Pay for Performance vs. Variable Pay

Friday, July, 20 2012

At the recent 64th SHRM Annual Conference and Exhibition in Atlanta, John Rubino, founder and President of Rubino Consulting Services (RCS), a global human resources consulting company, suggested that traditional “Pay for Performance” or so called “merit” based pay practices are detrimental. Rubino went so far as to say that such practices might even be “demotivational” to the employee and their cohorts. Furthermore, he invoked the name of Einstein in support of his allegations that annual percentage increases to an employee’s base pay year over year was not necessarily a good idea.

So what is the basis of most traditional Pay for Performance systems? Simply, if an employee meets or exceeds their management’s expectations, they are rewarded, usually by increasing their base pay rate by “X” percent. In today’s business and economic environment, that percent is often in the range of 2% to 3%. The issues with that practice are several. A 2% to 3% increase spread over a year is a meager amount at best. In most cases, the increase is further reduced by significant taxation. Traditional merit matrices often accelerate pay movement for those lower in the range and decelerate pay movement for those higher in the range. For those who have reached the range’s top, generally there is no increase. Since merit budgets must be allocated across ALL employees, traditional Pay for Performance systems compel employees to compete rather than cooperate with each other. So it is conceivable that an “outstanding” performer could receive 2% while a meets employee could receive 3%. Lastly, someone within the organization MUST receive zero for the traditional merit matrix to work for a few to get even 2% to 3%.

Rubino quotes Einstein in saying that compound interest is a powerful tool. Building on an employee’s base pay year after year is, in fact, an example of compound interest building up over the employee’s working life time. And yes, 2% to 3% does seem like a harmless amount until you think in terms of the 30-40 years of a typical working career. Combine that with the multiplier and ripple effects on life insurance, 401(k) match, pension, disability, and paid time off plans and you can begin to understand why Rubino might perceive traditional Pay for Performance systems in less than a positive light.

What alternatives does Rubio offer up as available? The most common are flat dollar lump sum payments which do not add to base and generally do not have the same multiplier and ripple effects on other benefit plans as adding to base pay. From a motivational impact, a $1,000 check carries more value than $38.46 every other week. Properly designed profit sharing plans have the potential to also provide an incentive for employees, although they must be aligned with the organization’s culture and values and communicated well. These variable pay concepts are not new and have been successfully used by many employers. But they do require time to work. And in an environment where organizations are sometimes bidding for the very top most talent, time can work against an employer.