Module 5--Pay for Performance and Salary Budgeting Flashcards
What is the THREE STAGE PROCESS for Pay for PERFORMANCE?
Pay for Performance
Pay for performance can be looked at as a three-stage process:
1. Establish measures
2. Communicate links between measures and assessment
3. Assess performance against measures
What are the two forms of Delievering PAY for PERFORMANCE
■ The first is variable compensation, short-term incentive plans
that are based on organizational performance. Rewards in this area are fully self-funded because they pay out only when organization performance is at an expected or exceptional level.
■The second way to deliver pay-for-performance is through a base compensation system, to reward outstanding performance, and most often, this is done in the form of a MERIT INCREASE program.
What is the ESTABLISH MEASURES
Establish Measures
■ Types of measurements – Measures may be FINANCIAL or NON-FINANCIAL
■ FIVE STANDARDS of Performance measurement systems
* BALANCE SCORECARD – focuses on financials (shareholders), customers, internal processes, plus innovation and learning
- EVA (Economic Value Added) – combines results, which are readily measurable, with enablers, some of which are not
- Shareholder Value Added – incorporates the cost of capital into the equation
- Activity Based Costing and Cost of Quality – focuses on the identification and control of cost drivers (non-value-adding activities and failures, respectively), which are themselves often embedded in the business processes
- Competitive Benchmarking – involves taking a largely external perspective, often comparing performance with that of competitors or other best practitioners of business processes
■ No one-size-fits-all approach
* Multiple, seemingly conflicting, measurement frameworks and methodologies exist because they all add value. They provide unique perspectives on performance and offer managers a different set of perspectives by which to assess the performance of individuals, teams and organizations.
* Under some circumstances, one particular perspective will be exactly right for an organization, whereas in another circumstance, it would be counterproductive. The key is to recognize that there is no single best way to view business performance.
What is the COMMUNICATE LINKS?
Communicate Links
Communication is the key to any successful pay for performance program. If communication is inadequate, employees will not understand what they are being measured against and what is
important to the organization.
The organization must communicate the links between established measures and performance assessment.
What is the ASSESSMENT? (How are you Assessing Performance)?
Assessment
■ The third component to pay for performance systems is the assessment. Basically, organizations (managers) will assess employees against the measures established. Assessment usually comes in three different forms:
- Individual – How did the individual perform based on the measures determined for the job?
- Team – How did the team perform based on objectives? When assessing team performance, it is important to look at how the team performed and how individuals participating on the team performed.
- Organization – Did the organization achieve desired results (both financial and non-financial)?
■ How does an organization assess employees?
* Formal
* Informal
* Performance appraisals
* 360 Feedback
* Coaching/mentoring
What is the COMPENSATION STRATEGY
Principle that guide the design and the delivery and the administration of the pay programs within your company?
What is the COMPENSATION PHILOSPHY
It is the Statement of What your company believes about how people should be paid.
What is the COMPENSATION STRATEGY and PHILOSOPHY?
Compensation Strategy and Philosophy
Where does base pay fit within the organization’s business strategy? To answer this question, an organization must first understand its compensation strategy and philosophy.
■ Compensation strategy – The principles that guide design, implementation and administration of a compensation program at an organization. The strategy ensures that a compensation program, consisting of both pay and benefits, supports an organization’s mission, goals and business objectives. It may also specify what programs will be used and how they will be administered.
■ Compensation philosophy – A defined compensation philosophy is a statement of what the organization believes about how people should be paid. It should support the business strategy
and be a good fit with the organization’s culture. A key component is how the organization intends to pay relative to its competitors for people – i.e., the desired market position.
- Lag the market – The company will consciously set its pay equal to current market levels at the beginning of the year. The company’s pay philosophy will then “lag” the market as the year progresses.
- Lead-lag – The company will consciously set its pay at mid-year anticipated market level.
The company’s pay philosophy will then “lead” the market for half of the year and “lag” the market for the second half. - Lead the market – The company will consciously set its pay at anticipated market level. The company’s pay philosophy will then “lead” the market until the start of the next year.
