Performance Based Compensation System

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Performance Based Compensation System:

The corporate world has changed over the last decade. Lots of industries have been set up and lives of the workers have changed phenomenally over the years. The jobs have changed and the compensation structures have changed drastically. There has been great competition among the private sector companies has grown tremendously. In this era of great rivalries, the biggest asset or the defining factor for success in any organization are the employees and the skill-sets they have acquired. The companies around the world have struggled to retain their star performers. The modern day companies also keep an eye on the star performers of their rival companies and try their best to win them over by offering lucrative salaries. The modern day companies have seen the value of individual performances in the corporate world. The modern day companies rely heavily on individual performances and there have been many instances that a single individual has changed the fortunes of the company. In today’s corporate world retaining star talent is very important and the performance of company has been directly proportional to the attrition rate of the company. The companies put extra effort in identifying key performers and ensuring their loyalty. In the bid to retain key performers it is very important to compensate the employees aptly. Money is one of the most important factors in motivation of employees. Companies now dole out incentives and pay packages have increased consistently over the years. It is contrary to what the pay structure was earlier. Earlier pay structure was fixed and pay was based on seniority. But nowadays no company can afford that approach in the compensation structure. The modern companies have welcomed performance based payment structure with open arms and more and more companies are shifting towards performance based compensation structure. Now the compensation structure is dynamic and salaries have lots of components. There are many performance base components like bonuses and incentives. There are many non-monetary components as well. The different types of performance based compensation are commission and piecework. Earlier, compensation was fixed and was determined by government regulation and several other factors. But rising inflation has made it difficult for people across the world. They are ready to work harder in order to earn extra bucks. The company also faces a dilemma of planning the compensation structure aptly so that it does not have an adverse effect on the finances of the company. Thus planning the compensation structure is very important so that it is a profitable situation for both company and employees. It is a double edged sword for the HR department and the onus is on HR managers to frame a good compensation policy for the company. They also have to take care of the fact that all the employees are treated equally. The HR can do this in following ways:

Analysing the Jobs:

This includes analysing all the jobs of the company and clearly defining the tasks. The employee should be clearly told about his responsibilities and what is expected of him.

Job Evaluation:

This includes comparison with the rivals and analysing where the company is lacking in this department.

Job Pricing:

This task deals with the change in rates and planning appropriate compensation for the job.

Some advantages of having a performance based compensation plan are:

  • The biggest advantage is motivating and retaining key talents. It helps in motivating employees and keeping them interested in their work. Retaining star performers is one of the key areas of concern for any organization. There is cut-throat competition and talented employees don’t hesitate to leave the organization for greener pastures. Thus it becomes very important to retain star performers by motivating them regularly by incentives, awards and recognition. The HR department should take care of key employees by encouraging employees and solving their concerns.
  • Positive competition amongst employees is encouraged by this system. Every employee wants to earn more rewards and recognition. Thus they strive to work harder. The company benefits as employee’s personal benefit is aligned with company’s profit.
  • Performance based compensation system also helps in increasing the knowledge base of the employees. The employees strive to perform well and to excel in their work; they need to increase their knowledge base. Thus it motivates employees to work hard and learn new stuffs. For example, in an IT company it motivates the employees to learn new cutting edge technologies. In IT sector the technology keeps changing. Thus the employee needs to keep learning continuously. If they are rewarded for this hard work, it keeps them motivated.
  • It increases the speed and efficiency of operations. The employees are able to complete their work with greater speed because they are motivated and strive to excel. This helps in improving the reputation of the firm and gets more clients.

However, there are some disadvantages as well. The performance based compensation system backfires sometimes if not implemented properly. Some of the disadvantages are as follows:

