8. PAY FOR PERFORMANCE – Hurconomics for Talent Management: The Creation of a Business-driven HRD Missionary

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Pay for Performance

Linking Pay Cheque with Purpose

The benefits of linking pay cheques with purpose are aptly summed up by the following quote by Robin Sharma (2003), a well-known expert on leadership and the author of books like The Monk Who Sold His Ferrari:

When you link paycheck with purpose, you connect people to a cause higher than themselves. Your people will start feeling good about what they are doing and when your people feel good about the work they do, they will begin to feel good about themselves as people. That’s when real breakthroughs start to happen.

You must show them that by helping you achieve your future goals, they will also realize their future goals. By integrating what is meaningful to you with what is meaningful to them or, at the very least, by showing them how the attainment of your vision for the company will help them feel fulfilled, they will come to understand that you care about their hopes and dreams. They will come to trust you, and, with trust dominating the corporate culture, achievements once viewed as impossible become probable.

Performance-Linked Pay (PLP) or Performance-Related Pay (PRP)

Performance-linked pay or performance-related pay generally refers to the variable part of pay that is attributed each year (or on any other periodic basis) to performance. PLP systems are generally applied at the level of the individual employee, but are also sometimes applied at the team/unit level or the organizational level. PLP excludes: (a) automatic pay increases by grade promotion and in-step (in-grade) pay increases (not linked to performance); (b) various types of allowances which are attached to certain posts or certain working conditions (for example, overtime allowances).

PLP: A case study

Sometime in the mid-1990s, a financial services company started losing its senior-level employees to new competitors. This company had about 200 employees and was doing extremely well. The employees included CAs, MBAs and other professional staff. The company had high potential for growth, but it was not in its interest to raise the salary of top-level managers, as such a move would raise the expectations of all staff and spell disaster. Its competitors were offering salaries that were three to five times the salaries paid by this company. A couple of managers at the top still preferred to stay with the company. Their reason was that their current company was a stable one, and their jobs were secure. Although the new company offered far higher salaries, its continuity and that of the jobs in that company seemed doubtful. In other words, these managers preferred a secure job and stable growth. However, the old company could not count on the same reasoning being applied by every top-level manager and feared some employee turnover.

A consultant was called in. The consultant interviewed almost all the employees, studied their aspirations and worked out an incentive system that was called performance-linked pay. The assurance given was that if the company performed well in any year, the employees would get a part of the company’s profit in the form of PLP. There was no limit on the PLP, as it would depend on the profit made by the company in that year. The company’s board would decide a part of the profit and apportion it as PLP. This would be distributed among employees depending on their individual and team performances.

The company had an interesting philosophy. Organizational performance was the first to be rewarded, team performance the second and individual performance the third. The company believed that organizations performed well if every individual and team performed well. It also believed that not all departments contributed directly to profits in financial terms, but should nonetheless be rewarded for their indirect contribution. For example, in a financial services company, the administrative and legal services may not contribute directly to financial profits. However, the administrative department would contribute indirectly by facilitating the smooth functioning of top executives, and the legal department could help avert legal problems by creating a knowledge base through the computerization of its documents by the IT department.

The company decided that at the end of the year, the board would set aside a part of its profit as PLP. If in a year the profit was 10 times the salary bill of the company, it might decide to set aside 10 per cent of its profits, which meant that everyone would get twice their salary that year. If the profits were 20 times the salary bill, employees could even get twice their annual pay. If the profits were small they might get a much smaller amount. A part of it (say, 30 per cent of what was set aside as a proportion of the employee pay bill) would be given as an annual performance bonus to every employee who was on the rolls of the company, irrespective of her/his individual contribution. Another 30 per cent would go to every member of the ‘A’ category performance team that year, and 40 per cent to every ‘A’ class individual performer in that year. However, every member of the ‘B’ category team that year would only get 20 per cent and the ‘C’ category team would get nothing. Similarly, at the individual level the ‘B’ class performers and ‘C’ class performers might get only 25 per cent and 10 per cent respectively. The percentages would vary from year to year and would be fixed by the top management, depending on the extent of performance variations between teams and individuals. The categorization would not depend on any predetermined distribution, but on the KPAs or performance indicators set for each team and individual.

Using this process, the company defined the KPAs or performance indicators for each department as well as for each individual. Performance planning was introduced. The incentive scheme worked very well and the company was able to contain the employee turnover for the next several years, and was also able to pay PLP to its employees.

