The term “pay-for-performance compensation” refers to performance-based pay programs where an employee is incentivized and rewarded for achieving goals or objectives. Pay-for-performance plans are extremely popular – according to our recent Pay Practices and Compensation Strategy survey, 75% of organizations currently leverage pay-for-performance compensation as part of their overall compensation plan.
Pay-for-performance compensation can come in many varieties depending on your organization’s budget, compensation philosophy, and organizational goals. When designing a pay-for-performance plan, you’ll want to consider the outcomes your organization is looking to achieve, the frequency with which you’ll reward employees, and the total increase you’ll be budgeting to fund these programs.
How Does Pay-for-Performance Compensation Work?
There are two general categories of pay-for-performance compensation: merit pay increases and variable pay programs. As you look to implement a pay-for-performance program in your organization, you can use either of these two types of pay-for-performance plans – or both – to incentivize employee performance and drive your desired outcomes.
Merit Pay Increases
A merit pay increase refers to an increase to an employee’s base pay due to high performance. These raises are typically delivered an annual basis, and are budgeted for as part of the annual salary increase budgeting process. Merit pay increases are the most commonly used pay-for-performance model for recognition of employee performance, as they differentially reward top performers for their contributions with a bump to their base salary for the following year.
However, according to Chris Fusco, the Senior Vice President of Compensation at Salary.com, the external market is progressing in pay faster than merit pay increases alone can match. This makes top performers in your organization a flight risk, because they could potentially walk out the door just to take a job that offers more competitive pay.
Addressing Market Movement with Pay-for-Performance Programs
In this competitive environment, many organizations are turning to variable pay programs to keep top recruits’ and top performers’ pay competitive with the market. Whereas salary increase budgets have remained flat at 3% for the last several years, data from Salary.com’s Pay Practices and Compensation Strategy Survey shows that many firms are adding budget to their variable pay programs. According to our survey, the percentage of organizations committing at least 10% of their payroll budget towards non-discretionary bonuses and discretionary bonuses has more than doubled since 2017, while the percentage of organizations committing less than 3% of their total payroll budget to such programs has diminished over time.