6
REWARDING TALENT

The reward systems in most organizations do not focus on skills and competencies, business strategy, team and organization performance, or the differences that exist in the workforce with respect to what individuals want, need, and value. Instead they still follow a traditional bureaucratic model and are based on job evaluation systems, merit pay, and a fixed set of fringe benefits. These reward systems are usually the same for most or all hourly employees. Salaried workers, executives, and perhaps salespeople usually have plans that are based on job evaluations and include merit pay raises and benefits. In some organizations these plans include stock, profit sharing, and the giving of bonuses. Overall, however, most reward systems fail to focus on the key issues of today’s work environment.

How do reward systems need to be designed to fit the organizations and individuals that operate in the new world of work? The answer is obvious: they need to focus on the skills and competencies individuals have, on the contributions that they make to improving organizational performance, and on the needs, desires, and preferences of employees for cash and noncash compensation. To accomplish this, a reward system needs to adopt a number of practices that have not yet gained widespread acceptance and adoption.

PAY FOR SKILLS, NOT JOBS

The predominant compensation approach in corporations dictates that individuals are paid primarily based upon the hierarchical level and nature of the job they hold and its market rate. The key tool in this approach is an evaluation system that scores jobs on a scale of measurement that examines job attributes. With this methodology and salary surveys, the amount paid to particular positions within an organization can be compared with the pay in other organizations.

The problem with basing pay on jobs is that it is individuals, not jobs, that have a value in the labor market. It follows from this that the best way to attract, retain, and motivate skilled talent is to base pay on the skills they have. Today most organizations do pay some individuals based on the skills they have, but this practice is still the exception rather than the rule. For example, some knowledge workers are paid based on the kind of skills they have, but in many cases these individuals are not paid based upon their individual levels of their expertise but on the type of expertise they have. In many areas, including finance, accounting, engineering, and human resources, and certainly in areas like software and various areas of research and development, individuals should be paid based on the kind and level of expertise they have that is relevant to the work they do.

Some organizations target their pay rates above market levels, others pay at market levels, and others pay below market though they rarely say so publicly. Missing altogether or playing only a minor role in this approach to determining pay is a focus on the skills and knowledge that are critical to an individual’s work performance and incentives for individuals to develop and improve those skills and knowledge. Instead, they are incentivized to move on to more highly evaluated jobs because that is the way they can get a pay increase.

The movement of Procter & Gamble and other corporations toward self-managing teams in their high involvement management plants, which began in the 1960s, led to the limited adoption of paying people for their skills. These high-involvement workplaces paid individuals based primarily on the number and kind of skills that they had, not on the jobs they were doing at a specific point in time. This encouraged these individuals to develop a broader understanding of the work processes, to become more flexible, and to improve their skills. It was a significant step toward establishing the effectiveness of skills-based pay, and it showed that it can replace traditional job evaluation–based pay with a more effective approach that contributes directly to organizational effectiveness.

The next step should be the movement of all organizations toward paying most, if not all, of their talent for the market value of the skills they have that are relevant to the organization’s work and strategy. A skills-and knowledge-based system is an excellent way to motivate talent to learn new, critical skills and to help attract and retain individuals with the right skill sets. Because talent, not a job, has value, it can provide a valuable tool for attracting and developing the kind of talent organizations need to be competitive in knowledge-based businesses.

A skills-and knowledge-based pay system creates the opportunity to compensate the most valuable individuals above market levels and to encourage people in the organization to master those skills that are major determinants of an organization’s effectiveness. This is a key element in creating a talent management system that supports an organization’s strategic agenda and agility. For this very reason technology companies including GoDaddy, Google, and Netflix are increasingly adopting this approach, particularly with respect to their knowledge workers. They determine what their talent is paid by looking at what the market pays for individuals with the same or similar skills. For example, individuals are paid based on multiple levels of software skills that are priced according to the market.

