Using performance feedback to calculate pay

Awarding higher pay and bonuses to top performers seems like the straightforward way to incentivize and retain great employees.

The most popular format, being performance based bonuses, keep base pay manageable and provide incentives for better performance. However, research shows us that this may not be as simple as it seems.

A study by Willis Towers Watson found that only 20% of employers in North America actually believe merit pay is effective in driving high performance.

Traditionally, money was seen as the main incentive used to motivate employees. Higher productivity results in higher salaries and bonuses. For companies, it’s been used as the main tool to attract, retain, and engage employees. Today, we’ve learned that the key to motivation is much more complex than that.

What psychologists and thought leaders have found is that money can actually demotivate employees from working at their peak performance by leading to a prioritization of rewards over learning and innovation. In one of the most widely viewed TEDTalks, career analyst Dan Pink explains that it’s actually intrinsic motivators like autonomy, mastery, and purpose that drive real motivation.

To provide their employees with more opportunities to grow and develop, many companies are now moving to continuous, peer-based and rating-less systems. The key question that many of them face is how they can continue to make compensation decisions, without inhibiting the feedback process.

We did some research and identified five trends companies are following to delink performance from pay.

1. Keeping one annual review for compensation decisions

The most commonly used method is to introduce more continuous and informal feedback as well as quarterly performance reviews, but continue to keep one annual review specifically for making compensation decisions. Rather than being in the dark until the annual review, employees will know where they are and how they’ve improved at each quarterly check-in. Compensation is still linked to end of the year feedback but the feedback they receive throughout the year is focused on growth and development.

2. Using rating-less systems

With more and more companies switching to rating-less reviews, this question has emerged as the main obstacle: without ratings how do we calculate compensation? Some companies have taken the position that ratings based reviews leave too much potential for bias. For example, a person’s communication skills can often be assessed differently depending on how communicative the rater is or how much they value communication within the team. However, when compensation decisions are based on a qualitative review the potential for rater bias actually increases, giving managers more leeway to decide how they want to award pay. Here are two ways companies are overcoming this:

Performance Calibration

Calibration meetings include a group of managers who discuss the performance of each employee. Together, they come up with the best way to allocate pay and bonuses. Including multiple perspectives into the decision process is meant to separate rather than bias from reviews and allow for a more accurate allocation of pay.

Peer Reviews

Who better to ask about an individual’s performance than their teammates? Instead of depending on managers to make the majority of the decisions, some companies are basing pay solely on peer reviews. To avoid introducing ratings, employees are asked a series of questions about their peers, for example:

3. Objectives and Key Results

Setting Objectives and Key Results (OKRs) is the process made famous by companies like Google, Intel, Adobe and Linkedin. The idea is that allowing employees to set their own goals provides greater clarity in what’s expected and what needs to be done to perform well. On top of this, individual OKRs can more easily be aligned with team and company objectives. How these companies set compensation:

4. Getting Employees to give more feedback

Rather than trying to separate pay from feedback, some companies are actually using bonuses based on peer feedback to boost engagement. A joint study by SHRM and Globoforce found: “Peer-to-peer is 35.7% more likely to have a positive impact on financial results than manager-only recognition.” And dramatically, “When companies spend 1% or more of payroll on recognition, 85% see a positive impact on engagement.”

5. Complete transparency

Some companies are rejecting individual performance based bonuses altogether in favor of complete transparency. For example, Buffer has come up with their own salary formula based on the person’s role, experience level and loyalty (years with the company). This essentially eliminates the compensation question altogether. In this type of system, everyone knows exactly where they stand and feedback can truly be focused solely on growth and development.

Alternatively, some companies have decided to slash the idea of individual rewards altogether, instead basing pay on team performance. Keep in mind that a study by PWC found that the ideal team size in this type of system is under five employees, with 60% of people becoming demotivated over five and 90% becoming demotivated in a team of over ten. Familiarity with team members was also an important factor.

Conclusion

It’s important that you find the best system for your culture and company objectives. Whether you place emphasis on teamwork or want to give individuals more autonomy over their personal development, it’s essential to research and understand which method will work best for you. No matter what you choose, the most important thing is that you clearly communicate to your managers and employees how this new system will work and how it will impact them.

Download our free guide to develop a solid feedback system in order to improve team engagement.

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