Compensation modelling for performance appraisal To understand the process/ logic/ science/ maths behind the various numbers that keep floating around during performance appraisal, eg why is the increment/ variable pay X%?

1. Compensation modelling for Performance appraisal
HR professionalsstruggle with performanceappraisalseachyearandprocessesvaryfrom one
organizationtoanother. Some struggle tounderstandthe process/logic/science/mathsbehind the
variousnumbersthatkeepfloatingaround,egwhyisthe increment/variable payX%?Andthere is
limitedinformationavailableoninternet.
Hence,I have triedtoput togethermythoughtson the holisticprocessof compensationmodellingfor
performance appraisal.
The followingare the stagesinarrivingatthe final model:
1. Assessmentof companyperformance
2. Assessment/Translationof SBU/Departmentperformance
3. Definingthe populationspreadfor apre-decided ratingscale
4. Definingthe SBU/ Departmentspread
5. Decidingthe % payoutfor eachlevel of performance
Thiswouldusuallyhave the followingelements:
a. IncrementPayouts
b. Performance BonusPayouts
c. PromotionPayouts
d. Market CorrectionPayouts
6. Level wise spread
7. Checksforthe finalizedmodel
Factors affectingthe overall modellingprocess:
 InflationRate (Annual) –The servesasthe broadbenchmark(forincrement) foranaverage
performeratmiddle managementlevel
 Budgeted/ProvisionedIncrementrate –Thisservesas the ‘upwardceiling’,if the company
performance hasbeen100% or lower
 Companyperformance
 Percentilethatthe companywantsitself tobe peggedatfrommarket perspective
 Appropriate correctionsniche/critical roles
 Overall compensationPhilosophy
o Industrylifecycle stage
o Companylifecyclestage
o Workforce demographics(age etc.)
o Productportfolio
o FixedvsVariable
1. Assessmentofcompany performance
How hasthe companydone inthe last year? Top managementevaluatesthe performance of the
companyinthe lastfinancial yearandjudgeswhethertheyhave:
a. Overachievedthe plannedtargets
b. Achievedthe plannedtargets
c. Under achievedthe plannedtargets
Thiscouldbe intermsof financial indicatorslike revenues,PAT,marketcapitalization etcorevenin
termsof customergrowth, milestone dealsetc,whichmighttranslate intomoneyinfuture.
2. Assessment/Translation of SBU/ Department performance

2. The nextstage is to identifythe performanceof the variousdepartments.Once the company
performance isfixated,the SBU/Departments are ratedrelative to(above orbelow) the company
performance.
How haseach SBU/ Departmentfaredinthe overall scheme of things?Have some done betterthan
expected,Have some notbeenable tomeettheirtargets.
For departmentslikesales,marketing etc,it’dbe easytomeasure as theirtargetsare fairlyobjective
while forbackendfunctionslike finance,HR,Adminetcit’dbe slightlydifficulttomeasure astheir
targetsare quite subjective innature.
3. Definingthe populationspread for a pre-decidedratingscale (usually5 point)
Each & everyindividualhascontributedtothe overall growthof the company.But,some would have
done betterthanothers.
Thenwe try to segregate the entire population, basisthe performance.Thisisdone topromote a
performance/meritbasedculture.
The usual distributionisa‘normal curve’.An ‘exactlynormal’curve hasnoskew eg, equal numberof
people intop& bottomcategory (egA & E or B & D). [Here were assumingthe scale toa 5 pointfromA
to E, A beingthe highestratingandE beingthe lowestone.]
The peak of thiscurve is highas illustratedinscenario1.Thismeansthatthe difference inincrementfor
A to B wouldbe fairlyhigh.
To reduce the differential,we spreadthe populationtoreduce the peak,asillustratedinscenario2.
In reality,the curve is‘approximatelynormal’ andskewed,usuallynegatively,asillustratedinscenario3.
Ratings Ideal spread
(High peak)
Curve to
reduce peak
Company
performance curve
A 5 5 5
B 10 15 25
C 70 60 40
D 10 15 20
E 5 5 10

