Paying your employees based on their performance is a powerful strategy that can lead to positive results for your business. Not only does it motivate employees to do their best, but it can also help you identify and reward exceptional work aligned with company objectives. 

In today's ever-changing business environment, pay for performance is a powerful strategic lever that can have profound impacts on your organization’s success. It goes beyond sales commissions: performance-based pay is all about extra rewards that motivate employees to reach higher levels of productivity and, more importantly, outcomes.

Because it can significantly impact your bottom line, it's worth taking a closer look at what it is and how you can use it in your own organization. This way, you can start putting together plans that ensure your team gets incentivized properly and appropriately — key ingredients when striving toward mutual growth.

This article will dive into the pay-for-performance compensation model and its pros and cons. We’ll also share the impact incentives have on employee performance and close with how CaptivateIQ fits into the picture.

What is pay for performance?

Pay for performance (or performance-related pay) is a variable pay model where employees can receive more compensation when they meet or exceed specific goals, such as sales volume and customer satisfaction, set by their managers or company executives.

It’s a pretty standard strategic lever for business today as it can significantly improve productivity, morale, and cost efficiency. In fact, according to a recent Salary.com survey, 77% of companies in the United States are using variable pay programs.‍

The pros of pay for performance

Why do three out of four of companies use some form of variable pay (like performance pay)? Simply put: It works!

There are many pay-for-performance benefits with a successfully implemented program. As this Forbes article suggests, pay-for-performance is a game changer.

Here are some of the “game-changing” benefits.

Increased productivity

Doing more with less is the name of the game in today’s business environment. Increasing employee productivity is one avenue for achieving “more with less.”

One of the best levers for improving productivity is to reward effort. When employees know certain actions will be rewarded, they are more likely to put in extra effort and produce better results. 

A key advantage of a pay-for-performance model is that it incentivizes continuous achievement and success while aligning compensation with contributions.

Enhanced motivation

Discipline is essential for getting work done and staying on schedule — and motivation can inspire you to make it happen.

But only some in an organization are motivated by the same things. Some excel with intrinsic motivators (doing something because it is enjoyable), while others perform better with extrinsic motivators (doing something for financial incentives). Nevertheless, these tangible rewards can motivate a team to work harder, smarter, and more efficiently. 

And there is some data to support this.

Implementing a pay-for-performance compensation model in your workplace can increase motivation and productivity amongst employees.

Improved morale

A motivation-based compensation system helps maintain employee morale by providing recognition and acknowledgment for a job well done. 

Greater clarity around roles and responsibilities

A clear delineation of duties leads to improved efficiency and fewer conflicts among team members. 

Cost efficiency

Underperforming employees typically require more supervision and resources than high-performing ones. However, letting go of underperformers or offering them lower wages can still be expensive for businesses; paying them based on performance can help avoid this issue altogether. 

Competitive advantage

Paying employees based on performance is becoming increasingly common, so those businesses that don't adopt this strategy may find themselves at a disadvantage when competing for top talent.

Higher retention rates

Employees who are rewarded for their work tend to be more engaged and invested in their job. As mentioned above, they are more likely to go the extra mile to do a good job and be productive. 

With incentive plans in place, you can provide for your employees in ways beyond just financial compensation. When employees are recognized for their effort AND rewarded for it, they are inspired to continue to develop their careers in that same workplace. Additionally, when employees feel fairly compensated for their work, they are less likely to look for other jobs, leading to lower turnover rates.

The cons of pay for performance

The pay-for-performance model is not all unicorns and rainbows. Like any plan, there can be disadvantages as well. 

Here are some of the common problems with pay-for-performance.

Teamwork

Wait. Teamwork is a good thing, right? Not so fast.

Teamwork may be less emphasized and incentivized depending on your compensation model. This can result in individuals focusing on their performance rather than the team's success.

An individual-focused approach may work in some organizations, but as they say, teamwork makes the dream work. While most businesses want a unified workforce, you will quickly create a hostile work environment if you pit your staff against each other for incentives.

Quantity over quality

Quality is almost always the name of the game.

