Merit Pay Program Design and Effectiveness September 18, 2014

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1 , Performance Development International, LLC Merit Pay Program Design and Effectiveness September 18, 2014 Presented by: Rena Somersan Principal Verisight, Inc.

2 Verisight delivers differences that count Retirement plan compliance and administration Compensation consulting Health and welfare consulting Retirement consulting Actuarial consulting ESOP consulting Government representation and reporting Surveys and benchmarking Employee Education Flex plan services 2

3 Overview Survey conducted June/July 2014 Conducted by Verisight in conjunction with Dow Scott, Professor, Loyola University - Chicago Participation solicited from clients, prospects, and local HR/compensation associations More than 200 participants Diverse industries, organization size, and ownership Presenter Rena Somersan, Principal, Verisight Brian.Repsold@ Rena has more than 20 years of consulting experience linking organizational strategies with desired human capital performance and outcomes. Typical engagements range from developing compensation systems and variable pay plan design, evaluation of performance management system effectiveness, to benchmarking human capital trends. Rena s lived and worked in Japan, and while living in Istanbul Turkey, has experience implementing compensation systems there too. 3

4 Industries Industry Percentage Response Manufacturing/Wholesale 22% Healthcare and Social Assistance 14% Professional, Scientific and Technical Services 14% Finance and Insurance 10% Services (Other, except Public Administration) 5% Retail Trade 4% Educational Services 3% Utilities 3% Information 2% Transportation and Warehousing 2% Other 21% 4

5 Company Size - Revenue Company Size- Revenue Percentage Response Less than $50 M 17% $50M to less than $100 M 10% $100M to less than $500 M 13% $500M to less than $1 B 16% $1 B to less than $5 B 29% $5B+ 16% 5

6 Company Size - Employees Fewer than 100 employees 10% 100 to % 500 to 999 9% 1,000 to 2,499 18% 2,500 to 4,999 8% 5,000 9,999 12% 10,000 to 19,999 10% 20,000 and over 15% 6

7 Ownership Status Privately owned company 40% Publicly traded/listed company 33% Not-for-profit 23% Government or public sector 2% Other 2% 7

8 Self Assessment of Company Performance Top 20th percentile 33% 60 to 79th percentile 33% 40 to 59th percentile 31% 20 to 39th percentile 3% Bottom 20th percentile 1% 8

9 Merit Pay Program Coverage All employees in your organization 63% All salaried or exempt employees 25% Only managerial and professional employees 12% All exempt union employees 0% 9

10 Merit Pay Program Goals and Effectiveness How Important are Merit Program Goals How Effective are Merit Pay Programs at Meeting Goals Not Important Marginally Important Important Not Effective Marginally Effective Effective Communicates to employees that the contributions they have made to the organization or department are appreciated 3% 8% 89% 8% 25% 67% Motivates employees to perform at higher levels 2% 12% 86% 10% 32% 58% Motivates top performers to stay (i.e., retention) by giving them larger relative pay increases or positioning them toward the top of pay ranges Communicates to employees that the organization has a performancedriven culture (i.e., meritocracy) 3% 12% 84% 12% 27% 61% 8% 8% 84% 9% 29% 61% Enhances employee perceptions of pay fairness by rewarding merit 4% 13% 83% 12% 29% 59% Rewards the accomplishment of specific organizational behavioral objectives, such as teamwork or customer service Forces managers to distinguish high performers from low performers for allocation of limited merit increase budgets 6% 12% 82% 10% 32% 57% 10% 10% 80% 11% 28% 60% Attracts high performers (i.e., recruitment) to the organization 18% 18% 64% 25% 31% 44% Motivates poor performers to leave (or improve) by giving them lower relative pay increases or positioning them toward the bottom of the pay range Adjusts the pay structure to accommodate annual or bi-annual labor market increases, so high performers populate the top of the range and poor performers and new employees populate the bottom of the range Discourages average or low performers from applying for jobs in your organization 15% 28% 57% 28% 41% 31% 26% 27% 47% 21% 29% 50% 60% 25% 15% 54% 32% 14% 10

11 Effectiveness of Performance Criteria Used to Award Merit Increases Frequency of Use Not Effective Marginally Effective Effective Very Effective Communicates employee contributions 99% 6% 29% 51% 14% General competencies or behaviors associated with most jobs (e.g., leadership, timely response to work demands, meets goals on time, works well with team) Accomplishment of performance goals set for the job or person in the job 91% 2% 25% 58% 15% 90% 3% 22% 56% 19% Accomplishment of the job duties listed in the job description 80% 5% 30% 56% 9% Exhibiting behavior associated with effectively performing the specific job (e.g., behaviorally anchored Rating Scales BARS) 59% 7% 26% 52% 15% Open-ended: performance essays or discussions 48% 5% 34% 53% 7% 360 degree feedback 24% 15% 29% 44% 13% Team rating instrument 12% 17% 35% 35% 13% 11

12 Responsibility for Rating Employee Performance The employee s direct or immediate supervisor 92% Department head or manager, even if they are two or morelevels above the employee 3% 360 degree or multiple raters are used to score employee performance 2% Other 3% 12

