What is Performance Related Pay and How Does It Work?

Keeping employees motivated at work can be a tough issue to solve.

A great way to change this is through performance related pay (PRP). PRP is different from a regular bonus. Instead, it’s a system that links salary progression to overall success at work.

But PRP systems come with their own legal rules. If they're not managed correctly, employees could end up being underpaid or discriminated against.

In this guide, we'll look at what performance related pay is, laws on equal pay, and how to manage a fair system at work.

What is performance related pay?

Performance related pay (PRP) rewards employees for high performance or efforts.

Employees receive PRP on top of their 'fixed hourly rate'. It’s usually given through commission or bonus payments.

For example, a car salesperson receives their normal wage for every hour they work. But, for every car they sell, they're paid another £100 in commission (through the salary system).

PRP processes are usually used in sales-based environments. But it’s harder to offer it to public sector workers, like doctors or teachers. This is because they don’t usually sell or produce a physical item.

But employers can still reward staff for their work performance or loyalty. For example, an employee gets 10% commission for every new person they bring to the company.

Are there different types of performance related pay?

Yes, there are two types of performance pay: short-term and long-term schemes.

PRP isn't solely based on growing a pay scale or giving out financial rewards. Employers can offer so much more. Let’s look at the different types of performance related pay:

Short-term schemes

A short-term scheme offers performance payments like bonuses or sales commission.

They’re usually based on the sales achieved by individuals or the work they've done. Short-term schemes help to grow overall performance and motivation daily.

Long-term schemes

A long-term scheme is used to convince individuals to stay employed at a business.

As well as performance pay, they may be offered things like a pay rise or company shares. In the end, long-term schemes help increase staff retention and company loyalty.

What are the benefits of performance related pay?

Having a healthy performance-based culture is useful to every company. Through hard work, both parties end up with a financial advantage.

A good PRP system grows motivation, productivity, and loyalty. In the end, it's a ‘win-win’ for you and your staff.

Let's look at the benefits of performance related pay:

Encourages better work performance

Most people would prefer to be rewarded for their hard work. That's why PRP helps encourage better work performance.

You can see this through individual performance, as well as collaborative work. Employees focus on their own personal goals, as well as company success.

Encouraging high performance levels passes onto their team. Other employees start to work harder so they can be paid the same rewards.

Boosts work productivity

Linking pay to performance helps to increase your business’s output and revenue.

By setting aside a ‘financial pot’, you'll be able to boost productivity through PRP. It’s also seen as an ethical way to grow productivity.

That’s because employees aren't forced to work overtime to hit their targets. They decide to perform better on their own; but the business reap these benefits, too.

Builds work relations

PRP is often rewarded for individual performance. But you can offer it to teams, for their collective performance element.

When a team works together, it builds stronger work relations. They support and motivate each other to reach the same goals.

In the end, they’re collectively rewarded for their efforts. This can then motivate them when working towards their to the next target or project.

Improves staff retention

When employees feel respected and valued at work, they’re less likely to leave.

PRP is a great way to improve staff retention because it helps keep employees happy and motivated. A positive, collective workplace can also attract talented new candidates.

What are the downsides of performance related pay?

Employees need to be able to grow their work skills (or development needs). And they should be able to do this without worrying about it affecting their job.

But these kinds of attitudes leave employers with a few questions. What really motivates their employees? Just bonuses?

Let’s look at the downsides of performance related pay:

Unhealthy competition

PRP can create unhealthy competitiveness at work.

Certain employees may do anything to get financial incentives. This type of risk-taking can ruin workplace relations and harmony.

A clear example of this is seen during the UK’s financial crisis in 2008. Big bankers exposed their companies to boost their own annual pay packages.

Expensive process

Not all businesses can afford to have PRP systems in place. Depending on your financial incentives and employee numbers, PRP can be expensive.

Sometimes, a business's finances can change overnight. You might suddenly lose revenue or face an economic downturn.

A sudden financial change may mean there’s no room in the budget for incentives. This could mean that your employees lose their PRP.