Adopting a skills-and knowledge-based pay system is increasingly feasible. More and more data exist on what individuals with particular skill sets are paid. And with modern information technology, skill assessment is easier and more effective than ever before. Further, paying for skills is directly tied to the need for organizations to emphasize agility, develop talent with key skills, and position people as a source of competitive advantage.

There are some key operational issues that appear when organizations move to a skills-and knowledge-based reward system. For example, decisions need to be made about which employees can learn and develop certain skills and eventually whether they have mastered them. There are no easy answers to these issues, but as we will see in chapter 7, they need to be part of the ongoing performance management discussions that take place with individuals about their careers and their value to the organization.

An organization that pays for skills and knowledge needs to make clear statements about when and how decisions will be made about opportunities to learn new skills and acquire new knowledge. Organizations also need to be very clear about which skills they need and are willing to pay individuals for having. It makes no sense to simply reward individuals for acquiring what are strategically irrelevant skills given their position in the organization. A second component that needs to be in place for an effective skills-based system to operate is valid measurement of whether an individual has acquired particular skills and competencies. How this will be done needs to be made clear in advance, particularly when individuals contract to learn a new skill.

Finally, there is the issue of what happens when an organization no longer needs a particular skill set. In today’s rapidly changing environment, this can happen with technical and many other types of skills. The best approach here is to let individuals know that the skill (or skills) they are being paid for is no longer needed in the organization and to give them a window of time to replace it with a new skill that is needed. If they fail to replace it, their pay is reduced because they no longer have the skills that justify their current pay rate.

One pay-for-skills option that can be used in some situations is giving individuals a bonus, one-time recognition, or other reward for learning a new skill. This is particularly appropriate when an individual’s base pay is already relatively high compared to the market and where a pay increase will put him or her significantly above market levels. Rather than putting the individual into a situation where the salary cost of employment is excessive, he or she can be offered a one-time cash bonus, stock in the company, or some other reward for learning an additional skill or a new capability.

Given that the nature of work is changing rapidly and new skills need to be learned or acquired in a relatively short period of time, a focus on paying talent based on what it can do is the best approach because it rewards and motivates skills development. In some cases it is less expensive, and in many cases it is more effective than replacing individuals with new talent that possesses the desired skills. This is particularly likely when the learning time for the needed skills is not long or the market (and market price) for talent with the skills is very high.

Paying for skills fits well with how the gig-or talent-demand economy operates: this economy is very much based on paying for what someone can do. Thus, when decisions are being made about how to get work done (e.g., gig work versus employee work), it makes a direct comparison much easier.

Yes, paying for skills is a big change, but it is the approach that is needed to move from a bureaucratic job description–based world to the skills-and competencies-based world of agile, effective organizations. It must happen if organizations hope to change and to motivate individuals to develop the right skills. It also allows an organization to pay people in a way that is consistent with the idea that there are certain key skills that need to be rewarded and retained. Paying more for these key skills is a very effective way to accomplish this.

The market for talent is increasingly becoming a skills-based one. It is no longer primarily a job-based market, and the most effective way for an organization to attract and retain individuals who have the strategically important skills it needs (or any skills, for that matter) is to base their rewards on what they can do and what the organization needs them to do rather than base them on what other organizations pay people for doing similar jobs.

MARKET POSITION

Simply stated, having high reward levels relative to the market can pay off for an organization, particularly when it is done for performance and skills that are pivotal. Why? It aids the attraction and retention of all talent, but particularly key talent. Pay and other rewards are key to individuals being attracted to and satisfied with how they are treated by an organization. Therefore, it will contribute to a low turnover and a positive buzz about what the organization is like as an employer. Of course, it is not the only thing that attracts and retains employees, but it is hard for an organization to present itself as an attractive employer when it is absent. Yes, organizations can emphasize their social purpose and mission, and in some cases this can make up for having a pay and rewards position that is at or below the market level, but this appeals to only a limited number of people and can be a difficult position for many organizations to argue.

