Not tying performance reviews to pay raises is a sore spot for me, and has been for many years. I thought that in these times of tough but enlightened management, this dinosaur practice was behind us. I’m sorry to report it isn’t.
Recently, a colleague working for a southeasten Wisconsin division of a global company received an annual performance review from his supervisor. It was about 10 pages long. The supervisor rated the employee on several dozen factors, on a scale of 1 to 5, with 5 the highest. The supervisor’s comments followed each rating.
The employee had been at the company a long time and leads an important business unit. The ratings were truly exemplary, mostly fives and a few scattered fours. The commentary that followed each rating was specific and laudatory.
So here’s the rub. The employee found out that the top salary increase, which wasn’t announced during the review, will be 2.5 percent in 2010. This employee knows that others receiving lower ratings will also be eligible for the 2.5 percent increase. What does this say to a top performer and a mediocre performer? The answer is obvious.
For some reason, there continues to be this myth that if you separate a performance review from a salary review – in some cases by six months or more – the employee will never tie the two together. Also, some believe, a great performance review does not necessarily lead to a great raise.
A performance review actually rewards or encourages better performance. A salary review is predicated upon the economic circumstances of the company. One school of thought says that if you keep salary increases unpredictable and low, then you won’t build in additional overhead that you will subsequently regret if the business suffers a downturn.
Well, there’s an answer, and it isn’t new by any means. It’s called discretionary and non-discretionary employee incentive plans.
The discretionary plan
This is an amount that the owner uses to reward key employees who really made a difference in the company’s overall performance during the 12 months preceding the review. The total amount is usually based on a net cash flow as a percent of sales, or net operating profit as a percent of sales. It seldom exceeds 10 percent of an employee’s base salary. The amount distributed will vary from one employee to the next.
The non-discretionary plan
This plan is typically the foundation of most incentive compensation plans. Basically, the payout is determined on company performance, using the same or similar measurements mentioned above. The distribution, however, is proportional to the employee’s base salary.
For example, management decides that its incentive non-discretionary payout can equal 5 percent of total payroll. Let’s assume a $1 million payroll, so the pool is $50,000.
If Mary’s base salary is $65,000, she will receive a 5 percent raise, or $3,250. If Jim’s base salary is $50,000, he will receive a 5 percent raise, or $2,500. The idea is that the higher your salary, the more you are contributing.
Use both
This is why a combination of a discretionary and non-discretionary plan is so important.
Let’s say, in our example above, that Jim has received an outstanding performance review, and Mary has received an average review. A discretionary incentive allows management to give Jim a higher incentive amount, even though both he and Mary receive raises based on the same percentage of their base salaries.
At least two other performance review variations are worth mentioning.
One, for lack of a better term, we can call a “negotiated” review. Subordinates rate themselves first, and then sit down with their supervisors to reach agreement on each item rated. Historically, subordinates tend to underestimate their performance with this “bottom-up” type of review.
The second review, which tends to be less popular in smaller companies, is the 360 review. In this review, the supervisor and immediate peers rate the employee. The employee might also do his or her own review. Again, this can be a negotiated review before it’s signed, sealed and delivered.
Regardless of the type of review, the worst ones are based upon judgments and emotions, and the best ones are based upon observable, measurable behaviors such as reaching objective goals, completing projects, and teamwork.
It’s all a matter of parameters. If the parameters are loosey-goosey, then that’s how the employee will perceive the review.
I’m urging readers to take a common sense approach to performance and salary reviews. Give everyone some kind of base increase if possible. Use the discretionary and non-discretionary incentive as extra cash in your wallet to tell the high performers you are rewarding them for “Olympic” performance.
The rest?
They’ll soon get the message.
