Linking Pay to Performance

As a part of the process of coaching and motivating employees, most employers take some time every six months or every year to sit down with employees and discuss their performance. This practice is know as performance appraisal. In addition to talking with the employees about how they have been doing in performing their jobs, you can also use the performance appraisal to set goals for the employees for the period until the next time you evaluate performance.

How well the employees measure up to those goals can help you determine how much of a raise they deserve.

Pros and cons. Some experts say that linking pay and performance is not a good idea, and that pay should not be used to motivate employees to do a better job because they stop focusing on things like quality of work and how to improve their performance and start focusing on money and how much the raise is.

Others feel that pay for performance pits employees against one another in competition for the highest raises. That's why some businesses give the same, across-the-board raises to all employees. It eliminates competition and ensures that the whole workforce is working toward the same goal. But, if everyone gets the same raise, there is no motivation to exceed expectations and go the extra mile in the job. Only you can determine which approach will work best for your employees.

For better or worse, most companies use money to motivate employees in some form or fashion, whether it be by bonuses, commissions, cash awards, or bigger raises for good performance.

How to link pay and performance. If you do decide to pay for performance, the hard part is making the connection between how well someone has performed and how much of a raise you'll give to that employee. There are some basic steps to follow in making that link:

  • Know what your salary budget will be as a percentage of your total budget, considering your sales forecast for the coming year.
  • Decide what form the raises will take.

 
Example

Will you make raises a certain percentage of each employee's pay? Or will you work with actual dollar amounts?

If you use percentage points, it becomes easier to rank employees in terms of who gets what percentage. For example, your best performer could get 5 percent, while your average performer could get 3 percent, and your poor performer could get 1 percent or no raise at all. Using this method simplifies the process of ranking, but it does not take into account what each employee is currently making. Using the example above, if the best performer makes $20,000 a year and the average performer make $35,000 per year, then the best performer's raise will be $1,000 and the average performer's raise will be $1,050. Despite a higher percentage, the average performer still gets more money than the best performer.

If you use actual dollars, you can make sure that the person who performs the best get the most money. The problem becomes figuring out how to divide the money.

  • Do performance appraisals on all employees.
  • Rank employees based on their performance and the criteria that you set for them.
  • Divide the money up according to that ranking.

 
Example

If you use a percentage method and you have a set dollar amount in your budget for raises, decide how much each person is going to get and the calculate that back to a percentage of that individual employee's salary. For example, if you have $500 set aside for raises and two employees, and you decide that Employee A (who makes $15,000) will get $300 and that Employee B (who makes $17,500) will get $200, the percentages for Employee A and Employee B will be 3.3 percent ($300 15,000) and 1.1 percent ($200 $17,500), respectively.

If you don't have a certain amount of money set aside for raises, just use percentages to rank your employees, with the best performers getting higher percentages and the poorer performers getting lower percentages.

If you calculate raises based on actual dollars rather than percentages, how do you divvy up the money? The simplest approach is to rank the employees and use this formula: take the amount of money you have and divide it by the number of employees. That would give you the amount of the average raise. Use that as a baseline and add and subtract from that number depending on where employees fall in your ranking. For example, if you had $2,500 set aside and five employees, the average raise would be $500 ($2,500 5). Therefore, the employee in the middle of the ranking would get $500, while the two employees who were ranked above him or her would get more than $500, and the two below would get less than $500.



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