Paying For Performance: 5 Common Scenarios Every Leader Faces

Episode #359 Paying For Performance: 5 Common Scenarios Every Leader Faces

THE NITTY GRITTY OF PAY DECISIONS

Last week, we released a bumper podcast episode on remuneration. How do remuneration packages work? What’s involved in different types of incentive payments? How is each pay component evaluated?

Having built those foundations, in this week’s newsletter I take it to the next level by walking through five practical scenarios that you’re likely to face as a leader, when you’re making decisions about people’s financial rewards.

Gaining a better understanding of these situations and knowing how to handle them will massively increase your confidence for the conversations that inevitably follow.

I begin by setting the scene on how to read the play, and then I dive into the five scenarios:

• Scenario 1: Annual salary reviews;
• Scenario 2: Using financial incentives to secure rare talent;
• Scenario 3: Using KPIs to determine short-term bonus payments;
• Scenario 4: Locking in a potential flight risk; and
• Scenario 5: How to ask for a pay rise.

READING THE PLAY

When we talk about pay, it’s important to understand the environment you’re operating within. You can’t just make unilateral decisions about how you pay people – unless of course you’re the owner of the company.

In most businesses, pay is a pretty sensitive topic, so it’s controlled quite closely. What factors are going to influence your decisions?

Whether you’re the CEO or a frontline leader, every organisation has its rules: some are written and some are unwritten. The better you understand these rules, the more likely it is that you can get the right results for your people.

Company size is the first thing you need to look at. The bigger the company, the more likely it is that you’ll have to follow structured pay policies – and the more likely the pay process is going to be centralised. Positions, levels, and salary bands are normally well-defined.

In smaller businesses, pay is more likely to be dictated by individual employment contracts, which are negotiated on a case-by-case basis.

If you’re leading a team of, say, 10 people in a smaller company, you’re going to have quite a bit of flexibility about how you pay them, and this often means it’s easier to justify paying one of your people above the odds.

But if you’re leading a team of 1,000 people in an ASX 100 company, it’s more likely you’ll face constraints… it’s going to be harder to sell any exceptions to your boss, and of course to the process owners in HR.

Seniority makes a difference too. As you go up through the ranks you tend to have more flexibility in who you bring on, and how much you pay them. As long as you protect your overall salary and wages budget, it’s more likely that you’ll be afforded the flexibility to deal with some of the individual cases.

Cultural differences are also likely to play a part. Some cultures are true meritocracies, where everyone expects that those who perform are going to reap the greatest financial rewards. But there are other cultures where the dominant consideration is to not rock the boat and to try to keep everyone happy.

These cultures have loads of problems, and not rewarding the best performers is just the tip of the iceberg. The moral of the story is, make sure you know what type of culture you’re dealing with.

Another consideration is that some companies have a system of allocating fixed funding pools to each executive group, or even to lower level teams.

The more evenly the organisation tries to balance the financial pools, the more difficult it is to differentiate between those who are doing the heavy lifting and those who are getting a free rider effect from the high performance. Often, fixed funding pools deliver narrow ranges for pay increases, which makes it harder to differentiate.

Some companies impose forced performance rankings, in an attempt to distribute everyone’s performance along a bell curve. Every team has to have a certain percentage of people in each category of performance – from not performing at all, through to exceptional performance.

I like this in principle, because it gets around the leader who says, “All my people are high performers.” But it also means that every team has the same constraint, regardless of team quality, standards, and results.

I have been in companies where the star performer in one team is nowhere near as good as the worst performer in another team.

Whatever your company’s size, culture, and approach to pay reviews, you have to do everything you can to differentiate between individuals. They say that pay isn’t a primary motivating factor per se, and that may well be the case… but it’s not hard to predict what’s going to happen when your star performer finds out that she’s getting paid the same as a colleague who probably should’ve been sacked years ago.

SCENARIO 1: ANNUAL PERFORMANCE REVIEWS

Most leaders have to make pay decisions for their people… and most leaders hate having to do it.

Smaller companies may assess pay increases on the anniversary of an individual’s commencement date, but it’s more common to have a process for the whole company that’s undertaken on an annual basis.

The size of any individual’s pay increase will depend, at least in part, on the performance ratings they’re given by their manager. There may be some post-rating moderation to even up some of the imbalances between different leaders and their teams, but generally you’ll need to score your people’s performance.

This can be hard, because low ratings can lead to conflict.

