Describe the Key Elements in Designing a Pay-for-Performance Plan

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A business worker in a tidy office.
A business worker in a tidy office. (Image: Ryan McVay/Digital Vision/Getty Images)

Implementing a pay-for-performance plan can be challenging because it involves changing from an organizational culture of entitlement to one based around performance. The potential upside of pay-for-performance plans is that they will attract and motivate top talent and better link employee actions to organization goals. A well-designed pay-for-performance plan will support your organization's mission and appeal to your top performers.

Management Training

A key element in any pay-for-performance plan is a manager's ability to train employees properly and evaluate them fairly. If employees believe they are treated unfairly, their morale and productivity will suffer rather than improve. In designing a plan, ensure training managers create good performance measures, provide ongoing feedback, and accurately gauge performance levels. A good performance measure must be specific. For example, a performance measure for a package delivery company would be to deliver 90 percent of packages on time. The plan also should allow senior management to review compensation decisions made by front-line managers.

Communication

A pay-for-performance plan is ineffective if employees don't understand how they can earn rewards. Management should provide employees with clear instructions on how to accurately estimate their own incentives and rewards based on their performances. For example, sales people might be told that they will receive a 10 percent bonus on all monthly sales over $1,000. Regular communication about the company's performance relative to goals also is important, especially if one component of the pay-for-performance system is based upon departmental or company-wide performance.

The Right Mix

A pay-for-performance plan will typically have several types of incentives, such as long-term, short-term, individual and group. For example, the plan might provide for a graduated annual pay increase of 0 percent to 7 percent at the individual level, as well as a large bonus if the company meets profitability goals. In manufacturing environments, pay could be based upon the amount of widgets an employee produces each week, with additional incentives if the department meets quality milestones. The mix should be monitored and reviewed by management.

Adequate Funding

A pay-for-performance system will fail quickly if there isn't enough money to pay the rewards that employees are due. When designing a pay-for-performance plan, calculate revenues and expenses under various scenarios to be sure your cash flow will allow you to cover the performance payments. Calculating personnel costs over a longer term, such as three years, also is important. For example, if several employees earn the highest possible raise, will you be able to continue to meet your payroll the following year?

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