What is the COMPENSATION PHILOSOPHY?
Compensation Philosophy
The compensation philosophy is a road map that organizations use to assist in the development of compensation programs. Not all organizations have a written compensation philosophy.
■ A compensation philosophy should cover the following components:
* Market position
* Basis of job value
* Pay mix
* Reward focus
* Structure
* Administration
■ It is not:
* A be all, end all
It will no be a set of rules
* A simple statement that proclaims, “We’re a 50th percentile payer.”
How do you USE a COMPENSATION PHILOSOPHY?
Using a Compensation Philosophy
■ Bounce new ideas – Bounce new plans, or modifications, against the philosophy to see if changes fit desired results
■ Proactive evaluation – Proactively evaluate existing plans against compensation philosophy to look for gaps in desired results
■ Possible needs – Evaluation will highlight possible needs for program changes to address gaps Remember:
■ A well-articulated compensation philosophy helps employees understand the intentions and beliefs of senior leaders.
■ Employees actually understand why certain programs are in place, which leads to a more engaged workforce and a higher-performing organization.
What are the PRINCIPLES of MERIT PAY PROGRAMS?
Principles of Merit Pay Programs
In regards to pay for performance and base pay, merit pay is one of the most frequently used methods.
■ Objective – The essential goal of a merit pay program is to link pay to performance in a manner that is consistent with the mission of the organization. There are two required conditions:
* Variations in employee performance must be measurable and measured.
* Managers must be provided with the necessary tools to determine the appropriate rewards.
■ Size – To motivate employees most effectively to meet or exceed performance standards, the absolute size of the merit increase must be significant enough to make a noticeable difference to
employees (e.g., the increase must not be so trivial as to be deemed inconsequential).
- A successful merit pay program will ensure that increases awarded to the best contributors will be substantially greater than increases awarded to average or less-than-average performers.
■ Timing – anniversary-date versus common (focal-point) review
■ Implementation – Under traditional merit pay programs, merit increases are built into employees’ salaries for as long as they remain with the organization. Hence, the increases are permanent and their values are compounded over time as additional increases are granted.
- One alternative to base pay increases is the use of lump sum payments. Lump sum payments are one-time payments made in lieu of traditional base pay increases and typically are delivered annually via the merit pay program. Thus lump sum payments recognize and
reward performance during a specific period or project, but prevent that same performance being rewarded repeatedly in the future, when subsequent performance levels might not justify additional merit payments.
What are the FACTORS affecting the Success of MERIT PAY
Factors Affecting the Success of Merit Pay
■ Managerial factors
* Executive support for the increases
* Managerial capabilities in planning and appraisal
* Supervisor/subordinate trust levels
* Managerial fortitude
■ Organizational factors
* Cost of measuring performance
* Competitiveness of pay structures
* Width of pay ranges
* Equitable internal-pay relationship among jobs
* Organization’s pay-performance linkage
* Organizational culture
* Effective communication
■ Individual employee factors
* Measurable differences in performance
* Performance appraisal
* Employee belief in fairness of appraisals and increases
What are some CONSIDERATIONS in the AMOUNT OF INCREASE?
Considerations in the Amount of Increase
■ Current pay level/position in range
* Where is the employee’s pay in the current range (first quartile, second, third, etc.)?
■ Performance rating
* How well is the employee performing?
■ Merit increase guidelines
* What form of merit guidelines does the organization follow?
■ Increase history
* What has the employee received historically as an increase?
■ Performance improvement
* Has the employees performance improved since last merit increase?
■ Scarcity of particular skills
* Is the employee considered a “critical talent” or has a “hot skill?”
■ Individual potential
* What is the individual potential for this employee?
What is the BASE PAY Investment?
The Base Pay Investment
One of the decisions that must be made in the development of a merit pay system is whether to link base pay to performance and timing. Most organizations continue to link base pay with performance over time. As a result, it is worthwhile to examine the criteria that may be used to differentiate pay levels under a performance-based pay approach.
