwise known as hourly employees would NOT be eligible. The reason for this is, is that with nonexempt employees, if you pay them an incentive you need to retroactively calculate the value of their overtime based on that incentive.

In most organizations that they found that this is administratively too burdensome – there’s not enough banks for the box there. So, there’s a strong trend away from paying bonuses to nonexempt employees.

A key component of your pay for performance system is, what does the market pay similar employees of similar duties and responsibilities in terms of a target bonus. That’s the key consideration and when you’re looking at nonexempt pay in the market, there’s typically little to no incentive value. This would be a typical communication or calculation to a CEO in this example, where it’s clearly spelled out the different performance measures that are in this case revenue growth and profit growth, the weighting of those measures at 75-25 in favor revenue.

How do you define basic levels in pay for performance systems?
How do we define our target, what’s our goal? What’s our stretcher or kind of our hard to hit but not impossible to hit goal? And what’s our maximum we just actually blew it out how do we define that in terms of actual performance?

Clarity in an pay for performance system is essential
In this case the person is making 200,000. So, the current target bonus is 40% of their base salary($80,000). Just say that the threshold bonus is 15%($30,000). So, if we hit 4% revenue growth out of a possible 12% revenue growth, we’re going to pay out 15% or $30,000.In this case we’re clearly communicating to the Chief Executive Officer; if you hit these threshold numbers, this is the pay out. This is so clearly communicated if I’m trying to understand what I need to achieve in order to earn certain pay out, I can look at this example and say, “Well if I hit my stretch goal for revenue growth and the target goal for profit growth, I know what the weightings of those are, so I can calculate exactly what am I being incentive to do. What are the levels that I need to achieve and what is the payout associated with each of those.”

Again the idea here is not to create confusion about the link between performance levels of metrics and the bonus amount – not to have a black box. But to clear it all out there so, the calculations are very straight forward and all employees, in this case, the CEO but that all employees understand exactly what that link is.

Edited remarks from the Rapid Learning Institute webinar “Incentive Pay Plan Blunders That Can Cost You a Fortune.” By Kevin Nussbaum and Ed Rataj

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