Performance-based pay schemes are popular mechanism for improving company performance – particularly for senior managers. They usually involve incentives or bonuses for achieving specific targets. But to work, they need to be set up correctly and, above all, communicated clearly.
Traditional pay strategies have seen employees rewarded for service and loyalty, receiving salary increases based on inflation or collective negotiation. Increases were often regarded as entitlements, with little or no link to performance.
This is all changing.
Businesses can no longer afford to pay simply for long service and inflation. Establishing performance targets and making individuals accountable for achieving these has become essential for business success. Incentives and bonuses help to drive the process.
The objective of performance-based pay is multi-faceted. It’s integrated into pay packages to ensure holistic remuneration strategy that attracts, retains and motivates key individuals. Linking senior managers’ performance and reward is designed to:
* focus attention on certain key aspects of the organisation’s performance;
* motivate individuals to achieve specific results that are aligned to the business strategy;
* share portion of the financial success with those most able to influence results;
* promote the appropriate balance between long and short-term thinking, and
* align employee interest with that of shareholders.
What’s in name?
Performance-based pay can take many forms – profit share, incentives, bonuses, pay ‘at risk’, commissions, gainsharing, lump-sum payments and so on (and we haven’t even started on the smorgasbord of long-term incentives available). Interpretations of these terms abound and poor communication and lack of understanding of their respective objectives lead to some interesting debates and crossed wires.
As start it’s imperative to differentiate between ‘bonus’ and an ‘incentive’. Incentives have specific performance measures that need to be achieved before payment is made. robust, well-designed incentive scheme follows the theory of ‘if this, then that’. In other words the ’cause and effect’ is spelt out very clearly ‘up front’ and there is no uncertainty in the minds of either employee or employer as to what the outcome will be.
Discretion doesn’t come into it and managers (or boards in the case of CEOs) have no obligation to move the goalposts closer if the performance criteria aren’t met. Incentives are particularly suited to CEOs and other management roles, sales staff and project-oriented jobs.
Setting the performance targets is the most critical step with incentives. It is essential to determine what needs to be achieved to gain the reward. Appropriate measures are selected with the necessary ‘stretch’ to motivate the individual. These must be balanced against the probability that the goals will be accomplished.
Incentives should focus on just one or two critical, quantifiable measures. They are not there to reward for performance in the ‘whole job’.
‘Bonuses’, on the other hand, tend to be more discretionary and usually reward for achievement retrospectively. They are more subjective, less defensible and rely on decisions based on individual judgement. But they do have their place – particularly for roles where performance is not as easy to quantify, such as business support roles or administrative staff.
The most common mistake made with bonus schemes is that they are linked to arbitrary “key” objectives which, when scrutinised, turn out to be what the person should be doing as part of their normal job anyway. What waste of everyone’s time and effort.
It is perfectly sound practice to have tailored incentive schemes for those employees who can directly affect results, and bonus scheme for others – whose contribution is indirect and where the line of sight is more remote.
Few organisations have mastered this differentiation and the confusion that results is what leads to negative perceptions about performance-based pay schemes.
Self-fulfilling prophecy
Whatever you choose to call it, variable pay, by its very nature, should fluctuate from one year to the next. If it doesn’t, it means that an ‘entitlement mentality’ has probably set in where employees are automatically paid out on discretionary basis whether performance targets are met or not. This scenario undermines the objectives of the scheme and breeds cynicism and mediocrity.
A number of factors underpin the upward pressure on pay for executive positions in New Zealand. For start, the gap between New Zealand’s pay and that of other developed countries provides an incentive for highly mobile managers to move offshore. Increasing the remuneration of key managers may be necessary to retain them. (This is, to some degree, offset by New Zealand’s offering as lifestyle destination and the relatively high buying power of disposable income.)
Other factors include recent economic growth and drop in the rate of unemployment that has significantly influenced the supply and demand relationship in favour of key employees. Furthermore, technology-based start-ups and other Initial Public Offerings (IPOs) are drawing talented people away from traditional corporate work, with the potential for massive capital gains and more casual work culture. In addition, the continued movement of head offices from New Zealand is taking challenging, interesting work offshore.
Variable pay is an effective means of meeting the demands of these upward pressures, while retaining the fixed cost of remuneration, and as result its incidence has increased substantially over the past five years.
Kira Schäffler is director of NZ remuneration consultancy Higbee-Schäffler. Email: [email protected]
Ideal Salary Survey
Part Two – Incentives
Management and remuneration consultants Higbee-Schäffler are conducting an “Ideal Salary Survey”. What do you think constitutes the Ideal Salary? This is part two of series of articles on the importance of salary package benefits and we want you to respond to the questions on the survey form in this issue of Management magazine or go to Management’s website at www.management.co.nz.
The questionnaire has been compiled in consultation with Higbee-Schäffler, which will analyse the results and, at the end of the year, compile the data to reveal our readers’ Ideal Salary Package.
Fax back the questionnaire in this issue or visit www.management.co.nz to take part in Management’s Ideal Salary Survey and we’ll email you copy of the complete survey results at the end of the year.
Incentive Pay – Market Trends
The increased incidence in performance-based pay for chief executives (almost all CEOs in the private sector are eligible to participate in some form of variable pay scheme) is direct result of organisations striving to link remuneration to performance.
While still relatively conservative compared with other developed countries, variable pay is increasing in New Zealand. In the private sector employers have almost exclusively moved away from traditional ‘bonuses’ (which tend to be more discretionary in nature) to targeted incentive schemes which identify and articulate performance expectations and resulting rewards.
The Higbee-Schäffler database indicates that about 90 percent of private sector medium-to-large New Zealand companies offer incentives to senior management. Furthermore:
• In 48 percent of these organisations, target incentive pay exceeds 20 percent of fixed remuneration. further 30 percent of organisations have targets at between 15 percent and 20 percent of fixed remuneration salary for senior managers.
• While remuneration structures are very varied, incentive payments for CEOs, general managers and managing directors are most often in the range of 20 percent to 25 percent of fixed remuneration. Incentives for other senior managers are most often in the range of 15 to 20 percent.
• In the Hig
