HUMAN CAPITAL PRACTICE

®
CORPORATE LEADERSHIP COUNCIL

™
Implementing Variable Pay-for-Performance in India

A survey by Hewitt Associates suggests that over the past decade, more than three quarters of Indian organizations have consistently
ranked pay-for-performance amongst the top criteria in their reward strategies. In fact, over the years, the percentage of total
compensation offered as variable pay has nearly doubled across all surveyed sectors in the India industry. However, companies in
India encounter serious challenges in successfully implementing variable pay plans. These challenges typically arise due to
companies’ inability to accurately define performance criteria and effectively communicate variable pay plans to employees.

As a consequence, with employee perception toward the larger pay-for-performance system turning negative, failure to address the
above mentioned impediments promptly has the potential to adversely impact employee performance and motivation. In a tight
economy, companies would typically want employees to perform above and beyond their call of duty; but employees will fail to rise to
the occasion until they view a clear link between their compensation and performance. Moreover, in a competitive labor market,
companies with poorly implemented variable pay plans run the risk of losing critical employees to peer companies that offer well-
defined and communicated pay plans.

To summarize, the two key root causes of employee dissatisfaction with the pay-for-performance system are one, unclear performance
criteria which employees are unable to understand, and two, inadequate communication of the pay-for-performance system to
employees. This study discusses how companies can use a combination of individual and organizational results, reward both results
and behaviors, and utilize employee input to clearly define performance criteria; and target pay-for-performance communication through
the compensation function and the direct manager.

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 Implementing Variable Pay-for-Performance in India

C HALLENGE #1: P OORLY D EFINED P ERFORMANCE C RITERIA

One challenge that organizations in India encounter while implementing pay-for-performance systems is failure to build employee trust
in the larger performance appraisal system, including the criteria used to evaluate performance and determine variable pay.
Performance criteria may be unclear or may not adequately capture the results and behaviors that drive performance. This, in turn,
also affects employees’ understanding of the connection between performance and pay, leading employees to perceive the pay-for-
1,2
performance process as unfair.

Organizations should clearly define performance evaluation criteria in order to maximize employees’ perception of fairness in the pay
process*; this includes using a combination of individual and organizational objectives, rewarding both results and behaviors, and
3,4
obtaining employee input in setting criteria as explained below:

REWARD BOTH RESULTS AND BEHAVIORS

Organizations should avoid becoming only “results focused” or only “behaviors focused” in evaluating employee performance.
Research by the Compensation Roundtable suggests that a 60%–40% combination of results-based and behaviors-based evaluation
criteria drives the greatest process fairness perception among employees. Evaluation criteria that are only results-based or only
behavior-based have the lowest impact on improving process fairness perception. One likely explanation for the importance of
behavior-based criteria in increasing process fairness perception is the lack of control employees, particularly at lower levels, often feel
with respect to corporate results which are often a part of results-based criteria. As such, employees will react favorably to the inclusion
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of behavior-based criteria, which are a direct result of the tasks that employees perform themselves.

U SE A C OMBINATION OF I NDIVIDUAL AND O RGANIZATIONAL RESULTS

Employees perceive pay processes to be fair when the organization uses a combination of individual and organizational performance
criteria to determine incentive payouts. Organizations should design results-based criteria that are evenly weighted between
organizational results and individual results. It is interesting to note that despite the lack of control employees feel with respect to
corporate results (as highlighted in the previous paragraph), employees still attach importance to linking pay and performance criteria to
organizational results and strategic goals. In particular, organizations should focus on the following elements of evaluation criteria,
these three characteristics of evaluation criteria tested have more than twice the impact on process fairness perceptions as the average
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across all other levers tested (10%):

Figure 1: Evaluation Criteria with Maximum Impact on Pay Process Fairness Perception

36.5%
33.5%

23.8%
Change in Process
Fairness Perceptions**
Average Change Process
Fairness Perception=10%

Change in Effort=2%

Tie variable pay to achievement of Tie variable pay to future Align individual performance goals
organizational objectives organizational strategy with company goals

*Pay-for-Performance Process Fairness is defined as the employee perceptions of fairness in procedures used to evaluate performance and allocate
variable pay.
**The change in process fairness perceptions is calculated by comparing two statistical estimates: the predicted process fairness level for an employee
who scores “high” on the lever and the predicted process fairness level for an employee who scores “low” on the lever. The impact of each lever may be
modeled separately.

