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Performance Pay -
Getting It Right
At it's best, performance pay is an incentive that
motivates people to act and make decisions in ways that are aligned with what is best for
the organisation.
If the performance pay system is not designed in a way that is appropriate for the
organisation and the business it is operating in, it may instead inspire behaviours that
go against organisational values and strategy, i.e.:
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Too soft targets can mean that people set out
to under-achieve what is possible in order to secure their bonus, thus undermining the
budgeting and planning processes of the organisation. |
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Too hard targets can mean that people give up
and either "muddle along" till next year, or make things worse for the
organisation by i.e. deferring income to the following year and incurring costs in the
current year in order to secure their bonus for next year instead. |
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Too high a focus on financial measures and
short-term goals in determining bonuses may mean that anything that doesn't get measured
doesn't get done / gets ignored, to the long-term detriment of the organisation. |
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Lack of communication about how performance
pay is determined can undermine the system and instead cause de-motivation. |
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Lack of transparency of the system can cause a
lot of time being spent on working on the system rather than on the business (usually by
the organisation's more strategic minds). |
So, what are the components of the ideal performance pay
system?
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Hurdle for performance pay to kick in –
Most organisations today have a "hurdle" of a minimum of 80% of a crucial
financial target (i.e. EBITDA) achieved before any bonus is paid. This means that in years
when financial results are well below target, performance pay for executives is a no-go. |
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Focus on both long-term and short-term
strategy – A balanced set of measures is needed to drive focus on both lead and lag
indicators since lead indicators (such as resourcing, innovation, customer satisfaction
and staff morale) determine the organisation's ability to meet its lag indicators in
future years. |
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Performance range – We recommend setting
a lower limit for performance pay to kick in and an upper limit, which represents both a
stretch target and a cap for performance pay. |
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Weighting – Targets should be weighted to
reflect the degree of difficulty and the impact on strategy. The higher the impact and the
more difficult, the higher the weighting should be. |
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Alignment of targets – All KPIs need to
be crosschecked to get alignment across the organisation, either via direct KPIs that
measure critical assistance across functions, or via a component of performance pay being
dependent on achieving joint outcomes. |
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Ownership and transparency – The best
functioning performance pay systems have a high degree of ownership and buy-in from staff.
This can happen through open communication about the contents of scorecard targets and
transparency in how scores are calculated. |
What Next?
If you are interested in more information please give us a
call on +61 2 8399 0011 and ask to speak to one of our consultants.
Alternatively e-mail us at info@emdgroup.com.au or use the form on
our Contact Us page. |
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