  • It discourages teamwork. Individuals get so obsessed about their personal performance that they ignore working in teams which is very important for success of any organization. The performance based compensation system makes the employees selfish and they forget that cooperation among the team is necessary to complete the task successfully. Most of the organizations require team work and collaboration from their employees. However performance based compensation system leads to mistrust and lack of coordination. It can reduce competitive advantage and effectiveness of the organization.
  • It can also lead to drop in quality. The performance based compensation system makes employees obsessed with financial rewards which may lead to overlooking of quality and the processes. This is an area of concern especially in the product based companies where the quality of product is very important factor in the success of the organization. Performance also includes speed of completing the task. Sometimes, in order to earn incentives, employees tend to complete the work too quickly overlooking the quality in the process. This proves to be a major disadvantage for the organization as this leads to loss of name and business.
  • It may promote inequality between employees. Older employees can’t match up to the speed of younger employees; however their quality of work may be better because of their experience.
  • It may lead to favoritism and sycophancy. The performance of the employees is generally analyzed and rated by the seniors. Sometimes, this leads to office politics and favoritism and employees are evaluated on the basis of things other than their performance. This leads to a very counter-productive environment in the office as undeserving people are rewarded. The deserving employees feel left out and have no option but to leave the organization.
  • Sometimes employee works very hard and expects rewards, which for any reason he may not get. This leads to a drop in performance in the next quarters and he is demotivated.

There are numerous merits as well as demerits of the system and the HR team has a daunting task when they go about planning the compensation strategy. The strategy cannot be implemented overnight. The compensation structure has to be planned according to the organization. It has to be customised according to the needs of organization. The working conditions in different sectors are different as chalk and cheese. What works in one organization may not be of much use in other. What works in manufacturing may not work in IT sector and vice versa. The compensation strategy has to be planned accordingly and implemented with a little caution. It is the need of the hour but companies should take care that it does not lead to mistrust amongst employees.

Compensation Strategy:

The organizations around the world have realised the importance of performance based compensation system. They have realised that they have to shift to this method to survive in today’s corporate world. However a major change like this cannot be brought about in one day and lots of planning needs to be put into this. The strategy should be in line with the overall goal of the company which is maximising wealth. There are few factors which should be kept in mind before bringing about a change in the compensation structure are:

  • It should add to the capital resources of the organization. It should help in long term appreciation of the capital value of money. Also the cost of the strategy is a critical factor. The cost to the organization should be low. It is not possible to invest an exorbitant amount in a strategy for any organization.
  • It is regarded that the money is an important source of motivation. But money can motivate only till the next incentive is due. Thus the strategy should also consider other strategies apart from incentives which can keep the employees content and loyal.
  • Implementation of value based company management system. A system should be planned and it should be clear in terms of implementation. The objectives of the strategy should be easily understandable.
  • The objectives and goals should be clear and defined and should be achievable.

Thus the compensation strategy needs to be planned with lots of care and several factors need to be considered. The employees need to be taken into confidence before bringing about the changes. Some of the important factors that are needed to be considered which are as follows:

1. Linking compensation and total business strategy:

Most organizations have clearly defined goals and they know how to achieve that goal. Compensation is a tool to help to make employees move in same direction and relate to organizational policies.

For example, there will be a difference between the strategies of a young, new aspiring company and an established organization. The former will award employees who will bring in new clients and expand business whereas the latter will reward quality performance. It will not think about adding small clients. Some other company may identify world-class customer service providing as its top strategic objective. It would need to reward the activities (inallareas of the organization, not just the customer service department) that lead to outstanding customer service. The company which relies on innovation will award an employee who innovates something new. In short, the bonuses will differ from one organization to other and the parameters to measure performance will differ as well.

Compensation sets the direction for the employees. In the absence of proper policy the employees don’t have a direction. Compensation strategy identifies your top strategic objectives, defining what they mean in terms of organizational behaviour and designs your compensation plan in a way that rewards and recognizes those behaviours.

2. Changing the culture and reinforcing it with compensation and rewards:

A good compensation strategy alone doesn’t guarantee turn around in the fortunes. In order to achieve permanent change in behaviour, the culture and the environment should be changed as well. Then compensation should be used to reinforce those changes.

Only dangling money in front of people, doesn’t change their behaviour for a long time. It may lead to small change but people soon go back to their old ways. One doesn’t get sustained productivity improvements unless there is a change in the culture. That involves identifying and analysing the results you want to achieve as a company, identifying the tasks and behaviours that lead to those desired results, and then designing a compensation plan to reinforce, reinstate and reward those behaviours so that they become permanently instilled in the organization.

It is very important to walk the talk. Just defining organizational culture on paper and not practicing it at the top level won’t do any good. If an organization says that it values quality but rewards speedier work with lesser quality; then it is sending a wrong message to the employees.

Compensation sends powerful messages to your employees about who you are as an organization; helps in building your image. It describes what you value and lays down skills and results you reward.

