Pay for performance normally works something like this. You figure out goals for each employee that ties back to the overall corporate objective and then set the employees variable pay (bonus or incentive) based on the degree to which the employee meets those objectives.
1. The Planning Horizon is Too Long
Most pay for performance planning cycles are based on a yearly cycle. Business is fast paced and things are constantly changing. If the individual goals become irrelevant or the job description changes you have to adjust or risk confusing the employee or worse, robbing them of the ability to succeed. Remember to tie pay to performance you need to set SMART goals at the individual level. The specific part makes it hard to adapt.
2. Difficult Setting Goals That Flow Up to the Top Objective
It sound pretty easy on the surface, but it can actually be difficult to clearly set individual goals that flow all the way to the top organizational goals. The more layers the more difficult this can be. If it is not clear how an employee's goals tie to the corporate goals you can have both heading off in different directions. Worse, you can actually have individual goals in various parts of the organization that conflict.
3. One Failure Can Ruin the Success Chain
If you do manage to set up good individual goals that flow up to the top of the organization, be aware someone higher up in the chain can ruin the impact of everyone below them. This can also happen on an entirely separate branch of the goal success chain. Say sales meets their goals but oversells the capabilities of operations to deliver? You could have a lot of sales but a bunch of unhappy and unprofitable customers.
4. Individual Goals Destroy Teamwork and Create Silos
When you tie pay to performance you are basically inciting employees to achieve their goals even if it means destroying teamwork or not applying common sense. I've seen this vividly applied in the real world. It took an entire team to sell a project to the client and the team came together on its own. When it came time to divide up the credit some critical contributors behind the scenes did not get credit. You can imagine the result the next time the team needed to come together (sorry I am too busy).
5. Money Is Not (Always) A Primary Motivator
If money has the same impact on everyone's performance, why do some top performing sales people make way more than others? Shouldn't they all be motivated the same amount? Some people can be motivated by money alone, but most seek motivation and satisfaction in other ways. You would be wise to tailor motivation to the individuals as well as other solid leadership and management principles. Money is a very short-term motivator. Pay your top performers very well, they are gems and you don't want to lose them over pay. But if an employee is motivated by something other than pay you are better off using than than focusing on pay for performance.
6. They are a Variable Expense Whether or Not Company Succeeds
Pay for performance is a variable expense. Yes, you can tie the incentive to overall corporate performance as well. The problem is if a top performer always achieves their targets but the company does not, they will not get the performance part of the pay. Yes, they may feel pretty disconnected from impacting the overall company targets because of the way personal goals are set. For many organizations this becomes a variable expense whether or not the company does well.
7. They Demotivate If They are No Longer Relevant or Achievable
If you realize your goals cannot be achieved for whatever reason, they become a strong de-motivator. Because they are set at the start of the year, they may become quite disconnected from reality. The opposite can also be true. If I exceed my goals by mid-year, I could coast for the rest of the year and save my discretionary effort (or sales, etc.) for next year's quota.
Bonus Truth - Excuses and Blame
Pay for performance encourage's defensive work. As soon as a projectstarts people start looking for reason's why it is not their fault and someone else's in case anything goes wrong. In fact you want to encourage teams to be self-correcting and self-improving. Everyone should be looking at ways to make things work better and succeed.
For small and mid-sized businesses without the in-house expertise, pay for performance can be difficult to set up correctly and manage wisely. It can be made to work but also has the problems I outlined above so you need to set it up very carefully.
I am a big fan of paying people well for their expected performance as part of the base and then tying variable pay to a self-funded bonus structure based on overall company objectives. If they don't live up to expectations you can deal with it real time. This offers the benefits of having everyone work towards the same goals as a team and only paying them out if the company meets its objectives. The payout structure can vary by position. The team will point out the sluggards.
This strategy for "profit sharing" means less work and overhead for small and mid-sized business owners and a lot less risk.
I am not at all saying companies should pay everyone the same. I am not saying employees should not have individual goals or be held accountable for performance standards. I just feel strongly that leadership and people management are real time happenings and not something you do once a year.
What is your experience with pay for performance? Leave a comment below.