Making pay-for-performance plans pay off

imo-blogPay for performance systems are easy to get wrong — encouraging the wrong behaviors while creating uncertainty and resentment. Here are four steps to getting them right, developed with the input of turnaround CEO Bob Papes.

Share this article!


It’s vital that CEOs and business owners pay people what they are worth. Pay should be fair, and should combine (A) what the job market says a role is worth, and (B) each person’s actual results.

Pay for Performance systems are easy to get wrong — encouraging the wrong behaviors while creating uncertainty and resentment. Here, developed with the input of expert and turnaround CEO Bob Papes, are four steps to get them right.

It’s important to do this right, because the alternative is ugly.  Consider a story Bob lived through, of a truly idiotic compensation plan that led to horrific results.

A Horrible Warning

Bob was brought in to turn around a firm that had just come off of record high revenue, that generated “obscene bonuses” disconnected from the true health of the firm.

Key mistake: prior management was paid based on “profitability” with no reference to HOW that profit was created.

So, the prior managers jacked up the prices they were charging to their sister plants inside the larger organization — an arrangement that was known to be temporary — and by harming these captive yet temporary customers, created good-looking short term results. They then paid themselves handsomely.

At the same time, they had no prospects, no pipeline, nothing on the horizon to replace this revenue that they knew perfectly well was going away.

When Bob arrived, fully 50% of their sales had gone away, and the firm had no idea how they would replace any of it.

Reward the How

It’s a common mistake: rewarding blindly for results, regardless of how they are achieved.

LESSON 1: Define both the goals and HOW the goals will be achieved. For example, only give credit for revenue that comes from someone’s efforts — not from windfalls.

Reward not Activity but Results

Another big mistake is to base compensation on activity, instead of results. Suppose a sales person’s bonus is based on “number of new accounts” — he may well go out and open dozens of tiny accounts with tiny clients, creating a lot of extra work for the administrative staff while not bringing in much revenue. You can’t blame the sales person — given that bonus plan, the behavior is perfectly rational. It’s just not helping the firm.

LESSON 2: Base the goals on the RESULTS that the business needs. For sales, define a mix of top line sales growth, profitability, sales to new clients, and keeping existing clients happy. When you start with the results the whole firm needs, you can then allocate goals that add up, across all staff, to those needed results.

Get Buy-In by Jointly Setting Goals and Targets

You can err by setting goals too high, such that the goals seem unrealistic and thus demotivating.

LESSON 3: Build the goals and targets jointly with each person, so they have input and buy-in.

Some Principles of Performance Pay

If the firm does not make the profit target, you just cannot pay performance bonuses.

There’s a temptation to pay bonuses anyway because you like people and want them to feel good. Don’t. If you aren’t making money, you cannot with integrity pay a performance bonus.

Performance compensation plans are not a substitute for good, active management.

Some managers put in all the work to build a detailed, performance based compensation plan, and then imagine they can stop managing — they think the comp plan will steer for them. It won’t. There is no substitute for good, active, supportive management.

Hourly Workers and Salaried Staff

You want two types of plans – Gain Share for the hourly workers, and Performance based for salaried staff.

“Gain Share” for hourly workers is based on what they can, themselves, generate – things like production level, quality, on-time delivery and safety.

These should be paid monthly, and paid from the savings that come from beating the goals. If more safety means we save $6,000, share that $6,000 with those workers.

Suppose you agree to share 50% of the savings with the workers. You then define the specifics, you monitor it closely and share the performance numbers with the workers very frequently. Such programs pay for themselves.

“Profit plus Performance” is for salaried workers – this should be tied to annual profit targets.  One approach can be:

Create an overall pool based on profit level, or team performance

Give each person a chance to earn their share of that pool, with shares based on seniority or level of responsibility

Award them a percentage of their share based on performance on their goals

Performance Pay is Not a Gift

Too many companies give a Christmas Bonus that quickly becomes perceived as an entitlement. Once it’s perceived as an entitlement, it has little effect as a reward. In lean times when you cannot afford it and the Christmas Bonus goes away, people become enormously upset. That’s not a good system.

There’s an entitlement risk with profit sharing plans. That happens especially when the payout is disconnected from individual performance.

Most employee have no idea why their profit sharing payout went up or down, and their own efforts are unrelated to the result.

Good Performance Targets

The targets need to be objective, quantified, fair, and balanced across the actual needs of the firm — and mutually created with the person being measured.

Buy in builds commitment. Commitment builds performance.


Create different plans for hourly vs salaried people, maximizing their influence over their own performance

To work as an incentive, performance pay must be earned, not an entitlement

A true pay for performance plan will build your bottom line

A good performance plan enables better management because it requires you to define good performance — such a plan doesn’t substitute for active management

Tom Cox is a Beaverton consultant, author and speaker. He coaches CEOs on how to boost performance by building ever-higher levels of workplace trust.