Pros & Cons of Performance Related Pay

Performance related pay is any form of pay system in which some component of remuneration or salary progression is contingent on performance, either individually or jointly, usually measured against a set of pre-agreed objectives.

The following practical guide for employers on implementing performance related pay sets out how this type of salary system works, the benefits of linking pay and performance, as well as the potential pitfalls that can arise when adopting this approach to reward and remuneration.

We also provide some best practice tips on how employers can introduce an effective, fair and equality assessed performance pay system in the workplace.

 

What is performance related pay (PRP)?

Performance related pay (PRP) is a salary system that can be used by employers as an alternative to paying their staff a fixed hourly rate, or in addition to a basic rate or annual salary.

A PRP scheme is typically where a person’s entitlement to pay is either solely or in some way linked to their individual output, although pay can also be linked to the overall performance of a team or even an establishment as a whole.

The most basic type of PRP system, commonly known as piecework, can often be found in manufacturing or farming. For example, someone working on a farm might get paid a set rate, say fifty pence for every kilogram of fruit that they pick. There is no fixed hourly rate, rather the individual will be paid depending on how many kilograms they pick, not by how many hours they spend on the farm, albeit subject to still being paid the national minimum wage.

In the manufacturing and farming industries, it is usually relatively simple to utilise a PRP system, as there is a quantifiable, countable product. In an office-based environment, where there is no physical item produced or collected, it can become more complex to adopt. That said, provided clear targets can be identified against which performance can be measured, this type of pay system can still be implemented.

In fact, PRP is commonly used in sales-based environments, where employees are typically given a basic salary entitlement, but with the opportunity to earn bonuses or commission, thereby getting paid largely on their results. As such, pay is not solely based on performance, but is still predominantly target-driven. For example, someone working in recruitment may receive a basic salary but be entitled to say 10% commission of any profit earned by the company for every new candidate they place in an available job role.

 

Why do employers use performance related pay?

From an employer’s perspective, performance related pay can be an extremely useful tool to incentivise their staff to work harder, faster and more productively.

PRP systems have been utilised across various private sector industries in the UK for several decades now. They have even made some inroads into public sector pay structures, for example, the Quality and Outcomes Framework is a voluntary reward and incentive programme which provides payments to GP practices for compliance with targets across a range of clinical activities.

The basic logic behind performance related pay is that it aims to strengthen the link between the input of effort by the employee and the financial incentives they receive in consequence. This should, in turn, motivate the individual to expend more effort and increase their output, which should ultimately improve the organisation’s overall outcomes.

While linking a person’s pay to their performance has been criticised by many as a potentially arbitrary and unfair way to reward employees, the ability of financial incentives to improve efficiency and boost productivity cannot be denied, both on an individual and joint basis.

The use of individual performance related pay is designed to engage employees more directly with the goals of the organisation and embed a high performance and entrepreneurial culture. Similarly, the use of team-based bonuses, where success is linked to the overall performance of a particular group or department, can help to improve the way in which people work together with a common goal in mind. As such, this can encourage both individuals and entire teams to invest in the overall success of an organisation, making them work harder as a result.

Arguably, it also establishes greater fairness in the treatment of staff by providing a tangible financial reward for those who deliver desired results, or arguably invest greater time and effort in their work.

 

What are the potential pitfalls when using performance related pay?

Even though PRP systems can help to incentivise staff and boost productivity, there are potential pitfalls for using performance as a basis for pay. In particular, it can skew an employee’s efforts toward those aspects of work that are measured and incentivised, while causing neglect of equally important areas that are more difficult to measure or are un-incentivised. This type of effort displacement can often cause issues of quantity over quality.

Equally, performance related pay could lead to unhealthy competitiveness or an increase in the level of risk-taking, especially where performance indicators become high stakes. This was the case in the run up to the 2008 financial crisis, as a number of big bankers exposed themselves and their organisations to significant risks to boost their end-of-year pay packets.

In contrast, the use of performance related pay can lead to a drop off in motivation for those rated as middle or low performers. For someone who is already struggling with the challenges of a demanding job, it can be incredibly disheartening to be told that their entire financial worth is linked to the output that they are capable of producing in a given period. In turn, a tendency toward a narrow focus on short-term quantifiable goals can have a detrimental effect on the performance appraisal process, with attention diverted away from development needs and toward financial reward. This can leave lower performing employees exposed to a risk of losing their jobs, without the opportunity for improvement.

It can even be the case that the use of a PRP system can discriminate against those from vulnerable groups, where this type of pay rewards employees differently for doing the same job. In particular, this can increase the risk of unequal pay between men and women, exposing an organisation to an increase in unlawful discrimination and equal pay claims.

