Comp 101: Crafting a Solid Pay-for-Performance Plan

When it comes to compensation, employers and employees do not always agree. Only 41% of employees believe that their employers have achieved pay equity, and 26% think that the companies they work for do not ensure pay equality.

This differing perception is problematic. Understanding that corporate compensation is a matter of perception is, however, the first step to solving this issue.

Read on to learn how compensation and performance management work together to promote pay transparency and help you communicate more openly with your employees about the value of their contributions.

What are the four types of compensation?  

Employee compensation can have different meanings for different companies depending on the industry and workforce. The four most common types of direct compensation for employees are:  

• Hourly wage: The hourly wage is the most common and direct form of compensation and is typically used for unskilled, semi-skilled, and part-time employment.  
• Salary: Usually, an annual amount is evenly divided across multiple pay periods, so employees receive the same amount with each paycheck throughout the year. Salaries are generally paid for positions that require higher education or specialized skills.
• Commission: Commission-based compensation is intended to motivate employees to perform at their best and is suitable for industries where the employer cannot guarantee a constant workload.
• Bonuses: Performance-based bonuses provide companies with a flexible way to reward employees for outstanding performance.

What is performance-based compensation?

Performance-based compensation motivates employees to achieve top performance and rewards them for reaching set goals. It is usually an additional component to the fixed salary. Performance-based compensation is variable and depends on the employee's performance.

The following presents two ways to link compensation and performance management to foster a shared understanding between employees and management.

Develop a performance-based compensation strategy

By linking compensation to employee performance, HR departments and employers create clear pay guidelines and help employees recognize their value and increase it.

HR managers should lead this strategic compensation planning by first developing compensation strategies (and the associated measures) together with management. They should then ensure that these strategies are based on relevant data – because your employees will want proof. Data and performance metrics from your performance management can help with this.

When developing your compensation strategy, you should consider the following three points:

• Compensation should be fair and reflect the value of the employee's contribution.
• Increases in compensation should be reasonable and reflect the employee's ongoing performance as well as changes in the labor market.
• Compensation should motivate all employees to perform better.

There are many ways to reward performance beyond just cash payments. Depending on your situation (e.g., industry, company size, growth stage, etc.), you should combine the base salary with other creative employee incentives.

It is important to develop a well-thought-out mix of monetary and non-monetary incentives that fits your company, links them to specific performance metrics, and pays out the rewards regularly.

Get creative with your performance-based compensation initiatives!  

Since performance-based employee rewards don’t necessarily have to be monetary or pre-planned, you can get creative here. The important thing is to find out what kind of reward your employees want. Talk to their managers, conduct surveys, or simply pay close attention.  

There are many examples of performance-based compensation that can serve as inspiration.  

• If you know a particularly high-performing employee who loves orchestras, give them tickets to an upcoming concert.
• Or if you want to reward an entire team for successfully organizing an event, treat them to a lunch.
• Traditional bonuses are also very effective when tied to specific work achievements.

With a smaller budget, you can also show your appreciation for the performance of other employees through other incentives:

• A personal lunch with the CEO or another executive
• A paid day off after an important deadline
• The opportunity to work from home

Improve salary transparency for your employees  

Compensation, including salary increases, was a key issue in 2023. This makes it clear that the problem lies in employees' perception of their compensation. Compensation is an exchange of value, and values are a matter of perception. Even the best strategy for fair compensation only matters if employees perceive the same value.  

That is why it is important to apply best practices for salary transparency and communicate openly with your employees about their compensation to align their perception with reality.

Managers should be prepared to discuss compensation individually and align the value they offer (e.g., salary, benefits, experience, flexibility, etc.) with the specific value an employee brings (e.g., industry experience, expertise, product and competitive knowledge, etc.).

Develop a communication package for employee compensation

Most managers do not know how to talk to their employees about compensation. Before managers have these conversations with their employees, companies need to develop a plan for employee compensation communication.

After the HR department and management have created a strategic compensation plan, managers need training to convey this plan to individual employees.

The HR department should provide managers with the following 'compensation communication package':

• Talking Points for the Employee Compensation Plan
• Information about the compensation plan
• Details about each employee they manage
• Tips for different conversation situations

After the training, managers should be prepared to discuss the compensation strategy with their employees, explain the reasons for the strategy using data, and know how to implement goals with individual employees to show appreciation while also highlighting opportunities for a salary increase.

Create an open culture to build trust regarding compensation

When leaders explain the details of their employees' compensation, employees better understand their value and feel more confident that they are being paid fairly.

Employees are then also more open to suggestions on how they can improve their compensation. These two factors lead to fewer misunderstandings and misperceptions.

Since misperceptions can never be completely avoided, an open company culture is essential. Employees should be encouraged to discuss questions or concerns about their compensation with their leaders if they feel uncertain. With clear compensation strategies and trained leaders to communicate them, answers are readily available.

This allows leaders and employees with different value systems to work together quickly to bridge them and restore a shared understanding. Our total compensation calculator helps you with this. With this tool, employees can see the full value of their compensation package – including benefits, vacation, perks, and more.

A solid pay-for-performance strategy and open communication are vital to overcoming the widespread perception gap regarding pay equity. By clearly linking employee performance data to fair compensation, companies foster trust and align employee value perception with reality. The challenge lies in providing managers with the tools to have these sensitive, data-backed conversations. IceHrm supports this strategy by facilitating the performance management required to gather the necessary data, which can then be used to justify PFP decisions (Strategy 1). Furthermore, while the article mentions the value of a total compensation calculator, IceHrm's comprehensive feature set centralizes the complex data points—from salary and benefits to leave accruals—making it the ideal system for creating a transparent "communication package" and ensuring employees always have a clear view of the full, tangible value of their total compensation package.