Exposing the pay for performance myth (Guest Commentary)

Annual pay for performance systems are antiquated, wasteful and no longer serve a constructive role in rewarding or motivating performance. In other words, they’re bad for fostering engagement.

With wage or merit increases averaging in the two to three per cent range (with little differentiation) for the last 10 years, wage increases have become a useful hedge against inflation that further drives a sense of entitlement among employees. 

Emerging technologies will make it possible to reconnect the link between pay and performance — but it will require a massive paradigm shift to more effectively incent performance. 

In the current traditional and largely static work environment, HR practitioners are well-versed in long-held compensation practices requiring everyone to undertake large amounts of effort just so leaders can tick the box and finalize the merit increases. 

Having completed a great number of merit compensation cycles over the years, I confess that getting the process over with was always a huge relief. Endeavouring to ensure equity and fairness based on an underlying process of subjectivity and discretion always seemed flawed. If anything. the process itself exacerbated greater issues of equity and fairness. 

Rating and calibration were a primary cause for the variance. While it was easy to agree on consistent definitions for performance ratings, the application proved far more elusive. Some leaders had a reputation for being soft markers while others prided themselves for setting high standards — and a host of others simply played it safe.  The result always precipitated a lot of debate and frayed tempers that would result in the acceptance of the imperfect process.  

To fully understand this flawed process and how to change it, the process itself must be examined a little more closely. 

Typically, merit percentage increases are allocated based on overall affordability and the market requirements needed to attract and retain talent — even though they do little to motivate. We must bear in mind workers commit a major part of their life energies to the company. They endure difficult commutes, unreasonable work demands and managers and co-workers who do not always relate to their point of view, which can all be forgiven as long as there is a reasonable accommodation for these efforts and a sense of appreciation by the company. 

In reality, however, what happens is a complete disconnect between their work effort and the actual pay adjustment. Upon learning of the “merit” increase, many workers end up ever more resolved to look for another job at the first opportunity.

So, how does a well-meaning system end up doing so much harm?

Everyone agrees managers have their own job responsibilities in addition to their people management roles. Even exceptional, well-meaning front-line managers cannot possibly account for a complete objective assessment of each of their direct reports.  In many instances, they are not even trained on how to do so. Those who do endeavour to keep track do so through their own subjective lens — which may or may not always line up with the employee’s perceived sense of value. 

Then, of course, we have the forced performance distribution. Although very few organizations admit to using such distribution curves, in the end — whether explicit or implicit — they always prevail. Any manager with more than her share of high performers will always be told to scale back to comply with the corporate budget and performance guidelines. 

The last key factor is timing. Typically, merit budgets for the following year are set in the fall of the current year. Performance reviews and the compensation cycle for the preceding year are typically held in Q1 of the following year. This is a very long time period for any performance recognition or reward to be effective. 

That, in part, is the lunacy of the pay for performance approach —and it doesn’t end there. The final point of disrespect conspires to have the managers meeting with their workers to advise them of their increase, although in reality it turns into more of a “sell” job than anything else. 

Despite all these issues, this process is repeated year after year.  It is far from being a pay for performance model. 

How then do we transition from such an established and accepted process to a healthier method that actually promotes great performance and employee engagement? The answer is not as complex as one may imagine. It involves courage and leadership to do something different, away from the pack mentality. 

Historically, we’ve treated the merit increase exercise as an expense and a payout. The underlying key, however, will be to shift this paradigm from an expense to an investment. This is done by bringing the merit monies forward and putting them in a pooled account so employees can access such based on their level of engagement and performance. The actual earnings would be reflected immediately and the payouts themselves could be done quarterly so there is direct linkage between the effort generated and compensation.

One way of doing this is by reserving a portion of the merit increase — say 0.5 per cent — and bringing it forward to create this investment pool reserved for performance. In actual fact, what ends up happening is a hybrid approach between the investment model and traditional approach. 

No doubt, some will argue that bringing monies forward becomes cost-prohibitive as compared to the traditional model. All things being equal, I would agree. However, when coupling the new approach with innovative social platforms that allow for true capture of quantified performance metrics , the playing field becomes altered forever. How good will employees feel knowing where they stand while fully understanding the connection between their performance and their pay increase? It means less reliance on management’s discretion which can only serve to improve engagement. 

This is a bold new approach and while many companies may at first be slow to adopt, once the door opens, few will turn back. Innovative companies will bring to bear new methods that will make pay for performance not only meaningful but fun and engaging. Such technologies will, in large part, enable this transformation from an annual merit window into a more just-in-time dynamic performance model. The elegance of such an approach means it doesn’t have to be an all or none, but organizations can evolve over time, allowing for workers to buy in along the way. 

Traditional merit pay increase cycles evaluate performance through the rear-view mirror over a long span of time. Transitioning into a more “just in time” pay model along a quarterly payout continuum, based on more quantifiable and transparent metrics, reinforces the connection between the worker effort and the payout.  This investment approach will evolve existing after the fact “reward” type increases into a more forward “incentive”- based model that will in turn promote better performance and engagement behaviours.