Article
7 min read
Author
Shannon Hodgen
Published
November 17, 2022
Last Update
July 11, 2024
Table of Contents
What is pay-for-performance compensation?
The benefits of using performance-based incentive plans
The downsides of performance-based compensation
Effortlessly pay your team no matter where they are
Determining the best employee compensation system for a global team is a complex task, given all the factors that may influence your decision: currency fluctuations, local cost of living, tax implications, and employee expectations—just to name a few.
If you’re leaning towards performance-based pay, this guide will help you understand how pay for performance works, its pros and cons, and the best practices for its implementation.
Pay for performance, often referred to as P4P, is a strategic compensation approach designed to optimize employee productivity and align it with organizational objectives through a dynamic system of financial incentives.
In this compensation model, employees are motivated to exceed their performance targets as you give them an opportunity to earn more if they outperform the pre-set benchmarks.
Performance-based compensation may include merit-based salary hikes, result-driven bonuses, and variable compensation schemes.
Human resources departments typically participate in the creation of performance-related compensation strategies.
They measure different metrics and KPIs to evaluate the employee’s performance and assign adequate incentive pay to top performers, such as goal attainment, customer satisfaction, or corresponding numerical output (like revenue for sales teams).
💰 Pay-for-performance programs are considered direct compensation and may depend on your employee’s:
Yes, there are several types of performance-based incentive pays. The most common are:
A 2022 study found that pay incentives can increase job satisfaction, positively affect overall company performance, and reduce HR costs by lowering absenteeism and turnover rates. What are some other benefits of pay-for-performance compensation?
By directly linking compensation to performance, employees are motivated to excel in their roles and achieve their goals, as their efforts are rewarded with financial incentive programs.
💡 See also: Can You Give an Independent Contractor a Bonus?
Pay for performance can attract top talent, as high-performing individuals are drawn to organizations that recognize and reward their contributions. It also promotes employee retention by offering a financial incentive to stay with the company for a longer time.
To properly implement performance-based pay, you need to establish a robust performance management process, which can help easily identify top performers and those who may be struggling and need specific performance measures to improve.
💡 See also: Performance Management for Remote Teams: All You Need to Know
Employees strive to improve their productivity and efficiency to earn higher rewards on top of their base pay, leading to increased overall output and performance levels.
The model sets clear performance expectations and goals, providing employees with a well-defined path to success and advancement. Regular performance reviews and feedback discussions encourage employees to continuously improve their skills and performance, fostering a culture of growth.
When compensation is tied to organizational objectives, employees are more likely to focus on tasks that contribute directly to the company's success. This model also fosters a culture of accountability, as employees take ownership of their roles and outcomes.
With this compensation model, employees can earn more based on their efforts, meaning greater financial incentives for those who excel. Organizations can tailor incentive structures to align with specific roles, departments, or business goals, creating a customized approach that suits their unique needs.
⭐ Did you know? Deel offers On-Demand Payroll that gives EOR customers unmatched payroll flexibility, with extended cutoff dates and off-cycle payments.
Pay-for-performance compensation structure may not be ideal for every organization. Here are some potential shortcomings of this pay model.
Overemphasis on individual performance and rewards can lead to unhealthy competition among employees, damaging teamwork and collaboration.
Solution: Include team-level performance bonuses to balance individual vs. team performance. Involve teams in setting performance goals that align with the organization's objectives. This fosters a sense of ownership and commitment to working together to achieve common outcomes.
Evaluating performance objectively can be challenging, leading to potential bias in performance assessments. Managers might unconsciously favor certain employees or focus on easily quantifiable metrics, neglecting other important contributions.
Solution: Focus on behaviors and results rather than employee personality. Combine manager and peer reviews to ensure an objective image of each employee’s past performance. Consider calibration meetings with the company HR and leadership teams to ensure everyone’s evaluated objectively.
The constant pressure to meet performance targets can lead to increased stress and burnout, particularly if the goals are unrealistic or the rewards don't justify the effort.
Solution: Set realistic goals and use a balanced scorecard approach where you’ll evaluate different performance dimensions rather than just financial metrics. This will also help employees avoid becoming narrowly focused on the metrics that are directly tied to rewards and neglecting other important aspects of their roles or the organization's overall goals.
If employees feel the performance metrics are unfair, unattainable, or not aligned with their responsibilities, they might become disengaged and unmotivated.
Solution: Nurture honest and transparent communication within your team. Create a streamlined system so that employees can leave anonymous feedback if they have any comments or questions about your pay-for-performance plan. Encourage regular one-on-ones between managers and direct reports so that employees have a safe space to share concerns.
Designing and managing a fair and effective pay-for-performance system can be complex and time-consuming, requiring well-defined metrics, performance evaluations, and communication strategies.
Solution: Invest in technology solutions that automate data collection, performance tracking, and compensation calculations. This reduces manual effort and minimizes errors. Most HR tech tools also allow you to maintain a centralized database that houses performance data, compensation calculations, and historical records, so the information is readily accessible and organized.
HR technology helps you build and sustain trust with your team members by showing them you have accurate data about their work engagement with you, have their history of progression and performance, and understand and apply the compliance requirements for them based on their employment status and country.
—Casey Bailey,
Head of People
While high performers benefit from the model, average performers might receive minimal increases, leading to decreased motivation and satisfaction.
Solution: Implement tiered pay-for-performance initiatives offering different levels of compensation increases. This ensures that even average performers receive some recognition and motivation. You can also provide a structured plan for employees who are struggling to meet performance expectations and help them progress.
Performance-related pay or not, Deel helps you manage compensation for your global workforce in one, unified platform. You can use Deel to:
And much more!
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