Performance Related Pay – Definition, Objectives and Conditions

Rewarding performance is the element of the performance management process which seeks to give employees some kind of return for achieving their targets. This is wider than just financial recompense and includes such things as praise, greater opportunities for training and development, and promotion. Very often one of the things most sought by an employee is the recognition that he or she is doing a good job and where, for example, this is expressed in terms of bonus it is very often the recognition rather than the cash that really matters. It is only when money enters the equation that rewarding performance become very tricky and the emphasis her is therefore on the financial aspects.

People very often consider performance management solely in terms of Performance Related Pay (PRP). PRP is a method of remuneration that provides individuals with financial rewards in the form of increases to basic pay or cash bonuses which are linked to an assessment of performance, usually in relation to agreed objectives. This definition captures what performance related pay is all about.

When there are business pressures to improve performance a common reaction of many managers is to want to pay for the results, even though the organization may have no comprehensive system of performance management. However, it is never appropriate to introduce Performance Related Pay unless there is already such system in place. It is very difficult to get this aspect of process right, and there are numerous examples of Performance Related Pay schemes, which may be called, ‘merit pay’, ‘performance bonuses’, ‘incentive bonuses’, etc that have fallen into disrepute. For examples, a recent in-depth study by the Institute of Manpower Studies in three organizations, a building society, a food retailer and a local authority, found that merit pay was more likely to demotivate than motivate employees. Similarly, a recent study of managers in British Telecom found that some 60% believed that Performance Related Pay was applied unfairly.

Objectives of Performance Related Pay

Given that it is difficult to get it right, why do organizations seek to relate pay to performance and why is it apparently an increasing trend, particularly in the public sector and especially in those parts that have been recently privatized? The introduction of Performance Related Pay can have a number of objectives:

• To motivate employees as they will see that their rewards are directly related to their efforts.
• To increase employees’ focus on and commitment to corporate objectives.
• To help develop a performance culture or to reinforce the existing culture.
• To reward the contribution made by individual to the organization’s success.
• To help recruit and retain high-quality staff.
• To ensure that rewards are in line with organizational performance.

Conditions for the successful introduction of Performance Related Pay

For Performance Related Pay to be introduced successfully, the following factors must be obtained:

• The scheme must be appropriate to the organization’s culture. There is no such thing as an off-the-shelf scheme, and in some cases it may not be appropriate to have any scheme at all.
• The scheme must be closely linked to a comprehensive performance management process. Without such a process, Performance Related Pay can’t be expected to work properly.
• The performance management process must include a robust mechanism for setting objectives and targets that meet the criteria set out earlier, and for reviewing, assessing performance against these.
• There has to be top management commitment to the process, so that it is owned by line managers and not merely seen as a personnel system.
• While the measures on which performance is judged should as far as possible be quantifiable and objective, some more objective ones will inevitably need to be included.
• One of the key considerations is to ensure that the managers operating the scheme are thoroughly trained in its principles.
• The scheme should be sufficiently flexible to be able to take account of changes in business or individual circumstances.
• The link between financial rewards and performance must be clear one and should be effectively communicated to the employees.
• There is a need to ensure that performance measures are not just quantitative but also qualitative in nature including, for example, such measures as teamwork and innovation.
• The rewards should be seen to be appropriate in terms of effort put in and the results produced. If they are regarded as derisory the scheme will soon fall into disrepute.
• In goal setting, account should be taken of the need to achieve long-term objectives as well as short-term ones, and any Performance Related Pay scheme should be designed to reward both.
• The scheme should concentrate rewards in those areas of business that are deemed to be of prime importance. In other words, if it is the intention of organization to try to improve return on capital employed, then this should be one of the factors that are incentives.
• Jobs must be clearly defined and accountabilities spent out, if individuals are to achieve the required result.
• Finally, there should be total clarity about why the process is being introduced and what it is to achieve. Without this clarity it’s better not to proceed.