75% of companies surveyed by Salary.com connect performance and compensation. It makes sense, right? Do great work, see big $$ rewards. But performance can’t be boiled down to good/bad, and compensation isn’t just a number.
The connection between compensation and performance is a delicate science. Let’s explore how theythe impact each other, along with five steps for connecting them effectively.
Various factors contribute to your ability to recruit and retain the employees you need to drive your business forward. An important factor is the compensation your organization offers.
“In a shrinking labor market, getting compensation right is a critical component of any strategic approach to talent acquisition and retention,” according to Payscale.
Having a strategic compensation approach allows organizations to attract quality talent, especially when there are more open jobs than employees to fill them. In a tight labor market, If compensation doesn’t meet a candidate’s expectations, they will look for a better offer.
Even if you’re able to attract an employee to join your organization, a competitive compensation strategy is required to keep your workforce satisfied. To retain employees for longer, and avoid the high costs of turnover, you need to continue to engage them by offering a desirable total pay package.
Compensation may be the foundation for an employee’s rate of pay—however, it’s essential to remember that compensation is not just a paycheck. A strategic total pay package includes all the benefits employees receive from a company. In addition to salaries, compensation might also include:
- Health insurance benefits
- Retirement investments,
or other perks (transportation programs, gym memberships, product discounts) that an employee receives from an employer.
The Society for Human Resource Management (SHRM) recommends following a three-step process to craft and implement a strategic compensation plan:
- Determine the sources of external market data
- Conduct market analysis, develop pay structures
- Calculate their cost
As part of the process, employers should evaluate and analyze elements such as market location, industry, workforce size, and healthcare costs. To get an idea of standard salaries, many employers purchase competitive salary data, or reach out to peer organizations to gather benchmarks. Industry or geographic surveys can also help determine competitive compensation packages.
In human resources, the word “performance” is almost always followed by the word “management.” The world of work focuses on managing and driving employee performance to help the organization achieve its goals. It’s nearly impossible for an organization to succeed if they don’t address both good and bad performance.
Performance is defined as the execution of an action. In the context of employment, performance describes how an employee completes job tasks. Each job has a set of requirements—knowledge, skills, and abilities—which someone must possess to perform well.
Until recently, conversations about employee performance were often reserved for the annual review. Organizations have realized that delaying feedback for a year not only makes it hard to implement changes. Even with yearly reviews in place, many organizations are now asking managers to conduct more frequent performance conversations to provide timely, relevant, and actionable feedback.
Continuous performance conversations are also driven by today’s workforce, which has a desire for meaningful feedback. According to a study conducted by Gallup, employees who have regular meetings with their managers are nearly three times as likely to be engaged than employees who don’t regularly connect with managers.
Employers need practices that enable productivity, feedback, and engagement while ensuring employees are effectively compensated for their work to adapt to this approach. The important relationship between performance and compensation is what we’ll consider next.
Individual performance-based compensation
Many organizations use a compensation strategy based on individual performance ratings or assessments. In this model, employees receive a percentage increase, bonus, or incentive, based on their demonstrated achievements. Typically, performance assessments and compensation increases occur during the same time of year, but the growing trend is to discuss performance and compensation separately.
The software firm Adobe updated its performance-based compensation approach when they noticed a yearly spike in employees leaving the company after each annual review cycle, according to SHRM. To address this unwelcome turnover trend, the team at Adobe created a new system which requires quarterly conversations between managers and employees, instead of a single annual review. These quarterly check-ins provide a chance to talk about ongoing goals and expectations and professional growth and development without including the pressure of pay in the conversation.
This type of ongoing feedback is essential to help reinforce and redirect employee behavior. Frequent and timely conversations also make it easier for employees to connect how their work directly impacts the organization’s results. That connection can ultimately serve to inspire and drive immediate performance improvements.
When performance conversations happen frequently, an annual compensation conversation becomes a time when managers focus on pay, celebrate milestones, and highlight organizational performance. With one compensation discussion and ongoing performance conversations, employees already know where they stand for pay adjustments. In this model, they’ve received continuous performance feedback, which is reflected in their compensation. It creates a clear, easy-to-understand connection between performance, compensation, and results.
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5 steps to connecting performance and compensation
To retain talent and address current business needs, organizations take various approaches to connecting performance and compensation. According to the 2020 Compensation Best Practices report, organizations are rewarding top talent performance in multiple ways, the top five being:
- Higher base pay increase than overall employees
- Bonus or incentives (no formal plan)
- Career development opportunities
- Goal-based bonuses
Connecting performance to compensation doesn’t happen without some planning. Start with the following five steps to create a framework that works for your organization.
- Identify the metrics. You need to determine the parameters on which performance will be measured. Will there be a rating scale? Who will rate employee performance: their manager, 360° feedback from peers, or others? Are the metrics based on subjective assessment, outcomes achieved, or both? The parameters need to be clear for management and employees to avoid confusion that can quickly lead to broken trust.
- Establish timeframes. Just as methods of measurement need to be clear, so do the timelines for measurement. Performance data should be available to track progress, use for decision-making, and to evaluate results. Identify a compensation and performance assessment cycle that makes sense with your business and helps you drive performance.
- Track performance against goals. Goals are a critical part of setting performance expectations. Managers should work with their teams to set goals and then track progress and performance against those goals. Ideally, your organization has an HR information system where managers can capture the goals, share them with employees, and continue to check in on those goals throughout the year.
- Include recognition and rewards. Performance isn’t just about what employees earn. They are also looking for intrinsic rewards—a sense of purpose, autonomy, connection. Make sure your compensation and performance strategies include a focus on recognizing employees for everything they contribute. Recognition for contributions can positively impact your bottom line—70% of employees said they would work harder if their efforts were appreciated.
Highlight the entire compensation package. Make sure to communicate everything in your compensation package. Without prompting, it’s easy for employees to forget everything else you’re providing—from healthcare to transportation, to flexible work options. Those benefits are significant and are part of their total compensation.