October 2006 by Jason Corsello, Business & IT Services Director, jcorsello@yankeegroup.

com, 617-880-0338

Compensation as the Foundation to a Talent Management Strategy
Executive Summary
Decision Point: The Bottom Line: Key Concepts: Who Should Read:

Workforce Transformation Through HR Technology, Outsourcing and Services Strategies Performance-driven compensation is transforming the way organizations align individual, group and company goals to determine business outcomes. HR, talent management, human capital management, performance management, compensation management CEO, COO, CHRO, vice president of human resources, CIO Practice Leader: Keith Mallinson, Executive Vice President—Business, kmallinson@yankeegroup.com, 617-880-0375

Compensation is the cornerstone of an effective talent management strategy. The ability to enable consistent, reliable and standardized compensation processes that are linked to key performance drivers of individual and organizational strategies can affect many facets of the business. Some of these facets include: • • • Improved employee morale and retention Increased employee engagement and productivity Strengthened governance and compliance with company and regulatory issues

Integrating a talent management vision—maintaining visibility, control and alignment of performance and compensation tied to business outcomes—has become critical to the success or failure of today’s organizations. Additionally, recognition of how well a company performs, and how the workforce contributes to that performance, can translate into an employment brand that will attract the best talent and ensure the company’s reputation as a desirable employer for both active and passive candidates. However, achieving this brand is not easy. Compensation plans must be rational in design; robust in deployment, governance and management; and methodical in communication and rollout. Compensation must also seamlessly integrate all talent management components, especially performance management (see Exhibit 1). The ability to leverage performance and compensation data in a single view can provide some compelling insight into what motivates a high-performance employee. Performance-driven compensation can shape the future of the workforce as well as the business. In this Yankee Group Report, we outline: • • • • The definition of effective compensation management and why it’s critical in building a high-performance workforce How compensation affects an integrated talent management strategy The approaches and technologies that can enable a performance-drive compensation strategy Recommendations for moving a performance-driven compensation strategy forward
© Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved. This Yankee Group Report is published for the sole use of Yankee Group Decision Service subscribers. It may not be duplicated, reproduced, or retransmitted in whole or in part without the express permission of Yankee Group. All rights reserved. All opinions and estimates herein constitute our judgment as of this date and are subject to change without notice. For more information, contact Yankee Group, 31 St. James Avenue, Boston, MA 02116. Phone: 617-956-5000. Fax: 617-956-5005. E-mail: info@yankeegroup.com.

Exhibit 1. Aligning Performance-Driven Compensation
Source: Yankee Group, 2006
Define skills, competencies and metrics aligned with business outcomes Outline compensation plans and policies and alignment with budget

Establish individual performance goals, ratings and objectives

Administer compensation plan and structure

Complete performance review and appraisal Performance Management Align pay and performance Compensation Management

Access career development and adjust compensation plan

Plan succession and workforce based on business strategy

High-Performance Workforce

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October 2006

Table of Contents
I. II. Introduction .............................................................................................. Effective Compensation Management....................................................... Defining Performance-Based Compensation .............................................. Why Performance-Driven Compensation Matters ...................................... Adopting a Performance-Driven Compensation Solution............................ III. IV. Trends Shaping Compensation Management ............................................ Four Approaches to a Performance-Driven Compensation Strategy........... Compensation-Focused Talent Management Vendors ............................... Performance-Focused Talent Management Vendors .................................. Suite-Focused Talent Management Vendors .............................................. ERP-Focused Talent Management Vendors................................................ V. 3 4 5 6 7 7 9 9 9 9 9

Conclusions and Recommendations.......................................................... 10 Recommendations ..................................................................................... 10

VI.

Further Reading......................................................................................... 11

I.

