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Performance Pay - Getting It Right

At it's best, performance pay is an incentive that motivates people to act and make decisions in ways that are aligned with what is best for the organisation.

If the performance pay system is not designed in a way that is appropriate for the organisation and the business it is operating in, it may instead inspire behaviours that go against organisational values and strategy, i.e.:

b1.gif (814 bytes) Too soft targets can mean that people set out to under-achieve what is possible in order to secure their bonus, thus undermining the budgeting and planning processes of the organisation.
b1.gif (814 bytes) Too hard targets can mean that people give up and either "muddle along" till next year, or make things worse for the organisation by i.e. deferring income to the following year and incurring costs in the current year in order to secure their bonus for next year instead.
b1.gif (814 bytes) Too high a focus on financial measures and short-term goals in determining bonuses may mean that anything that doesn't get measured doesn't get done / gets ignored, to the long-term detriment of the organisation.
b1.gif (814 bytes) Lack of communication about how performance pay is determined can undermine the system and instead cause de-motivation.
b1.gif (814 bytes) Lack of transparency of the system can cause a lot of time being spent on working on the system rather than on the business (usually by the organisation's more strategic minds).

So, what are the components of the ideal performance pay system?

b1.gif (814 bytes) Hurdle for performance pay to kick in – Most organisations today have a "hurdle" of a minimum of 80% of a crucial financial target (i.e. EBITDA) achieved before any bonus is paid. This means that in years when financial results are well below target, performance pay for executives is a no-go.
b1.gif (814 bytes) Focus on both long-term and short-term strategy – A balanced set of measures is needed to drive focus on both lead and lag indicators since lead indicators (such as resourcing, innovation, customer satisfaction and staff morale) determine the organisation's ability to meet its lag indicators in future years.
b1.gif (814 bytes) Performance range – We recommend setting a lower limit for performance pay to kick in and an upper limit, which represents both a stretch target and a cap for performance pay.
b1.gif (814 bytes) Weighting – Targets should be weighted to reflect the degree of difficulty and the impact on strategy. The higher the impact and the more difficult, the higher the weighting should be.
b1.gif (814 bytes) Alignment of targets – All KPIs need to be crosschecked to get alignment across the organisation, either via direct KPIs that measure critical assistance across functions, or via a component of performance pay being dependent on achieving joint outcomes.
b1.gif (814 bytes) Ownership and transparency – The best functioning performance pay systems have a high degree of ownership and buy-in from staff. This can happen through open communication about the contents of scorecard targets and transparency in how scores are calculated.

What Next?

If you are interested in more information please give us a call on +61 412 026 909 and ask to speak to one of our consultants. 

Alternatively e-mail us at info@emdgroup.com.au or use the form on our Contact Us page.

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