■ Career stages – Pay levels within the range typically vary depending on an individual’s career stage. Organizational expectations at the differing career stages need to be identified. An example of career stages positioned within a pay grade is summarized on the graphic.
* New to role (does not fully meet standards) – learning; not yet performing full scope of job requirements
* Emerging (meets standards) – deep into learning curve; developing competencies; productivity gaining; continuing to require some direction
* Established (exceeds standards) – fully functioning in role; demonstrating desired competencies and behaviors; productive; using sound judgment; mastering functions, serving as a mentor
* Expert (consistently outstanding) – mastering the job function; performing complex responsibilities; credible reputation; unique talent; highly productive; may be serving in a leadership role; consistently exceeds standards over an extended period of time.
■ Evolution of the employee role – Organizations “invest” in the potential of new employees in the hope that over time they will develop into valuable assets.
What is POSITION IN THE RANGE?
Position in Range – Pay Progression within Range
Another way to view the base pay investment and advancement through career stages is to add the factor of time to achieve a particular range penetration. Note that in this system (depicted on the slide) range penetration is truncated depending on performance. It is possible to be rated “Meets Standards” for many years and not reach the maximum.
There are two key decisions:
■ How far should a particular performance level take an employee into the range?
■ How long should it take?
What is RANGE PENETRATION?
Range penetration is a measure that describes how far in the pay range an employee’s pay has progressed. It’s also used to determine the base pay investment in relation to performance overall.
Range Penetration
Another way to calculate where an employee is positioned in the range is to calculate range penetration.
Examples: Pay rates of 2.850 and 2,725 in the following salary range:
Maximum = 3.100
Midpoint = 2,850
Minimum = 2,600
Range penetration does not focus on the middle or midpoint of range.
Range Penetration
The Base Pay Investment
2,850 – 2,600 250
_______________ = ________ = 50%
3,100 – 2,600 5000
2,725 – 2,600 125
_______________ = ______ = 25%
3,100 – 2,600 500
How does Range Penetration Help?
It helps identify how much salary growth is available to the employee within the job that they currently hold. Second, it helps employers determine if their pay ranges are too wide or possibly too narrow for the organization to comfortably support
What is Compa-Ratio Calculations?
A useful concept relative to pay ranges, position in range and salary increase budgets is compa-ratio.
Compa-ratio is another way of calculating where an employee is positioned in the range. It is the ratio of actual pay to structure midpoint, expressed as a percentage. The term can also be used to indicate the ratio of actual pay to competitive pay, although usually it is referred to as the market index.
Compa-ratio usually is, but not always, compared to 100.
What is CONTROL POINT?
CONTROL POINT
Another way to determine where an employee is positioned in the range is to calculate the control point. The control point is the point within a given job’s pay range or broadband that is targeted for
fully qualified, satisfactorily performing job incumbents. It can also be determined for multiple jobs:
■ In a traditional salary structure, the control point is most commonly the midpoint of the range, but variable control points higher or lower than the midpoint may be used to respond to the market.
■ For broadbands, there are often many control points within one broadband. To monitor employee pay against control points, most companies divide actual employee pay by the control point (similar to the calculation of a compa-ratio).
Example of Control Point – As Applied to Broadbanding
Market rates for three senior level engineer jobs differ. The Company’s policy is to set control points for each job to monitor individual pay against competitive market rates.
What are MERIT INCREASE GUIDELINES?
Merit Increase Guidelines
Once the amount of increase and the timing are decided, the merit increase guidelines can be established.
■ Performance only
* Employee receives a merit increase based solely on the individual performance
■ Increase as a percent of midpoint
* Employee receives merit increase based upon individual performance as a percent of the range midpoint
■ Performance and position in range
* Employee receives a merit increase based both on individual performance and location of their salary within the range
What is the PERFORMANCE ONLY APPROACH?
