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<p>Base pay is the largest single element of human resource cost. Getting the most out of expenditures on base pay is or should be a priority. Most organizations state in their human resource policy manual or employee handbook that they pay for performance, but do they really? Can base pay be used to pay for performance?</p>

<p>Major surveys suggest many organizations have lost confidence in traditional "merit" increase plans. This is because scarce base pay adjustment dollars have so many demands on them-responding to competitive practice, reflecting the value of work performed, paying for geographic differentials, rewarding tenure, and a host of other purposes, leaving little money or opportunity to reward skill, competence, or performance. Often organizations feel not enough dollars remain to recognize differences in performance so they make only meager attempts to do so.</p>

<p><b>Double-barreled Solution</b></p>

<p>One way organizations focus on paying for performance is through the broadening use of variable pay and incentives. Incentives do not fold into base pay and must be re-earned each performance period. Eighty percent of companies now use some form of variable pay or incentives below the supervisory or management level. Variable pay has become the "tool of choice" for rewarding employee performance. Not only does variable pay reduce the risk of becoming either an entitlement or a "gift that keeps on giving" for one good year of performance, incentives are also agile, flexible, able to be customized to match a host of changing and evolving organizational needs, and actually work.</p>

<p>It seems apparent to us that no matter how effective a tool for rewarding performance adjustments to base pay may become, incentives and variable pay will be the premier way to reward performance. If base pay can be made to be more responsive to performance, it is possible that pay for performance can be addressed with a "double-barreled" solution. Here is how base pay and incentives may be combined to support creating a performance culture:</p>

<ul>
<li>Base pay adjustments: Ties the largest element of cash compensation, base pay, to performance differences. The eventual goal is to pay the employees with the most critical skills and competencies for translating this capability into strong performance or value added to the business over time. Because base pay is seldom successfully cut or reduced, the priority is to design a base pay system that pays more to top performers with critical skills and competencies over time. Sustained performance over time is something base pay can recognize, but getting from where base pay is now to this solution requires change.</li>

<li>Incentives and variable pay: Reward short and long-term results. Link the employee as an individual or as a member of an organizational unit, team, function, or company to business goals and customer success measures. Evidence and experience suggest that the best compensation ROI comes from a straightforward incentive plan for all employees throughout an organization or organizational unit.</li>
</ul>

<p>The combination of the two elements is a potentially powerful one that communicates a performance culture. Clearly showing that performance matters from the start is the best way to combat the creation of an entitlement mentality.</p>

<p>If there is a "problem" with incentives, it is that no matter how large the incentive opportunity is, it is smaller than the base pay employees are paid (exceptions are some sales professionals and executives). And it may even be less than the base pay adjustment budget managers have to distribute annually. If the major component of pay is based on something other than differences in skills, competencies, and performance, employees understand that non-performance elements are more important pay determiners than are those related to performance differences.</p>

<p><b>Why Repair "MERIT PAY"?</b></p>

<p>High-performance organizations attract talented people who want their performance rewarded. The top 20% of performers often generate about 80% of the results achieved by an organization. However, base pay is universally more likely to be correlated with length of service and years of experience than differences in employee performance by any measure. This often makes it difficult to communicate to a workforce that performance is rewarded. It is nearly impossible to build credibility in a communications message about paying for performance if it is not consistent with practice.</p>

<p>How many believers in paying for performance do you think a CEO will get if the message to communicate is, "I know our company pays mostly for years of service and experience and not performance. However, believe what I say and not what I do-paying for performance is the way we <i>wish</i> it were."? Fixing how raises are granted is important but difficult to do. Improvements can be made to clarify the message about the value of adding value to the business.</p>

<p><b>Improving Base Pay for Performance</b></p>

<p>First, stop what you are doing relative to granting base pay adjustments. Although this may be like turning a ship headed for an iceberg, it is essential and gives the message that a course correction is in the making. Trying to "fine tune" an annual budget number in order that monies presently deployed for everything from competitive practices to recognizing performance has proven to be unreasonable. There is little evidence of success by merely attempting to re-arrange the deck chairs on the sinking merit-pay Titanic. You can certainly try to do this, but it is difficult to communicate change when the workforce is seeing minor versions of the same old solutions and not a significant difference.</p>

<p>Meaningful change must start with visible change so people do not say, "This too will pass." Introduce different ways to use base pay and base pay adjustments to help incentive plans pay for performance. Create a new learning platform for pay management so the rules change and the communications surrounding how people are paid and what they are paid for change as well. Put strategic intent into the largest expense many organizations have-what they spend on base pay. Don´t just hook on some technology gimmick that helps manage pay better but improve the foundation so it magnifies organizational goal performance.</p>

<p>Most attempts to make merit pay work fail because they are generally based on admonitions to "try harder" or "make the existing solutions work" or "train people better." All of this is good advice and should be considered. However, it seldom seems to work. Jawboning supervisors and managers is an important way to improve how they pay for performance. The problem is keeping at it. Since so many initiatives come and go that employees are often dizzy, organizations tend to go back to the way it was before with a "this too will pass" view of a new initiative because "we know another new one is just around the corner."</p>

