What Every Organization Should Know About Performance-Based Compensation

by Leah Davis, CPA

The practice of evaluating employee performance as a primary basis for compensation is widely accepted in the private sector. Slowly but surely, these types of performance-based compensation systems, in which pay increases are based on performance rather than length of service, are becoming more common in the public sector as well. Today’s workforce, as well as a growing number of councils, demand them.

But for many organizations, the thought of establishing a performance-based compensation system can be daunting. Although it can’t be done overnight, this type of change is possible. And it’s likely to help solve a persistent challenge: retaining high performers.

Here are a few tips for establishing an effective performance-based compensation system within your organization.

Leah Davis discusses the importance of making a full cultural change when implementing a performance-based compensation system

First, start the conversation with your organization’s leadership.

Once you’ve decided to make the change, assemble your administrator, human resource director, and department heads. Together, discuss the following questions to get a clear picture of your organization’s current performance management system and culture:

• How have we been measuring performance and awarding compensation increases in the past?
• Does our current system motivate desired employee behaviors and outcomes, or are we just checking task-related boxes?
• Does our current system align with broader organizational strategic direction and priorities?
• Are we providing valuable feedback and communication to employees throughout the year, or is this an annual only conversation?
• Are our managers and supervisors prepared to change the conversation and overall culture related to performance management?

With a solid understanding of what’s currently being done and where you’d like to be in the future, you can plan to make the appropriate changes.

Many organizations still use a paper process to evaluate employees on an annual basis. If this describes your organization’s current process, here’s how you can begin to establish a performance-focused culture.

As I mentioned above, establishing a performance-based compensation system takes time. Most organizations will likely need at least two years to complete the transition.

Step one: Let your employees know their performance evaluations are going to be different and help them understand why. This communication is critical; failing to change the way your organization talks about performance can undermine your efforts from day one.

Step two: Change the performance conversation by adding more open-ended questions to performance evaluations forms. Use these questions to drive real conversations around an employee’s career goals, rather than job tasks, and how these relate to the organization’s strategy. The goal: everyone knows where they fit in and how their role contributes to the broader vision.

Step three: Performance is about more than completing the task at hand, and effective performance management and coaching is a learned skill. For this reason, provide training for your managers so they feel equipped to evaluate an employee’s attitude and cultural fit and can effectively communicate their evaluation.

Step four: Employees want honest and timely feedback. Require managers to have informal performance conversations with their direct reports at least quarterly. This could be as simple as taking an employee out to lunch to talk about strengths, challenges, and opportunities for development.

Step five: Let your employees know where they stand. High performers want to know; low performers need to know.

Step six: Be flexible. Regularly evaluate the effectiveness of your new performance management process, forms, and communication, and make changes whenever necessary. There is no one-size-fits-all approach to performance. Commit to customizing the system as you go, until you land on what works for your organization.

The result: A high-performing organization

Establishing a performance-based compensation system at your organization may sound daunting, especially if it’s something you’ve never tried before. But with thoughtful consideration and planning, as outlined in the steps above, it can be done. Rewarding employees for performance—rather than length of service—is critical to attracting and retaining the talent your organization needs to thrive.

If you’re ready to create an effective performance-based compensation system at your organization, we can help you take the first step. Contact our AEM Workforce Solutions team to learn more.

Leah Davis, CPA, is the President of AEM Workforce Solutions and also a Partner at Abdo, Eick & Meyers. She has over ten years of experience owning and operating her own business, providing outsourced Human Resources and payroll support.

You can reach Leah at 507.524.2347 or click here to contact her via email. 

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