Pay differentiation, the practice of varying pay awards for employees, is common practice in 93% of UK organisations surveyed, according to research by Towers Watson.

The research, which surveyed 124 UK organisations, found that base pay rises were 67% higher, on average, for employees identified as high performing.

Respondents with pay budgets of less than 2.5% offer high performers pay rises twice as high as their average-performing colleagues.

Respondents with average or more generous pay budgets (3% or more) tended to single out high performers to a lesser extent, offering them 67% higher rises than the organisation’s average.

The research also found that individual performance was the top driver for differentiating pay (93%), followed by market alignment (72%), internal consistency (57%), key skills (44%) and potential (39%).

The research also found:

  • Despite constrained pay budgets, respondents reported a typical budget of 3% for base pay increases, equal to UK inflation.
  • 28% of respondents differentiated more in 2012 than in 2011, while 11% said they differentiated less.
  • 37% of respondents ask line managers to explain the rationale behind the differentiation policy to their employees, but a quarter of respondents do not communicate the approach at all.
  • Almost a third (30%) of respondents differentiate bonuses to a greater extent than base pay.
  • Only one in 10 actively ring-fence a separate budget for differentiation, meaning in most instances above average pay increases for one group need to be offset by below average increases elsewhere.

Chris Charman, a director in Tower Watson’s UK rewards practice, said: “It is very encouraging to see organisations continuing to focus on rewarding high performance and interesting to see that this tendency becomes increasingly pronounced the more an organisation’s budget is squeezed.

“However, we were surprised to see that when budgets were more generous, the focus shifted to market alignment rather than onto high-skill or high-potential employees.

“Not communicating the reason behind pay differentiation is a potential missed opportunity for many employers. We know that clear communication around reward and how reward programmes work increases understanding and the value placed on them. It is common sense that employees need to know what it takes to get high rewards; after all, that’s the purpose of a performance pay system.

“Pay is only one of many motivating factors, but it is a critical one to get right [because] getting it wrong carries many significant downsides. It is also important to remember that the process is fair and seen to be fair. Where this isn’t achieved, our research shows that employee engagement can take a hit.”