Depending on your incentive system, your team may feel that getting more work done and filling quotas is the right approach for more incentives. When implementing your pay-for-performance plan, emphasize the quality of performance, not the quantity.

Focusing on short-term results (a little too much!)

When people are rewarded based on their short-term performance, they may be more likely to focus on tasks that can be completed quickly and easily instead of longer-term goals that may be more difficult but have a greater payoff. Management might also become overly focused on achieving short-term results, which can take away from their investments in employee development and training and ultimately lead to lower productivity and decreased efficiency.

Setting a standard

Once employees become accustomed to incentives, the pay-for-performance model may become “the new norm.”

That’s not necessarily a bad thing. However, if there is a month/quarter/year where your organization does not provide the pay for performance incentive, you may have a mutiny* on your hands.

‍*Or just a few unhappy employees.

Be sure to scale your incentives with the reality of your business – anticipating down years.

Impact of incentives on employee performance

The impact of incentives on employee performance is quite clear. 

A 2010 meta-analysis conducted [by] the International Society of Performance Improvement (ISPI) found that properly constructed incentive programs increase performance by anywhere between 25 and 44 percent. The same study found that these incentive programs engage participants and help companies attract quality employees. (Source)

While a pay-for-performance plan may be a deliberate decision on employers' behalf, performance-based incentives examples exist in other places.

For example: In many elementary schools, teachers reward children with toys, stickers, or other forms of motivation for positive behavior. While not the same as more advanced work incentives, the underlying principle is the same. People work harder when they feel their effort is recognized and rewarded.‍

Performance-based incentives for employees should go beyond stickers and toy box prizes (obviously). 

Unfortunately, simply having the idea to implement a pay-for-performance program is not the same as actually implementing an effective one. Unstructured incentives can have serious consequences. 

There are plenty of bad incentives examples out there. Take cash bonuses. The bonus only comes through if you meet your set quota. This can create an incentive to overreport sales, which can hurt the company. 

Implementing a pay-for-performance system

Pay for performance might be the answer if you're looking to motivate your reps and increase sales output. But cookie-cutter solutions are not the answer — what works wonders for one company could prove utterly ineffective with another business. That’s why it’s critical to tailor commission structures accordingly to ensure maximum impact!

Establishing clear parameters that reflect fair and attainable targets is also critical: you need to provide rewards that feel attainable, so employees remain motivated. 

The same concept holds true when considering merit-based raises — be sure they happen often enough so hard work doesn't go unnoticed or unrewarded! If an employee feels like their hard work will only be acknowledged possibly after an intense year of effort, it may make the pursuit of the goal not feel worthwhile, as the incentive would seem very distant.

Here are some other tips to ensure a successful implementation:

1. Define what "performance" means for your company and employees. What are your measures of success? Performance metrics often relate to how well an individual or group is meeting expectations, improving skills, and adapting to changing demands in the workplace or marketplace.
2. Clearly outline the expectations and goals of the pay-for-performance system to all parties involved. This includes establishing a timeline for measuring results and determining if the system works as intended.
3. Make sure both management and employees are on board with the new system. Manage employee expectations by regularly communicating about their progress and how it relates to their pay.
4. Periodically assess the system's effectiveness to ensure it meets everyone's needs. Make changes as necessary.
5. Celebrate successes and learn from failures together as a team.

The role CaptivateIQ plays in performance-based compensation

Compensation is often your most significant sales expense. 

It’s also the single most impactful go-to-market investment your organization makes. If managed effectively and efficiently, it can influence revenue generation more than any other business lever. 

Sales reps (95%) agree that the right technology stack is essential to meeting their revenue goals and rank compensation software amongst their most indispensable tools.

That’s why performance-based pay has become one of the most popular forms of incentive compensation. It offers a way to encourage and sustain exemplary performance by providing pay increases based on improvements in productivity, quality of work, or cost savings.

CaptivateIQ empowers businesses to get pay for performance right — for their teams, their goals, and their market — now and in the future.

Learn more about incentive compensation management.