Here are my five tips for handling annual performance ratings:

1. Don’t wait until review time. Make sure everyone’s aware of their performance rating well before the formal salary review process. If you don’t do this, you may be reluctant to give them bad news at review time.
2. Make performance assessments multidimensional. This has to go beyond people’s KPIs. How have they conducted themselves in their day job, according to the expectations you’ve set? Remember, the KPIs are rewarded through short-term incentives – base pay is a function of overall performance.
3. Don’t encourage the talented jerk. Find a way to assess people’s behaviours and make it clear how this impacts the overall ratings.
4. Don’t cluster people around the average. It’s so easy to fall into the trap of telling everyone they’re “doing a good job”, which results in a lot of average or just above average ratings. If it’s a five-point scale, use the whole scale to assess people fairly.
5. Don’t be a slave to the rating numbers. For example, when you get a multidimensional assessment of behaviour and performance, it may come to you as an average score based on all the factors. If you catch yourself – or your peers, or your boss – arguing about people’s ratings, just check yourself. You’re going to be able to tell because the conversation’s going to go something like this: “Well, Emma is a 4.11, but Marty’s only a 4.08, so Emma is clearly better.” The numbers should be malleable and subject to a reasonableness test.

Once you know who the top performers are, you need to allocate their money accordingly.

You may be given a pay rise ‘pool’, which might be, say, 5% of your total salary and wages bill. Here’s something really important: if you have 5% overall to allocate, you shouldn’t just apply a 5% increase to everyone.

Your really high performers should get 10% plus… and those who are hanging on by a thread should probably get 0%.

Most people should get at least a small bump to deal with increases in inflation and the general cost of living – but don’t use this as an excuse to allocate a uniform 5%.

As long as you stay within your funding allocation, you should think about how to use the salary increases to reinforce the performance messages that you’ve been giving all year.

Most importantly, make sure you have a direct conversation with every individual about how they’ve been assessed and why. This flows directly into their pay, so they should at least know your rationale, whether the outcome exceeds their expectations, or massively undershoots their self-perception.

SCENARIO 2: USING FINANCIAL INCENTIVES TO SECURE RARE TALENT

For your really high performers, don’t stop at the base salary increases.

When I say really high performers, I’m talking about that top 5% across the whole group – the rare 1 in 20 talent. Look for other ways to fast-track them.

I’ve used this McKinsey statistic several times: top performers deliver 800% more value than the average performer.

Let’s just assume that McKinsey wildly overestimated that figure. What if it was only half as good, and they delivered 400% more value? That’s four times more output than you get from the average person. Do you reckon it’s worth paying them 50% more than the average?

For example, you could move them from an analyst role to a senior analyst role. This might put them into a different salary band, giving them the type of increase that rewards them for the value they deliver.

But, if you can’t upgrade their role, you might need to take the problem on more directly. In the past, I’ve given superstars big increases in base salary. I don’t think I’ve ever doubled it, but I know I’ve gone to at least 160% of current salary in a single review.

In one case from $200,000 to $320,000… and, I’ve got to tell you, at $320k, they were still underpaid.

If you do this though, it’s going to get the attention of the process guardians. In the instance I just mentioned, HR was all over me like a cheap suit. But I was ultimately able to convince them to allow the exception based on the individual’s superior performance, their value to the company, and the cost and risk of replacing them.

Overall, I stayed within my budget… how?

By getting rid of anyone who couldn’t meet the performance standard, and using the savings to fund my top people.

If you can do this, it’s going to massively increase the value your team delivers from every dollar you spend on labour. As I said in last week’s newsletter, a good principle to live by is to buy half as many, and spend twice as much.

If you can’t give them a big bump because of restrictions at your level or in your company’s processes, at least work out when their next promotion opportunity might be and paint that picture for them.

Of course, as soon as you start talking about promotion, you have to assess their potential as well as their performance. This can be a lot more subjective, so make sure you have tangible feedback on why you think they may be ready for the next level.

Whatever you do, don’t make any promises, but at least let them know what your intentions are on their future pathway. If you go down that road, try to outline a development plan for them:

• What is their next potential opportunity to move up?
• What would they need to do to be ready for that role?
• What’s the company prepared to do to help them get there?

When it comes to your top performers, make sure you lock them in as firmly as you can, because losing them is incredibly expensive. If you can sweeten the pot with anything like formal education, a high visibility project, or an opportunity to access the networks higher-up in the company, it’s going to demonstrate your commitment to their growth and development.

Rare talent requires rare treatment, so take this into account whenever you make pay decisions.

SCENARIO 3: USING KPIs TO DETERMINE ANNUAL BONUS PAYMENTS (STIs)

Let’s get back to the rather more mundane subject of Short Term Incentives (STIs). These are usually one-off annual payments that are awarded based on the delivery of pre-agreed KPIs.

If you aren’t completely at ease with what these are and how they’re structured, go and have a listen to last week’s episode, where I explained it in depth.

There are two really important things to remember when dealing with STIs:

1. STIs are completely discretionary. No one is entitled to an STI, and the company is well within its rights to not pay them – for any reason at all – for example, if the company suffered a big financial loss in that year. This has to be really clear to your people.
2. STIs are paid for achievement of outcomes that are over and above the day job. People are paid their salary for coming in and doing a great job. If they do it really well, they’ll usually get a decent pay rise… but it doesn’t mean they should also get a big bonus. That depends on whether or not they deliver something more.

