PERFORMANCE RELATED PAY GUIDE FOR BUSINESSES

WHAT IS PERFORMANCE RELATED PAY?

Performance related pay (PRP) is a process that links an employee’s salary increase to their individual performance. The concept of PRP is that performance is measured against pre-determined objectives agreed between a manager and employee over a set period of time, usually a year.

• Salary increases usually get added to an employee’s basic pay, on an annual basis, although in some circumstances they can be a one-off cash lump sum payment.
• Businesses can use PRP when they are not able to measure an employee’s performance on output or sales figures.

The purpose of performance related pay is to reward strong performance, rather than simply recognising length of service. This system prioritises high performance over tenure. It ensures that salary increases reflect individual contribution, so high performers are rewarded appropriately while lower performers do not receive the same incentives.

WHAT IS THE DIFFERENCE BETWEEN PRP AND A BONUS?

A bonus is typically a discretionary payment used to recognise hard work, celebrate company success or show appreciation, for example, after a strong financial year. In contrast, performance related pay is a structured, merit-based system where salary increases are tied to pre-agreed performance objectives. While bonuses are often linked to occasions or company outcomes, PRP directly reflects an individual’s measurable achievements.

WHY DO BUSINESSES USE PERFORMANCE RELATED PAY?

Businesses use PRP to try to motivate and encourage employees to work harder, achieve higher performance and become more effective. PRP rewards those that are good performers. Employees may feel a stronger sense of agency and control over their own salaries with a PRP system in place. This can alleviate potential frustration associated with salary increases only taking place on a yearly basis. 

WHICH TYPES OF ROLES AND INDUSTRIES USE PRP?

There are a few roles and industries that utilise a performance related pay system. One of the most common would be sales, where the representative receives a commission for every sale they make. The commission is based on an agreed-upon percentage. Other examples of roles that use PRP include:

• Managerial and executive roles
• Specialist roles where output can be measured
• Senior public sector roles and leadership positions

Industries that utilise PRP:

• Financial and banking institutions that have a strong emphasis on targets
• Law consultancies that pay off client wins and project success
• Private sector organisations where performance is prioritised

HOW CAN PRP AFFECT TEAM OR INDIVIDUAL PERFORMANCE?

It’s no secret that one of the most common frustrations amongst disgruntled employees is related to salary. Employees on a set salary may feel at times their hard work isn’t being recognised from a fiscal perspective. A PRP scheme can provide a metric-based system in which an employee who is meeting target objectives receives the agreed-upon compensation. This can be a positive way to recognise hard work, but can also lead to others feeling dissatisfied if they’re unable to meet those standards. It’s important that objectives and metrics are made clear, so employees understand what’s expected of them.

TYPES OF PERFORMANCE RELATED PAY

There are two main types of PRP. These are:

1. Short-term schemes – which utilise commission or bonuses which can be based on sales achieved by individuals or work completed. These schemes are a way for employers to have an incentive for employees to increase and improve their performance. For example, an employee may receive a percentage of each sale they make or a bonus for reaching project milestones.
2. Long-term schemes – are used to increase loyalty amongst employees and, as pay increases, can offer share options for employees also. These schemes are designed to build long-term loyalty within a company. For example, an employee may receive stock options which they can cash in after a certain number of years, but only if they remain with the company or meet performance standards.

ADVANTAGES OF PRP

Benefits of performance related pay include:

• It can act as an incentive to increase employee performance and efficiency, as employees want to achieve the best pay increase.
• It can improve motivation, focus and morale in the workplace.
• It can assist in achieving a strong bond between employee and company.
• Usually most effective when rewarding employees on an individual basis for effort and not for group performance.
• Rewards the best employees and high performers.
• Helps to create a healthy performance-based culture.
• Can lower costs and help businesses to remain profitable.

POTENTIAL DRAWBACKS OF PRP

Drawbacks of PRP can include:

• Setting difficult goals or unclear objective metrics can frustrate employees.
• A competitive workplace can result in a negative work environment.
• Employees may expect more payments for work and performance above and beyond their goals.
• The sole focus of only wanting to achieve a goal can impact morale.
• Sometimes the measuring of performance can be subjective, for example, a dispute with a supervisor could result in lower performance ratings.

HOW DO BUSINESSES MEASURE PERFORMANCE?

Managers and employees will agree on individual objectives that the employee will need to meet over a period of time, usually one year. These are usually set as SMART goals (Specific, Measurable, Attainable, Relevant, Time based)

These objectives are in addition to an employee’s day-to-day responsibilities; they will be specific tasks or projects they are required to work on.

During the year, a manager and employee will meet regularly to discuss the employee’s performance and to see how things are going. The manager should see if there is any assistance the employee requires to meet their goals. The frequency of these meetings will be agreed between both parties; they will usually be fortnightly, monthly or in extreme circumstances, quarterly.

At the end of the appraisal period, both parties will rate how they feel the employee has done against their goals. Pay increases will depend on how employees have performed; high performers will generally receive a higher increase than average performers.

HOW TO IMPLEMENT PRP SCHEMES

To implement PRP systems in a small business, businesses must ensure they:

• Determine the needs of the process and define the metrics clearly – holding face-to-face meetings with key stakeholders.
• Set organisational and individual goals – these should be SMART goals (Specific, Measurable, Attainable, Relevant, Time based).
• Track progress on a regular basis – to ensure what is required is being achieved, as well as provide any additional resources to help employees.
• Communicate achievements – recognition and feedback are essential to positive reinforcement and the success of the process.
• Provide coaching, training and development where needed – for both employees and managers. If employees are struggling with their goals, they may need extra support from managers; Managers may need coaching on how PRP can motivate their employees.
• Reward success.
• Evaluate – to ensure the process is fulfilling the needs of the business.

HOW OFTEN SHOULD BUSINESSES REVIEW THEIR PRP SCHEME?

A business should review its PRP scheme on an annual basis. However, if you’re consistently falling short of projected goals and desired outcomes, you may want to intervene early to determine what exactly isn’t working and ways to improve this process. By periodically reviewing your PRP scheme, you can help ensure its continued success and support employees when needed.

HOW TO CALCULATE PRP PAY?

This will vary depending on the nature of the business, project and milestone. A structured performance related pay process that clearly links an employee’s performance rating to a pay increase may involve performance appraisals, sales figures, project outcomes or a combination of objective and subjective measures. The rationale, objective and calculation must be explained to the employee to ensure transparency and fairness.

COMPLYING PRP WITH UK LAW

It’s essential that a PRP scheme complies with UK employment law. This is where it’s important to have the support of an expert HR team that has a comprehensive understanding of relevant legislation with regard to PRP to keep your business compliant.

PRP HR CONSULTANCY WITH CLOVER HR

If you would like further guidance on performance management, we provide a range of HR services for your business, please contact the specialist team at Clover HR on 0330 175 6601 or email us at info@cloverhr.co.uk.