The company introduced another innovative way of disbursing PLP. It decided that with the consent of the employees, a certain portion of PLP would be given to the individual only at the end of the third year; until then it would be held in company-monitored stocks and other investments and an attempt would be made to multiply these investments. The individual would be eligible to draw that amount with its returns at the end of the third year. This was a retention policy. This is an innovative method and is even better than ESOPs.

ESOPs do have some problems: the allocation of shares, the cost of the shares at the time of allocation and their unpredictable decline. ESOPs lost their popularity after the dotcom disaster, and have since never quite recovered. I see no reason why they cannot be revived, as there are very few incentive schemes available to companies because of the FBT and other taxation policies of the government. In assigning ESOPs, the organization should carefully think through the various issues involved. Assuming that the company attends to the legalities, the most important consideration for using ESOPs as an incentive is that it should be wanted by the individual. The individual should see it as a choice and it should be given to her/him at the price equivalent of the incentive money the company wanted to reward the employee with for making a difference to its profits or performance.

Incentives are necessary and are a good way of keeping up employee motivation and morale, reducing absenteeism, increasing retention and contributing to employees’ quality of life. In the past, employee incentives used to depend largely on their experience and length of stay in the company. Loyalty was rewarded through career progression and incentives linked to status. The ‘management’ of yesteryears was committed to its employees. It believed that it was the employees who built the company and the longer they stayed, the greater was the company’s responsibility to look after them. As an individual grew in age, her/his needs would increase, and hence the company’s incentives were based on growth in terms of seniority. Incentives would be linked to the employee’s accommodation. As an employee’s family grew, a larger house would be needed; the children’s educational and other needs would be met by loans from the employee’s provident fund; at retirement, a pension fund would be made available by the organization.

Nowadays, things are different. Long-term incentives have lost their value; they act as mere satisfiers, and not motivators, except for those who still live in the past psychologically. The current generation of industry promoters and their young employees thinks short term and has higher expectations. Employees do not remain committed to organizations and are unwilling to stay for long years. Also, every organization has competitors who are constantly poaching by offering higher salaries. Compensation surveys and compensation consultants have done their bit to make known (and sometimes exaggerate) the salary structures of other companies. Employee mobility is the order of the day. In such circumstances, it is natural for organizations and individuals to think of getting the best they can from each other in a short time. It is, therefore, imperative that incentive systems and schemes be re-thought and re-designed to make them more attractive.

The psychology of the current generation

The following considerations weigh the most with employees today, so they must be kept in mind while designing incentive schemes:

  • There are constant demands and comparisons: ‘Get the best now; who has seen tomorrow?’ ‘Organizations grow and fall. When they grow it benefits the founders and the shareholders, and no one knows whether they will be magnanimous enough to make their employees crorepatis … so take what you deserve and make your life as bright as you can.’
  • In reality, living and working in any Indian city has its advantages and disadvantages. Bangalore has excellent weather, but is very congested. Mumbai is organized but the cost of living is very high. Delhi is good but needs to be safer and less polluted. So the prevailing philosophy is, ‘A good job in any city is fine. You need not be wedded to a city.’ Job opportunities now extend to Singapore and other countries; the Gulf is no longer as attractive as it once was.
  • One must own a house, a car and all other gadgets from the very beginning of one’s career, and so one must find a job that allows one to possess these.
  • If one is not rewarded periodically, and told that one is doing well, one can always quit the job and look elsewhere. There are many recruitment agents and agencies that will call home, much like those who sell credit cards and insurance policies.
  • One no longer needs pension, insurance and other securities. Who knows how long one will live anyway? If one is in her/his thirties or forties why bother about pension, which promises an uncertain future at best? Better to get the money in hand and invest it in a pension scheme. The pension can move with one from company to company through these schemes. One should own a house that can also yield returns; and if one owns a car it is not necessary to stick to a company for the sake of the car.

With this changed mindset, organizations are under pressure to disburse in the short term the rewards they intended to pass on to their employees as long-term benefits. Many employees prefer to receive their pension, medical benefit, leave travel concession and leave entitlements in cash, and not even in the form of shares, as the share market is unpredictable and, in any case, the management may not offer the shares at an attractive price.

Under these circumstances, the PLP concept devised by the financial services company (referred to earlier in this chapter) is perhaps the wisest option. In future the PLP distribution may be half-yearly.

