This article discussing the pros and cons of pay-for-performance compensation models was originally published in May 2015. All relevant copy and statistics have been updated as of June 2025.
In today’s talent market, companies need to capitalize on their competitive advantages to attract, engage, and retain the best employees. It’s no surprise that pay is a deciding factor in for many employees when making decisions about where to work — and when to leave. 54% of employees said an increase in compensation or better benefits is very important when considering a new role.
That means your compensation strategy is an excellent way to stand out as an employer. One strategy that works for lots of companies is the pay-for-performance model, in which compensation is tied directly to performance. 93% of private companies report using some kind of performance-based compensation plan.
Is your organization exploring new comp strategies or revamping its existing performance-based pay structure? Dive into some of the pros and cons of this strategy.
What Is the Pay-for-Performance Model?
Pay-for-performance is a compensation strategy that links financial incentives — like bonuses or extra PTO — to individual performance outcomes. While these incentives are typically rewarded on top of base salaries, merit raises that increase base salary are also a pay-for-performance tactic.
For example, sales employees often receive sliding-scale bonuses for achieving their monthly quota. If they exceed their goals, the bonus increases, but they also receive a smaller bonus if they don’t meet their goals. Team performance can be incentivized, too, with rewards for high-performing departments that include team outings or catered lunches.
Pay-for-performance plans are the right move for many organizations, but there are some crucial factors that HR and other leaders in the business need to consider if you’re using or introducing this pay structure. We put together a list of 12 pros and cons of the pay-for-performance model to help you decide what’s right for your employees.
6 Pros of the Pay-For-Performance Model
Pay-for-performance programs are not unpopular — there’s a reason they’re commonly used. The strategy has benefits for employees and the organization, including:
- Boosts Employee Engagement and Productivity: Incentivizing high performance has been shown to motivate employees to do their best work and increase output. Engaged employees are happier at work, which leads to better outcomes.
- Increases Transparency: Performance-based pay structures require concrete goals that trigger the rewards. That means employees know exactly what they need to accomplish to earn bonuses or pay increases.
- Strengthens Employer Brand: This compensation management strategy is appealing to many job seekers, so be sure your recruiters include it in job descriptions and discuss it with candidates. It appeals to high-performing, motivated employees — exactly the type of candidate you want to attract.
- Improves Retention: Performance-based pay sometimes includes rewards for staying in a role, or incentives that increase in value as tenure increases. For example, a company might offer employee retention bonuses awarded at five-year anniversaries, with increasing bonuses every five years.
- Promotes Internal Mobility: Pay-for-performance makes it easy to identify top-performing employees who are eligible for promotions. It’s also a great way to identify the skills employees might need to improve or the strengths they can hone.
- Builds High-Performance Culture: This pay strategy helps foster a culture where high performance is rewarded, which can inspire employees to level up their skills, smash their goals, and earn those incentives.
Beyond Pay: What Employees Want
Pay is unquestionably important to your people, but priorities are changing. For the first time, compensation was outranked, and employees consistently want to work at a company that treats them like people:
- 83% of employees said work-life balance was their top priority.
- 82% ranked compensation and benefits as their number one concern.
- 48% would not work at a company that didn’t share their values.
- 41% would quit if they don’t receive career development opportunities.
6 Cons of the Pay-For-Performance Model
Pay-for-performance systems have downsides, too. It’s important to understand them so you can make an informed decision about whether this strategy is right for you.
Take a look at six cons of pay-for-performance:
- Requires Strong Performance Management: A fair, effective pay-for-performance model that motivates employees to perform at their best needs a clear, structured performance management strategy as its foundation. Without it, employees are in the dark about what they need to achieve and how to get there.
- Can Impact Work Quality: If you only incentivize work output, you might put work quality at risk. Be sure to set realistic goals that ensure quality is maintained.
- Risk of Increased Stress: Pay-for-performance doesn’t motivate everyone — for some team members, it can lead to increased stress and lower morale. Harvard Business Review reports that you can mitigate this risk with clear expectations and incentive structures.
- May Impact Retention: Employees who aren’t motivated by performance-based pay may not stay long-term. On the plus side, that means you cultivate a workforce more in line with your company culture.
- Risk of Unhealthy Competition: If employees become too focused on improving their own performance, they may be less inclined to help out their colleagues, which can negatively impact teamwork.
- Potential for Favoritism: Performance-based pay can create instances where favoritism can come into play. This is where structured, clear systems again help guard against the risks.
Keep in mind that these cons are really just considerations — factors to account for if you use pay-for-performance strategies. When you understand the cons, you can set up your strategy to address them head-on.
5 Tips For Making Pay-For-Performance Work
Pay-for-performance has the potential to foster a culture of driven, motivated employees whose productivity is unmatched. Make it happen with these tips for a strong strategy:
- Communicate your program to every employee. Ensure they can access documents about bonus structures or how to earn other incentives. If you’re making any changes to your compensation strategy, inform your workforce well ahead of the change and give them the opportunity to ask questions.
- Set clear performance expectations so there’s no question about what it takes to earn rewards. Discuss incentives with new hires from the start and ensure every employee understands their output is connected to their pay.
- Track progress and evaluate performance often. Employees should be aware of whether or not they’re on track for incentive pay, which managers can discuss during weekly one-on-ones. Regular formal performance reviews also help promote transparency and accountability.
- Use performance and compensation software to connect performance and pay objectively. With the right performance and compensation software, you can track goal progress, align performance ratings with compensation structures, and eliminate bias so your employees can trust that their rewards are earned and equitable.
- Recognize employees for soft skills, too, not just their contributions to achieving KPIs. Teamwork, creativity, and leadership are harder to measure than the number of contracts closed or tickets resolved, but they’re no less important. Your recognition program should include a mix of public shout-outs, personal thank-yous, and non-monetary incentives in addition to financial incentives.
Pay-For-Performance Made Simple With Software
The most important factor in making pay-for-performance work is clarity. You need a clear incentive plan, SMART goals that tell your people exactly how to earn those incentives, and clear, equitable performance reviews and discussions.
What better way to achieve compensation clarity than with ClearCompany? Our Compensation Management software has all the tools you need to implement a fair, transparent performance-based pay strategy:
- Effortlessly link performance to compensation with integrated tools for fair, data-driven rewards.
- Drive engagement through transparent, goal-aligned pay structures that employees can trust.
- Simplify complex compensation planning with customizable and scalable solutions.
- Make unbiased decisions using real-time performance insights connected to pay outcomes.
- Streamline your workflow by integrating performance, feedback, and compensation in one platform.