The key issue with paying above the market rate, of course, is the cost. Can it be justified? Frequently it can be if it reduces turnover and attracts a better quality workforce. But there is an additional consideration: whether an organization expects and demands above-market performance from its employees. If it does this by terminating those individuals who are below market in their performance and skills, it is an effective approach to determining where the pay and rewards levels are set in an organization.

Netflix is a good example of an organization that has a high-pay, high-performance culture. The company makes it very clear that individuals who do not perform above the market level will not continue to be employed. It also makes it clear to its talent that it pays above-market wages with the expectation of performance that is also above market. This gives Netflix the advantage of legitimately being able to set high goals for individuals and having credibility when it removes average and below-average performers. It also attracts individuals who have selfconfidence and believe that they are high performers.

In a pay system where the amount of pay is based on the skills individuals have, it is important to allow for and enable adjustments in pay when individuals learn new skills and when the market for their skills changes. This may mean more than an annual change in an individual’s pay. At the very least, all individuals should be reviewed every year—and in the case of key talent, every quarter—to be sure that their pay level is at the appropriate market position. If it is below market, they should be granted a salary increase to bring them up to whatever position in the market has been targeted for the skills they have. As noted already, in most cases this means an above-market position. If the market for their skills has actually decreased, they should be given a freeze notice rather than a pay decrease. This means that their pay will not be moved up unless and until the market for their skills moves above what they are currently being paid.

PERFORMANC-EBASED REWARDS

The evidence is clear: basing rewards on performance can be a powerful motivator of performance. Rewarding performance is not only an effective motivator of performance, it is a way to attract and retain the best performers. In order to motivate performance, rewards need to be clearly connected to performance, and they need to be important. Frequently organizations try to accomplish this by giving the highest salary increases to their best performers and through the use of profitsharing plans, stock plans, and bonuses. Organizations also sometimes create a variety of recognition programs that reward performance. All of these are viable ways to create a meaningful connection between pay and performance, but vary greatly in their effectiveness.

The least effective way to reward performance using financial incentives is to give “merit” salary increases; it also is the method most frequently used. Among the reasons for its low effectiveness is that the amount of money available tends to be very much determined by inflation, not performance. As a result, in many time periods the salary increase budget is so small that it is impossible to create a meaningful reward difference between good performers and poor performers. Simply stated, a 3 percent merit budget is hard to divide up in ways that leads good performers to feel they have received significantly more than lower-level performers.

Profit sharing and stock ownership plans can have a positive impact on talent performance, attraction, and retention. They will not work for all talent, but they will for most. With respect to performance, the impact of profit sharing plans on talent motivation is likely to be minor unless the amount received can be tied directly to an individual’s or small group’s performance. The problem is that most individuals do not see a clear connection between their performance and their reward amount when it is based on organization performance. This problem is even greater for stock ownership plans. However, like profit sharing plans, they can help create a culture of involvement, attraction, and retention if they lead to above-market compensation levels.

What is needed for a pay plan to have a major impact on motivation is a bonus plan that has a level of funding and a measurement approach that allows it to make a difference of at least 9 percent between what good performance earns and what poor performance earns. The amount of bonus can be determined by a budgeted amount or triggered by various levels and kinds of organizational effectiveness—for example, company profit.

Driving the amount of money in a bonus plan off organizational performance has a number of advantages, including causing talent to focus not only on their individual performance but also on organizational performance. The negative in this approach is that when individuals perform well but the organization does not, even the good performers will receive little or no bonus. As a result, they may see little connection between their performance and their reward.

The right mix of individually determined and collectively determined rewards is very situational; there is no answer that is always best. A careful analysis is needed of the organization’s business model and the degree to which individuals are best focused on their own performance, on the organization’s performance, and on how volatile the organization’s overall results are likely to be. What needs to be true, in almost all bonus periods, is that there is money available, and individuals who perform well get a significant bonus at the end of the period.

