In today’s war for talent, an increasing number of organizations are leveraging performance-based compensation plans, like bonuses and merit increases, to reward top employees. Research suggests that tying performance to compensation will influence employee behavior positively, boosting retention and productivity.
Of course, measuring performance can be quite subjective without a merit system in place. Here are six steps for creating a merit system which can then be used to determine payouts in a pay matrix.
1. Top Manager Buy-in
Leadership in your organization must approve and support the merit system budgetarily, and agree on consistent performance metrics. If your merit system is not supported at the top, and managers are not on the same page about how to determine performance rankings, your pay matrix may not be calculated fairly.
2. Accurate Job Analyses
Managers must have a realistic view of their employees’ job functions. Job descriptions offer a good starting point, but observing the tasks that employees actually undertake and how their day-to-day work fulfills longer-term goals, will comprise an accurate job analysis.
3. Clear Rating System
Some organizations use a “1-5” scale, where 1 represents the lowest-performing employees, 3 represents average employees, and 5 represents the highest-performing employees. The factors that determine an employee’s performance rating will differ by team and position, but the model for calculating these should be fair across the organization. Of course, your system may not be pitch perfect. The goals and requirements to achieve a “5” on the finance team may be more difficult to meet than they are for an employee on the marketing team, or vice versa, for a particular pay period.
4. Appraisers are Trained
Our Pay Practices and Compensation Strategy survey found that more than 70% of employers train their managers on how to conduct performance evaluations. However, only 55% of employers train managers specifically on how to discuss compensation. Providing the technical training on how to give a performance review is important, but if managers in your organization are not adequately trained to discuss compensation, they may be communicating misinformation. Or worse, they could cause an employee to become confused and disillusioned if they cannot get a clear or understandable answer to their compensation questions.
5. Full Rating Scale
It may be tempting to assign performance ratings of “average” (3) and “above average” (4) to all employees on a 1-5 scale, but a pay matrix only works if you are willing to leverage your full scale. That means you must rate employees well above and well below average, and trust these ratings are the right decisions based on performance metrics. Your distribution doesn’t have to be perfectly equal, but assigning all 3s and 4s to employees could break your merit increase budget and signal to employees that they can coast and still be rated a “3,” but that great work will never earn them a “5.”
6. Employee Acceptance of System
Employees have to perceive the merit system is well-designed and fair. If your organization practices pay secrecy and withholds specific details of a merit system or pay matrix, you run the risk of employees believing their payouts were not calculated fairly. Strong communication is key to ensure managers’ and employees’ expectations are properly set from the beginning of each performance period.
Any potential benefit of performance-based compensation depends first and foremost on there being a high-quality performance merit system. Once you have that in place, you’ll be ready to calculate payouts through a pay matrix.