In the performance only approach, the performance rating is tied to a specific percent increase that is added to base salary. This approach works very well because it is simple and easy for everyone to understand. Leaders who are asked to implement the program can easily understand, and employees can understand both how rewards were determined, and they have context to know that they were determined consistently across the organization.
What is PERFORMANCE ONLY–INCREASE as a PERCENT of BASE PAY?
With this method (and the one on the following page) the employee increase is based on performance. In the example above, the increase is based solely on the performance of the employee, with no additional factors “added-in.”
■ Advantages
* Simple and understandable
* Employees with same performance receive same percent increase.
■ Disadvantages
* Larger amounts go to people higher in the range for the same performance.
* Employees with same performance receive different amounts/increases. (Dollar value might be different)
■ Option
* The amount of increase may also be based on the midpoint of the range (or on a control point), as shown in the next example.
What is INCREASE as a PERCENT of MIDPOINT?
Increase as Percent of Midpoint
With this method, an employee will receive an increase, not based upon their current compensation, but on the midpoint of the range.
For example, a current year increase for “meets standards” equals 4% of midpoint.
This process can allow high performers lower in the range to accelerate more quickly through the range, while slowing down employees that have reached midpoint or above. This method is most commonly used in a situation with broadbanding and control points.
?? Why is this approach not used more frequently?
The advantage of this approach is that it tends to position people well within the salary range based on a pay for performance strategy within your organization.
What is PERFORMANCE and POSITION in RANGE?
This method introduces another factor – position in range. This method has several results:
■ It causes the rates for employees with the same performance to converge on a target quartile or point (based on the salary range profile).
■ Employees who are farther from the target point are moved more quickly (below that point they are more vulnerable to competitor “pick-off”), and employees who are near the target point are
slowed down. Employees above the control point receive 0%.
Typically an employee learns rapidly during the first year on the job. Organizations recognize this in pay programs by providing larger increases as a percentage of base pay to newer job incumbents.
What happens to long service employees with this approach?
What is the STRATEGY for DETERMINING MERIT PAYOUTS?
Strategy for Determining Merit Payouts
Step 1: Anticipate distribution of performance ratings
* Estimate the percentage of employees that will be receiving each rating
Step 2: Determine anticipated mean performance ratings
* By determining the anticipated mean performance rating, you will be able to determine where to place specific merit percentages relative to anticipated ratings.
Step 3: Develop two-dimensional matrix of increases
* Utilizing both the anticipated distribution and anticipated mean, populate your merit matrix with desired percentages.
Step 4: Determine payout
* Based upon anticipated distribution and percent of employees in each quartile, determine the total payout for this merit matrix.
Step 5: Revise if necessary
* If you determine your overall budget figure is too high (or too low) adjust the merit percents until the desired percentage is reached.
What is STEP 1 the STRATEGY for DETERMINING MERIT PAYOUTS
Step 1: Anticipate Distribution
■ Historical information
* One way to anticipate the distribution would be to review historical distributions.
* By using historical distributions you can observe what has happened with performance appraisals and observe any fluctuations that may have occurred.
■ Speak to raters
* Another method of anticipation is to speak to the raters in each department, to determine how they feel about their employees’ performance.
■ Review definition of each rating
* By reviewing the organizational definition and expectation of each rating, the rater will have a better understanding of what the organization is expecting for an employee receiving
each rating.
What is STEP 2 the STRATEGY for DETERMINING MERIT PAYOUTS
Step 2: Determine Anticipated Mean Performance Ratings
■ By determining the anticipated mean, you establish a set guideline. This mean will show how high or low the distribution will fall within the ratings. Calculating this mean is the same as determining a weighted average.
What is STEP 3 the STRATEGY for DETERMINING MERIT PAYOUTS
Step 3: Develop Two-Dimensional Matrix for Increases
■ The simplest way to construct a merit matrix is to utilize the anticipated distribution of performance ratings and actual employee percent breakdown within the range.
■ For the example on the following pages we will assume the following:
* 5.5% = Budget
* 3.70 = Mean rating
■ Determine what the targeted increase in the most populated cell should be.
