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.

American Retirement Model – Private Savings

American Retirement Model – Private Savings

Traditional Defined Benefit plans now cover only about one fourth to one third of US workers. However, significant numbers of workers are eligible for Defined Contribution plans in one of several forms. Most workers are also eligible for some form of Social Security benefits once their reach their normal retirement age. What is missing is the former third leg of the Three Legged Stool i.e., Private Savings. The concept was that workers relied on a combination of Private Pension, Social Security, and Private Savings to provide income during their post-employment years. However, since the late 1980’s, Traditional Defined Benefit plans have steadily been replaced by Defined Contribution plans. Combined with stagnate to very low real wage growth, many Americans lacked the disposal income to both participant in Defined Contribution plans and fund Private Savings. Thus Americans, as a whole, have saved significantly less than their foreign cohorts have. The result is not many Americans will have a substantially lowered standard of living during their retirement years.

At the same time that Traditional Defined Benefit plans were being replaced with Defined Contribution plans Americans became increasingly more mobile in their employment. This was due to employees switchinmg employers as well as workforce reductions, company mergers, failures, downturns, and changes in the make-up of the industrial base and workforce of the American econonmy. None of these actions were conducive to sustained long-term employment capable of supporting savings. Compounding this situation was a lack of real wage growth by most workers.

In reality, most middle-income wage earners are left with a “Two Legged” stool consisting of a Defined Contribution plan and Social Security. The result being that many workers will need to delay retirement for several years or even continue working well past even their delayed retirement age. While working past the normal retirement age for many may be seen as highly desirable and a means of making significant contributions to society, for others will be a matter of necessity. Additionally, it has the potential of continue to “gray” the current workforce and limit upward opportunities for those subrogates awaiting their boss’s retirement. Unfortunately, as the recent recession has shown, sometimes an employee’s willingness or desire to remain in the workforce is overshadowed by the employer’s desire to reduce that same workforce.

While early retirement might sound attractive, many of those early retirees are accepting reduced benefits in the form of lowered Social Security benefits and early withdrawals from there, Defined Contribution plans. Even for those who planned and saved well, early withdrawal of monies by several years could change how long the remaining funds will last. Faced with an economy that may not recover for several years, many workers may not have any choice but to accept early retirement, under-employment, and a lowered lifestyle.