Linking compensation to performance

The traditional pay scale models are not viable any more, believes EJ Sarma. It is time for IT organisations to re-engineer their salary systems

Every month Nand Kapadia and Ganesh Mahale eagerly wait for one thing — the pay cheque. Nand is the director and Ganesh the office boy in the same company. Like them millions await their pay cheques every month. The pay has become a symbol of someone’s worth in the organisation vis-a-vis the worth of the work being performed by the person. Figuring out how much any one is really worth has been never easy.

Recently we hired a very senior executive for an IT client. After prolonged deliberations we offered Rs 40 lakh per annum. We thought we had done a pretty good job because the pay was equivalent to that of the managing director. Six months later the executive started raising the very issue of his perceived worth and claimed that he should be drawing Rs 50 lakh. The managing director and other directors had never had any salary hike for the past three years. The former had in fact brought the organisation from its inception to the current level. The new executive had agreed on performance target of $2 million and failed to deliver. Yet, he argued that his compensation was unfair and was not reflecting his worth.

The traditional pay cheque

Traditional pay scales in companies reflect job characteristics like importance of the work, decision/responsibility level. The salary has been and will continue to represent the positional level in the organisation. Even in companies which attempted merit pay, the quantum was so small it failed to register any impact on the performance.

Pay hikes are similarly linked to promotions. Employees expect not a jump but a big leap in pay but would not agree or even discuss how much their performance would go up in the elevated position. The HR community also spends considerable time in collecting market and industry data. The market ultimately decides pay levels, but it also assumes that people occupying similar positions in organisations, or having similar experience or skills, must be on the same salary irrespective of contributions.

The pay levels for positions go up or down, based on supply and demand levels (We have witnessed pay rates going up over $100 per hour during the Y2K crunch). The issue therefore is—should we allow the market to dictate pay, or the position or hierarchy to drive the pay, or should a good portion of the pay come from performance and contribution?

The traditional pay scale models are not viable any more. Hence, it is time for IT organisations to re-engineer their salary system. The meaning of pay has to change just like the economic and social orders have undergone a change. IT organisations are already on the road to change the meaning of compensation. Comparable worth is a complicated issue and hence very many organisations are defining the meaning of worth itself. The basis to determine pay is gradually shifting from position to performance, status to contribution. This will have some revolutionary consequences. Companies are working on the theory of doing more with less. They are driven hard to conserve precious human as well as financial capital. The route therefore is not far away from performance and pay cheque linkage. The new mantra must be, “get paid only if there is contribution”. That is remuneration according to the expected level of contribution. The guaranteed pay syndrome must now end.

The new order

Having said all the above I think it is worthwhile to look at merit pay system also. Merit pay is the first logical step to link performance to pay. Pay the base salary as per the job rank, and then do annual or semi-annual raises based on performance (this is still conservative in my view). It still protects the traditional hierarchy based system.

Quite often this contradicts the view that the organisation’s performance is team work, as pay raises here come only for individual performance. Many would agree that pay raises should come only through performance, but which performance? That of the individual or the organisation?

Individual performance as a determinant of pay increase has been identified as the most important internal equity. Companies must then lean towards systems wherein the better performers at least will see the linkage of raises to their contributions.

Evidence shows that there is positive association between organisation performance and compensation. There is a universal agreement among lower level people that managers receive unfairly excessive amounts. The question of getting more by paying less will be answered if there is a system of thin guaranteed pay and fat variable pay that depends on the company’s performance. The fixed wage cost thus can be brought down.

As the compensation mode moves away from status or position price to contribution and performance, the work culture also undergoes change. Work cultures are no more authoritarian and encourage constant innovation, risk taking, quick problem-solving, the status as basis for pay also must vanish soon. One such linkage is given in the table. The model clearly establishes in simple way the linkage between individual and company performances. The model proposes actually a reduction in pay if both the company and the individual do badly. One retains the pay if the company achieves 100 percent target and the individual also performs reasonably well.

In conclusion we can say that there is considerable merit in linking compensation to corporate and individual performance. Successful introduction will depend on striking balance between the two.