Performance Reviews: Compensation Tied to Performance

Employees want and expect to be compensated for their performance each year. You want to keep top performers, so you pay them based on their performance. Sounds simple, right?

Unfortunately, employee compensation is a complicated topic. It is very contextual and specific to your individual organization — your size, location, industry, and culture. Let’s take a look at some of the  common types of compensation increases:

Cost of Living Adjustments (COLA)

A Cost-of-Living Adjustment (COLA) is intended to be a salary adjustment made across the board, to everyone in the organization. COLAs are given to counteract inflation, and they are not tied to performance.

Market Adjustment

As a small business leader, knowing your market is critical. You need to know what the market pays for the talent in your company. To learn this, the best course of action is to purchase a compensation survey. If you search anecdotal websites, like Glassdoor or Monster, you will be flooded with salary information that is not confirmed, aligned to your roles or verified. A true compensation survey will give you reliable benchmarks that you can align to the roles within your company, are based on your market, industry, competition, and company size. Most companies can get market data with a minimal investment. There are human resources organizations, like AAIM, for example, that provides comp data as part of an annual membership. You may also be able to get comp data through your company’s partners. Either way, they are generally not expensive and you need the data to base your employees’ salary ranges.

A market increase is needed when you have trusted, verifiable market data that demonstrates that someone is not making what they could make if they went out on the open market.

Merit Increases

Merit increases are based on performance, which should be tracked and documented — with feedback given — year-round.

A best practice in administering merit increases is centering increases around a merit pool, a percentage of the totally payroll budget, that you apply to people’s salaries based on performance. It can be tiered out. Let’s say your merit pool is 3%. If you aren’t performing well, you may not receive any increase in compensation. If you are performing as expected, you may receive an increase between 2-3%. If you’re performing very well, you may receive more than 3%. But the average should come back to 3% overall. If a person isn’t making market rate and is performing very well, they may be qualified to receive both a market increase and a merit increase.

If you are in a small company, compensation can be a little more complex. Companies with less than 10 employees likely do not have salary ranges or much differentiation in job descriptions, so understanding the market and competition for your talent is arguably even more important. You need to make sure you’re not getting caught off gaurd and lose a valuable employee because you are paying under market.

Before rolling out any compensation changes, consider the following:

Your Timing

If your organization has never implemented performance appraisals or offered merit increases, shifting to a performance-based focus will take some time. Start simple and ease into it, giving them consumable pieces of information rather than rushing implementation and overwhelming your employee base. Give the organization time to adjust to what it means to have performance reviews and cascading goals, and to understand the benefits of merit-based compensation. Track with your organization to see how they are receiving and responding to the change.

Your Messaging - Providing Total Rewards Statements

As part of your compensation discussion, it’s important to align the message to the type of increase you are providing and to make sure that it is a meaningful discussion.  In addition, it’s very impactful if you can give your employee a Total Rewards Statement, which is a summary of  the value of all of the benefits they receive as an employee. This includes their base salary, bonus structures they have or may be eligible for, paid time off, 401(k) contributions, benefits, and perks. The value of all these things together is a true picture of their total compensation package and can be a powerful statement to your employee.

Your Organization

In addition to knowing your market, you need to know your company and your people. What I have provided for you here are basic compensation frameworks. Apply them in a way that makes the most sense for you and your group. You can always continue to mature the process, adjusting as needed to make your organization most successful. 

Originally published in  Small Business Monthly's December issue of 2023 by Julie Tuggle-Nguyen, EVP of Human Resources