Thought leadership

Should You Pay for Performance?

Should You Pay for Performance?

As an employer, you probably assume that paying for performance is something that you should at least try to do.  This article is intended to provide a framework within which you can decide whether or not paying for performance makes sense for your organization.

What is performance?

It is always necessary to define what “performance” means.  Chances are it means different things to different individuals in your organization.  To some, it may mean having the tools to achieve results.  To others, it may mean the end results themselves.  This is a critical distinction.

The tools are the means of achievement:  the enablers, if you will.  They include skills, traits, and behavioral competencies.  These are the characteristics of the employees that enable them to produce results.

The end results are what happen as a consequence of the individual’s competencies.  Results include goal achievement, meeting standards, and other accomplishments that can be objectively measured in terms of quantity, quality, and/or timeliness.

Organizations need to define exactly what they mean by performance if they hope to be able to effectively pay for performance.  In most cases, it means paying for the end results.

Why link pay to performance?

Why would an organization choose to link pay to individual or group performance?  There are four primary benefits:

  1. Motivate improved productivity consistent with overall organizational objectives
  2. Improve communications between supervisors and their employees
  3. Help facilitate team processes
  4. Substantiate higher compensation levels


1. Motivating improved productivity

The academic community and other theorists regularly question whether financial rewards are actually motivational, or just excuses for organizations to manipulate their poor, overworked employees, who would much prefer to be motivated by the implicit value of the work itself.  (See Kohn, Alfie Punished by Rewards. Boston: Houghton Mifflin, 1993/1999.)
Although there is much to be said for creating meaningful work for employees, I believe that financial rewards are, for most people, powerful motivators.
Most organizations with whom we have worked are very interested in creating ways to manage performance in such a way as to realize productivity and efficiency gains.  This generally becomes a process of establishing individual and/or team goals that support the organization’s overall business plan or mission.

2. Improving communications

Focusing on productivity provides a unique opportunity for organizations to improve communications at all levels.  We have become a society in which unconscious assumptions exist about almost everything.  In the workplace, both employees and their supervisors have their own perceptions about their jobs that frequently don’t match.  Sometimes, employees are not even sure who their supervisors are!  This, of course, leads to considerable confusion and, eventually, to inefficient work habits and less than optimal results.
Developing a system through which performance results are articulated and documented requires participation on the part of all employees.  This involvement in a communication process often leads to improved productivity in and of itself – even before the connection to financial rewards is made.

3. Facilitating team processes

Often, attempting to force team behavior by providing team rewards is a recipe for frustration.  This is particularly the case when “teams” exist primarily in the minds of management staff.
However, an organization that has functional, established teams whose members acknowledge them as such can benefit from a pay-for-performance plan that provides meaningful financial rewards for collaborative goal achievement.  In this context, the facilitation of team processes can be enhanced by making sure that all team members participate equally in the payoff, even if some team members are higher-paid, and/or have higher levels of responsibility than others.  In a sense, they all sink or swim together.  This creates more peer pressure to perform, which is one of the fundamental benefits of establishing teams in the first place.

4. Substantiate compensation levels

Many organizations have an imperative need to attract and retain top performers in order to meet their business goals.  Paying for performance then becomes the obvious answer.  If it can be shown that difficult-to-achieve goals were met and/or exceeded, and that they resulted in greater outcomes or better operating efficiencies, senior management will feel comfortable proposing higher pay levels, at both base pay and incentive levels.


Here are some basic issues to consider when deciding whether to pursue a pay-for-performance approach in your organization:

LEVELS OF BASE PAY: Are they generally high, low, just about right, or mixed? We suggest that base pay should be structured and consistent before attempting any form of performance-based variable pay approaches. A clear pay philosophy should be established that incorporates understanding of your labor market, your competitors, and what you want to achieve as an organization.

ORGANIZATIONAL CULTURE: Is it performance-oriented? For example, some not-for-profit organizations are more concerned about employee development than they are about productivity or measurable outcomes.  In some instances, it may be difficult to measure outcomes, and the culture has fostered a mentality that contributing to the mission is enough of a reward.

MANAGEMENT TOOL: Will the organization adopt pay-for-performance as a way to manage? In order to be effective, there must be conceptual changes that affect the day-to-day management approach.

SENIOR MANAGEMENT: Does the organization’s management group have the right competencies to manage and support a pay-for-performance approach? Usually, it’s only highly skilled managers who are able to effectively work with their employees in the context of a pay plan linked to performance.  Not only must they be able to do this, but they must also want to do it – it takes time and effort to do it right.

Defining (or redefining) an organizational pay philosophy and developing a corresponding pay structure is not an easy or obvious process.  Many organizations avoid the uncomfortable transition between their old, traditional plan (or no plan at all!) and a new, performance-based one.  With some thorough discussions and careful implementation however, the benefits are substantial.

Shari Dunn

Upon receiving her B.A. degree in psychology from the University of California at Berkeley, Ms. Dunn headed to New York City to take a position in the human resources department of the Marine Midland Bank, and later worked at Nabisco in operations research. Returning to the San Francisco Bay Area, she became a Research Associate for McKinsey & Co. Next, she moved to Deloitte (then Touche Ross) as a consultant. It was at these two ...

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