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Q&A about Base Pay Rewarding

 Performance

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Improving Variable Pay or Incentives

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QUESTIONS & ANSWERS
from WorldatWork Webinar March 29, 2007
CAN BASE PAY REALLY REWARD PERFORMANCE?
YES, IT CAN!
By Jay R. Schuster and Patricia K. Zingheim

  1. Have you seen pay for performance work in a union environment? Any suggestions/tips.

In a union environment, the going is harder because many entitlement, tenure, and trust issues need to be addressed as part of the transition to paying for performance. And we don’t need to mention issues of work rules and the role of the union’s leadership as it relates to the work relationship between organization leaders and the workforce itself. All that aside, we have seen it work and have been party to making it work—particularly using variable pay, not base pay.

One way to start is to provide an additional variable pay program outside the union agreement where this is legally possible that grants some additional lump-sum variable pay dollars on as frequent a basis as reasonable based on business metrics that are visible and within the workforce’s direct influence. The logic is to show the union leadership and workforce that performance can be measured objectively and fairly and that a variable pay award can be the source of trust-building. Another way is to pose a business case to the union based on competitiveness for business and jointly begin to address paying for performance as a bargaining issue. The US auto companies and legacy airlines are a case in point. They should have undertaken discussions of this kind many years ago before customers were negatively impacted by management, stockholders, and employees having their share of profits, leaving nothing for customers. So the customers went elsewhere. We have seen successful unionized workforce pay for performance in retail, healthcare, and manufacturing—it is worth doing but it requires a commitment to the long term and leadership “heavy lifting.”

  1. Based on your experiences, what is the typical mix between base pay and variable pay within the Luxury Retail Industry? Is it typically 80% Base / 20% Variable?

We hate to say “it depends,” but in this instance it does. The better the metrics for variable pay and the more they can be strongly influenced by the team or individual, the more the mix can be toward variable pay and should be. Rather than high base pay, we would like to see more in variable pay than 20%—for example, 30%—but the first 10% of the variable pay award may start based on a more attainable level of performance than where the next 20% cuts in. Or the first 10% could be an issue of performance management, and the remaining 20% an issue of hard metrics of sales, customer retention, high-profit product or service sales, or something of a strategic nature. Variable pay lets companies pay strongly for top performers—better than competition for excellent performance—but it does not become an annuity and must be re-earned. We would not start with the mix goal but with the metrics and then work to develop the right base/variable pay mix. But we like as much in variable pay as we can have because variable pay is the ultimate reward for performance. You can put less in variable pay if base pay is based on sustained value-added over time and linked to performance. The example we gave of ranking people based on pay and then performance as a diagnostic tool will let you know how much you need to put on performance in the future.

  1. We have traditionally combined our merit increase with a cost of living so to speak. Being this budget is very small (last year the increase averaged 3.7%), how do we incorporate pay for performance in base pay?  We have normally tried to average P50 on base with exceptional upside potential on the variable side.

You have a major cultural and communications opportunity here. Your goal should be to create a performance culture by visibly paying for performance. Cost of living is a death knoll on paying for performance because it has nothing to do with paying competitively. For example, Hawaii has a high cost of living but compared to the rest of the US is less competitive because it is easier to attract good talent to Hawaii for less money. We would communicate that your goal is competitive pay and not cost of living and build an educational program telling how competitiveness differs from cost of living—this is an important step to take. If your organization allocates 3.7% to pay adjustments you need to communicate that this is for competitive practice and base pay adjustments for sustained strong performance over time. We would reserve a portion of the 3.7% budget to reward the top performers in the organization with larger increases regardless of the competitive situation—focus on key skills, performance, and results. Reserve 0.7% for high performers only and let the rest go for competitive adjustments.  Then the managers meet together and make performance and pay decisions. Allocate base pay to competitiveness and sustained strong performance over time, variable pay can reward annual performance results, and you have total pay for performance—but you need communications and a culture change to get there.