The PLP concept gives organizations a lot of flexibility. With PLP, they can decide:

  • on their retention philosophy and how to link PLP with it.
  • on the value addition measures by individuals, groups, and the organization, and fix the percentages (30:30:40 or 10:40:50 or 33:33:34).
  • to grade the teams and individuals into three classes (‘A’, ‘B’, ‘C’), or four classes (‘A’, ‘B’, ‘C’ and ‘D’), or more.
  • to keep changing the allocation to ‘A’, ‘B’, ‘C’ and ‘D’ categories—if the total allocation to the individual is 30 per cent of the salary, then those rated ‘A’ could be given the entire 30 per cent; or those rated ‘B’ could be given 20 per cent, those rated ‘C’ could be given 10 per cent, and those rated ‘D’ could be given 0 per cent. These percentages may change from year to year. They may also change for team performance.
  • to vary the retention amount from 50 per cent to less or more, and from three years to one year or more.

With these variables, PLP becomes a great incentive scheme. Additionally, organizations could top up PLP with one-time performance incentives that promote innovations, cost savings, new customer services, and so on.

An organization should decide on the things it values, put a price tag on them and provide the incentive as soon as the awaited behaviour or event occurs. It should remember that incentives given with delay cease to have any incentive value and sometimes may even work as a negative force. For example, if a person saves her/his company money or devises an innovative new product, she/he could be rewarded in stages. Stage 1 is acceptance of the idea, Stage 2 is its implementation, and Stage 3 is the outcome. In Stage 1, the incentive may be small, like a certificate along with a small amount of money. In Stage 3 she/he could be rewarded with larger incentives. Thus, incentives may be used as an effective tool to promote innovation, cost savings, customer expansion, better speed and quality of service, job loyalty, and so on.

Group incentives play another important role in building a team culture. Teamwork and collaboration are sorely needed in India. In order to promote synergy and teamwork, it is useful to have team incentives. Team incentives could be in the form of celebrations, group picnics, group awards, movies, parties, and so on.

Incentives have a significant role to play. Organizations should constantly be thinking of innovative ways to motivate people. Thanks to changes in the Indian taxation system, Indian corporations can now focus their attention on incentives that encourage retention, loyalty, innovation, teamwork, efficiency and competitive advantage rather than tax savings and other incentives that yield long-term benefits.

The Need for PLP in the Public Sector and Civil Services

There is an urgent need for the public sector to be able to attract and retain talent in the way that the private sector does. There is an alarming pay differential between managers or high-skill workers in the private and public sectors. This presents a serious threat to the recruitment of high-quality managers in the public services and government sector.

PLP in the government and public sectors can have the following uses:

  • It can improve performance.
  • PLP can be used to assist or stimulate organizational change. It might help achieve a cultural change by letting employees know the values and expectations of the organization.
  • PLP creates alternative career paths, where performance is more important than grade and seniority. This has an important impact on strategic human resources management and constitutes a strong incentive for improved staff development and training.
  • It can improve the recruitment and retention of staff.
  • It can improve accountability of civil servants.

PLP helps to contain salary costs and reduces the pay bill of the organization through better control over pay increases. The introduction of PLP strategies can indeed help contain salary costs by reducing the incidence of automatic progression through salary levels. The individualization of pay may sometimes also be a way to circumvent the collective bargaining process, thus reducing the influence of trade unions and re-establishing managerial control.

There may be other managerial or political reasons to introduce PLP. In some cases, improving performance may be a secondary objective for introducing PLP. The real motivation could be to use PLP as an instrument to obtain political support for more funding or more flexibility over pay (OECD 1993 and 1997).

References

Marsden, D. and Richardson, R., 1994, “Performing for pay? The effects of ‘merit pay’ on motivation in a public service”, British Journal of Industrial Relations, Vol. 32 No. 2, pp. 243–61.

OECD, 1993, Private Pay for Public Work. Paris: OECD Secretariat.

———, 1997, Performance Pay Schemes for Public Sector Managers: An Evaluation of the Impacts, Paris: OECD Secretariat.

———, 2002, Survey on Strategic Human Resources Management, Paris: OECD Secretariat

———, 2003, ‘Background Paper on Performance-related Pay of Government Employees: Assessing Reforms across OECD Member Countries’, Experts’ Meeting, 7 October, Paris: OECD Secretariat.

Rao, T. V., 2006, ‘Reward Systems’, Paper presented at Retention Seminar, February, Ahmedabad.

Sharma, Robin, 2003, Leadership Wisdom, Mumbai: Jaico Books.