Pay for performance is a hot topic in the compensation space. As companies tighten budgets, compensation leaders have to pull whatever levers they can to be able to hire top talent and retain their best performers. But implementing a new compensation philosophy is no small task.
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Here, weâll cover what is pay for performance, why it matters, and some key considerations to think through if you want to create a performance-based pay strategy for your business.
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When it comes to salary raises and equity refreshes, it used to be common for companies to take the âpeanut butter approachâ and spread the budget around equally to all their employees. This approach is appealing: itâs easy, satisfying, and feels fair. And a lot of companies could afford to do it.
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Cut to today, and the macroeconomic landscape has changed. Companies are dealing with factors like inflation and economic uncertainty, and many are struggling to grow. That means budgets for raises are tighter, and equity burn is a bigger concern. Taking the peanut butter approach is harder to do in the current business climate.
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These factors and the pressure they create has led to a growing trend in pay for performance.
Compared to the peanut butter approach, pay for performance is more targeted. It involves incorporating your merit cycle and performance ratings into your compensation strategy in order to reward high performers with higher compensation than lower performers. This could come in the form of salary increases or raises, bonuses, or employee equity.
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Pave Data shows that many companies use some type of scale to rate employee performance during the merit cycle, the most popular of which is a five-point scale.
When companies use a performance rating, the scale will typically include rankings like âbelow expectationsâ, âmeets expectationsâ, and âexceeds expectationsâ. Within companies in Paveâs sample, the majority of employees received a rating of âmeets expectationsâ or aboveâonly about 8% were rated below expectations.Â
In a pay-for-performance model, these merit cycle ratings would be mapped to the raises, bonuses, or equity grants outlined in the compensation strategy.
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For more insights on merit cycles, download Pave's free Merit Cycle State of the Union report.
Pay for performance matters for compensation leaders because it helps them allocate smaller budgets more efficiently. If thereâs less money to go around when itâs time to give raises, allocating that budget to the highest performing employees is smart spending.Â
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Pay for performance also builds a culture that rewards employees for great work, which can be a motivator for your team. At Paveâs Total Rewards Live event, Michael Ng, VP of Total Rewards at Stitch Fix, spoke about the importance of understanding the difference between equity and fairness.Â
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âThe words âequalâ, âequitableâ, and âfairâ are often used interchangeably, when we all know that there are nuanced but important differences,â Michael said. âEqualâ quite literally means âthe same.â To pay fairly, people who go over and above should receive more, while those who lack motivation and miss goals should receive less. To pay fairly, we must differentiate pay. This is the essence of pay for performance.â
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When employees perceive your compensation practices as fair, theyâre more likely to stick around.Â
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âPay for performance can also be a powerful tool for retaining critical roles,â said Katie Aldred, Consulting Partnerships Lead at Pave. âRewarding your top performers in positions that are most impactful for the business helps you keep your superstars in-seat for the long run.â
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If youâre considering a performance-based pay strategy, as stated above, itâs not just about cash raises and bonuses. Employee equity is another lever comp leaders can pull within a pay for performance model, which can have the added benefit of helping to manage equity burn.
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Despite the growing emphasis on pay transparency and equity, many organizations struggle to implement true pay for performance cultures. According to Paveâs benchmarks, the market medians Q1 of 2024 showed that:
This raises questions about whether current compensation practices truly reward high performers. In many organizations, top performers might be 2x, 3x, or even 10x more impactful than the bottom quartile of employees. Yet, the compensation treatment shows only a 5.2% preference for top performers rather than 100%, 200%, or 1000%.
To create a genuine pay-for-performance culture without increasing the overall merit cycle budget, companies may want to consider more drastic measures:
For example:
However, these approaches come with their own set of challenges and cultural implications. Organizations must carefully weigh the trade-offs between strict pay-for-performance models and broader pay equity goals.
When implementing these changes, consider the following steps:
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Pay for performance is gaining traction in the current market landscape. If youâre interested in implementing a pay-for-performance model, or evolving the version you already have, Pave can help.Â
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Pave Market Pricing can help you improve your compensation strategy by putting benchmarks into action and updating comp bands. In addition, leverage Paveâs Compensation Planning tools to run your merit cycle and align it with your comp workflows, all in one tool.
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Ready to learn more? Request a demo today.
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