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Reward strategy temperature check

There are pros and cons to both performance- and market-based reward systems

The introduction of the National Living Wage, pensions auto-enrolment and skills shortages in certain areas of the economy are all forcing firms to think about how they use their resources, and how they can make their pay budgets stretch further. What is emerging from this is a tension between the idea that employee pay packets should be based on individual performance and the idea they should be based on the market rate.

In the US there has traditionally been a view that a job is worth only what the market will pay; something that can make it difficult to get the most out of top talent who may feel they aren’t being recognised for their individual performance. But such a structure can help to avoid huge pay disparities and biases based on factors such as gender. This approach has also been adopted in the UK’s public sector where it’s common for roles to be allocated into salary bands.

“Salary ranges that are defined by the market give an accurate representation of what you should be paying someone, from entry level up to and beyond fully competent,” points out Suzanne Tanser, reward manager at Croner. “Pay scales with targets will improve performance and increase employees’ salaries as they develop.”

Adopting a slightly less rigorous – but still externally-focused – approach can help companies in the war for talent, by allowing them to pay above and beyond for the right person; an approach common in roles such as sales. “The main advantage here is that it gives the opportunity for employers to really compete in attracting talent, particularly where there is a talent shortage,” says Fiona McKee, head of HR at payroll firm SD Worx UK and Ireland. “There are definitely roles where the market can drive the reward agenda, particularly for roles in the technology space where the competition for talent is fierce.”

But in practice a market-driven approach can be difficult to implement, says Sandy Pepper, professor of management practice in the department of management at London School of Economics. “Most companies say they pay the ‘market rate’ and many say they aim to pay ‘upper quartile’ but this defies the law of averages,” he says. “What is meant by the market rate? Is it calculated by reference to the geographical labour market or occupational pay market? There is often tension between the demands of the external pay market and internal pay equity.”

Defining what the market rate really means can clearly be problematic, but there are further challenges to allocating reward in this way. Having a purely local market-based philosophy can run into problems within the context of global businesses, particularly for employees who move from country to country, points out Duncan Brown, head of HR consulting at the Institute for Employment Studies. “I recall one business where each division had its own pay structure but would move people from one business to another,” he says. “But then [employees] find out the market for Business B for finance managers pays 20% less, so they’re not going to do it unless [the employer] manages those relativity swings.” Often high-value, luxury benefits can help manage any shortfalls, particularly for those in high tax rates, adds Chris Adcock, director of strategic growth business at Reed HR.

According to Tamsin Sridhara, senior director in Willis Towers Watson’s UK talent and reward business, the cost pressures of recent years mean many companies have moved away from a purely external market-led approach, to instead placing greater emphasis on individual employee performance. “A lot will depend on what your whole talent dynamic is; so is the success of your business really dependent on [individual] staff or is it about collaborative effort?” she says. “There isn’t the same answer for everyone.”

One way to take a more employee performance-focused approach, says Tanser, is to link pay increases to achieving targets. “A lot of people are now looking for potential progression over base salary, and this [model] can provide that,” she says.

But whether basing reward on market or employee performance, neither model seems to offer the perfect solution. Putting too much emphasis on performance brings its own downsides. Ben Frost, general manager of reward products at Korn Ferry, says an obvious issue is who decides what constitutes good performance and the level of any subsequent pay increase.

“Firms can run into trouble when there is a subjective view on which roles create value, especially when some roles are disproportionately filled by men or women,” he says. “At a like-for-like level, where people are doing work of equal value, pay needs to be equal when everything else, like experience and performance, is equal.”

Robert Ordever, managing director of O.C. Tanner Europe, also points out such an emphasis could demoralise those who don’t hit targets or are deemed not to have performed well. “Performance-related rewards may motivate employees in the short term, but when employees are seen to underperform and thus go without reward they become disengaged and look elsewhere,” he says. He believes reward should seek to meet three criteria: encourage effort, reward results and celebrate careers by recognising service milestones.

An important consideration in the design of any scheme is internal equity or fairness, adds Brown. He gives the example of a public sector organisation that replaced an unpopular performance-related pay arrangement with an equally unpopular flat-rate scheme. “They didn’t like high flexibility and they didn’t like having no flexibility at all,” he says.

The use of non-monetary recognition can have a big impact here, he says, by acknowledging over-performers.

It’s an approach adopted by recruitment firm Sellick Partnership, through its ‘Stars of SP’ initiative and ‘The Wheel of Success’ scheme for top performers. “These recognise excellence across the year and give every employee the opportunity to win some amazing rewards,” says Jo Sellick, managing director of the firm.

Cash plan provider Simplyhealth, meanwhile, has attempted to reward performance in a more equitable manner. “Having removed performance ratings that historically influenced bonuses, we introduced a group-wide bonus scheme where every employee shares in the success of the organisation, as well as a recognition scheme that offers rewards to employees who are able to demonstrate sustained high performance, personal development and who role model our behaviours and values,” says Simplyhealth’s head of reward, Paul Thomas.

And now some businesses are turning their attentions to employee performance models that reward future as well as past performance, says Ruth Thomas, senior consultant at Curo Compensation. “Focusing just on employee performance tends to be backward-looking, considering only contribution in the prior year,” she says. Instead Thomas believes the answer may lie in also focusing on future performance: “With today’s pace of business we also need to recognise the value of employees in the short- to mid-future term, looking at who has the skills or relationships required to achieve key business priorities.”