Do you pay for performance or employee potential?

Pay for performance, meet your possible replacement: pay for potential.

5 minutes

Professional worker with accounting documents, laptop and taxes or bookkeeping

Pay is number one

Let’s start with this. No matter how much America’s workers seek benefits, career opportunities and work-life balance, pay is usually their top job factor. From Baby Boomers to Gen Z, compensation just matters—a lot. According to a Paychex survey of 2,000 employees, the number one reason workers leave jobs is because of low salary. And employers know this; Per our own “Best-in-Class Workforce Management Insights” report, 77% of 500 executives believe salary is the most important factor to their employees. The proof is in the pudding.

Pay is complicated

There are many sticky points with pay. Obviously, employers and employees must agree on numbers, which often results in compromises. There are issues brought to light by the Fair Labor Standards Act (FLSA), such as minimum wage (raising or not raising the federal figure) and overtime (determining who qualifies for it), and the fact that costs of living have accelerated faster than some jobs’ wages. Oh, and we can’t forget pay inequality. Because, believe it or not, women continue to earn roughly 80 cents for every dollar men earn in equivalent jobs.

Pay for potential is making things more complicated

If those sticky points aren’t enough, enter pay for potential. What is it? Basically, instead of paying for today’s performance, it’s paying for tomorrow’s potential. It’s not about tasks that were, or are being, completed; it’s about tasks that will be completed. There’s some projecting involved, which can be risky, but it can also be rewarding. Whatever happens regarding employees’ future performance, the idea is this: By paying them generously now (and not in the form of bonuses later), you’re providing them confidence and motivation to accomplish great things in the future. You’re also investing in them so that they’re more likely to invest in your business instead of hop to another job.

A pay for potential vs. pay for performance hypothetical

To illustrate these two approaches, we’ll create two fictional characters: Elizabeth and Melissa. They both just landed marketing manager jobs at competing companies in the same mid-size market: Company Potential and Company Performance. The thing is, Company Potential believes in the new school pay for potential approach, and Company Performance believes in the old school pay for performance approach.

Elizabeth and Company Potential

Elizabeth and Company Potential are up first. Now, based on the position, local market and her experience, Elizabeth expected to earn a salary around $100,000. Fortunately for her, Company Potential has extra appreciation for her talent, considers the cost of turnover, and offers her a pay for potential salary of $115,000. Flattered, Elizabeth accepts the offer without hesitation and hits the ground running.

While Elizabeth is off to a fast start, Company Potential is assessing the situation. They’ve invested $15,000 more than what was probably necessary in Elizabeth’s salary. With that extra cost, they’re hoping for—or even expecting—extra motivation and a top-notch performance. Through the first month, they get exactly that, as Elizabeth made a terrific new hire herself, expedited some critical changes and ramped up website traffic and engagement.

Over the course of the next 11 months, Elizabeth continues to prove her value. She’s consistent and rarely has off days. How much of this can be attributed to her pay for potential salary, as opposed to her personality, company culture, work-life balance, etc., is open to interpretation, but that $115,000 certainly doesn’t hurt. One thing that is not open to much interpretation is Elizabeth’s likelihood of staying at Company Potential; it’s unlikely any competitor will steal her for a higher salary. (And remember, salary is the number one reason people switch jobs).

Melissa and Company Performance

Melissa and Company Performance are up next. This time, based on the same criteria as before (position, local market and her experience), Melissa expected to earn a salary around $100,000—and that’s exactly what she was offered, because, remember, Company Performance still pays for performance, without weighing upside as heavily. While the competitive offer was enough for Melissa to accept, it didn’t exactly make her jump for joy.

Melissa starts her job just like her previous two jobs, with determination and poise. And like any responsible company should, Company Performance begins to evaluate her first few weeks. While their expectations are just as lofty as Company Potential’s for Elizabeth, is it fair for them to expect the same performance, in the same position, for $15,000 less? So far at least, everything is going well; Melissa is making an impact with new strategies and fresh ideas.

Over the course of the next 11 months, Melissa consistently exhibits her hard and soft skills. Again, just like with Elizabeth, how much of this can be attributed to her pay for performance salary, as opposed to her personality, company culture, work-life balance, etc., is open to interpretation. But if she made $115,000 instead of $100,000, would there be an even greater return? Her employer is left to wonder. They’re also left to wonder if another company—perhaps Company Potential—will inevitably lure her away with bigger bucks.

What your business should do

You should carefully analyze your unique set of circumstances, because there’s no one-size-fits-all solution. Do that by answering these questions:

  • What are you currently paying?
  • What are your competitors paying?
  • What’s your retention rate?
  • What should your retention rate be?
  • Is your employees’ motivation meeting your expectations?
  • Is your employees’ performance meeting your expectations?
  • If your employees lack motivation or performance, is it because of pay, or rather, culture, benefits, career opportunities and work-life balance?
  • Does your budget accommodate higher pay?

By getting the lay of the land—your land—you might feel more inclined to select and implement a pay approach. There’s no completely right or wrong approach, but there is a trend. And it’s the fact that more companies are adopting the pay for potential philosophy.

They’re seeing the correlations between pay and productivity and pay and retention. And they’re seeing a few more employees exceed the all-too-common average performance reviews. Not to mention, companies realize that Millennials are racking up student debt and Gen Zers are moving out on their own, making money matter a bit more.

So, understand your business better than ever before you adopt an approach. But in the back of your mind, know that we’re in a candidate-driven market—a market where getting paid well is an expectation and a proven way to find loyalty.

For some can’t-miss guidance on pay, check out our Salary Calculator.