Pay for Performance: Pros and Cons of Performance-Based Pay

Pay for Performance: Pros and Cons of Performance-Based Pay

Introduction

Many employers have implemented a pay-per-performance compensation model to boost employee motivation to do great work. By establishing performance-based compensation, employers may drive productivity, as employee performance directly impacts pay. However, employers need to understand how performance-based pay works and the pros and cons of pay for performance.

Additionally, there are strategies for successfully implementing a performance-based compensation model that employers should consider to achieve their desired results. Continue reading to learn more about incentivized pay so you can decide whether a performance-based compensation model is right for your business.

What is performance-based compensation?

Performance-based compensation, or pay for performance, is a payment model that companies use to pay employees based on their job performance. With this model, companies pay employees additional payments for reaching or exceeding goals and objectives. Bonuses are a common example of performance-based compensation, in which the employer gives an additional lump sum of wages if the employee performs well during a specific time. Earning commission on sales may also be an example of performance-based pay. Employers may implement this payment model to increase employee motivation and productivity, potentially benefiting both parties.

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Are there different types of performance-based compensation plans?

There are various types of pay-per-performance compensation plans or models that employers follow. Three widely-used performance-based compensation models are:

  • Merit pay
  • Discretionary bonuses
  • Non-discretionary bonuses

Merit pay is a common payment model that looks like increasing one’s salary based on performance or giving someone a raise. With this model, high performance might be reaching certain financial goals, exceeding expectations, showing excellent leadership skills, and more. With merit pay, raises are typically given yearly to employees who have performed well. Merit pay may also coincide with promotion bonuses.

Discretionary bonuses are a variable pay-per-performance method in which bonuses are awarded for outstanding performance. These bonuses may be allotted if employees go above and beyond their expected duties. With this method, there may not be specific goals employees need to reach to receive bonuses but instead could occur on the spot based on the employer’s discretion.

Non-discretionary bonuses are bonuses for instances in which employees meet specific, pre-determined goals, such as a certain number of sales, active users, or other objectives. These goals may be short- or long-term, company-wide, team-based, or individual.

The pros of using performance-based incentive plans

When deciding if performance-based compensation is right for your business, it’s essential to understand the pay-for-performance pros and cons. As for pros, there are numerous benefits to implementing an incentivized pay plan for employers and employees. Some of the  advantages of administering a performance-based payment model include the following:

Increased motivation

A performance-based compensation model can significantly increase the motivation of employees, providing a tangible reward to work. With the desirable incentive of receiving higher pay, employees are more likely to work hard to accept that reward. When employees achieve goals in this compensation model, motivation and morale are increased even further as one can see the benefits directly gained from their hard work.

Boosted productivity

Productivity may also increase drastically when financial incentives are brought into the mix. Employees are likely to be productive and reach concrete and numerical goals. This increased productivity increases revenue for employers, making it a win-win for everyone.

Improved company culture

When employers reward employees for outstanding performance or behavior, such as excellent leadership skills, employees are more likely to exhibit the positive values expected of them. Additionally, as employees have more control over the wages they will receive, a culture of power balance and equality is cultivated. Pay-per-performance models can help nurture a culture of hard-working and satisfied team players.

Attracting better workers

By offering performance-based incentives, companies are more likely to attract better, harder-working employees. Financial incentives on top of a base salary range can help companies stand out in their industries and receive more interest from talented candidates. Employer-provided benefits are a significant factor in one’s job decision, so don’t overlook the importance of this provision when growing your team.

Less micro-managing

With financial incentives established, employers can rest assured knowing their employees will be motivated to work hard toward their goals. Thus, employers and managers no longer need to micro-manage employee activity. This is a major benefit to employees and employers, as attention and resources can be allocated elsewhere for employers while employees can feel trusted.

Establishing clear expectations

Having a pay-per-performance model with concrete goals sets clear expectations for employees. In other work models for which clear goals are not established, employees may need help knowing where to allocate their efforts or whether they are doing their jobs well. With clear, established guidelines, employees are more likely to feel confident in their roles and know they are carrying out their expected duties.