There are some conditions under which paying for performance makes sense for temporary, short-term, contract, and gig employees. If they have a carefully prescribed task to perform with measureable outcomes, a very strong case can be made for rewarding them based on their performance. Since in most cases they have no chance at being given a full-time job or being rewarded in other ways for their performance, offering them a financial incentive that is based on their performance fits a need and makes a great deal of sense. What kind of financial incentive is appropriate? The answer in most cases is cash, since it has a universal high value.

In the case of most nonemployee talent, cash rewards should be based on individual performance. There are some situations where a group incentive is appropriate—primarily those where a cooperative group task is involved and performance is best or only measurable at the group level. In any case, it should be an immediate reward clearly tied to measurable performance during the time nonemployees are doing work for the organization. It is important that the nature of the deal be presented to the individuals when they agree to do the work. They should also be given ongoing feedback on how well they are performing relative to their opportunity to earn a reward.

One additional note. In some cases it may be particularly important for temporary or short-term workers to have an incentive to perform well. In cases where they are paid on an hourly basis, the incentive for them is in the direction of performing slowly or in a “reserved” manner. The major reason is that once these individuals finish their gig, they may be out of work because they do not have another gig lined up. As a result, rather than being motivated to perform well, they are motivated to perform at the lowest possible level of productivity that they can get away with to prolong their work relationship. Pay for performance can motivate them to perform more rapidly. It is not an “everything” solution, but it can bring an important motivator into play for employees that are not regular employees of the organization.

Overall, the most generally applicable approach to paying talent for performance is some combination of a budgeted bonus plan that rewards individual performance and a business unit or a corporate performance–funded bonus plan like profit sharing. These two approaches to paying for performance should be designed to operate relatively independently, so that if the organization does not do well, individuals who perform well can be rewarded based on the money put aside for individual bonuses.

Bonuses for individuals should not replace market adjustments to base pay; they should be paid out based on performance, not market movement. The combination of market and performance pay gives individuals the chance to increase their base pay because of changes in the market and/or in their skills, and to receive a bonus or merit salary increase based on their individual performance. This design has the advantage of creating a performance focus on the part of individuals because it provides a high level of assurance that if they perform well, they will be rewarded for it. It also has the advantage of keeping the pay of an organization’s talent in line with the market so there is no threat of losing them for pay reasons.

REWARD SEGMENTATION AND CHOICE

Many organizations give different kinds of rewards to individuals at different levels in the hierarchy and in different types of jobs. For example, senior executives often receive stock and very different benefits from those given to lower-level employees. In the 1970s some organizations began using flexible or “cafeteria” style benefit plans that offered all employees a choice of what “fringe” benefits they receive. In these plans, individuals are given a “budget” and allowed to “buy” the benefits they want.

Recently, a number of companies have taken the reward choice idea to interesting new levels. First, they have increased the benefits and perks they offer to job holders. Today, particularly in Silicon Valley and in technology firms in general, employees can choose to have concierge services, extra vacation days, engage in various kinds of on-site physical exercise (Ping-Pong is popular in Silicon Valley firms), partake of entertainment, and go to a cafeteria with many food options. The reality is that individuals value rewards differently, and that to optimize the return on the investment organizations make in them, it makes sense to try to match the rewards to the preferences of individuals. In the absence of this, organizations may give individuals rewards (fringe benefits, in particular) that are valued at a level that is below their cost—not a good way to spend compensation money.

The key point here is that individuals increasingly differ in what they value and what they want. As a result, choice is a winner; it helps assure that what organizations give to individuals are things that they want and value.

Admittedly, choice can go too far and organizations can end up attracting and retaining individuals for the wrong reasons or spending more than they need to because they give things or amounts that are not important when it comes to the attraction, retention, and performance of talent. This is particularly true in cases where individuals are given various kinds of recreation and off-the-job benefits that are not performance-based rewards and do not add to their ability to perform their work. Indeed, they may distract individuals from doing their jobs and developing their job-related skills. Admittedly, they may help attract and retain some talent, but it may not be the right talent, and the price may be too high. This is particularly true when the benefits are available to all employees at no cost. Unlike flexible benefit plans, in these plans, often there is no limit placed on how many services and options individuals can choose, and no trade-off choices need be made.