3. Defining the compensation policy:

To implement a new policy, it is very important to define the policy clearly. It should contain clear, focused compensation policy which needs to answer some fundamental questions like:

  • What do we want to pay for?
  • How to pay for different jobs?
  • How does it affect our competitive posture?
  • How will we split the pie amongst our employees?

The compensation statement should clearly specify the result the organization wants to accomplish, and the expected behaviours required to achieve those results. It should identify what exactly should the organization pay for, and how do we want to position our organization in the marketplace. The pay policy should be designed by the top management keeping in mind the views from all stake-holders. It should reflect the values of owner/CEO. It should reflect the realities of economy. It should take into consideration the realities of pricing structure and market share. It should lay a foundation for the consistent hiring and promotions. It should be competitive with the market.

4. Thinktotalcompensation:

In today's fiercely competitive labour markets, compensation provides a powerful tool for attracting and retaining quality people. There are many components of the salary which gets unnoticed by the individuals. There are many components of the salary which are as follows:

  • profit sharing
  • housing rent allowance
  • retirement and pension plans
  • benefits
  • shares or equity
  • incentives and bonuses
  • recognition and rewards
  • holiday and personal time off
  • Opportunity income (education reimbursement, professional development programmes, etc.).

If you don't think, talk, market and sell total compensation, you're leaving a lot of money on the table. Talk about compensation frequently and impress upon employees that it includes a lot more than base pay. When declaring compensation for potential employees, always use total compensation, because base pay never tells the whole story and there are more factors. There are many things which are added on to the base pay.

It is recommended providing employees with an annual total compensation statement which lists the complete package of rewards and recognition they receive for working in your organization.

A total compensation statement comes as a positive surprise for the employees because the bottom-line number always exceeds what they normally think of as their compensation. An organization can't afford to lose employees who might get lured away by promises of a bigger base pay by other companies. An organization has to make sure that all your people understand and appreciate the full range of compensation and benefits they enjoy in your company. An organization has to ensure that all employees appreciate all the components of the salary. It also helps when other employers try to lure your employees. They are aware about different components and ask right questions from the prospective employers.

5. Measure your return on invested payroll:

It is important to measure the return on investment and analyse the results. Most companies don't even try to measure their return on compensation, leave alone determine whether it is a good one or not. To measure the return on investment, one should look at: productivity, bottom-line results, employee turnover, and ability to recruit and retain key people, morale, customer service or any number of measures.

Organization should analyse the return on investment and invest in right employees. It is important to invest in right employees and ensure return on investment. It is the imperative of human resource manager to ensure that right employees are awarded and retained.


Implementation of the plan is important factor and it needs to be taken care of. All the stakeholders are supposed to be consulted before deploying the new plan. Employee feedback should be taken into consideration before the plan is implemented. It is important to implement the plan in phases and take feedback. Feedback plays an important role in analysing the benefits and shortcomings of the plan. The top management should walk the talk and always stick to the policy. The policy change cannot be implemented in a day. It has to be brought about slowly. It is very important that the employees don’t feel left out. Various stakeholders should be taken in confidence before bringing about the change. The employees should be made aware through workshops and the policy should be clear in everyone’s mind. Otherwise, it can lead to a bad taste in employees. Also, the policy should be tailor-made according to the organization. As discussed earlier, the policy or plan which works for one organization might be unsuitable for other company. After the policy has been implemented it is necessary to review the plan in quick intervals. The human resource team should get in touch with all the employees so that they get to know about their feedback. The policy should be able to retain the star performers. It is also important that a sudden implementation doesn’t affect the employees in an adverse way. It should not lead to useless cut throat competition and favouritism. It may happen that in greed of incentives, people forget the virtue of teamwork and collaboration. If it happens, the whole plan will misfire. So implementation should be such that these problems don’t occur. The policy should be goal oriented and the policy should value all star performers.

Short Note:

The time has arrived that we move from conventional compensation system to performance based compensation system. This is the need of the hour. The market has been witnessing a never before revolution and there is a huge demand for human capital. Thus, it becomes very important to take measures to retain our key performers. However, we should be cautious in implementing the plan. If we don’t plan it out properly it can misfire and demotivate the employees. However, if implemented properly it can benefit the organization a lot and motivate the employees. It can lead to great improvement in performance of the organization. Our attrition rates will decrease and a motivated workforce will collectively move towards achieving the goals of the organization.