Higher employee retention

In addition to attracting top talent, having performance-based incentives can help businesses retain employees. As employees reap the rewards of their hard work under a pay-per-performance model, they are more likely to remain happy, loyal employees. Additionally, employees are more likely to feel supported by a company culture of less micro-managing, clear expectations, and improved leadership. Higher employee retention reduces business costs in the long run, making this a valuable asset to employers.

The cons of performance-based compensation models

While performance-based compensation models can bring many pros to the workplace, they also come with disadvantages. Understanding the advantages and downsides of incentive-based models is essential to discern whether they are suitable for your business. Some of the disadvantages of pay for performance include:

Quantity over quality

With numerical goals and objectives established, employees may focus on quantity over quality when working toward financial rewards. To avoid this issue, employers may also want to establish qualitative goals to go along with the quantitative ones. For example, higher-quality customer reviews and a set sales goal may be a more comprehensive objective for employees to strive towards.

Individualism

Another disadvantage of pay for performance is that employees are more likely to focus on reaching individual goals than setting goals together as a team. In some instances, employees may even put each other down to be the ones to reach their rewards. This is why having team-based incentives may be a smart idea when considering a performance-based compensation model.

Unclear goals

While establishing clear goals and objectives helps employees feel confident in their duties, having clear goals can be beneficial. For example, discretionary bonuses may be allotted on an ad-hoc basis at the discretion of employers, with no concrete goals involved. As a result, employees may feel lost when acquiring bonuses or raises, decreasing motivation, and morale. Additionally, more qualitative goals, such as improved leadership and communication, involve more subjectivity, which can confuse employees. Overall, employers need to be clear in their incentive payment model goals. Otherwise, the strategy can backfire.

Increased employment costs

While increasing productivity and employee retention can decrease employment costs in the long run, a poorly-implemented pay for performance model can do the opposite. If your pay for performance model decreases morale, motivation, and, thus, employee retention, your only result might be increased employee wages and benefits. To establish a successful performance-based compensation strategy, continue reading our expert tips below.

Implement successful performance-based pay plans

When establishing a performance-based compensation plan, it’s essential to get it right to achieve the full benefits for you and your employees. To ensure your pay for performance strategy is successful, consider including the following elements:

  • Clear goals: The milestones for obtaining a financial reward must be clear. For example, numerical goals would classify as clear goals. While a goal like "increase revenue" remains broad and subjective, a goal like "increase revenue by 22%" is clear and definitive. Having distinct goals helps employees feel confident in their work.
  • Transparent performance evaluation process: The process for evaluating employee performance should also be clear. This might look like having quarterly reviews on set dates throughout the year so employees can know whether they are on the right track. Additionally, the evaluation process should be provided to employees in writing once the program commences, including how employers will determine if goals are met.
  • Tools to track performance: Using digital tools is essential for performance-based plans. With a unified progress management tool, employees and employers can remain on the same page throughout the year. Additionally, employees can easily receive feedback from having the opportunity to improve their work before the goal date arrives.
  • Qualitative goals: Employers should also consider implementing qualitative goals, such as outstanding work ethic, leadership, and other behaviors. However, employers must have clear guidelines for evaluating these non-numerical goals.
  • Team-based goals: To avoid hyper-individualism in the workplace, employers should consider establishing team-based incentives. This way, entire teams will be more motivated to work together amicably toward one ultimate goal.
  • Fairness: Employers must stick to their word and provide the promised rewards. Additionally, employers must be fair to all employees, evaluating them on equal levels. Failure to be equitable can decrease employee retention, which is the opposite of what businesses strive for.

Conclusion

Establishing a pay-for-performance compensation model can be incredibly beneficial to one’s business. However, employers need to create clear and equitable performance-based compensation programs for this strategy to increase motivation, productivity, and morale. Skuad helps companies quickly pay and manage their global teams, so business owners can focus on what they do best. Schedule a demo today to learn how Skuad can take your business to the next level.

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