 

What does the law say about employee rights with performance related pay?

Despite the potential pitfalls, performance related pay is a perfectly legal form of pay system in the UK that can be implemented by employers, provided this meets the national minimum wage requirements and does not discriminate against any particular group of people.

This means that employers must ensure that any criteria used for rewarding performance are fair and equitable for everyone involved. Employers must also ensure that performance is linked to clearly defined and quantifiable targets that can be easily and objectively measured.

If an employee receives a lower bonus or commission payment because they’ve been discriminated against in some way because of a protected characteristic, including gender, this could result in a claim for unlawful discrimination or equal pay. Even if you do not intend to discriminate against certain members of staff, the costs of getting it wrong can be huge.

It’s also important to bear in mind that where a PRP system is in place, any failure to pay what an employee is owed could be classed as a breach of contract for which an employee would be entitled to bring a claim for unlawful deduction from wages.

 

How can employers effectively implement performance related pay?

There are various ways of implementing a performance related pay scheme, where the preferable model to be adopted may depend on the exact nature of the work to be conducted and the structure of your business. However, for a PRP system to succeed, effective arrangements must be in place to define, measure, appraise and manage performance.

One of the most important factors when putting a PRP system in place is to base this on clear, measurable targets, where it’s easy for both the employer and employee to assess exactly how and when these targets have been met. The scheme should provide clarity over the structure of an individual’s appraisal process, how their rating has been arrived at and how that rating has been converted into a financial reward.

It’s generally preferable for performance payments to be related to objective criteria, with limited scope for managerial discretion, although where discretion remains, clear guidelines should be established on the exercise of that discretion to ensure a consistent and transparent approach across the board.

When deciding on the targets to be met, equality considerations must also be taken into account. When undertaking an equality impact assessment, you must evaluate all aspects of the scheme design and staff outcomes. In particular, the design of any scheme should check that the performance criteria and objectives are not discriminatory, for example, these must be equally achievable in jobs typically carried out by women and men.

Consideration must also be given to any indirect discrimination in the criteria selected, such as attendance records, and whether part-time staff are disadvantaged in comparison to full-timers. In some cases, you may need to consider including competence or behavioural skills, where target-only PRPs can increase the risk of gender bias within the workplace.

 

What best practice tips can be followed when implementing performance related pay?

Introducing a performance related pay scheme can be tricky, but the following best practice tips can be used to help you navigate this process:

Planning: by planning ahead, ideally with the advice of an expert in performance related pay, this will allow you to explore all viable options and potential pitfalls, helping you to identify the type of scheme that will work best in your workplace.

Piloting: by piloting any scheme before rolling this out, you can ensure that this meets its objectives, and does not operate unfairly or in a potentially discriminatory way. All aspects of the scheme should be assessed to ensure fairness in its operation.

Training: by training managers in how the scheme operates, this will assist with the effective and fair operation of the scheme, where the use of performance related pay, even with objective criteria, can still sometimes be open to the prejudice and bias of managers.

Appraising: by providing sufficient time to carry out individual performance appraisals, and by focusing on personal development and not just performance-based targets, this can provide vulnerable employees with the opportunity to improve.

Monitoring: by carefully monitoring the way in which the scheme is working, including any complaints of unfairness, this can help you to identify any equality issues that need to be addressed, on either an individual or collective basis.

Reviewing: by reviewing your pay system on at least an annual basis, together with any data collected in relation to potentially discriminatory matters, this will provide you with the opportunity to address or pre-empt any potential problems.

Record keeping: by keeping up-to-date records of all matters related to your performance related pay system, including payments made, appraisals undertaken and the reasoning behind any decision-making, this can help to defend any allegations of unfairness.

Need assistance?

DavidsonMorris’ HR specialists work with UK employers on all aspects of workforce management, including reward and remuneration strategies. For expert advice specific to your organisation and personnel needs, speak to our experts today.

 

Performance related pay FAQs

Is performance related pay a good idea?

There are various justifications for linking pay and performance in the workplace, in particular encouraging high performance levels, although this can also lead to unhealthy competitiveness, increased risk-taking and other negative employee behaviours.

What are the advantages of performance related pay?

There are several advantages to performance related pay, including incentivising staff to work harder, faster and more productively. This type of pay scheme can also help to engage employees more directly with the goals of the organisation.

How do you implement performance related pay?

There are various ways in which performance related pay can be implemented in the workplace, from short-term schemes, like bonus payments or sales commission, to long-term schemes, like company shares.

How does performance related pay motivate employees?

The basic logic behind performance related pay is that it aims to strengthen the link between the input of effort by the employee and the financial incentives they receive, motivating the individual to expend more effort and increase their output.

 

Last updated: 17 April 2021