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As companies increasingly break free from the perceived tyranny of traditional yearly employee performance ratings, one of the biggest challenges is figuring how to pay people for their accomplishments. Loathed as annual ratings and the process behind it may be, those numbers provided a yardstick, however flawed, for deciding how much to deposit into an employee’s paycheck. This is the third in a series of blogs on performance management trends and challenges.

In my previous blog I wrote about the fallacy that companies are eliminating employee performance ratings.  What companies are actually doing is replacing annual reviews and ratings with continuous feedback, “potential” scores, and in some cases, “shadow” or “comp” rankings that employees aren’t aware of but factor into important decisions. The impact on compensation planning has been palpable.

“I’ve had the same conversation with up to 40 customers during the past year with people basically saying, ok we’re getting rid of this annual rating, now what?”  said Leslie Apony, Manager of Customer Value and Adoption at SAP/SuccessFactors. “They are struggling to determine how to make compensation decisions, including pay for performance. You still have to differentiate your top performers. That’s why we’re seeing more spot and retention bonuses.”

According to Apony, calibration is at the heart of the pay for performance issue. She advocates a pay for performance strategy directly linked to the achievement of agreed-upon goals, something she said up to 60 percent of companies have been doing. I also asked steve.hunt, Vice President of Customer Value at SAP/SuccessFactors, for his thoughts on employee motivation and engagement in the context of a sampling of strategies prevalent worldwide:

Performance and potential rankings: One option is to move completely away from a single performance score to using performance and potential rankings, especially for equity and bonuses. “More and more companies want to leverage 9-box ratings for compensation and succession decisions,” said Apony. Pay becomes not only a reward for past performance, but also an investment in an employee’s future contribution.

Project-based compensation makes sense in some industries like professional services, where employees are assigned to achieve results during a specified timeframe on behalf of clients. This highly transactional strategy can work short-term, but treating people as contractors can jeopardize long-term employee commitment.

Market benchmarks: Apony also sees organizations returning to market benchmarks, (compa-ratio or position in range), to set guidelines which take into account the relationship between the salary of an employee and the pay range for that employee. However, this approach excludes a pay for performance approach and differentiation of rewards for top performers. There’s no built-in mechanism ensuring that non-performers do not receive increases or awards. Companies risk paying people based solely on job title and qualifications instead of their actual contributions.

Pooling: Some companies are returning to pooling. Long popular in Asia, pooling provides managers with a chunk of compensation budget to cascade through the organization. The concern is that minus guidelines, managers are left to their own discretion, making it difficult to ensure consistent and fair pay decisions.

Cafeteria-style plans are on the rise, empowering employees to select and weight their unique compensation variables including base pay, bonuses and equity. While this doesn’t solve the problem of how to calculate base pay, bonus or equity increases, employees can tailor compensation more to their personal preferences.

Perhaps the biggest challenge for companies is to avoid getting shackled with another kind of flawed approach to both employee performance management and compensation. Hunt said determining how to reward performance may be difficult, but it’s essential to high performance.

“There’s no single method that works well for every company all the time. The most successful organizations tend to be those that openly address the difficult issues, and emphasize transparency around how pay decisions are made and why the company opted for its approach. You will never have a process everyone likes, so focus instead on creating a process you believe in and can effectively explain when someone asks why they didn’t receive the raise they expected,” he said.

Watch for upcoming blogs on succession planning and development. As always, I welcome your thoughts as this conversation continues.

Related content:

Hidden Problems behind Eliminating Performance Ratings

Fixing Performance Ratings:  It’s not about what you eliminate, it’s about what you create

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