Introduction
Compensation is the cornerstone of every organization’s talent management strategy. It drives the long-term planning for a company and affects key performance drivers for the workforce. Today, three critical factors to managing talent are creating a perfect storm in the way companies define their talent management strategy: • The impact of the aging workforce: According the Social Security Administration, 77 million US baby boomers will be leaving the workforce, and the generation that will replace them consists of only 46 million people. This translates into approximately 8,000 employees leaving the workforce daily. Workforce planning and retention has become more important than ever. Increased HR priority: According to a recent survey by CFO magazine, 95% of companies rank human capital management as the most important factor (44%) or one of the top two or three factors (51%) in the success of their business. In fact, a majority of those respondents suggested increased use of technology as a way to help bridge the gap to manage their human capital effectively. HR is becoming top of mind for most global companies. Realization of HR’s affect on the business: Towers Perrin released a report last year suggesting a “…15% increase in employee engagement will increase your operating margin by an estimated 2%.” HR organizations are now able to measure and monitor their affect on the organization like never before.
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Companies must bring their talent management strategies to new, uncharted territories. Not only do employers need to create a favorable employment brand, but they must also maintain the enthusiasm employees initially bring to their jobs. Moreover, management must understand the rewards that the great majority of workers seek from their job—and then satisfy them. Employee engagement and retention is critical to any business. A migration to performance-driven compensation has begun. Well-defined compensation plans are most tangible and critical to employee engagement and successful alignment with business strategy. The ability to leverage combined performance and compensation data is essential to understanding what drives individual employees and how it affects business outcomes. This Yankee Group Report will focus specifically on performance-driven compensation as the centerpiece to a high-performance workforce.

II.

Effective Compensation Management
Compensation management aligns workforce pay and incentives with corporate financial objectives. Not surprisingly, this area draws keen interest from both management and employees. Compensation management is designed to motivate the workforce using advanced modeling, planning and reporting automation to provide cash and non-cash incentives to employees. Organizations are beginning to integrate performance and compensation management capabilities to build and strengthen a payfor-performance culture. Yankee Group forecasts 19.6% growth in compensation management during the next 4 years. We attribute this forecast to more performance-based compensation programs and pay-for-performance initiatives emerging across all functional departments. Performance management and compensation are critical components to a robust talent management strategy. Their successful alignment with other core talent management processes such as recruitment and learning, and integration with competencies and career development plans can be powerful (see Exhibit 2). The data and content, which can be leveraged and reused across the talent lifecycle, could potentially transform the way a company hires, promotes and rewards its employees. Compensation decisions influence the entire talent lifecycle. Compensation strategies affect performance at the individual and organizational level, and determine the way companies identify and source talent. Effective compensation strategies should be mutually aligned with employers, managers and employees to successfully drive desired business results.

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October 2006

Exhibit 2. Components of a Talent Management Solution
Source: Yankee Group, 2006
Manager and Employee Self-Service Intelligence, Analytics and Reporting

Succession Management Career Development Competency Management Recruitment Management Performance Management Compensation Management Learning Management

Integration Layer ERP/HRMS

Defining Performance-Based Compensation
Performance-based compensation—also known as pay-for-performance—is becoming increasingly important to senior executives and line managers alike as part of an overall effort to derive better productivity from employees. Setting effective performance-based compensation policies—including enacting best practices of alignment performance and compensation—will enable companies to differentiate from their competition. However, most companies today still have not formalized a plan to align performance and compensation. In fact, a recent poll by the Human Capital Institute suggests that more than 79% of companies have neither a formal approach for even performance management nor a model that leverages some form of paper-based approach to performance management. Performance-driven compensation includes three distinct approaches: • Merit-based: Merit-based compensation includes seamlessly applying merit increases based on defined calculations including job level, pay grade, performance rating and comp ratio. Merit-based compensation can include cash and non-cash incentives including base salary, variable pay, bonus pay and stock option grants. Promotion-based: Promotion-based compensation enables managers to plan and recommend pay adjustments for promotions, job changes or new roles and responsibilities that are created based on performance. Incentive-based: Incentive-based compensation typically includes lump-sum adjustments such as bonuses. Incentive-based programs link individual, group and company objective achievements directly to a bonus payout and enable a manager to move an employee to another pay grade using a lump-sum adjustment to salary.

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Performance-based compensation requires the art and science of leveraging data and using a formulaic approach to align compensation and performance. Performance-driven compensation can be rooted in performance or compensation, but it requires a systematic approach to align performance-based scoring metrics with compensation design, planning, policies and budgetary constraints. According to a recent survey by Hewitt Associates, most employees will receive a modest raise in 2006 as employers reward employees with performance-linked bonuses rather than with broad salary increases. In the past few years, the trend has been for employers to increase the bonus eligibility for more employees, while shifting their share of the payroll devoted to variable pay.

Why Performance-Driven Compensation Matters
When implemented correctly, performance-driven compensation strategies should mutually benefit both employer and employee. The benefits include establishing confidence in an organization’s compensation structure and incentives, fostering a performance-centric culture and avoiding legal tangles and noncompliance issues. Transforming from a traditional compensation model to a performance-driven compensation model affects a company at multiple levels (see Exhibit 3). However, when insufficiently deployed, compensation programs can ultimately lead to higher employee turnover, lost productivity and—potentially—a negative reputation as an employer, which could adversely affect future talent acquisition. Employees can become quickly disengaged when compensation strategies are inconsistent in methodology, design and implementation, or are continually changing to the disadvantage of the employee. Unpredictability in performance-based compensation could have repercussions in staff retention, engagement and can result in unfavorable employment branding.