The answer to the effectiveness question with respect to most nonfinancial benefits can only be determined by analyzing usage, retention, and performance data. Now that so much data exist and can be analyzed, it is possible to make evidence-based decisions about the effectiveness of most reward programs. Some reward preference data can be gathered using opinion surveys and other tools that indicate employees’ preferences for different kinds of rewards. In most cases, however, the best data on preferences and the best way to ensure that the rewards chosen are the right ones comes from giving individuals a choice of rewards. If they have a choice that includes cash, they will consistently pick benefits that have a high value to them, and as a result, the organization will receive a good return on its reward costs.

What should not be lost in the fascination with nontraditional benefits, and the changes that are occurring in the kinds of rewards some organizations are offering today, is that members of the workforce differ dramatically in what they value and what attracts and retains them. This fundamental point means that organizations cannot rely on a relatively small number of reward types and that they need to allow individuals to determine what they receive in order to get full value for the cost of the rewards. Putting together a package of rewards that most or all individuals will value, at or above cost, is becoming an increasingly complex task. Thus, a limited predetermined set of rewards for individuals is becoming less and less the way to operate. It is simply not likely to produce a high “hit” rate and a good return on the cost of the rewards.

Finally, it is important for organizations to determine which rewards attract and retain the right employees. It may be that retention can be improved by offering Ping-Pong and dry cleaning, but who does it attract and retain? Is it the most cost-effective way to retain the best performers? Little research exists that answers these questions. In most cases, they are best answered by organizations using analytics and research evidence that focuses on their workforce and looks at how effective different rewards are at attracting and retaining talent.

PUBLIC PAY

Most organizations keep the pay levels of many of their employees secret. There is, however, a growing trend toward making pay data public. Many organizations now give out the pay ranges for jobs and the ranges for bonuses, but the pay of most individuals is still kept secret in most private sector organizations in the Americas, Asia, and Europe.

There are a number of arguments in favor of secrecy. According to traditional wisdom, it prevents comparisons that are disturbing to individuals, protects rights of privacy, and in general leads to more effective pay administration because decision makers do not have to be worried about negative reactions to their decisions.

There is no doubt that keeping pay secret does prevent some disruptions that might occur if pay information were public knowledge. It makes it impossible for individuals to see whether they are paid more or less than others whom they may think are less—or for that matter, more—deserving. But it also allows age, race, and gender discrimination to go unmonitored, and it makes it impossible for individuals to know whether they and others are paid according to company policy. It is one thing for an organization to say that pay is based on performance; it is quite another for its members to be able to see that it is. Finally, secrecy makes it impossible to hold managers and organizations accountable for their decisions regarding pay, and as a result, they often make worse decisions than they would make if they were held publically accountable.

Overall, there are good reasons to believe that public disclosure of pay rates will lead to pay being more fairly administered and to a positive impact in the workplace. My research shows that with secrecy, individuals misperceive what others make. In general, they tend to overestimate the pay of individuals at their level and as a result they feel their own pay is lower relative to others than it actually is. The result is lower motivation, more dissatisfaction, and a greater risk of turnover.

Secrecy can make it less clear that a strong positive relationship between pay and performance exists and as a result, can decrease the motivation of individuals. Of course, in all too many cases, pay is not tied to performance and thus making pay public will just prove to employees that there is no relationship. The answer here is to create the connection and make it public. It is not—as is often done in organizations that practice secrecy—saying there is such a connection when in fact there is none and hoping that it will be believed.

