Performance-related pay (PRP) is a compensation system that links an employee’s salary to their performance. This can be done through various methods, such as bonuses, commissions, or merit-based pay increases. PRP aims to motivate employees to perform at a higher level and increase their productivity (Lucifora and Origo, 2015).
Key Facts
- Objectivity and consistency: Line managers play a crucial role in implementing PRP effectively. It is important to involve them in designing systems to ensure consistency and transparency when assessing achievement. Some schemes use forced distribution arrangements to remove marking differences between managers. However, highly competitive schemes that are seen as “winner takes all” may demotivate employees.
- Pay award distribution: Pay is not the only motivating factor, and the performance element of pay is often relatively small. It is important to carefully consider how pay awards are distributed, especially for middling performers. In times of low inflation, the pay bill increase is usually limited, which can demotivate lower or middle-level performers.
- Development needs: Linking pay awards to the performance review process may inhibit open and honest discussions about an individual’s developmental needs. One option is to separate the pay review aspect of performance assessment from the broader performance/development review.
- Time-consuming nature: The processes associated with PRP, such as performance reviews, can be time-consuming. It is important to allow enough time for managers and staff to fully engage in the PRP process.
- Undesired impacts on employee behavior: While financial incentives can increase worker performance, if leveraged too strongly, they may distort motivations or weaken the motivating effect. The size of incentives should be commensurate with what employees can do to increase their performance. Linking pay to both individual and team achievements may be better than focusing on one or the other.
Types of Performance-Related Pay
There are several types of PRP schemes, each with its own unique characteristics:
Piecework
Employees are paid a fixed amount for each unit of output they produce. This method is commonly used in manufacturing and assembly line jobs.
Plant-wide or Organizational Incentives
These schemes reward employees based on the collective output of a team or workplace. The more the group produces, the higher their pay.
Appraisal-Related Pay
Employees are assessed against predetermined company goals, and bonuses are awarded based on their performance.
Merit Pay
Employees are rewarded for outstanding performance within their roles, often without specific targets or quotas.
Payment by Results
Bonuses are earned based on an independent appraisal of results, typically after the completion of a project.
Competency-Based Compensation
Employees are paid more as they gain new skills and competencies that are valuable to the company.
Profit-Related Compensation
Employees’ bonuses are tied to the company’s overall success and profitability.
Objectives of Performance-Related Pay
PRP schemes are implemented with the following primary objectives:
Increasing Performance Levels
PRP can motivate employees to perform at their best by linking their pay to their achievements.
Promoting an Entrepreneurial Culture
PRP encourages employees to be more independent and innovative in their work.
Maintaining Fairness in Compensation
PRP ensures that employees are rewarded based on their individual contributions and performance.
Measuring Performance and Compensation
Measuring performance for the purpose of PRP involves setting standards and goals against which employees are evaluated. These goals can be objective, such as sales targets, or subjective, such as customer satisfaction ratings. A combination of objective and subjective measures is often used to ensure fairness and accuracy.
Compensation under PRP schemes can be determined using various formulas or assessment scales. These formulas link pay to performance in a structured manner, ensuring consistency and transparency.
Implementing a Performance-Related Pay Scheme
Successful implementation of a PRP scheme requires careful planning and consideration of several key issues:
Involvement of Managers
Line managers play a crucial role in assessing employee performance and implementing PRP effectively. They should be involved early on to ensure consistency and objectivity in performance evaluations.
Thorough Planning
The PRP scheme should be tailored to the company’s culture and specific needs. A generic structure may not be suitable, and it is important to understand employees’ expectations and preferences.
Identifying Pitfalls and Needs
Potential issues, such as unintended behavioral changes or inequalities in pay, should be identified and addressed before implementing the scheme.
Measuring Impact on Employee Behavior
PRP can have a significant impact on employee motivation and behavior. It is important to monitor its effects and make adjustments as needed to ensure positive outcomes.
Advantages and Disadvantages of PRP
PRP schemes offer several benefits, including increased employee morale, reduced company spending, and clearer performance goals. However, there are also potential drawbacks, such as a shift in employee focus, encouragement of unnecessary risks, and discouragement of lower-ranked employees.
Conclusion
Performance-related pay is a complex and multifaceted compensation system that can have a significant impact on employee motivation, performance, and behavior. Careful planning, implementation, and monitoring are essential for successful PRP schemes that achieve their desired objectives and avoid unintended consequences.
References
- Lucifora, C., & Origo, F. (2015). Performance-related pay and firm productivity: Evidence from a reform in the structure of collective bargaining. Industrial and Labor Relations Review, 68(3), 606-632.
- CIPD. (2023). Pay performance factsheet. Retrieved from https://www.cipd.org/en/knowledge/factsheets/pay-performance-factsheet/
- Lazear, E. P., & Shaw, K. L. (2007). Personnel economics: The economist’s view of human resources. Journal of Economic Perspectives, 21(4), 91-114.
FAQs
What is performance-related pay (PRP)?
Performance-related pay is a compensation system that links an employee’s salary to their performance. This can be done through various methods, such as bonuses, commissions, or merit-based pay increases. PRP aims to motivate employees to perform at a higher level and increase their productivity.
What are the different types of PRP schemes?
There are several types of PRP schemes, including piecework, plant-wide or organizational incentives, appraisal-related pay, merit pay, payment by results, competency-based compensation, and profit-related compensation. Each type has its own unique characteristics and is suitable for different industries and job roles.
What are the objectives of PRP schemes?
PRP schemes are implemented with the following primary objectives:
– Increasing performance levels
– Promoting an entrepreneurial culture
– Maintaining fairness in compensation
How is performance measured under PRP schemes?
Performance measurement for PRP involves setting standards and goals against which employees are evaluated. These goals can be objective, such as sales targets, or subjective, such as customer satisfaction ratings. A combination of objective and subjective measures is often used to ensure fairness and accuracy.
How is compensation determined under PRP schemes?
Compensation under PRP schemes can be determined using various formulas or assessment scales. These formulas link pay to performance in a structured manner, ensuring consistency and transparency. The specific formula or scale used will depend on the type of PRP scheme and the company’s policies.
What are the advantages of PRP schemes?
PRP schemes offer several benefits, including:
– Increased employee morale
– Reduced company spending
– Clearer performance goals
– Encouragement of a high-performance culture
What are the disadvantages of PRP schemes?
Potential drawbacks of PRP schemes include:
– Shift in employee focus towards tasks that are easier to measure and compensated
– Encouragement of unnecessary risks to achieve higher pay
– Discouragement of lower-ranked employees who may struggle to meet performance targets
What are some key considerations for implementing a successful PRP scheme?
Successful implementation of a PRP scheme requires careful planning and consideration of several key issues, such as:
– Involvement of managers in assessing employee performance
– Thorough planning and tailoring the scheme to the company’s culture and needs
– Identifying potential pitfalls and addressing them before implementation
– Monitoring the impact of the scheme on employee behavior and making adjustments as needed