Exhibit 3. Traditional vs. Performance-Driven Compensation
Source: Yankee Group, 2006

From Traditional Compensation…

…to PerformanceDriven Compensation
Variable, performance-based

Fixed, merit-based

Entitlement-centric

Engagement-focused

Objectives aligned with individual performance

Performance objectives aligned with business outcomes Real-time, continuous process

Annual or biannual process

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October 2006

Adopting a Performance-Driven Compensation Solution
The consequences of not having an integrated compensation strategy can be significant. Conversely, integrated performance and compensation can be a source of motivation and encouragement for employees and employers. The success of performance-based compensation depends on the mutual alignment, expectations and results of employers, managers and employees. It answers the “what’s in it for me” question for all key stakeholders (see Exhibit 4).

Exhibit 4. Performance-Driven Compensation Must Have Mutually Benefiting Outcomes
Source: Yankee Group, 2006

What’s In It For Me?
For Employers Increases ability to manage performance aligned with business outcomes Provides clarity and alignment around corporate objectives Drives shared ownership, responsibility and accountability of corporate initiatives Builds a high-performance culture that can be favorably branded to prospective employees For Managers Provides a consistent, automated review process that's aligned with compensations policies Drives execution of key initiatives by clarifying and aligning individual and team goals Retains key talent by highlighting and rewarding superior performance For Employees Maximizes input into performance-based goals that align with individual compensation and business objectives Continuous, ongoing input into performance and career achievements Engages employees throughout the organization by providing them with relevant information necessary for career success and growth

III.

Trends Shaping Compensation Management
The success of the compensation management market and the technology vendors that support the market is due in part to significant industry trends that have improved the purchase, adoption and use of the solutions. Companies of all sizes are adopting integrated compensation and performance-driven compensation with great success. Some of the broader market trends for increased adoption of performance-driven compensation include: • Integrated functionality and usability: Many vendors have invested heavily in the usability and integrated functionality of their solutions. The ability to integrate data seamlessly and streamline navigation and adoption for compensation and performance management enhances the users’ experience and encourages them to use the solutions more. A single data model technology infrastructure is ideal to maximize performance and simplify application management.

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Dynamic influences in global governance and compliance: Companies are being forced to adjust to ever-changing global regulatory and compliance issues that outline how companies can manage and compensate their workforces. In addition to automating HR processes, companies are now focusing internally to build a performance-based culture centered on metrics-based business outcomes. They are also driving additional company value by adapting and improving the way they manage their global workforce. Rapid acceptance of the software-as-a-service (SaaS) model: A dramatic shift is occurring in the way companies are buying and deploying new enterprise applications. SaaS, also known as on-demand, has enabled vendors to deliver solutions in a more affordable, low-risk environment. The diminished impact of security issues and a strong ROI have helped build the SaaS demand model. A key feature of SaaS is the ability to manage a single data model technology infrastructure for seamlessly integrating functionality and usability. SaaS minimizes the risk of deploying new solutions, minimizes training and places the onus of upgrades on the vendor to continue its innovation. Multinational capabilities: Global enterprises are demanding multi-currency, multilanguage capabilities and local domain expertise to support changing regulatory and compliance issues and performance-based compensation strategies. Distinct geographical and in-country practices and cultural standards must also be accommodated to satisfy companies’ unique incentive requirements and expectations. Migration toward performance-driven compensation: Companies are increasingly looking for opportunities to align individual performance with corporate performance. Individual performance ratings that drive successful business outcomes are beneficial to both employer and employee. Aligning pay and performance should not only increase the financial performance of an organization, but also that inflection will affect employee engagement and satisfaction and will ultimately reduce employee turnover (see Exhibit 5).

Exhibit 5. The Inflection of Pay and Performance
Source: Yankee Group, 2006

Business Performance

PerformanceDriven Compensation

Inflection of Pay and Performance

Employee Turnover

Employee Engagement (in Time)

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October 2006

IV.

