There are a few interesting conversations going around HR and compensation conferences this year. One has to do with performance management, going “ratingless,” and the best ways to link performance with pay. One of the underlying questions seems to be whether merit matrices are still the way to go when it comes to acknowledging performance with pay. The answer, as with most things comp, is that it depends. The following are some considerations for whether it will work for your organization.
Do you have enough budget to meaningfully differentiate increases for top performers?
The increases of 2017 just aren’t the same as the increases of 1980, when organizations had increase budgets of 10 percent. According to PayScale’s 2017 Compensation Best Practices Report (CBPR), 31 percent of organizations budgeted a 3 percent increase. For 26 percent of organizations, the average increase actually given was 3 percent. In such an uncertain market with a highly mobile workforce, the budget for a fixed cost like base pay just isn’t as available.
The challenge is that 3 percent raises may not be an effective tool to encourage high performance. One study has suggested that, in order to be motivated to do more, employees need to see a raise in the 7-8 percent range. Perhaps that’s why 34 percent of respondents to the CBPR reported their highest raises were greater than 10 percent.
Sometimes, depending how many different ratings you have, a merit matrix can significantly differentiate pay for your highest performers.
In this example, you see that the highest performers who are low in range receive that mystical 7 percent increase, while those who merely meet expectations receive increases that are a full 3.1 percent lower. At the top end of the range, high performers receive almost double what average performers receive. In this case, I’d say that the 3 percent budget is allocated well-enough to appropriately differentiate the top performers. If your top performers only differ from your average performers by a percentage point or two, they may not feel appropriately recognized for their contributions.
Can you drive performance through variable pay or cash-based recognition?
What other options do you have for recognizing performance in your organization? Do you currently have incentive plans that reward individual and/or team performance? (A quarter of organizations give team incentives.) Here’s an option to consider, especially if you have a modest compensation budget, or need more in the variable vs. fixed costs:
- Price your jobs competitively to the market and use some budget to ensure folks are in range. On some cadence that fits the speed of your business, re-evaluate your jobs relative to the market. For most jobs you might do an annual cadence, but you may find that you have a hot list of 12 or so jobs that you evaluate more frequently. Give market-based increases for those positions where the market shows a steady upward pattern.
- Complete your internal evaluations (pay equity, compression, etc) to make sure you’re paying fairly across the organization. Use budget as needed to fix potential issues.
- Invest more of what was typically your budget increase to an incentive pay pool. Set goals and priorities that align to your business goals, and pay out against those goals on a cadence that makes sense for your business. The advantage to having more to draw from in the incentive budget is that you pay out when people perform. Technically, the costs are variable and if you set your goals well you’ll have excellent return on your compensation investment. In terms of performance management, because the payout is based on goal-attainment, a performance rating is technically superfluous (for compensation).
This option is not yet super-prevalent, so it may work best in organizations that tend to be at the leading edge of new trends. It will require a clear compensation strategy, excellent communication and top-notch goal-setting.
What would the change look like to or from using a merit matrix?
One thing to not overlook, when deciding whether or not to adjust the link between performance and pay is whether there is an appetite for such a change in your organization. Have you recently been through a lot of change? That may impact the organization’s ability to accept more change. On the other end of the change spectrum, if your organization has done things the same way for as long as you can remember, it may be hard to get them to move to a new way of doing things. Consider the impact on employees, managers and executives as you decide whether a merit matrix still works for your organization.
Ultimately, the nice thing about a merit matrix is that it provides an easy, visible framework for rewarding performance. That can aid in your communication about performance to employees, especially during compensation reviews. That said, if you’re unable to significantly differentiate pay for top performers, it’s possible that there could be a better way to spend your compensation budget. As the expert and keeper of your organization’s culture, it’s up to you to determine the best compensation plan to reinforce your culture and best accomplish organizational objectives.
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