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 Implementing Variable Pay-for-Performance in India

C HALLENGE #1: P OORLY D EFINED P ERFORMANCE C RITERIA (C ONTINUED )

O BTAIN EMPLOYEE I NPUT IN DETERMINING PERFORMANCE CRITERIA

Employees perceive pay processes to be fair when they provide input into the selection of their performance criteria. Organizations
should look to involve employees in setting performance goals and criteria for determining variable pay amounts. By actively engaging
employees in plan design, organizations drive forth the point that performance standards are not set blindly but are set with the idea
that each employee can contribute to meeting the same. Highlighted below is a company’s experience in leveraging employees in
designing the performance criteria; while the profiled company does not have presence in Asia, the challenge encountered is similar to
the challenge Indian organizations face as the Council identified in its informal conversations. As such, Indian companies can use the
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following example to develop variable pay plans which effectively involve all key stakeholders.

Case Example 1: Stakeholder Engagement Strategy

SITUATION Industry: Transportation

Alpha Company’s variable pay plan receives criticism from employees that performance objectives Revenue: $50 Billion–$100 Billion
are not specific enough. This results in not just resistance to using the plans effectively but Employees: 50,000–100,000
ultimately, a complete rejection of the entire pay-for-performance strategy.

ACTION
The company incorporates employee feedback in redesigning performance criteria and communicated the changes.

 HR consults with three management associations representing

Partner with Employees in
Designing Performance
Criteria
employees affected by the plan revamp every month for two years.
 HR solicits feedback from the management associations concerning
development of the individual measures of performance, both qualitative
and quantitative, including the relative weighting each should have
depending on the job category.

 Publishes objective results on national and business unit metrics on a

Provide Employees with
Constant Insight into the
Impact of the Variable Pay
Plan
monthly basis.
 Calculates employee performance according to these output metrics,
and grades performance on a scale of 1 to 15.
 Allows employees to calculate what they will earn at the end of the year
using performance scores, as well as business unit and organizational
performance—the employee can make this calculation at any time.

RESULT
The company encountered minimum employee resistance while designing and implementing the new program. The pay-for-
performance program was honored with the 2006 Excellence in Human Capital Award from the Performance Institute.

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 Implementing Variable Pay-for-Performance in India

C HALLENGE #2: I NEFFECTIVE C OMMUNICATION OF VARIABLE P AY P LAN E XPECTATION AND O BJECTIVES

According to Hewitt Associates, a majority of organizations in India identify ineffective communication of variable pay plan design and
objectives as a major impediment to successful variable pay plan implementation. The mere existence of a robust variable pay plan
does not necessarily translate into successful plan implementation; in order to fully benefit from the plan, organizations need to focus on
communicating the plan expectations and objectives across the employee population. As a result of this ineffective communication,
employees often view payouts as entitlements rather than incentives earned by meeting certain pre-determined criteria. This, in turn,
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adversely affects employees’ willingness to deliver exceptional performance.

LEVERAGE THE COMPENSATION FUNCTION AND DIRECT MANAGERS TO COMMUNICATE PAY - FOR-PERFORMANCE P LANS
Companies can leverage two key sources to effectively communicate variable pay—the compensation function and the direct manager.
By managing the content, timing/frequency, and channel of communication through these sources, organizations can build positive
perceptions of pay process fairness. In addition, managers who effectively differentiate performance and pay and communicate
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individual pay decisions to their direct reports can increase employees’ discretionary effort and retention likelihood.

Figure 2: Key Sources for Communicating Pay-for-Performance

Direct Manager Compensation Function

 Actively reinforce organizational messages
Content around performance expectations, the link
between pay and performance, and
emphasize variable pay potential rather than
just current pay.
 Focus content of communication on the
larger picture i.e. the link between
organizational goals, pay, and performance
criteria to drive fairness perception.

 Communicate variable pay during periods of

 Communicate pay for performance objectives
Timing and measures before the delivery of
organizational change and during
performance reviews.
performance pay.

 Hold at least two or more variable pay related

Frequency formal discussions in order to improve  Communicate about variable pay at least
employee fairness perceptions. once every two months.