At the end of the year, the company’s going to allocate an STI pool based on the performance of the business. On top of this, as we said last week, different role levels attract different STI percentages.

This can get pretty tricky – but if you’re in a company that has a broad STI program, HR is going to be able to help you to work this out.

The art in assessing KPIs that contribute to these bonus payments is in how you set the KPI, not how you evaluate it.

I once had a senior guy who was two levels below me, who successfully argued to be paid a huge STI, because he’d “done everything that his boss [my direct report] had asked of him”. The problem was, he was just about to be terminated for underperformance. His KPIs had been set for completing activity, not delivering value.

And if this guy did one thing well, it was generating lots of activity – but he was completely ineffectual.

Put time into ensuring the KPIs you set for your people are focused on results. Don’t let individuals lowball them, and get financially rewarded for mediocrity.

Using ranges to assess threshold, target, and stretch performance with different financial outcomes is a great method to use. If you set difficult targets and help people to achieve them, they will feel awfully good about working for you and the company.

And just one more thing on KPIs while I’m there, try to limit them to a few critical deliverables, 3-4max… simplicity and focus!

You can weigh each KPI based on its relative importance. And, even though I said they should be over and above the day job, if there’s a critical deliverable that’s in their job description like, say, the delivery of a key project, you might want to emphasise that and put some variable pay at risk as well, by making it a KPI.

Once again, most importantly, differentiate between your people to the greatest extent possible. This is one of the key levers for encouraging and rewarding performance.

SCENARIO 4: LOCKING IN A POTENTIAL FLIGHT RISK

What happens when you have someone in a key role whom you worry about, because they could be a flight risk?

This isn’t always a top performer. In fact, it may be a very mediocre performer, who just happens to be in a critical role. They may have spent their whole career hoarding knowledge rather than sharing it.

Either way, it presents a risk to the company.

Let’s say it is a great performer, who’s delivering incredible value. That’s easy: go back to Scenario 2: How to secure rare talent.

But if it’s a case of someone in a critical role who represents a key person risk, or a single point of failure, you have to try to mitigate that risk with some urgency.

I always think about this process in three steps:

Step 1: The hit-by-a-bus contingency. What’s my Plan B if I have to deal with that loss immediately? Can I get temporary labour out of the market? Is there a company that specialises in that area that I can negotiate a support contract with? Is there someone inside the company already, who I can prepare to step into the role in the short term, while I’m pursuing a better long-term option?

Step 2: Seek to lock the key person in with a retention bonus. In last week’s episode I outlined what a retention bonus is. It’s basically just paid on the expiration of a time period (say six months or a year). But I wouldn’t just do that as a passage-of-time thing. I’d also make the bonus contingent, which you’d assess on how well they’ve met Step 3 of my strategy…

Step 3: Give them accountability for documenting, training, and handing over the key skills and knowledge that are putting the company at risk in the first place.

A retention bonus is normally a great use of company money in these types of circumstances, because you’re aligning the incentive for the individual with a high value program of risk reduction in a critical area.

Retention bonuses should be the exception, not the rule; but they’re a pretty good tool to have in your kit bag when you find weaknesses that would otherwise damage your company’s ability to operate effectively..

SCENARIO 5: HOW TO ASK FOR A PAY RISE

Let’s get personal. How do you go about asking for a pay rise from your boss?

Let me give you a few ideas for what not to do:

Don’t ask based on your length of tenure: that’s absolutely irrelevant.

Don’t ask based on your relativity to someone else’s pay: it’s not a particularly strong case because you have no idea what anyone else’s circumstances are, or where they sit on the company’s talent map.

Don’t ask based on new skills the company has trained you in: they’ve already invested in your development, so it’s a little rich to double dip by asking them to pay you more as well.

Don’t ask based on the amount of money that you think the company might’ve made. Unless you have unfettered access to the company’s financial accounts, you really have no idea about its cost of capital, its carryforward losses, its investment profile, or its shareholder demands. And revenue is a really poor indicator of success.

Only one thing’s going to cut it:

Evidence of superior performance that has delivered exceptional outcomes for the business. SO:

• Document the value your team has created, emphasising the trend of improvement (and, of course, what you did to achieve that).
• Talk about the recognised high performers that you’ve developed who are now part of the succession plan.
• Talk about safety performance, projects delivered, costs avoided, customers secured.
• Talk about the comparison between what you’re being paid, and what you could otherwise earn in the market at this particular point in time.
• Show them all the things you’ve done, that are over and above your position description, that haven’t already been rewarded with other bonus payments.

If you approached me with a compelling case like that, you’d be very likely to receive a sympathetic ear – and a positive answer.

TAKE THE CONVERSATION TO THE HUB!

I hope you found those remuneration scenarios useful. There are many more, of course, but these are a few of the more common situations you’re going to face as you rise through your organisation. Feel free to continue this conversation on our No Bullsh!t Leadership Hub, our completely free community where we have a couple of thousand dedicated like-minded leaders sharing tips, challenges, and victories.

You can join the hub here.