We have all heard about Pay for Performance (P4P) and some of our companies have implemented a P4P program and are seeing positive results. But what is P4P and how does it work best? There are forms and incarnations of P4P that work better than others. Here is my take on it.

P4P is essentially rewarding highly productive workers with higher income. The top performers drive the business and provide the highest income potential for the company and therefore should receive higher cash rewards. P4P looks at compensation differently than traditional seniority or time/step based plans in that increases in income are generated by achieving – and sometimes surpassing – quantifiable contributions to the company. The program usually offers no guarantees for increases or incentives until certain performance measures are met. P4P is a great alternative for a company instead of a traditional compensation plan. The performance pay can come in the form of incentives (typically how they are paid) or by incremental increases to base pay.

P4P plans are a great way to build engagement among your staff and line the pockets of top performers with cold hard cash (and hopefully keep them from predatory recruiters who try to lure them away to better opportunities). But in order for this type of program to be a success there needs to be a few things in place. These are some of the basic steps to creation of a P4P plan.

Budget – Can your company afford the start up costs of a P4P program? The plan can be tailored to fit any company structure however some companies might have existing salary programs that include high base salaries. In these cases, there could be a higher budget requirement to both pay the salary and the incentive. Be sure to look at this before you work on developing a P4P plan.

Consistent Measurement – How does your company measure success? Be sure to come up with goals that are in line with the corporate strategy and vision of the company. Measures can and might vary from department to department but all goals should be tied to a greater corporate good. Some traditional measures are revenues per share, net income and operating profit. While these are good, there are more companies looking at earning before tax, depreciation and amortization (EBITDA) which gives a more succinct indication of how the company did financially as well as cost reductions and savings. Of course the ability of a company to stay liquid (statement of cash flows) is a good measure. Whatever you chose to measure, be sure it is important to the company.

Use Long Term & Short Term Incentives – Keep in mind that a good and appropriate mix of incentives that are both short (within a year) and long (more than a year) term will help add value and success to the plan. Long term incentives (LTI) are usually paid in stock or shares in the company. With the current stock market situation, be sure to look at LTIs objectively as they might not provide employees with drive to outperform. Short term incentives (STI) are best used for meeting goals on quarterly, semi-annually or annually. STIs could be tied to quarterly business objectives and then annual EBITDA, for example. The decision of which measure(s) to use should be based on what would work best for your company. There have been some big changes to how executive compensation plans are built so be sure to integrate the new rules and regulations into your LTIs for top executives.

LTI & STI Tip – be sure to cap your LTI and STI payout potential. If you don’t, you will inevitably have some shining stars that could break the bank. It is imperative to have a maximum payout so your top performers don’t go over their maximum. Or worse yet, upon review of the plan after implementation you see that some employees have gone over what was budgeted and then a cap is put in place. This could seriously reduce morale and invalidate the integrity of the plan in the employee’s eyes.

Communication of the Plan – The lynchpin out a successful P4P program is its communication to the staff. There might need to be a change in mindset among long term employees when implementing a new plan. The concise and clear communication of the new plan, how it will be paid and what measurements will be used is crucial. Consider your audience and put together an airtight communication plan that has buy-in from the top.

Review & Evaluate (and Realign, if necessary) – How did it go? This is the step where you look at how the first reporting period went and how the plan paid to employees. Perhaps the measures need to be tweaked or the incentive payouts need to be reviewed. Hopefully you found that the plan is working the way you anticipated it would. If so, hurray for you! Take time to carefully evaluate your plan and weigh the results against the intended outcome.

Putting together a P4P plan can be simple or complex based on the needs of your company. Organizations like WorldatWork, SHRM and IFEBP offer great ideas, webinars and information on the creation, development and implementation of these types of plans so be sure to get more information before charging in. Pay for Performance programs can give your company the edge it needs in attracting and retaining the highest performers.

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