■ Determine which cells will get no increases.
■ Decide if there should be minimal increases.
■ If performance is a more important determinant of salary increase than position in range, show more differentiation there.
■Start with the budgeted increase where your organization has determined it should be located based on organizational factors and base pay philosophy (lead/lag, etc.).
■ Determine which cells get no increase, then build the relationship between the cells based on your pay philosophy and reward for performance.
What is STEP 4 the STRATEGY for DETERMINING MERIT PAYOUTS
Step 4: Determining Total Payout
■ Cell Contribution Payout = (P × C × G)
P = Proportion in performance rating category = .45
C = Proportion in position-in-range category = .35
G = Guideline percent increase in cell = 7.5
■ If 45% of employees received a performance rating of 4, and 35% of them are in the lower quartile of their range with a guideline increase in the cell of 7.5%, what is the cell contribution payout?
■ Which cell matches the correct answer?
Answer: .45 × .35 × 7.5 = 1.181
■ Payout = 2.423 + 1.332 + 1.164 + .612 = 5.531%
■ Budget = 5.5%
What is STEP 5 the STRATEGY for DETERMINING MERIT PAYOUTS
Step 5: Revise If Necessary
Occasionally, the matrix will not equal your projected merit budget. If this is the case, you will need to revise your percentages in each box.
■ Increase percentages
* If you notice that your projected merit budget is smaller than your actual merit budget, you will need to increase the merit projections in the matrix.
■ Decrease percentages
* If you notice that your projected merit budget is larger than your actual merit budget, you will need to decrease the merit projections in the matrix.
The merit matrix process contains an element of trial and error with the percentages, however, it is a valuable tool in the merit distribution process.
What is a SALARY BUDGET?
Salary Budget
Although pay policy is a major factor, it does not represent the complete picture. We have already discussed merit pay, but merit pay is but one component in a salary budget. We ask the questions:
Where would I like my pay practice to be relative to the market? How much will that cost? And, do I want to pay that cost?
■ Pay Policy
* Company’s desired pay relative to market (competitive) pay at year end
■ Market-Based Salary Increase Budget
* Budget necessary to achieve pay policy by year end
■ Recommended Salary Increase Budget
* Budget recommended based on all internal and external factors, in addition to company
pay policy
The difference between market-based and recommended salary increase budget is based on applying
discretionary considerations to the market results.
What are the STEPS of MARKET MODEL ANALYSIS?
Steps of Market Model Analysis
■ Collect survey data
■ Age survey data to start of plan year
■ Develop a market model which describes the relation between aged external survey data and internal grades for benchmarked jobs
What are some OTHER Considerations?
Other Considerations
■ When multiple surveys are used, aging percent may differ based on the date each survey was conducted.
■ The quality of the market model increases when
* Survey matches are good
* Sampling is representative of the company’s population
■ Characteristics of the market model method
* The model integrates internal value with external value.
* Because of the linkage of the external pay to internal grades, the method is not too sensitive to fluctuations, caused by the inclusion or exclusion of a few benchmark jobs from one year to the next.
* The method assumes that the model is a good estimator of the pay for all jobs within each
grade, including those not surveyed.
* The method assumes you have an internal grading or classification system that assigns internal value to jobs.
What are some other DATA We Will NEED?
Data We Will Need
■ Benchmark job data
* Market and company data for surveyed jobs
■ Historical competitive pay movement during the year surveys were conducted
■ Anticipated competitive pay movement during the new plan year
■ Company pay policy
■ Assume you want to pay 5% ahead of competition
- Which of the following is one of the performance management systems used today?
A. Balanced Scorecard
B. Dashboard Metrics
C. Performance Analytics
A. Balanced Scorecard
- Which of the following is not one of the three types of compensation philosophy?
A. Lead-lag
B. Pay behind the market
C. Lead the market
B. Pay behind the market
- What best describes an objective of a merit pay program?