3. The spreadis selectedheavieratB & C ratingsbecause:
 The intentisusually togive moneytomostof the employees (populationdensityishighestatC)
 It helpsinnormalization.Eg, Bcan be movedtoC and C can be movedtoD & E.
4. Definingthe SBU/ Departmentspread
The above mentionedstage isrepeatedforeachSBU/ Departmenttoarrive at theirrespective
populationspreads/distribution.
For eachSBU/ Department,the spread/curve canbe obtainedas follows:
 Performance of SBU/Department< Company,the spreadshiftsleft
 Performance of SBU/Department = Company,the spreadremainsasitis
 Performance of SBU/Department > Company,the spreadshiftsright
The table below demonstrates the same:
SBU/
Department
A B C D E
Company/
Dept1
5 25 40 20 10
Dept2/ Dept3 7 27 40 18 7
Dept4 6 26 40 19 9
Dept5/ Dept6
Dept7

4. 5. Decidingthe % payout for each level ofperformance
Thiswouldusuallyhave the followingelements:
a. IncrementPayouts
Assuminginflationrate is10%.The incrementof the average performer(Crating) isassumedtobe
equal tothe inflationrate.
Then,decidingthe %incrementforthe restof the performance ratingisa mix of ‘science & art’
SBU/
Department
A B C D E
Company 15% 12% 10% 8% 5%
The same processisadoptedforeach SBU/ Department.
b. Performance Bonus Payouts
Thiscomponentisa reflectionof the lastyear’sperformance.
The higheryoumove upin designations, the higheris the variable as% of CTC andvice versa.
Designations↑ --->variable as%of CTC ↑
Assumingoverall company’sperformance forlastyear ispeggedat80%. The variable payoutof the
average performer(Crating) isassumedtobe equal tothe company’s performance.
SBU/
Department
A B C D E
Company 110% 95% 80% 60% 30%
c. Promotion Payouts
Employeeswhohave gotapromotion,are compensatedfortheirnew levels/designations.
Usually,froma modellingperspective,thisisequal tothe increment%(orsome factorof it)
proposedfora particular(currentNOTproposed/new) level/designation&rating.
While some companiesbelieve inthisschool of thought,othersdon’t.
d. Market Correction Payouts
Thiselementisproposedforemployees/roleswhose salariesislessthanthe currentmarketmedian
salaries. Thisinphilosophyisdone forroleswhichare critical toan organizationfromafuture road
map perspective.

5. Thisdata can be receivedthroughreportspublishedbyleadingHRconsultancieseveryyear.The
companycan get the same by participatinginsuchsurveysandwithpaymentof the appropriate
fees.
Companieswhichcan’taffordthese services,maygetthe understandingof the broadbenchmark
salariesbymappingtheircompetitionfordesiredroles.
6. Level wise spread
The higheryoumove up indesignations, the lowerthe % of incrementbecomesandvice versa.
Designations↑ --->%increment↓
Thisis because the salarybase movesupas youmove up indesignations,andevenasmaller%
incrementmeansasubstantial jumpinabsolute terms.
SBU/
Department
A B C D E
SeniorManager 12% 10% 8% 5% 3%
Manager 15% 12% 10% 8% 5%
Executive 20% 15% 12% 10% 8%
7. Checksfor the finalizedmodel
For a certainSBU/ department&designation&ratings,the currentmanpower/salarycostsare
multipliedbythe respective %incrementstoarrive atthe new manpower/salarycosts.
The weightedaverage of SBU’sspreadsshouldmatchwiththe companyspread.
Andthe summationof the cost impactof all SBU/ Departmentsshouldaddupto that of the cost impact
of the overall company.
The revisedmanpower/salarycostsare withinthe budgeted/provisionedfigures.
Afterthe above stepsare done,one maycontinue withthe usual processesof mappingthe individual
performance ratings&associatedincrements.
To summarize, compensationmodellingforperformance appraisal is alittle bitof bothscience &art.
Andthe keyis to balance betweenthe two, giventhe organizationalcontext.
One may wonderthatI have writtensomuch aboutbell curves,whereas several organizationsare
movingawayfromthe bell curve approachforperformance appraisal.AsfarasI think, some sortof a
categorizationof employeeswouldalways continue to exist. Ithink,the keyistokeepthe bell curve
‘flexible’ &notrigid.