SAP White Paper

Compensation

Can You Pay People Without Rating Them?

Reconciling Performance Management Trends and
Compensation Realities

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Table of Contents
4 Managing compensation in a changing
performance management climate

6 Your company eliminated annual performance

ratings

8 You still have ratings, but have adopted a

continuous approach to performance
management

9 You’re using informal methods of rewarding

employees such as spot awards

10 Employees expect more transparency around

compensation than ever before

Lauren Bidwell, Ph.D. and Steven T. Hunt, Ph.D.

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Can You Pay People Without Rating Them?

The field of performance management is

experiencing a transformation. This
transformation is focused on creating
new methods that emphasize coaching
dialogue instead of performance ratings,
rewarding employees more informally
and frequently, and being transparent
about how staffing and pay decisions are
made. These new methods are helping
foster better relationships between
employees and managers and enabling
more fair and accurate decisions about
talent. But for compensation
professionals, these changes can be
concerning as they can directly impact
processes used to allocate pay and
rewards.

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Can You Pay People Without Rating Them?

Managing compensation in a changing

performance management climate

To learn how companies are managing compen- Our findin s suggest there are right and wrong
sation in this changing performance management ways to navigate these changes. Failing to think
climate, the Human Capital Management (HCM) through the consequences that changes to per-
research team for SAP® SuccessFactors® solutions formance management have on compensation
spoke with compensation professionals from a practices can pose a serious threat to pay equity
variety of customer organizations. Our conversa- and effectiveness. But when managed the right
tions focused on four specific chan es that can way, many of the changes present opportunities
create signifi ant challenges for compensation for compensation professionals to positively
departments: eliminating formal performance transform the use of pay and rewards.
ratings, adopting a more continuous approach to
performance management, using informal and The primary focus of compensation is ensuring
frequent methods of rewarding employees, and that investment decisions related to pay are made
managing greater employee expectations for in an effective manner. In many cases, these deci-
transparency. sions require comparing employees against one

The Performance Management Change The Compensation Challenge

Eliminating formal performance ratings Maintaining a “pay for performance” philosophy
so the company invests more in employees who
contribute more to the company

Adopting a continuous, conversational approach Making compensation decisions using qualitative

to performance management performance information captured throughout
the year

Using informal, frequent methods of rewarding Ensuring informal, unstructured awards are dis-
employees such as “spot awards” and nonmon- tributed effectively and equitably
etary recognition

Greater employee expectations for transparency Ensuring information about pay is effectively
around compensation fueled in part by access communicated to employees and addressing
to third-party open sources of compensation data inequity concerns based on potentially misleading
third-party data

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Can You Pay People Without Rating Them?

another based on the value they provide to the this difference, that neither one was very effec-
organization. In contrast, a major goal of perfor- tive. As these two processes start to separate,
mance management is to provide employees with compensation professionals have an opportunity
coaching feedback that emphasizes a person’s to reimagine how pay decisions are made without
relative strengths and weaknesses. This feedback being constrained by performance management
tends to be most effective when it intentionally methods that may not have been designed with
avoids comparing employees against each other. compensation in mind. Today, compensation pro-
While compensation and performance management fessionals can build processes that focus on the
share common goals around maximizing employee primary objective of compensation: to generate a
engagement and motivation, they emphasize dif- return on investment and maximize the produc-
ferent techniques to achieve these goals. In the tivity of employees through effective use of pay
past, performance management and compensa- and other forms of monetary rewards.
tion processes were often so tightly linked, despite

Today, compensation professionals can

build processes that focus on the primary
objective of compensation: to generate a
return on investment and maximize
the productivity of employees through
effective use of pay and other forms
of monetary rewards.

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Can You Pay People Without Rating Them?

Your company eliminated annual

performance ratings
If you eliminate performance ratings, it is impor-
THE CHALLENGE: HOW DO YOU ENSURE
tant is that you replace the rating process with a
COMPENSATION DECISIONS ARE EFFECTIVE
well-defined consistent method of accurately as-
AND EQUITABLE WITHOUT RATINGS TO TIE
sessing employee contributions that will support
THEM TO?
compensation decisions. SAP customers de-
A critical component of a compensation profes-
scribed several ways to of doing this, including:
sional’s job is to ensure that compensation dol-
lars are being spent wisely. In other words, they
must ensure the company invests more in those 1. Replacing individual manager evaluations with
employees who contribute more to the organiza- manager calibration sessions
tion. Companies do not have to use annual per- Traditional performance reviews often involved
formance ratings to achieve this. But allowing having a manager and employee sit down on an
managers to make compensation decisions with- annual or quarterly basis to review past accom-
out any form of rating to guide them can pose a plishments, discuss future plans, and agree on an
threat to effective and equitable decisions. As overall rating of the employee’s performance.
compensation professionals at two technology Many companies are eliminating the rating por-
companies described: tion of this meeting. Instead, information related
to employee accomplishments is used during
“We’ve seen greater differentiation, but can’t say subsequent talent review meetings where the
whether the differentiation is dependent on manager meets with other managers to discuss
performance because we don’t have ratings. Our which employees are contributing the most to
belief is that nobody needs rankings or ratings to the organization. This approach removes the anx-
know who his or her highest performers are. But iety and distraction created by including an over-
the risk is how you know you are creating equity all rating in the performance review conversation.
across the company?” It also creates incentive for employees to accu-
rately document their accomplishments through-
“We did away with performance rating scores out the year, as they know this information may
which helped us move away from our old com- be used in talent review meetings that could im-
pensation merit matrix to processes that are pact decisions affecting their compensation.
more fluid HR gives managers general guidelines
for decision-making, but it’s tough to monitor
whether managers are using these guidelines
effectively since there are no ratings.”