A. To link pay to performance in a manner consistent with the mission
B. To ensure that everyone in the organization receives a pay increase
C. To guarantee that unacceptable performers advance to the midpoint of the range
D. To annualize compensation costs for the organization
A. To link pay to performance in a manner consistent with the mission
- Which statement is most accurate regarding the range penetration and progression for an employee who consistently “meets “standards”?
A. The employee will reach 100% range penetration in two years.
B. The employee will never rise above 25% range penetration.
C. The employee’s range penetration will typically be about 50%.
D. The employee is demonstrating desired competencies, but may not be awarded a merit increase.
C. The employee’s range penetration will typically be about 50%.
- Which of the following statements concerning Method A is most accurate?
A. It is the most costly.
B. It is the most defensible.
C. It is the most difficult to explain.
D. It requires the least refined performance-rating distinctions.
D. It requires the least refined performance-rating distinctions.
- Which of the following statements concerning Method C is most accurate?
A. It could be difficult to explain initially.
B. It is the most costly of the three methods.
C. It is the most defensible of the three methods.
D. It would be the easiest to explain to employees.
A. It could be difficult to explain initially.
- If the organization has a large percentage of employees in the upper part (4th quartile) of the ranges, and the typical performance rating is “Outstanding,” which method would require the largest salary increase budget?
A. Method A.
B. Method B.
C. Method C.
D. All methods will produce the same cost.
A. Method A.
- What data is needed to create a market-based salary budget?
A. Job descriptions.
B. Organization chart.
C. Turnover rate.
D. Company pay policy.
D. Company pay policy.
What data is needed to create a market-based salary budget?
A. Turnover rate.
B. Organization chart.
C. Company pay policy.
D. Job descriptions.
C. Company pay policy. **
Which of the following statements concerning Method C is most accurate? (See charts in Coursebook Pg. 150)
A It would be the easiest to explain to employees.
B. It is the most costly of the three methods.
C. It could be difficult to explain initially.
D. It is the most defensible of the three methods.
C. It could be difficult to explain initially.
Which of the following is not one of the three types of compensation philosophy?
A. Lead the market
B. Pay behind the market
C. Lead-lag
B. Pay behind the market
If the organization has a large percentage of employees in the upper part (4th quartile) of the ranges, and the typical performance rating is “Outstanding,” which method would require the largest salary increase budget? (See charts in Coursebook Pg. 150)
A. Method C.
B. Method B.
C. Method A.
D. All methods will produce the same cost.
C. Method A. **
Which statement is most accurate regarding the range penetration and progression for an employee who consistently “meets standards”?
A. The employee is demonstrating desired competencies, but may not be awarded a merit increase.
B. The employee will never rise above 25% range penetration.
C. The employee’s range penetration will typically be about 50%.
D. The employee will reach 100% range penetration in two years.
C. The employee’s range penetration will typically be about 50%.
Which of the following is one of the performance management systems used today?
A. Performance Analytics
B. Dashboard Metrics
C. Balanced Scorecard
C. Balanced Scorecard
Which of the following statements concerning Method A is most accurate? (See charts in Coursebook Pg. 150)
A. It requires the least refined performance-rating distinctions.
B. It is the most difficult to explain.
C. It is the most defensible.
D. It is the most costly.
A. It requires the least refined performance-rating distinctions.
What best describes an objective of a merit pay program?
A. To link pay to performance in a manner consistent with the mission
B. To annualize compensation costs for the organization
C. To ensure that everyone in the organization receives a pay increase
D. To guarantee that unacceptable performers advance to the midpoint of the range
A. To link pay to performance in a manner consistent with the mission
What is the formula for /Individual Compa-Ratio Calculation
Salary
_____________ = Individual Compa Ratio
Midpoint
What is the formula for Unit/Organizational Compa-Ratio Calculation
Weighted Average Salary
———————————— = Unit/Organizational Compa-Ratio
Midpoint
What is the formula for Market Index
Weighted Average Salary
———————————— = Market Index (Actual to Market)
Weighted Market Average
