VARIABLE PAY
Making variable pay work
“Variable pay is not a creator of performance rather a carrier of performance momentum. Variable pay creates value by communicating a business strategy that rewards employee performance.” This is one of the main conclusions to emerge from a study carried out by researchers at the University of Johannesburg and published in a recent edition of WorldatWork Journal.
The researchers examined the use of some 40 variable pay schemes operating in a large company in South Africa, covering more than 32,000 employees.
Underlying the research is a motivational theory known as expectancy-valency theory that states, in simple terms, that the more likely that people believe that they will receive a reward that is valued by them, the more likely they are to work for the award.
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Success criteria
While variable pay schemes are important, an enabling performance climate and sound performance-management process are essential preconditions for its introduction, says the study. These performance practices must enable and be aligned to the variable pay plan used by the business.
The report outlines 11 critical building blocks for variable pay schemes that need to be in place to ensure success. In addition, it discusses whether the size of rewards is an influence on effectiveness and explains the most common reasons for the failure of variable pay plans.
Clear line of sight
The paper also illustrates a statistical method used to predict if plans will be effective prior to implementation and how to diagnose the health of the plan once it is in place. A key lesson to be learnt is that variable pay measures need to be close to employees with a clear line of sight so that they can see how their individual performance can determine the amount they receive.
Critical building blocks
The 11 building blocks form a potential checklist that an organisation could use to ensure the correct features are in place as the variable pay design unfolds.
They fall into thee categories - congruency, instrumentality and performing.
1. Congruency
This is the extent to which participants understand, believe in and practice the required behaviour that leads to the achievement of business and variable pay goals.
Building blocks falling under this title include:
External alignment
Internal alignment
Efficacy/goal difficulty alignment
Understanding and acceptance
Continuous improvement
2. Instrumentality
This is the extent to which participants believe that they will be rewarded if they behave as agreed.
Four building blocks come under this category:
Certainty
Trust
Exclusivity
Business risk
3. Performing
The third category covers the extent to which high-performing leadership and practices exist in the business, including:
Performance management
The performance culture
Influence over funding and distribution
Another important determinant of success found by the study was the degree to which participants have influence over the funding of schemes and the distribution of funds. Where there is a greater amount of control on the part of participants, the report found plans had a greater motivational effect.
Reward size
The size of awards is obviously significant but the report adds that merely paying out more money does not repair a variable pay plan that is not designed appropriately. For this reason, reward size is not necessarily always a driver of performance.
In addition, the research highlights the danger that “norms” about the size of the variable pay award can develop and the schemes can become retention rather than motivational tools.
Diagnosing health of plan and predicting success
The study also takes an innovative approach to examining the health of a variable pay scheme by setting standardised values for each building block and then comparing them with the scores attached to the scheme under scrutiny.
Using this “factor analysis”, however, requires reward practitioners to establish a goal or standard for themselves and their plans to measure against.
Common reasons for failure
A number of reasons why schemes fail is also given by the researchers that include:
lack of a performance climate and proper performance management processes
lack of understanding among participants
inability of participants to influence outcomes
lack of trust from participants.
Key messages
While the report covered many areas, two of the key themes that emerge are:
Variable pay plans need to be put in place alongside effective performance management systems operating in an established performance culture.
Plan participants must believe that there is a connection between their efforts and the awards they receive.
A final word
“Effective variable pay depends on the assumption that employees value the reward to be earned from variable pay, can influence getting the award, and believe in a connection between their efforts and the award. This means the measures and goals for the plan need to be such that everyone in the plan does not receive an award no matter what level of performance they demonstrate.” - Lukas de Swardt, Theo Veldsman and Gert Roodt, WorldatWork Journal, fourth quarter 2006.
Want to know more?
Title: "Toward an Empirically Validated Variable Pay Methodology", by Lukas de Swardt, Theo Veldsman and Gert Roodt, WorldatWork Journal, fourth quarter 2006.
Availability: Contact WorldatWork, 14040 N. Northsight Blvd, Scottsdale, Arizona, USA AZ 85260, tel: 001 480 951 9191 or email: worldatworkjournal@worldatwork.org.
WorldatWork, formerly the American Compensation Association, is one of the HR professions oldest and most distinguished bodies. Founded in 1955, it "provides practitioners with knowledge leadership to effectively implement total rewards - compensation, benefits, work-life, performance and recognition, development and career opportunities - by connecting employee engagement to business performance”. WorldatWork is a not-for-profit association with a membership of more than 30,000 human resource professionals, consultants, educators and others, in 30 countries.
For further details about WorldatWork visit www.worldatwork.org.