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Can You Pay People Without Rating Them?

2. Replacing ratings of performance with ratings 3. Evaluating employees entirely based on goal
of employee value accomplishment
Rather than rating what employees have done in This process starts with managers working with
the past, some companies are focusing on what employees to establish and maintain clear job
they believe employees will contribute in the fu- goals. Employees meet with their manager on a
ture and using this to guide decisions about pay. regular basis to discuss, clarify, and if needed
For example, managers may be asked to rate the modify goals throughout the year. These ongoing
relative criticality of an employee’s skills and ca- discussions focus on improving goal clarity, sup-
pabilities for future business operations. This in- porting goal accomplishment, and evaluating
formation is then used to determine compensa- whether individual goals, tasks, and projects are
tion adjustments. As one SAP customer on track. Managers then reference specific oal
described: accomplishments when making subsequent de-
cisions about pay. As an executive at one compa-
“Rather than creating a performance rating, ny put it:
managers are expected to translate the informa-
tion [the perceived value of an employee] into an “We focus on what people have done for the
appropriate pay decision. There should be no company and not who they are as individuals”.
surprises at the end of the year”.
Companies that use this approach often include
Generating accurate predictions about an em- safeguards to ensure employee behaviors support
ployee’s future contributions requires managers company values. This is to avoid rewarding peo-
to know each employee at a deep level and have ple for accomplishing the right things the wrong
insight into the full range of that employee’s way. Some companies also calibrate goals based
unique skills and capabilities. For this reason, it on difficu y and importance so that certain goals
can be valuable to host calibration sessions where are considered more valuable than others when it
stakeholders from across the organization are in- comes to compensation increases.
vited to share feedback and points for compari-
son. At the very least, managers should be given
clear criteria for evaluating an employee’s future
value. Remember, employees are still going to ask
why they did or did not receive the pay they ex-
pected, regardless of whether decisions were
based on ratings of past performance or evalua-
tions of future value.

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Can You Pay People Without Rating Them?

You still have ratings, but have adopted a contin-

uous approach to performance management
Companies are ‘modernizing’ ratings by basing
THE CHALLENGE: HOW CAN MANAGERS
them on more ongoing information about how
GENERATE MEANINGFUL RATINGS THAT
well an employee’s actions directly support com-
REFLECT THE BENEFITS OF MORE FREQUENT
pany values and objectives, as opposed to evalu-
MANAGER-EMPLOYEE CONVERSATIONS?
ating general personal competencies and skills.
The reason many companies eliminated formal
As one compensation professional described:
performance ratings was not because ratings
cannot work, but because the rating processes
they were using generated data that was not con- “We used to have only mid- and end-year evalua-
sidered accurate or useful. For example, some tions. Now we have more informal check-ins and
companies’ performance rating processes were a year-end rating component that mirrors what is
so tightly coupled with compensation that they being discussed during those check-ins. Ratings
were basically a compensation justifi ation exer- used to be based on competencies and skills, but
cise (for example, if an employee is rated as a now managers base ratings on employee goal
“solid performer,” an automatic 3% increase is accomplishment and how employees reflect the
given, but if they are rated as an “outstanding company culture. It’s a whole different methodol-
contributor”, a 4% increase is given). Adopting a ogy for which Continuous Performance Manage-
more continuous approach to performance man- ment is very conducive.”
agement can provide opportunities to improve
how companies guide compensation decisions. Core to this change is using rating and compen-
Encouraging more ongoing dialogue between sation methods where managers actively discuss
managers and employees can help managers and review information about employee accom-
gain a deeper understanding of the true contribu- plishments gathered throughout the year. The
tions and capabilities of each one. This knowl- rating process should not be a two-week exercise
edge can in turn lead to more effective, accurate done at the end of the year. Ratings and compen-
ratings used for compensation decisions. As one sation decisions should be a continuation and
compensation professional described: summary of information managers have been
discussing with employees on an ongoing basis.
“Six or seven years ago, we dabbled with elimi- As one SAP customer told us:
nating ratings. Today, we’re rethinking the pur-
pose and putting our focus on results instead. “If managers and employees are having effective
Ratings are back ... We feel we need to modernize and transparent conversations about performance
the way we view compensation decisions and through the year, the actual rating becomes a
think about it more from a business point of view. “non-event.”
Are we spending our resources in the most
effective way?”