  1. What is best practice—2 or 3 times average base increase to top performers over “average” performers?

The relative multiple of salary increases for top performers compared to average performers depends on the size of the average increase. For example, with average increases at 3.0%, then the increase for top performers can be 2X or 6% or even higher. However, if the average increase is 5%, then the top performers may get 8% but may not get 10% because an individual’s base pay can end up too high for their value if they do not sustain their one year’s high performance. Also, at a 10% increase, the base pay of people—even high performers—may rise too quickly relative to their market value or may end up too high relative to their true market value after a few years. Although organizations want to pay top performers well, they really want to ensure that they pay sustained top performers well. This is where variable pay has an advantage—it can be 2X or 3X larger for top performers than for average performers and send a strong pay-for-performance message because it does not become a fixed future annuity.

  1. What do you do with your "vital, core" employee population while you are focusing on the top 20%?

We wish we knew what portion of your workforce is “vital, core” and what the definition of this workforce is. Assume for purposes of discussion that the vital, core workforce has the key skills and competencies which your organization needs to deliver products or services to customers. If this group represents 50% of the workforce, then approximately 20% of the total workforce may be the top performers among the 50% vital, core employees and defined as those who are best able to translate critical skills and competencies that are core to organizational success into performance results. First call for paying for performance will be the approximately 20% top performers identified from the 50% who are vital, core employees. Then the remaining 50% vital, core workforce has next call on available pay dollars. Your organization communicates priorities and shows everyone what is needed to become among not only the “vital, core” but among the best of this group that is critical to organizational success. The result is differentiated pay that may be individually determined based on performance but also role determined based on key skills required of the role that are vital to your organization’s success.

  1. Please can you give some examples of major companies that really differentiate base pay according to sustained performance?

We would rather not name specific companies without their permission although some examples that have presented at WorldatWork include General Mills and IBM. Many organizations that do an outstanding job of paying for performance view this as a proprietary talent strategy that generates differential advantage and don’t want to be specifically named.

  1. You mentioned that we could set aside a portion of the budget for rewarding top performers. What do you think is a good differentiation % for average base pay between top performers and the average over time? How much more base pay should top performers earn?

This would be a good question for you to study in your own company. We have seen companies set aside an additional 0.25% - 0.5% of their salary increase budget to reward top performers. Our experience is that 3% is the minimum perceived acceptable salary increase differential between top and middle performers. Clearly it must be significant and meaningful. Please see our answer to Q4, which is closely related to this question.

  1. How do you justify giving different increase amounts to different divisions and not affect working relationships, etc. Won’t the organization become divided?

Have the division managers help develop the criteria for determining if one division gets more than another and they become champions and sponsors of doing this. It will only become divided if the solution is not developed from a participative approach that includes management.

  1. What would you suggest as far as positions that are very tied into a regular weekly schedule such as a sanitation truck driver that doesn't have an opportunity to work on individual projects?

We would develop performance standards for sanitation truck drivers and reward performance on these metrics. Think in terms of common measures for all production-type jobs—productivity, timeliness, quality, safety, customer service. We bet the drivers could help develop the metrics and champion them since they are part of the solution. The more regular the schedule, we would believe that the more metrics and goals can be developed with the help of drivers and their managers and applied consistently. Getting drivers together periodically to view the results of the measures and problem solve performance will provide significant advantage as well—making the workforce part of the solution. We believe that the building of metrics can start with someone from operations communicating to the drivers the role they play in achieving your organization’s overall business proposition—in terms of customer service, cost, timeliness, liability issues, safety, operational effectiveness, and the like. Every role that is important to the organization has metrics, and the workforce and their management team can help you develop them.

The more "yes" answers you have, the better. If you have several "no" answers, now is the time to review and evolve your variable pay plan—making it subject to continuous improvement like any other process or system in the organization.

 

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