How to introduce performance-related pay

Performance-related pay (PRP) is a reward system where an employee’s pay is partly determined by how well they perform against set objectives or targets. It can take the form of pay increases, bonuses or one-off payments. Profit sharing can also be a motivational tool if linked to both employees’ and the organisation’s performance.

Charles Cotton, senior reward adviser at the Chartered Institute of Personnel and Development (CIPD), says: “Sometimes these increases may involve the payment of non-consolidated cash lump sums,” he says. ”However, a broader approach is to regard anything that links wider definitions of pay with wider definitions of performance, such as team or business performance.”

Reasons and benefits

The CIPD’s Pay, performance and transparency 2024 survey, published in February that year, found that two in five UK employers do not link pay and performance. Reasons cited include a lack of sufficient budget to differentiate pay rises or bonuses; concern it is too divisive; and that no one is pushing for its introduction. Despite this, it can be beneficial to an employer.

PRP can align employee performance with organisational objectives and outcomes, which can help with productivity, accountability and retention. It can also help to develop and recognise employee contribution.

If employees are rewarded for their performance with tangible, financial reward, it drives motivation, defines expectations and lays out success criteria, explains Anna Laiu, board dirrector at the Chartered Institute of Payroll Professionals (CIPP), and director of pay and reward at PPHE Hotel Group.

“It can help organisations drive equity by rewarding contribution rather than service length,” she adds. ”However, the caveat to that is if such a system is not correctly implemented, this can lead to demotivation or unhealthy competition, so appropriate care should be applied.”

Duncan Brown, principal associate at the Institute of Employment Studies (IES), adds: “Every employer wants to improve performance, but pay is a big cost. The collective performance of an organisation, as well as individual, is also important.”

Setting objectives

Employers should explore what type of performance they are looking for and how they want to reward it. When setting objectives for an employee or team, they should ensure it is specific enough to be measurable, along with whether it is achievable, realistic or relevant. They should consider how objectives will be achieved, while also regularly reviewing to reflect changing business requirements or employee needs.

Examples of objectives include sales targets, improvements in efficiency, customer or employee satisfaction scores, or driving leadership behaviours. These can be tailored to employees’ role, level and goals, and be aligned to reflect organisational priorities and strategies.

“Organisations can look at what they want to target and create a performance reward system to impact this,” says Laiu. ”For example, they can boost productivity through related incentives to incentivise and drive employees’ performance.”

Encouraging employees to contribute to the objective-setting process allows for updates if feedback highlights concerns, says Cotton. “Involving employees can also ensure they feel performance-related pay is something that is done with them, rather than done to them,” he explains.

Brown adds: “Employers should ask whether money motivates staff and if they are offering staff enough to motivate them. If not, it can risk damaging performance.”

Implementing, measuring and communicating

Before implementing PRP, employers need to decide on the metrics on how performance will be measured, such as key performance indicators (KPIs), behavioural assessments or performance appraisal ratings. They should look at what is appropriate for their industry and measure consistently to ensure equity and transparency.

“Employers should look at how [performance] will be rewarded and consider equal pay,” says Cotton. “There should be mechanisms in place to ensure the scheme rewards the right types of performance and does so fairly. It’s important that HR leads discussions with key stakeholders on this.”

When linking performance ratings to pay outcomes, employers should be clear what the pay outcome is based on and what the rating is.

They also need to explain the system, how it will link to their goals, and have clarity around eligibility, detailing who is included and how decisions are made to ensure fairness. Process guides, objective and implementation timelines and appraisal forms within a toolkit will be useful to ensure consistency.

“Employers must be clear regarding pay transparency as per European Union regulations,” says Brown. ”The more open they are that if employees perform well it will be reflected in their pay, the more impact it will have.”

To ensure employees understand any changes to pay strategies,  employers could consider holding briefing sessions or upload explanatory resources and videos to their intranet sites. Providing space for questions and feedback allows for continuous improvement based on employee and business needs.

They also need to create a communication campaign for the relevant audience, says Cotton. “Within the workplace, this can include line managers, technical staff, and new joiners,” he explains. ”Advances in AI can help HR teams shape messaging according to the audience, to ensure they get across what they need employees to understand.”

Laiu adds: “The tone should be adjusted to the way an organisation talks to its employees, avoiding jargon. Succinct and transparent two-way communication is essential, along with sending the same message consistently.”

Introducing PRP can benefit both an organisation and its employees if implemented correctly. Staff can feel effectively recognised and rewarded as a result, while also having a strong effect on a business’ bottom line.