 Use face-to-face/telephonic meetings to

Channel discuss variable pay plans. Avoid the use of  Hold one-on-one meetings as opposed to
e-mail-based communication. e-mail/print communication.

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 Implementing Variable Pay-for-Performance in India

C OUNCIL G UIDANCE

Given the dynamic market environment, Indian organizations need to continually reassess their pay-for-performance plans to ensure
that the plans is providing the expected return on the cost as well as helping the organization meet the revenue goals. More
specifically, organizations should keep a constant check on the following aspects of pay-for-performance plans:

 T HE T YPE OF VARIABLE P AY P LAN

Due to external market conditions, the level/amount and timing at which employers want to measure and reward performance often
undergoes a change. This requires organizations to change their variable pay plan to sustain in the new market condition. For
instance, organizations that want to retain employees with a skill set that is not easily available in the current external talent pool
may decide on changing from a short term variable pay plan to a longer-term plan for this particular employee group. To access
more Council guidance on the variety of performance linked short-term incentive plans and long-term cash and equity plans
organizations can choose from, please view the Council studies on Short-Term Incentive/Bonus Plans and Long-Term Incentive
Plan Design.

 EMPLOYEE E LIGIBILITY FOR THE PLAN

When implementing or revising a short-term incentive or bonus plan, organizations frequently need to reconsider which employee
populations will be eligible. That said, changes in customer requirements and cost constraints determine the additional employee
segments the plan will cover and the employee segments the plan will no longer cover. For information on how companies decide
on employee eligibility for variable pay plans, please access the Council study on Short-Term Incentive/Bonus Plans.

 MIX OF O RGANIZATIONAL, TEAM, AND I NDIVIDUAL GOALS

The mix of organizational, team, and individual goals can vary by function and business unit. The weights for each goal can also
undergo a change as a result of changes in the organizational philosophy, product requirements, and customer demands. The
Council offers the following resources to help member organizations determine the weight of various type of goals: Weight of
People and Talent Management Results in Bonus Calculations, Closing the Performance Gap: Aligning with Business Drivers, and
Performance Management: PepsiCo's Dual Performance Rating.

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 Implementing Variable Pay-for-Performance in India

1
Compensation Roundtable, Driving Performance through Pay: Understanding the Effect of Pay Design and Communication on Employee Behavior,
Washington: Corporate Executive Board (January 2006).
2
Tanu Talwar, Variable Pay: Impact on Productivity ExpressComputerOnline, Unknown.
3
Compensation Roundtable, Driving Performance through Pay, Washington: Corporate Executive Board.
4
Paul Loucks, Creating a Performance-based Culture, Benefits & Compensation Digest, July 2007.
5
Compensation Roundtable, Driving Performance through Pay, Washington: Corporate Executive Board.
6
Compensation Roundtable, Driving Performance through Pay, Washington: Corporate Executive Board.
7
Compensation Roundtable, Driving Performance through Pay, Washington: Corporate Executive Board.
8
Federal Times, Bigger Raises Expected with USPS Performance Pay, Federal Times, January 2005.
9
Hewitt Associates, "Hewitt Study Reveals Key Trends in Salary Increases Across the Region," www.hewittassociates.com (2007). [Accessed 24th
August 2009].
10
Compensation Roundtable, Driving Performance through Pay, Washington: Corporate Executive Board.

NOTE TO MEMBERS
This project was researched and written to fulfill the research request of several members of the Corporate Executive Board and as a result may not
satisfy the information needs of all member companies. The Corporate Executive Board encourages members who have additional questions about this
topic to contact their research manager for further discussion. The views expressed herein by third-party sources do not necessarily reflect the policies
of the organizations they represent.

PROFESSIONAL SERVICES NOTE

The Corporate Leadership Council® (CLC®) has worked to ensure the accuracy of the information it provides to its members. This project relies upon
data obtained from many sources, however, and the CLC cannot guarantee the accuracy of the information or its analysis in all cases. Furthermore, the
CLC is not engaged in rendering legal, accounting, or other professional services. Its projects should not be construed as professional advice on any
particular set of facts or circumstances. Members requiring such services are advised to consult an appropriate professional. Neither Corporate
Executive Board nor its programs are responsible for any claims or losses that may arise from any errors or omissions in their reports, whether caused
by Corporate Executive Board or its sources.

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