By Daniel Hunter

Pay differentiation, the practice of varying pay awards for employees, is common practice in almost all (93 per cent) UK organisations surveyed by professional services company, Towers Watson.

Those singled out most often for higher pay rises or bigger bonuses are employees identified as ‘high-performing’ who are rewarded with base pay rises 67 per cent higher, on average, than their peers.

Despite constrained pay budgets — organisations reported a typical budget of 3% for base pay increases, equal to UK inflation — organisations are consistently trying to make the most of this limited budget with over a quarter (28%) of companies surveyed differentiating more than they have done in previous years.

The research showed that individual performance was the overwhelming driver for differentiating pay. The second most important factor driving decision-making was market alignment (72%), followed by internal consistency (57%), key skills (44%) and potential (39%). Detailed analysis of the results showed some surprising differences between those with lower and average or higher pay budgets.

Organisations with low pay budgets (less than 2.5%) differentiate even further, offering high performers pay rises twice as large as their average performing colleagues. Companies with average or more generous pay budgets — 3 per cent or more— tended to single out high performers to a lesser extent, offering them 67% higher rises than the company average.

A consistent focus on performance endured in both cases but market alignment was more important to those with higher pay budgets (71%) than those in the low budget group (48%). Similarly, pay consistency was a priority for those with higher pay budgets (67% vs 43%).

“It is very encouraging to see organisations continuing to focus on rewarding high performance and interesting to see that this tendency becomes increasingly pronounced the more a company’s budget is squeezed. However, we were surprised to see that when budgets were more generous, the focus shifted to market alignment rather than on to high skill or high potential employees,” said Chris Charman, a Director in Towers Watson’s UK Rewards practice.

“Arguably, more value could be derived from retaining and engaging those with scarce and critical business skills or those who could potentially be tomorrow’s leaders. We see leading reward functions taking a broader view and collaborating more closely with colleagues in Talent functions in determining the optimal use of these scarce resources”

Organisations cited traditional enablers of differentiation in helping them to achieve their goals — the performance appraisal system (83%), a pay management matrix (62%) and a clear reward strategy (39%). However, only 18% felt supported by a clear talent management strategy and 6% by detailed workforce plans.

“The results support our experience that Reward and Talent functions could be more joined-up in their approach. I have no doubt business leaders would wish their scarce reward budget to also include, as much as is feasible, a focus on the skills and people that can make a disproportionate impact on business success now and in the future. Organisations generally know the business critical skills and the future pipeline of talent, so it is surprising that the Reward function are not saying they use these inputs more.” said Charman.

Other findings from the research include:

- 28% of organisations said they differentiated more this year than last, many more than the 11% that said they differentiated less;

- Line managers tend to drive the pay review process, typically within clear parameters set out by HR but half the companies surveyed felt that poor line-management skills had been a barrier due to an unwillingness to differentiate — 23% cited a lack of tools to identify talent;

- A third (37 per cent) of organisation ask line managers to explain the rationale behind the differentiation policy to their people, but a quarter do not communicate the approach at all;

- Bonuses are also differentiated by most organisations with almost a third (30 per cent) claiming to differentiate bonuses to a greater extent than base pay;

- Only one-in-ten companies actively ring-fence a separate budget for differentiation, meaning in most instances above average pay increases for one group need to be offset by below average increases elsewhere.

“Not communicating the reason behind pay differentiation is a potential missed opportunity for many employers," said Charman.

"We know that clear communication around rewards and how reward programmes work increases understanding and the value placed on them. It is common sense that employees need to know what it takes to get high rewards, after all that’s the purpose of a performance pay system.

“Pay is only one of many motivating factors, but it is a critical one to get right as getting it wrong carries many significant downsides. It is also important to remember that the process is fair and seen to be fair; where this isn’t achieved, our research shows that employee engagement can take a hit.'

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