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Can You Pay People Without Rating Them?

You’re using informal methods of rewarding

employees such as spot awards

THE CHALLENGE: HOW DO YOU ENSURE THESE To ensure managers are making the most effec-
MANAGER-DRIVEN AWARDS ARE DISTRIBUTED tive compensation decisions possible, companies
EFFECTIVELY AND EQUITABLY? should provide them with the necessary training
Many companies are making greater use of spot and resources including:
awards and non-monetary awards. These awards •• An overview of the company’s compensation
have the potential to be very motivating to em- philosophy related to on-the-spot and non-
ployees, but their informality and relatively small monetary awards
size often deems them unnecessary to monitor •• Clear definitions f award-worthy behavior
for equity issues. As a compensation professional based on organizational values and goals
described: •• Guidance for determining appropriate award
type and value
“A manager can’t award the same employee
more than $7,500 in a given year, but anything Giving managers more decision-making autono-
$1,000 or less is under total manager discretion. my around compensation does not mean manag-
Our HR business partner does not review or ers should not have to justify their decisions. In
monitor these decisions.” fact, giving managers more freedom to make pay
decisions should increase expectations that
The reality is that even small awards will frustrate managers can explain how they make these deci-
and demotivate employees if they are distributed sions. By asking managers to justify their on-the-
inequitably. As the same individual went on to say: spot and non-monetary award decisions, compa-
nies can mitigate the risk of rewards being given
“We think managers having more autonomy is a in an inappropriate or inequitable manner. Man-
good thing. But there is a trade-off in being able agers should also ensure that employees under-
to monitor decision accuracy. As gender pay stand why they are receiving the award. As one
equity becomes more critical, we recognize this compensation professional described:
tradeoff ould be an issue.”
“Managers can allocate budget [for awards] at
their will, but need to explain how they allocated
it and why. This is for both the employee and the
manager’s benefi . They need to be able to say
what specific beh vioral and/or cultural values
the award is aligned to.”

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Can You Pay People Without Rating Them?

Employees expect more transparency around

compensation than ever before

THE CHALLENGE: HOW DO YOU ENSURE THAT employees nor managers understand the com-
INFORMATION ABOUT PAY IS EFFECTIVELY AND pensation program. They don’t understand how
SENSITIVELY COMMUNICATED TO EMPLOYEES? decisions are made. It’s not resonating. It’s just
Employees have more means of accessing pay in- too overwhelming alongside all of the other
formation today than ever before (for example information managers and employees have to
through job search sites). With this accessibility regularly take in.”
comes a new level of expected transparency
around pay decisions. As part of a broader re- Managers are much more likely to have high
search study on changing compensation practic- quality, critical conversations related to pay deci-
es, we spoke with 50 front-line employees from a sions if they are provided training on how to do
variety of organizations and industries. These so. In addition to managers being trained on how
employees described a clear expectation of man- compensation decisions are made across the or-
agers being willing to have detailed conversations ganization, communication training for managers
related to decisions that affect their pay. But we should focus on:
know from our conversations with managers that •• The importance of communication in influen -
talking to employees about pay decisions can be ing employee receptivity to decisions
difficult and u omfortable. •• Improving interpersonal skills needed to navi-
gate difficult onversations – several compa-
Compensation professionals told us that managers nies stressed the value of in-person, live, and in-
struggle to have productive conversations with teractive training with a role play component
employees about compensation because they: where managers can practice delivering un-
•• Don’t understand how components of the com- comfortable pay decisions
pensation package are determined themselves •• Tips for what to say and what to be careful
•• Don’t grasp the importance of communication about saying
•• Weren’t directly involved in the compensation
decision and thus do not feel accountable for it All changes can be seen as threats or opportuni-
•• Don’t want to have potentially uncomfortable ties, and the performance management transfor-
conversations mation is no exception. The changing world of
performance management presents an opportu-
As one compensation professional described: nity for compensation professionals to rethink
the processes used to make and communicate
“We provide training videos to talent acquisition compensation decisions. But to achieve this,
and HR to ground them in the basics of our companies must think through the downstream
compensation philosophy. We provide training consequences of changes in performance man-
directly to managers related to compensation, agement on compensation and be proactive in
FAQs, and so on. But we did focus group inter- implementing strategies to overcome these chal-
views this year and the reality is that neither lenges ahead of time.

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enUS (23/02)
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