Causes demotivation

PRP can be incredibly disheartening for low performers in a demanding job.

It’s unfair to judge an employee’s entire financial worth in any given period. Especially when they’re doing their best.

Sometimes, employees can suffer from stress and burnout which leaves them demotivated. This can render your PRP processes less useful, as many employees may fail to see the point of working hard.

Creates unfair treatment

Linking pay progression to performance isn't always done fairly.

That's because setting measurable targets is tricky to get right. For example, a PRP system rewards a team if they hit their targets. But, due to system guidelines, employees who didn’t contribute to the project may still get extra pay.

PRP systems can even discriminate against certain vulnerable groups. Depending on the sector, systems can create unfair pay progression between men and women.

As a result, employees suffer from unlawful discrimination and unequal pay.

What is the UK law on performance related pay?

Employers aren’t required to provide staff with a performance related pay system. But there are relevant laws linked to them. These include:

• The National Minimum Wage Act 1998 (NMW).
• The National Living Wage Act 2016 (NLW).

You aren’t allowed to deduct their wages just because you’ve offered PRP. It’s not a replacement, it’s an addition. This goes for all businesses within the private and public sector.

Under the Equality Act 2010, your PRP process must not discriminate against any employee. This includes protected characteristics, like age, sex, or race.

If your process treats employees unfairly, they could raise this to an Employment Tribunal (ET). Here, a tribunal judge will decide on whether the process was unlawful.

Employers could face losing their staff and paying fines. You may even have to pay back any wages that were illegally reduced.

How to manage performance related pay schemes

People are paid to work; but they're rewarded if they work better. That's where performance related pay comes in.

It's important for employers to have a PRP system that's fair. And they should reflect your business attitude and morals.

Let's look at ways of implementing performance related pay schemes:

Create a performance related pay scheme

The first step to take is to create a PRP scheme.

It might seem like an obvious step. But every company has its own pre-agreed objectives and goals. That’s why it’s not advised to copy schemes used by other businesses.

Instead, make one that's suitable for your practices and staff. These incentives must be attractive enough to motivate them. For example, offering a pay rise, company shares, or even your own products (like a car).

Set fair and reachable targets

The next step to take is to set fair and reasonable targets.

Your PRP system should set clear goals for all employees. They should know what financial reward they’ll get if they reach them.

You can even set targets for particular groups, like the sales department.

Or you can have general ones that include all employees. These pre-agreed objectives may be added to your business policy and handbook.

Maintain your scheme properly

It's important to maintain your PRP schemes properly.

Make effective arrangements to track high performance. Employers can use digital tracking software. It’s less time-consuming and reduces human errors.

It’s important PRP doesn’t replace an employee's ‘performance appraisal’ process. These are reports used to review overall work ability and experience.

Reward employees for the right reasons

PRP schemes shouldn’t just be used to reward employees who hit higher targets. You should reward them for the right reasons.

You can reward staff for good work performance or collaboration. For example, a new employee has hit all their targets in the first month.

Remember, personal development is just as important as pay progression. So, reward your best employees for the right reasons.

Keep a record of your rewards

Employers must keep on top of how much 'money' is used for PRP schemes.

If not, you could find yourself facing financial troubles. Keep a record of all rewards given, whether they're money-based or not. It’ll help you budget better and minimise debt risks.

Review your schemes on an annual basis. This can help you deal with any issues that might lead to unfair payments or discrimination.

Get expert advice on performance related pay with Peninsula

Most employees will work harder when given an incentive to do so. That’s where performance related pay works best.

Use PRP processes to award employee performance and loyalty. In the end, your staff will help you reach overall business success.

However, if you don’t manage them properly, it could lead to repaying wages and facing company damage.

Peninsula offers expert advice on performance related pay. Our HR team offers unlimited 24/7 employment advice which is available 365 days a year.

Want to find out more? Contact us on 0800 028 2420 and book a free consultation with a HR consultant today.