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Performance Related Pay Schemes - Can They Be Made To Work?

Wednesday, August 25, 2010   By Mike Reddy


Employees who perform well should naturally receive more than their lower performing associates, right? An effective performance related pay (PRP) scheme should deliver benefits to both employer and employee since it is driven off the employee’s ability to earn extra for more effective performance in their job. It sounds intuitively right in theory, it looks good on paper, but the implementation of such schemes has proven highly problematic.

What is a PRP scheme?

The essential feature of a PRP (aka ‘appraisal related pay’, ‘pay for performance, ‘merit based pay’) scheme is that increases in pay are wholly or partially based on an appraisal of an individual’s performance against pre-agreed targets. This differentiates them from other productivity based systems such as payment by results or piece work.

In most cases the bonus paid is a percentage of the annual salary to be paid out on top of regular salary the following year. Employee and manager will generally meet at the beginning of the year to set the goals and objectives that must be achieved. They will sit down again at the end of the year to determine whether the objectives have been met and if the bonus has been earned.

Issues with PRP schemes

While there is widespread acceptance that the concept  is right in principle, human nature is such that putting this into practice can open a can of worms. It can be viewed as introducing inequalities in pay level and give rise to fear and jealousy among employees over how they might fare under the new system.

PRP has also raised resistance from some employee associations who view such schemes as an individualised method of payment running counter to the principles of collective bargaining. These objections will best be overcome if, through negotiation and/or consultation, employee associations have an opportunity to work with management in developing the details of the scheme so as to reassure themselves that the process will be fair to their members and deliver clearly demonstrated benefits to them.

The concept of fairness is pivotal to a PRP scheme. Because they are based on appraisal of the individual employee, often by their line manager, they are open to the perception that bias and personal favouritism can influence the result of pay reviews. PRP may also fall foul to the belief that pay is not related to performance, but to having the ‘right’ contacts and an ingratiating attitude.

The primary goal of a PRP scheme is to improve performance but ironically, PRP schemes can backfire by engendering self serving behaviours that lead to long term decreases in productivity. For example, a focus on short termism or an unwillingness to work as an active team member because they are too interested in pushing their own barrow to achieve their individual PRP award for the year. The aim should be to create a set of assessment criteria that promote both hard and soft behaviours in the context of both individual and team achievement.

Performance can be difficult to measure. In some industries like sales, job performance is easy to quantify through quotas and sales revenue. When it comes to nurses and teachers it is not so simple. The fact that in some jobs the critical skills can be difficult to identify and even harder to quantify at times makes PRP a questionable reward methodology

Performance appraisal – the bedrock of a performance related pay scheme

For a PRP scheme to succeed effective arrangements must first be in place to define, measure, appraise and manage performance.

A performance appraisal system in itself is of benefit to a business allowing it to objectively identify the strengths and weakness of its employees, highlighting training needs and assessing promotion potential. It is fully appropriate, and makes good business sense, to introduce an appraisal system for its own sake. Should it be decided subsequently to introduce a PRP scheme the performance appraisal system provides the perfect platform from which to launch - teething problems to do with the appraisal process itself will have been resolved and the effectiveness of the appraisal criteria already gauged.

The focus of a PRP scheme should be on encouraging high performance through an effective performance management and appraisal systems first – and only then on pay as an incentive to help achieve that goal.

Mike Reddy is a Chartered Accountant, business coach and advisor helping businesses in Sydney, Melbourne, Brisbane and Gold Coast to easily increase their profits and cash flow. He is currently President of the North Sydney Chamber of Commerce, a Regional Councillor for Sydney North East and a member of the Institute of Chartered Accountants Sydney leadership team. As well as advising businesses, Mike presents business development seminars and webinars and is regularly contacted by the media to comment on small business matters. You can connect with him on Facebook, Twitter and Google+.