Slowly but surely, pay information is being made public by organizations, but the movement is far too slow. A wild card with respect to making pay public are employment review websites like Glassdoor, which put pay data that is given to them by employees into the public domain. The problem with Glassdoor and similar sites making pay rates public is that they may not have accurate or complete data, and therefore, what is made public ends up hurting an organization more than if the organization itself made its actual pay data public.

For decades I have advised organizations to make pay public, and they frequently agree with the idea, but they typically point out that they need a “few years” to get their organization’s pay system and rates to where they feel comfortable making them public (secrecy tends to lead to indefensible decisions). The problem is that when I check in with them after those “few years” have passed, they typically have not made the improvements that are needed to have defensible pay rates and, as a result, making pay public is delayed further. The reason for this is what caused the pay system to get to an indefensible position in the first place: with secrecy, an organization is not and cannot be held accountable by employees for its pay decisions.

Recently, the growing diversity of the workforce has raised an increasing number of questions about the fairness of pay and the tendency for women and minorities to be paid less than white men. It is suspected and often true, but it is hard for individuals to challenge most pay decisions because they do not have data to support their claims. This has led to more demands that pay be made public so clarity can be developed about the pay practices of organizations and about the treatment of women and minorities. The proliferation of pay information on social media forums may be an indicator that many younger individuals do not support pay secrecy and that in the future there will be more public pressure to make pay information public.

There is an increasing amount of legislation in the United States that requires some pay information to be made public. It is likely that this trend will continue. Although it may not go as far as organizations being required to make the pay of their individual employees public, this may eventually happen, just as it happened decades ago for top executives and has happened for all employees in some countries.

One final issue with respect to pay secrecy is the hacking of company computer systems and the potential it has to make pay information public. This is just what happened to Sony when its salary database in the United States was hacked by the North Korean government.

At this point it seems safe to assume that any organization’s pay data can be hacked and made public. What should organizations do about this? They can, of course, install greater cybersecurity, but there is a better, simpler alternative: make pay public and administer it in a way that is defensible. This is more likely to increase organizational effectiveness and to cost less in the long run. Making pay public will improve performance if it shows a clear connection between pay and performance, since this will actually end up motivating individuals to improve their skills and perform better. Overall, making pay and reward practices public is potentially a win-win situation if an organization has reasonable, defensible, and strategically aligned pay policies and reward practices.

CONCLUSION

Traditional reward system practices do not fit well in organizations built for the new world of work. As Table 6.1 shows, practices need to be much more strategic and more focused on keeping, attracting, and retaining individuals with the right skills. One way to accomplish this is to focus the base pay system of organizations on an individual’s skill set. In this approach, individuals are paid for the skills they have that are relevant to their contribution to the organization’s performance and strategy. To align a skills-based approach to pay with an organization’s strategy, those skills that are strategically important should be more highly rewarded relative to the market than are less-important skills. The reason for this is simple: the retention and attraction of individuals with key skills is essential to implementing an organization’s strategy.

Pay for performance should also be an important part of an organization’s reward system. In most cases, today’s and tomorrow’s organizations should have systems that target both individual and collective performance with a multitude of rewards. Indeed, the kind and amount of rewards individuals get in most cases should reflect their choices and their individual work situations. Too often, given the diverse nature of today’s workplace, the rewards that traditional organizations offer are not valued highly by a significant portion of the workforce relative to their cost. Choice and variety are the answer here, not steering away from rewarding performance.

Table 6.1 Rewarding talent

Copyright © Edward E. Lawler III and Center for Effective Organizations at USC.

The complex issues that are raised as a result of today’s new workforce and workplaces very much require an evidence-based approach to rewards. Data need to be gathered about which rewards are attracting the right kind of employees, how effective rewards systems are in motivating performance, and the attraction and retention rates that are produced by various reward system practices. Given the dynamic nature of the workforce and workplace, evidence needs to be continuously gathered. Surveys and performance measures should be used to determine how effective the reward systems in organizations are at leading to strategy implementation and organizational performance.