The underlying objectives of any compensation system are to attract, motivate and retain good staff. But which compensation system is most likely to achieve that goal? The answer, not surprisingly, is that it depends.

There is no “magic bullet” — only a choice about what's right for your particular practice. There are literally hundreds of variations to choose from, but they are all derived from just a few theoretical models, which can be categorized as either base pay or performance pay. Most practices use some combination of the two categories to leverage the strengths of each. This article will examine two models of base pay — paying for the job and paying the person — as well as models that involve extra pay for performance — merit pay and practice-effectiveness pay.

Although no single model is right for everyone, the practice-effectiveness model does offer a number of advantages. Because this formula combines base salaries with variable bonus payments that depend on the performance of the practice, it helps control operating costs; rewards the right behaviors and builds unity; works with a variety of payment structures; encourages self-management and innovation; and breaks down bureaucracy. But before we analyze it, let's look at its rivals.

Paying for the job

Paying for the job is the “traditional” model that most people know. Each position is slotted into a grade level and weighted based on the education and experience the job requires and the number of staff who report directly to the person in the position. Pay raises are scheduled as an employee's tenure with the practice increases. The traditional model is designed to serve as a cost-control tool and to establish each job's relative worth in a practice. [For an example of how to apply this model and combine it with merit pay, see “How to Keep Salaries on Track and Under Control,” April 1998, and a discussion of the article in Letters — “Rewarding Performance vs. Longevity,” July/August 1998.]

The traditional model has a number of advantages:

• It facilitates centralized control. It gives an organization criteria with which to evaluate whether individual physicians or managers are paying their staff too much. It also makes budgeting relatively easy and makes salary expenditures predictable.

• It's a useful tool for evaluating internal pay equity. Because compensation for all jobs in the practice is based on one system, you can easily compare what staff across the practice are earning.

• It facilitates market testing of your pay scale's competitiveness. It allows a job in one practice to be scored using measures that are comparable with those used in other practices. With some of the widely used systems, extensive survey data are available to help practices set their pay levels based on what similar practices are paying.

• It has the appearance of objectivity. Although quantification doesn't ensure fairness, it does make a pay system consistent. Staff members may not be completely satisfied with their compensation, but at least they won't see the pay system as arbitrary.

In short, the traditional pay model can be appropriate if your practice needs high levels of internal equity and centralized control of compensation. But the traditional model has several disadvantages:

• It can inflate the pay system's operating costs. After implementing a traditional base-pay system, a practice may need to hire a consulting firm to provide ongoing compensation audits and survey data. In addition, the traditional model is a high producer of records and administrative overhead because it requires that each job be evaluated (with supporting documentation) and that the pay grades be revised annually.

• It encourages point grabbing and inefficiency. Staff members become quite sophisticated in how to get their jobs scored highly in compensation reviews. The traditional model rewards people for creating overhead and higher costs because overseeing larger budgets and more subordinates leads to higher pay.

• It compromises honesty in job descriptions. People quickly realize that the way to beat the system is to create flamboyant and overly inclusive job descriptions. Over time, the practice can end up paying everyone excessively.

• It rewards the wrong behavior. Giving a person more money simply for taking on new responsibilities rewards job changes rather than outstanding performance or development of needed skills.

• It doesn't accurately reward the performance of talented staff. Because compensation is determined by an employee's level and the job's rating, the model limits your flexibility to reward people based on their individual performance. For example, no matter how well a first-year billing clerk performs, he or she will earn less than someone who has been doing an average job for the last four years. This can hurt the motivation of your best performers and encourage them to look for jobs elsewhere.

• It reinforces a vertical career orientation. More responsibilities, especially supervisory and managerial, lead to more money. This drives your best technical and clinical staff into roles where they may not be as effective, and it does little to encourage the development of technical and clinical skills. This is especially counterproductive in practices that are implementing total quality management (TQM), continuous quality improvement (CQI) or other team approaches to improving problem solving, operational efficiency and clinical outcomes.

• It reinforces hierarchy and bureaucracy. By assigning value to jobs in terms of their hierarchical position and level of control, the traditional model fosters unnecessary and undesirable pecking orders and power relationships.

