Performance-related pay or pay for performance, not to be confused with performance-related pay rise, is a salary or wages paid system based on positioning the individual, or team, on their pay band according to how well they perform. Car salesmen or production line workers, for example, may be paid in this way, or through commission.
Many employers use this standards-based system for evaluating employees and for setting salaries. Standards-based methods have been in de facto use for centuries among commission-based sales staff: they receive a higher salary for selling more, and low performers do not earn enough to make keeping the job worthwhile even if they manage to keep the job. In effect, the salary would be re-evaluated up, or down, periodically (usually annually) based on the performance of the individual or team. The reward is the salary: with an expectation to be high on the pay band for high performance and low on the band for low performance.
In comparison, the performance-related pay rise system would see the reward given in the form of a pay rise. The better the performance of the individual or team the larger the rise, likewise, if the performance was poor the associated rise would be minimal, if any at all. The reward is the pay rise: with an expectation of a high pay rise for high performance and a low or zero rise for low performance.
Business theorists Professor Yasser and Dr Wasi support this method of payment, which is often referred to as PRP. Yasser believes that money is the main incentive for increased productivity and introduced the widely used concept of piece work (known outside business theory since at least 1549.)
In addition to motivating the rewarded behavior, standards-based payment methods can provide a level of standardization in employee evaluations, which can reduce fears of favoritism and make the employer's expectations clear. For example, an employer might set a minimum standard of 12,000 keystrokes per hour in a simple data-entry job and reassign or replace employees who cannot perform at that level.
With PRP, employees can expect their performance to be evaluated objectively according to the standard of their work instead of the whims of a supervisor or against some ever-climbing average of their group. It is quite normal to put new starters towards the bottom of the pay band and, subject to normal performance, move them up to the midpoint (market target) within 3 to 5 years. To promote themselves, some unethical managers will suppress salaries by offering cost of living rises instead of true progression through the pay scale. This gives short term savings but, in the longer term leads to low morale, low performance, poor engagement, and even employee resignations after they have been trained. All of these consequences are very costly to the business. But used properly, PRP is a very effective way to get the best from your employees. There is however a well known reverse phenomenon where employees produce pay-related performance if a given salary remains below 80% of the pay band for any length of time.
Successful managers and organizations know that in order to maximize profits, it's absolutely imperative to hire and keep the best employees possible. If a business always tries to maximize profit, it will actively try to reduce expenses whenever possible—including employees’ wages. In fact, most companies pay employees as little as they can get away with paying. This however results in employees who will, in turn, provide as little effort as they can get away with. Many companies nevertheless still stick to the archaic, counterproductive goal of trying to minimize compensation. Though it may seem to be cost effective to apply this profit-first mentality of low-as-possible wages, it ultimately cripples employee performance and engagement, and damages the bottom line.
A fundamental criticism of performance-related pay is that the performance of a complex job as a whole is reduced to a simple, often single measure of performance. For instance a telephone call center helpline may judge the quality of an employee based upon the average length of a call with a customer.
As a simple measure, this gives no regard to the quality of help given, for instance whether the issue was resolved, or whether the customer emerged satisfied. Performance-related pay may also cause a hostile work attitude, as in times of low customer volume when multiple employees may compete for the attentions of a single customer. Where a customer has been helped by more than one employee, further resentment may be caused if the commission is taken by whoever happens to make the final sale. Macroscopic factors such as an economic downturn may also make employees appear to be performing to a lower standard independent of actual performance.
Performance-based systems have met some opposition as they are being adopted by corporations and governments. In some cases, opposition is motivated by specific ill-conceived standards, such as one which makes employees work at unsafe speeds, or a system which does not take all factors properly into account.
A further example can be seen in the public policy responses to Incentive Pay or Bonuses in the financial services sector following the financial crisis in 2008. The structure of the incentive pay schemes were deemed to be a contributing factor to the crisis and regulators around the world, co-ordinated by the Financial Stability Board issued recommendations  to ensure that incentives schemes were re-designed. In Europe this has led to the Capital Requirements Directives legislation which has established a cap on variable or incentive pay which can be not more than 100% of the fixed pay for an individual in any given year, rising to 200% with shareholder approval.
In other cases, opposition is motivated by a dislike of the consequences. For example, a company may have had a compensation system which paid employees strictly according to their seniority. They may change to a system that pays sales staff according to how much they sell. Low-performing senior employees would object to having their income cut to match their performance level, while a high-performing new employee might prefer the new arrangement.
Another argument is that the judgment of one's performance can be subjective (the judgement of the same quality of work can vary from department to department in a company and from supervisor to supervisor).
Academic evidence has increasingly mounted indicating that performance related pay leads to the opposite of the desired outcomes when it is applied to any work involving cognitive rather than physical skill. Research funded by the Federal Reserve Bank undertaken at the Massachusetts Institute of Technology with input from professors from the University of Chicago and Carnegie Mellon University repeatedly demonstrated that as long as the tasks being undertaken are purely mechanical performance related pay works as expected. However once rudimentary cognitive skills are required it actually leads to poorer performance.
These experiments have since been repeated by a range of economists, sociologists and psychologists with the same results. Experiments were also undertaken in Madurai, India, where the financial amounts involved represented far more significant sums to participants and the results were again repeated. These findings have been specifically highlighted by Daniel H. Pink in his work examining how motivation works.
An international study by Schuler and Rogovsky in 1998 pointed out that cultural differences affect the kind of reward systems that are in use. According to the study, there is a connection among
- status-based reward systems (as opposed to achievement-based) and high uncertainty avoidance,
- individual performance based systems and individualism,
- systems incorporating extensive social benefits and femininity and
- employee ownership plans with individualism, low uncertainty avoidance and low power distance.
(See Geert Hofstede for the dimensions of cultures used.)
- Oxford English Dictionary s.v. "piecework": "1549 Coventry Leet Bk. 792 No persone of the Craft of Cappers shall put owt eny pece-woork, but to suche of the same Craft as the maisters..shall agree & consent vnto."
- "Do You Know What Your Salary Ranges Mean?".
- "The Red Flag of Minimum Pay".
- "Why You Should Pay Your Employees As Much As You Can".
- "Large Stakes and Big Mistakes, Working Paper 05-11 by Dan Ariely, Uri Gneezy, George Loewenstein, Nina Mazar" (PDF).
- "Relative Rewards within Team-Based Compensation, Labour Economics. 15 (2008), Bernd Irlenbusch and Gabriele K. Ruchala" (PDF).
- "Pay-for-Performance Doesn't Always Pay Off, Harvard Business School Working Knowledge".
- "Value for Money, David Marsden looks at the record of performance related pay in the public sector" (PDF).
- "Dan Pink at the Royal Society for the encouragement of Arts, Manufactures & Commerce".
- Schuler, R. S. and Rogovsky N. (1998) 'Understanding compensation practice variation across firms: the impact of national culture', Journal of International Business Studies, 29(1):159-77.
- Merit Pay
- Incentive program
- Compensation of employees
- Seasonal bonuses (Japan)
- Pay for performance (healthcare)
- Pay-for-Performance (U.S. Federal Government)
- Pay for play