Four Approaches to a Performance-Driven Compensation Strategy
Compensation-Focused Talent Management Vendors
Compensation-centric vendors focus on dynamic compensation planning that adheres to programs, policies and budgets. These vendors enable a real-time view of the planning process, budding compliance issues and the financial and budgetary affect on the organization. More recently, these vendors have integrated performance management capabilities that align performance and compensation in a pay-for-performance model. Successful vendors such as Salary.com and Workscape focus on intuitive, highly configurable applications delivered in a SaaS model. Workscape focuses on a large global reach with multi-language, multi-currency support. Salary.com leverages highly reliable market data from more than 3,400 job codes to differentiate its offering and normalizes industry and market compensation trends to drive individual performance and business outcomes.

Performance-Focused Talent Management Vendors
Performance-focused vendors center on the performance management process as the key driver to compensation- or merit-based decisions. These vendors provide performance appraisals and reviews and goal and objective management. They rely on that specific data as the foundation that drives an organization’s talent management strategy. Performance-focused vendors include Halogen Software, SilkRoad technology, SuccessFactors and MindSolve Technologies.

Suite-Focused Talent Management Vendors
Suite-focused vendors provide a full range of talent management capabilities including recruitment, performance management, compensation and succession planning. Many of these vendors have unique heritages, having grown through acquisitions. They differentiate through customization, offer multiple deployment options (e.g., on-demand, on-premises or hybrid) and sell on the promise of a seamless, fully integrated product portfolio. Suite-focused vendors include Authoria, Softscape, Vurv Technology and Workstream.

ERP-Focused Talent Management Vendors
Large established vendors such as Oracle and SAP provide a full suite of human capital management (HCM) capabilities including talent management, workforce management and traditional HR management system (HRMS) functions (i.e., payroll, benefits and personnel administration). These vendors, typically the system of record, manage the transactional requirements and data sources and can integrate with strategic talent management capabilities. This group has succeeded by providing the high level of customization required for many Global 2000 companies and has traditionally lacked best-of-breed vendors in terms of functionality and ease-of-use.

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V.

Conclusions and Recommendations
Performance-driven compensation is changing the way companies source, hire and retain key talent. As the cornerstone of an integrated talent management vision, performancedriven compensation can ultimately determine the long-term strategy and key business drivers for an organization. There is no one-size-fits-all approach to performance-driven compensation. Before making the strategic shift and technology investment, organizations must look at the technology benefits to all stakeholders including employers, managers and employees, as well as the impact on the workforce.

Recommendations
• Encourage multiple stakeholders to participate in the selection process. Yankee Group recommends bringing various stakeholders to the table including HR, line-ofbusiness leaders, finance and IT. The ability to bring multiple stakeholders together will not only lead to a better decision, but also will identify areas to extend the strategy beyond compensation and performance. Having finance as a part of the equation can also facilitate the business and financial impact of the strategy. Find matching technology that supports your organization. As the workforce becomes increasingly mobile and global, companies must examine talent management from a worldwide perspective. Dynamic, flexible HR processes that encourage workforce productivity improvements and focus on business outcomes must meet the changing global workforce requirements. Vendors must focus on strong global service that supports local expertise in building and shaping a strong workforce. Over-communicate before, during and after rollout. It is important to engage the workforce in terms of the reasoning behind deploying a performance-based compensation strategy. Continue to discuss the objective and strategy throughout the rollout process, even beyond the first few months of deployment. Additionally, communicate the potential benefits to the individual employee in conjunction with the benefits and intent for the company. Getting buyoff from management and users will require consensus building and setting clear expectations. Don’t assume end users will “get it.” Many solutions in the market today are userfriendly and intuitive for users. Nonetheless, don’t assume end users will immediately understand how to use the solution. Provide training to all employees so they understand the key components of the solution. Monitor usage and adoption on an ongoing basis to ensure long-term success of the strategy and solution.

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October 2006

VI.

Further Reading
Yankee Group DecisionNotesSM
Yankee Group Examines the Five Talent Management Vendors to Watch in 2006, January 2006 Recruitmax Continues to Execute on Its Talent Management Vision, January 2006 What You Need to Know Before Selecting a Workforce Performance Management Solution, October 2005 Human Capital Management Enables Workforce Alignment and Speeds HR Transformation, August 2005 Why Organizations Should Pursue an Integrated Human Capital Management Approach, June 2005 Why Technology Investment in Human Capital Management Should Be a Priority, May 2005 Workforce Lifecycle Management Is Key Enabler for High-Performance Organizations, March 2005

Yankee Group Reports
Fueled by Strong Demand, Worldwide Talent Management Market Will Surpass $2.3 Billion in 2006, April 2006 Workforce Lifecycle Management—The New Frontier for Human Capital Management, March 2005

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