May 2001

Performance Related Pay

There has been substantial growth in the use of performance pay systems over the
past 15 years. While the original performance related pay systems were
concentrated in the private sector, an increasing number of public sector employers
have introduced schemes recently, or are considering doing so.

What is it?

Performance pay schemes link pay to a measure of individual, group or

organisational performance. There is a wide variety of methods used, but all
schemes assume that the promise of increased pay will provide an incentive to
greater performance.

The most common types of performance pay

There are many different forms of performance related pay, which may be used on
their own or side by side. Employers may move from one to another. Most common
are:

· Piecework: a price is paid for each unit of output; this is the oldest form of
performance pay.

· Payment by results: bonus earnings depend on measured quantities or values of

output for individuals or groups, usually based on work studied time units; this
covers a wide range of bonus schemes.

· Plant or organisation wide incentives: bonus earnings or pay levels are based on
measured quantities or values for the whole establishment.

· Merit pay: bonus earnings or pay levels are usually based on a general assessment
of an employee’s contributions to performance; this is an earlier, less structured
form of the next system.

· Performance related pay: bonus earnings or pay levels are based on an

assessment or appraisal of an employee’s (or team’s) performance against
previously set objectives, usually part of a performance management system; this
is a fairly recent development, particularly in the public sector, which has grown
sharply in use since the 1980s.
· Competence based pay: reward and training are linked to competency
frameworks, based on the worker demonstrating certain skills (eg. problem
solving, decision making, leadership, customer service, dealing with differing
views) or achieving certain qualifications.

· Profit related pay: bonus or share options are based on the organisation’s profit
performance; this is widespread in the private sector, where share options are
often important for senior managers. Profit related pay has become less common
since the government phased out tax relief on PRP schemes.

The key to all performance pay systems

The key to all performance pay systems is the measurement required to determine
the output on which to base payments. The main steps are:

· Setting objectives
· Appraisal results
· Linking achievements to pay (and deciding where the money comes from).

Why do employers introduce performance related pay?

· to clarify objectives and engage employees with the organisation’s goals

· to motivate employees by linking pay to achievement of targets not length of

service

· to reward achievement and identify under performance; foster teamwork and

fairness.

· to contribute to overall improvements in productivity;

· to introduce more flexible pay systems or deal with recruitment and retention
problems

· in the case of some employers, to give greater power to managers and weaken
trade union influence in bargaining and representation of staff.

Does it work?

The effectiveness of any pay system depends many factors. However, there are some
problems inherent in all performance related pay schemes:

· Staff motivation and moral – A wide range of research has found schemes less
effective than expected. In the public sector this is frequently due to cash limits
making rewards for high performance ratings too small to motivate staff.
Problems of poor training for managers and inadequate communication with staff
have had a negative impact on staff morale. Studies of NHS managers in 1997 and
1998 showed that performance-related pay did not contribute to improve
 performance but did cause jealousies between staff and undermine moral.
(Dowling and Richardson, 1997, Marsden and French, 1998).

· Fairness -- Because performance related pay systems are based on appraisal of

the individual worker, often by their line manager, bias and personal favouritism
can influence the result of pay reviews. Instead of motivating workers,
performance pay can “undermine performance of both the individual and the
organisation by undermining team work, encouraging a short term focus and
leading people to believe that pay is not related to performance, but to having
the ‘right’ relationships and an ingratiating personality”. (Jeffrey Pfeffer, Harvard
Business Review, May/June 1998)

· Discrimination – Recent research found that performance based pay systems

often discriminate against women because: the appraisal process is subject to
gender bias and stereotypes; women’s skills are often undervalued by their
managers (and by women themselves); women—especially those working part-
time -- have fewer opportunities for training, and managers are less likely to
correctly assess women’s training needs. (M.T. Strebler, M. Thompson, P.
Heron, Skills, Competencies and Gender; Issues for pay and training, IES Study
333, 1997). Performance pay may run counter to the development of objective,
gender neutral job evaluation schemes which are being introduced to achieve
equal pay for work of equal value. A study by the Institute of Personnel and
Development, found that almost two-thirds of employers had no provision for
monitoring sex and racial discrimination in their performance related pay
systems.

Where PRP is introduced, UNISON supports the following safeguards:

· Negotiability on objective and design – There should be trade union involvement

from the start, with input on who should be included/excluded from the scheme;
the relationship between employment and pay; how the scheme will operate,
including joint monitoring and the appeals procedure.

· Transparency -- The basis for appraisal and how rewards are arrived at should be
transparent at both the individual and collective level.

· Fairness in operation -- There should be a fair and equitable approach to the way
the scheme is carried out for all staff. In competence pay schemes, all staff should
have equal access to training.

· Piloting -- The scheme should be piloted to ensure that it achieves its objectives
and does not operate unfairly.

· Adequate appraisal – Sufficient time should be available to managers to carry out

any appraisals. The workload implications can be considerable, especially for a
complex scheme.

· Training – Training should be available for all managers and staff.

 Additional reading

ACAS, Appraisal Related Pay, 1997

Dowling, G. and Richardson, R, Evaluating performance pay for managers in the

National Health Service; International Journal of Human Resource Management,
Volume 8, No. 3, June 1997

IDS Studies, Performance Related Pay, IDS 650, June 1998

Competency Frameworks, IDS 706, April 2001

UNISON, Competency Based Pay, 1996

UNISON Bargaining Support Group, 1 Mabledon Place, London WC1H 9AJ

Tel: 020 7388 2366 Fax: 020 7551 1766 Email: bsg@unison.co.uk