13 Characteristics of Performance Appraisal and Performance Management Process Requires supervisor and managers to tell employees their performance ratings 87% Uses online software designed for rating employee performance 56% Requires that supervisor and managers receive training 50% Uses a paper process which may incorporate MS word or excel types of software Conduct performance calibration meetings to review performance ratings across departments 38% 43% Roll-up process so supervisor ratings are compared to others at higher levels 33% Requires employees to receive orientation or training on the performance appraisal program 29% Requires supervisor to make a forced ranking or force distribution where only a limited number of top performance ratings can be given 20% Other 3% 13

14 Performance Rating Scales Scale Percentage use Four or five-point scale 77% Three-point scale 10% Other or multiple scales 8% Performance ratings are not used to determine merit increases 5% 14

15 Distribution of Performance Scores Most people fall into the middle with a bell-shaped; distribution around the middle Percentage Use 50% Spread is skewed towards higher performance ratings 39% Spread is skewed towards lower performance ratings 0% Employees are approximately evenly spread across performance ratings 1% Do not track this information 9% Other 1% 15

16 Method Used to Budget Merit Increases Percentage Use Budgeted in advance as a percentage of payroll based on predicted revenues and what other firms are budgeting for merit increases 79% Discretionary funding (i.e., the merit award pool) is typically decided by management just before awarding the merit increases based on affordability, turnover, etc.) 17% Self-funded through reduced costs or increased revenues/sales (i.e., the increase is typically driven by a formula established in advance) 1% Other 2% 16

17 Determinants of Merit Budget Size Not Important Marginally Important Important Affordability; given labor costs and expected revenues 3% 3% 93% Success of the organization in meeting its profit margins, revenue, sales, or other financial goals Survey predictions (such as SHRM or World at Work, etc.) of the amount other organizations are budgeting for merit pay increases 3% 6% 90% 12% 11% 78% Ability to attract and retain employees 8% 19% 73% Amount required to keep the organization s targeted position in the labor market (e.g., 50th percentile) 14% 30% 56% Conduct informal survey of competitors and/or own industry 33% 28% 38% 17

18 Merit Increase Award Schedule Annually, on the same date for all employees (focal date) 82% Annually, but not on the same date for individual employees; could be based on employee 11% Depends on the performance of individual employee; can range from a few months to more 2% More than once a year 1% Other 4% 18

19 Adjustments Made to Salary Merit pay increase rolled into base salary based on individual performance Market adjustments (pay is increased to keep up with market pay) Increase/adjustment based on position in salary range Cost of living adjustment to keep employee pay at least partially whole in regards to Increase in salary or wages based on organization performance Other 7% 6% 12% 35% 59% 82% 19

20 Merit Pay Increase Information Provided to Employees Percent Used Size of the merit increase or the amount of the new salary 94% The position the employee now has in the range 31% Average increase given to all employees 10% The range of rewards for different levels of performance 7% The amount of the merit increase that other employees received 2% Average increase given to team or department 1% Other 6% 20

21 Criteria Used to Evaluate Merit Pay Program Employees understand the merit pay program and how their increase was awarded Satisfaction of managers or supervisors with the merit pay program Company/organization overall performance such as total shareholder return, revenues, etc. Employee satisfaction with pay or merit pay or perceived justice Not Important Marginally Important Important Very Important 6% 10% 41% 43% 6% 15% 53% 26% 16% 13% 38% 33% 7% 22% 47% 23% Employee turnover 8% 28% 44% 20% Administrative efficiency of the appraisal process 13% 29% 45% 14% Rating of your company (e.g., Fortune s most admired companies) 57% 23% 15% 6% 21

22 Use of Merit Pay Guide Chart (increase matrix) Management Use of Merit Increase Guide Chart Yes 58% No 42% Individual performance score Position in range 72% 91% Length of time since last merit increase 10% Other 6% 22

23 Software Used to Administer Merit Increases Microsoft Excel or other spreadsheets 40% HRIS software, such as People Soft with merit pay add ons 27% Specialized compensation software that allows for merit pay administration 16% Performance Appraisal software with merit pay addons 11% Other 8% 23

24 Variation in Merit Pay Increases Base salary increase is not based on performance 5% Everyone receives approximately the same increase 13% Small variation (increase for top performers is 1.25 times the average) 27% Moderate variation (increase for top performers is 1.5 times the average) 35% Considerable variation (increase for top performers is 2 times the average) 20% Extreme variation (increase for top performers is at least 3 times the average) 2% 24

25 Variation in Merit Pay Increases Across all levels, high performers received an average salary increase of 4.8 percent, up from 4.0 percent the prior year. High Performers 4.5% 4.8% Satisfactory Performers 2.9% 3.0% 1.5X Low Performers 1.8% 2.1% Source: 2013/2014 Verisight/McGladrey Compensation, Retirement, and Benefits Trends Report. Mean Median 25

26 Merit Increase Amounts Year Average Range % 0-5.0% % 0-5.0% % 0-6.0% 26

27 Pay Structure Adjustment Frequency Not consistently adjusted OR as needed based on market conditions 23% Less than once every two years 5% Once every two years 12% Once a year 47% Multiple times per year 0% We don t have a salary structure 12% 27

28 Pay Structure Range Spreads No salary ranges Less than 30% 30 49% 50 69% 70 99% 100% 149% 150% 199% 200% or greater 1% 1% 4% 10% 9% 15% 22% 40% 28

29 Questions? Rena Somersan Principal Verisight, Inc