Top Strategies for Linking Pay to Performance Successfully

The annual salary review is a standard process for most companies and HR teams. Employees often expect a yearly salary increase to keep up with rising costs. But this process isn’t as simple as giving everyone a set raise and moving on—it’s an opportunity to reward employees who go above and beyond, contributing significantly to the organization's success.

This is where performance-related pay, or merit pay, comes in. Linking salary increases to individual performance is a straightforward way to ensure top performers feel valued and that those who need to improve are encouraged to do so. However, this concept sparks debate in boardrooms and break rooms alike. For some, it's a fair way to reward effort and results; for others, it can create unhealthy competition among colleagues.

The truth? Linking pay to performance can work—but only if done with clarity, trust, and a purpose aligned with your company culture.

Step One: Know Your Objectives

Before designing any performance-related pay system, ask: What are we hoping to achieve? Start with small and realistic goals, then build from there. Here are the four levels of objectives, from simplest to most ambitious:

• Attract top talent by reflecting market standards.

• Align rewards with organizational priorities—what matters most to the business?

• Ensure fairness—reward people based on their real contributions, not just tenure.

• Foster a culture of improved performance.

It’s tempting to aim for all four. Resist. Clarity is key. Focus on fairness (Objective 3) and alignment (Objective 2) first. When people see their efforts tied to meaningful rewards, they stay engaged, loyal, and motivated.

One Size Doesn’t Fit All

In global organizations, we value equality and fairness. But fairness doesn’t always mean equality.

Performance pay works best in roles that require skill, creativity, and discretion—like a software engineer. Their contributions can be far more impactful than someone in a similar role with less influence. Rewarding this difference isn’t divisive—it’s fair.

On the other hand, routine, task-based roles might need a different approach. The key takeaway is to tailor your system to the role.

Trust is Your Foundation

Here’s the hard truth—if your managers can’t evaluate performance fairly, no pay system will succeed. So before tying pay to performance, ask:

• Do managers have the skills to assess performance consistently and transparently?

• Is the performance management process trusted by employees?

• Can decisions be documented and defended?

• Do managers assess performance in the same way?

If not, take a step back. Invest in upskilling managers and strengthening processes. Without trust, any attempt at performance-related pay will create resentment, not results. High-performing employees will leave a company if they don’t feel their hard work is properly rewarded.

What Fair Pay Really Looks Like

Imagine two team members; both earn the same salary, but one consistently delivers innovative solutions, while the other meets only the minimum expectations. Without recognition, your top performer feels overlooked. Over time, they disengage or might even leave.

A fair system prevents this. Here’s one example:

• Base Pay Range: Employees earn a standard rate for their roles.

• Performance Pay: Strong, consistent performers progress faster.

• Non-Consolidated Bonuses: Exceptional performance earns extra pay—without inflating base salaries.

This model works particularly well for roles where individuals significantly influence outcomes. It ensures fairness, retains top talent, and rewards genuine contributions without unnecessary costs.

Performance Conversations Are Key

Linking pay to performance doesn’t start with spreadsheets—it starts with conversations. Performance management processes should already be in place, but here’s the truth: Linking pay to results often improves the quality of those conversations.

Why? Because managers are now compelled to provide meaningful feedback. Issues are addressed early, and successes don’t go unnoticed.

READ CASE STUDY | Nordic Insurance Provider Improves Performance with SAP SuccessFactors

The Pitfalls of Performance-Related Pay

When implemented poorly, performance-related pay can backfire. If performance measurement is not based on clear objectives or managers measure employees inconsistently, it can feel unfair. Favoritism can lead to disparate pay increases, and employees might engage in unhealthy competition or take unnecessary risks to hit targets. Meanwhile, those with mediocre or lower performance might feel discouraged.

Going Beyond Salary Increases

Sometimes, increasing a high-performing employee’s salary each year just isn’t feasible. This is why a well-rounded performance-related pay culture should include other reward mechanisms. Short-Term Incentive (STI) schemes or bonuses are key to recognizing top employees. Long-Term Incentive (LTI) schemes help retain talent that makes a lasting difference. Spot Award programs provide instant feedback to an employee, encouraging positive work and increasing recognition.

The same principles apply to these other reward tools; they must be based on clarity, consistency, and openness.

Practical Steps for Organizations

Before launching a performance-related pay system, consider this checklist:

• Define Clear Objectives: Start with fairness and alignment before aiming higher.

• Segment Your Workforce: Identify which roles benefit most from performance pay.

• Invest in Training: Equip managers with the skills to evaluate fairly and transparently.

• Strengthen Governance: Ensure pay decisions are well-documented and defensible.

• Start Small: Pilot performance pay with one department or role before scaling.

• Communicate Clearly: Be open with employees about how the system works and why it’s being introduced.

• Measure and Adapt: Continuously assess the impact on retention, motivation, and culture.

• Maintain Job Evaluation: Use job grading as a baseline but reward individual contributions on top.

• Combine Pay Methods: Balance base salary progression with non-consolidated bonuses.

• Test Your Systems: Ensure performance reviews are trusted before linking them to pay.

A Perspective from Effective People

In Europe, where workforce expectations lean towards equality and fairness, performance pay can succeed if it’s fair, transparent, and measured. The key lies in treating people like humans, not numbers. The right pay system doesn’t just motivate—it builds trust, reinforces culture, and rewards contributions in a way that employees respect.

With the SAP SuccessFactors HCM Suite, you can elevate performance management and create a pay system that aligns with your organizational priorities. Designed for fairness, transparency, and impact, SAP SuccessFactors helps ensure that people are rewarded for what truly matters.