Your organization wants to do away with ratings. But if you do that, how are you planning to determine pay increases?
The good news: you can make pay decisions without ratings. You first need to establish an approach to understand, differentiate, and measure performance. The three factors to consider are:
- Employee Performance Measurement Metrics:The ability to differentiate employee performance
- Merit Budget:Typically a fixed dollar amount that is set aside to recognize and reward employees.
- Pay Range Structure:Market data or an internally developed salary scheme (which should correlate to market data) will determine the minimum, mid, and maximum pay ranges for the positions in your organization.
I’ve put together a five-minute video outlining my process. A deeper dive into how everything works can be found in the rest of the blog post below.
Step 1: Establish Employee Performance Measurement Metrics
The 5-level rating scheme is too limited to measure performance meaningfully - it needs to go. But most see the only alternative as having no system to measure and track performance. Establishing a new, more robust measurement system is a must.
I use the employee performance continuum for a snapshot-in-time to identify an employee's coordinates in relation to the two performance dimensions:
- Work Results
- Observable Behaviors
This four-square model can be drawn on a napkin, but here's a downloadable form with instructions. Watch this video to see how the employee performance continuum, a visual model, can be used to evaluate an employee's performance.
I've had many debates on how this plotting is just "ratings in disguise." But this continuum goes much further than your typical five-point rating system: Meets Expectations, Exceeds Expectations, Needs Improvement, etc.
Using the employee performance continuum allows for a robust discussion about the individual's performance. I advise doing this process twice yearly. Don't stop measuring employee performance, but do get rid of the categories that are too narrowly defined and will always fall short of accurately describing work performance.
Once you have your performance measurement approach in place, allocating limited merit and bonus dollars is straightforward. Of course, you'll be constrained by the budget - there's only so much money to go around.
Step 2: The Total Merit Budget (Dollar Amount Available) and Allocation
Just like any other budget line item, the finance department needs to forecast payroll expenses. The merit budget is usually established by multiplying total payroll dollars by a number (commonly 3%). The finance department will use this figure to help project payroll costs:
3% of a $20,000,000 payroll = $600,000
In this example, there are $600,000 to allocate (this pot of money may cover merit, bonus and market-pay adjustments).
Allocations to Budget Holders
Next, the $600,000 will likely be allocated to the various budget holders: For example, the VP of Engineering receives $48,000 (an amount equal to 3% of Engineering's payroll of $1,600,000). The $48,000 may even be allocated to individual directors or managers who will then recommend merit increases based on each employee's assessed performance contributions.
The practice in your organization probably works similarly. Now that the budget is known let’s get back to the employee performance continuum. Once employee performance has been measured, the various performance levels which will inform how to allocate merit pay (and sometimes bonus and equity in the form of stock options).
The "ultimate" budget owner, the VP of engineering in this example, grants final approval for individual pay recommendations. At this point, adjustments to the recommendations are fine-tuned as the budget owner looks at the larger picture. This involves taking some dollars from one individual and rewarding someone whose performance impact is greater in the grand scheme.
Step 3: Determine your pay structure
Market data or an internally developed salary scheme, which should correlate to market data, will determine the minimum, mid, and maximum pay ranges for the positions in your organization.
When making your pay decisions without using any ratings, here are a few things to keep in mind:
Recognize an employee’s total performance – a combination of work results and observable behaviors. Consider greatly reduced or no change-in-pay for off-target performance related to value detracting behaviors, low work output/results or a combination of the two. This way you have more money to spend on your most valuable people.
It’s important to have a set salary range for any given position in an organization. This is determined by market indicators like industry average pay levels. Ideally, you want to work their compensation toward the middle of that pay range.
The allocation and size of raises
Once you have performance data and salary ranges figured out, you’ll have a much easier time determining pay increases.
Consider larger increases for:
High-level performers paid in the lower
Employees who have made a significant difference to the business.
Employees needing a market adjustment
Consider smaller increases for:
Employees already in the upper salary range dimension
Consider bonuses to supplement merit pay as a reward for top performers who are close to or in danger of exceeding the salary cap limit.
Reflect Pay Increases as Dollar Amounts
If you're stepping away from ratings, one important gesture is to express pay increases as a dollar amount instead of a percentage. Part of your pay policy could read, "adjustments in pay are reflected in the March paychecks as a $ amount." This way, the manager gets to thank employees that get an increase their hard work and quote a specific dollar amount.
Is your organization thinking about getting rid of traditional performance ratings? Have you replace ratings already? If so, how are you measuring performance and making pay decisions?