<p><b>Suggestions for Changing Base Pay Increases</b></p>

<p>A base pay increase stays with people throughout their entire career with the organization, no matter how their value changes. It is nearly impossible to reduce base pay to match performance and retain someone in the organization-unless, of course, they can´t find work elsewhere because they remain overpaid for the value they add or because they are just putting in their time to retirement. Anything you can do to align base pay with performance is heavy lifting, but if you can do it, this better aligns a huge opportunity cost with performance and value to the business. Here are eight action steps to help paying for performance greatly:</p>

<p><b>Action Step #1: Improve the performance management foundation</b>. Involve the organization in evaluating and improving the current performance management process. Cascade goals throughout the organization, engage people in their own performance management process, focus on adding business value and growth/improvement, emphasize ongoing feedback and coaching, and gain consensus on the calibration of the "performance bar."</p>

<p><b>Action Step #2: Don´t allocate base pay budget equally to all organizational units or departments</b>. Instead, allocate the increase budget with preference for organizational areas that have demonstrated high performance and excellent results or to those areas with critical skills and competencies essential to business goals and objectives. Alternatively allocate more base pay increase dollars to areas where the competitive labor market has moved the most and where more money is needed to remain competitive with the specific market in which the organization competes for talent.</p>

<p><b>Action Step #3: Include more than just the individual´s immediate manager in determining base pay increases</b>. Often managers alone do not do a good job of allocating base pay increases. A group of managers working together with their senior manager can determine increases using employee performance evaluations as the basis for the adjustments. This also helps improve goal setting and calibration of performance levels and helps move to more uniform solutions that make it more probable that similar results will receive similar pay treatment. Smaller companies can centralize base pay increase decisions based on performance evaluations and manager inputs. Creating shared responsibility for the allocation of base pay increases improves objectivity and accountability.</p>

<p><b>Action Step #4: Have managers rank people based on sustained value-added, contributions, results achieved, and other performance elements</b>. Then compare the ranking to current base pay to see what changes need to be made over time for greater alignment. The goal is to repair this inequity and redefine fairness in terms of value to the business. The objective over time is to pay the best performers more than competitive levels of base pay to make performance worthwhile and to reward people based on their track record of performance over time.</p>

<p><b>Action Step #5: Think in terms of resulting base pay (absolute dollars)</b>. Do not focus on percent increases that sustain existing inequities in base pay. Using absolute annual base pay dollars stops magnifying base pay inequities and permits lower-paid, better performers to catch up with higher-paid employees whose performance may not justify their existing pay. An equal-dollar award of, for example, $1,000 represents a larger percent for a lower-paid employee than a higher-paid employee who may be adding equal value to the organization.</p>

<p><b>Action Step #6: Focus more on the results achieved than on behaviors</b>. Results are the way businesses measure value-added and what makes businesses successful. Use the performance management process to coach people on behaviors to improve measurable results. Weight behaviors less than results. Alternatively, do not have behaviors impact pay unless they are negative enough to get in the way of results. For example, determination of goal achievement considers not only what was accomplished but how it was accomplished-particularly if behaviors were inconsistent with the organization´s values. Use recognition to reward behaviors. There are too few base pay increase dollars available to focus them on rewarding behaviors. Focus only on an individual´s sustained value-added to the organization over time.</p>

<p><b>Action Step #7: Give priority to differentiating the pay of top performers from everyone else</b>. Do what it takes to pay a premium for the high performers. Earmark a small part of the total salary increase budget to use only to enhance the increases of the high performers. Alternatively, as a supplement to base pay increases for high performers, implement a variable pay or lump-sum payment, for example, based on outstanding business results and make the awarding of this reward visible. Or if the initial pass on base pay increases overspends the budget, balance the budget by reducing increases to lower or typical performers rather than all employees or the top performers. Make performance excellence worthwhile.</p>

<p><b>Action Step #8: Know the competitive labor market and consider it when making performance base pay decisions</b>. Reserve most base pay adjustments for the top performers so increases are significant-especially those paid below the competitive labor market with a track record of sustained high performance over time. Employees with high base pay relative to their job´s labor market worth need to be a top performer to receive a pay increase or a variable pay award. Consider lump-sum payments instead of a base pay increase for higher-paid employees compared to the labor market. Look for ways other than increasing base pay to reward excellent performance over a short term for highly-paid employees. The short-term performance may not be sustained and the result may be an employee paid more than their overall value to the business over time. The unfair and unjust approach is to let someone´s base pay grow until they are overpaid late in life and in their career. It is better to be honest early in people´s careers rather than avoid telling them the truth and letting them be paid more than they are worth and then having them feel trapped at an organization or having the organization lay them off.</p>

<p><b>The Future</b></p>

<p>Using base pay for rewarding performance is important because of the message it sends about the largest element in the total pay equation. We have suggested alternatives to consider that go beyond trying to get managers to "do better" with the existing methodologies. Some involve substantial change from what is done now and when combined with variable pay can help organizations gain more value from their base pay adjustment dollars.</p>

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<p><b>Patricia K. Zingheim and Jay R. Schuster</b> are partners in <b>Schuster-Zingheim and Associates, Inc.</b>, a compensation and total rewards consulting firm. They are recipients of WorldatWork´s 2006 Keystone Award, the highest honor in the compensation, benefits and total rewards profession. They are the authors of two books, <i>Pay People Right!</i> and <i>The New Pay</i>. Their Website is <a href="http://www.paypeopleright.com/">www.paypeopleright.com</a>.</p>