Are You Hesitant to Base Compensation on Performance? Don't be.

At most companies, compensation is based on performance. If an employee shows that they’re worth their salary and more, they get a raise (and a bonus, depending on the job and company). Recently, however, there’s been a shift in thinking about the nature of pay-for-performance models, and some companies have tried to veer away from them. But does paying everyone equally really work out? How does compensating people differently benefit your company? The answers aren’t always pretty, but they’re important lessons to learn, as we’ll soon see why compensation needs to be based on performance.  

When a Rising Tide Causes a Storm

Even the most benevolent attempts at fixing a disparity in pay can have unintended consequences. Back in April, Dan Price (@DanPriceSeattle), CEO of Gravity Payments, decided to raise the minimum salary of all of his workers, regardless of work experience, to $70,000 a year. Sounds pretty generous, right? Pay your employees what you think they’re worth and they’ll step up and exceed your expectations.

Unfortunately, the results of Gravity Payments’ pay raise caused a rift in the company. As a follow-up story explains, many of Price’s best employees left the company, feeling that giving pay raises to people who had yet to show their proper worth was unfair to the people who had and were only receiving nominal raises (since they had a current salary closer to the $70,000 mark). They also lost clients who believed the company would raise its prices after seeing the news. So while it’s great to want all of your employees to be compensated fairly for their work, being too hasty about compensation without thinking about performance doesn’t pay off.

The Benefits of Differing Compensation

Some years ago, it was estimated that the ideal salary range was around $75,000, since happiness did not increase with compensation after that amount. However, recent studies have shown that the number must be adjusted by the cost-of-living in your area, which changes what the “ideal” salary range should be. Even when it comes to state and local living suggestions, there’s reason to question the idea that all employees should be paid the same, especially when remote work comes into question.

Differences in compensation can also help you attract quality employees. Not only will increasing compensation according to performance motivate employees to work harder, it will also attract more lucrative candidates. A recent study by SAP found what high performers want more than anything else was compensation (with 66% of them citing it as their most desired value), followed by merit-based rewards like bonuses (55%). When you’re known as a company who offers high compensation and rewards based on performance, high performers will come knocking.

Evolving Compensation

If you’re thinking about how you can change up your incentives plan in order to increase performance at your company, you’re not alone. At every level, companies are constantly changing around the ways they pay their employees. For example, 78% of companies are changing their executive pay programs this year, with 44% of them looking to increase the link between performance and pay. There’s never a “best” option when it comes to developing a compensation plan — it changes every year, based on what your employees want.

That doesn’t mean you can’t have a few key tenets guiding you. Most importantly, while it’s nice to be able to give everyone a great baseline pay for their efforts, disavowing the idea of pay for performance by compensating everyone equally is generally not a good idea. Instead, companies should use pay as an incentive to have employees work at their best, while making sure that their base pay allows them to live at a stable level. Until someone finds a better way (and people will always try), compensation will always need to be based on performance.

Bio: Chris Arringdale

Chris Arringdale is the Co-Founder and President of Reviewsnap, an online performance appraisal software that allows you to customize performance management, competencies, rating scales and review periods. Reviewsnap serves more than 1,200 customers worldwide including, Penske Racing, CubeSmart, PrimeSource and Nonprofit HR Solutions.

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