In short, the traditional model offers consistency and the perception of fairness in a practice's compensation system. But be careful: Once implemented, it can become a dominant part of a practice's culture and have unintended, counterproductive results.

Paying the person

The alternative to job-based pay is to compensate staff according to the value of their skills in the market. The most common approach is competency-based pay. This model is designed to motivate staff to develop the competencies — knowledge and skills for performing specific work — that the practice needs to accomplish its objectives. This model is most appropriate for practices that need high levels of intragroup teamwork, intergroup collaboration and adaptability to change. (For tips on setting up a system of competency-based pay, see the box below.)

Advantages of the competency-based model include these:

• It can lead to a broader perspective for staff. When this model is combined with a participatory management style, it encourages and rewards cross-training, learning and the assignment of responsibilities based on the skills that staff possess (rather than their “positions”). In turn, staff learn more about how the practice works, resulting in a big-picture understanding of what improvements are needed. This broader perspective allows staff members to be more innovative in making the practice more efficient.

• It reinforces a culture of improvement. The model delivers a tangible reward to staff for growing, learning and developing new areas of competency. It is compatible with TQM, CQI and similar approaches to improvement.

• It facilitates self-management and enables leaner staffing. Because the model rewards staff members for developing new skills, it prepares them to be more productive, take on greater responsibility and work more collaboratively with other staff. It also reduces the need for physician oversight. Maximizing the staff's potential can lead to leaner, flatter staffing configurations — and substantial overhead savings.

• It improves staff retention. Because they can develop skills continuously, staff members have more control over their pay. They are unlikely to find comparable jobs elsewhere because most organizations still use the traditional model.

• It builds acceptance for change. This model helps staff become more accepting of change because in it change represents the potential for professional growth — and better pay. As staff learn to accept change, the practice becomes better able to react to staff turnover, expansions, mergers or changes in the health care environment.

There are several disadvantages of the competency-based model as well:

• It produces high pay rates. As staff become more valuable to the practice and their tenure increases, individual salaries will increase. This doesn't necessarily mean that total payroll costs will rise. In fact, they can be lower than those generated in a traditional model, if the practice can use its fewer, but more competent, staff more effectively.

• It requires a large investment in training. Because peers train each other, productivity will decline initially. Physicians must be committed to staff training as the means of competency acquisition, and they must be patient early in the implementation process, giving the model a chance to produce the expected results.

• Market comparisons can be more difficult. Since most survey data relate to the traditional pay model, staff-salary comparisons may not be straightforward. You can overcome this challenge by examining data about what others pay for certain competency mixes rather than direct job-by-job comparisons.

• Individuals can “top out.” Practices generally establish an income ceiling for staff who master all competencies, but employees in the traditional model can also reach this kind of limit. In a competency-based model, this is less of an issue since staff have higher pay scales than traditional models offer.

• Administrative involvement can increase. Keeping track of each person's competency assessments, competency mix and pay rate requires time and effort. A computerized record-keeping system can help you deal with this. A competency-based pay model requires practices to commit to ongoing staff training and to developing an administrative infrastructure that will support the system. It may also require some mental effort to step outside the box of traditional thinking.

Merit pay

Merit pay, or extra compensation for superior performance, is a widely used model because of the belief that pay can motivate job performance and increase practice effectiveness. Research suggests that pay can do this when it's linked to actual performance. But this is not the case in most organizations. Considerable research indicates that merit systems fail to create a perceived relationship between pay and performance and fail to pay better performers more in total compensation. Hence, this model generally falls short in delivering its desired results. Here are some reasons why:

• It creates an annuity when combined with the use of salary ranges. Employees who are above-average performers for a few years can still bring home a good paycheck even if their performance is lacking in later years because their past achievements have increased their pay rates. Those with the most tenure, no matter their level of accomplishments, are often the highest paid in the practice. Merit-pay models that offer one-time bonuses for merit can avoid this annuity effect, but developing objective criteria for awarding these bonuses can be problematic.

• Linking merit pay to performance presents inherent measurement problems. Practices awarding merit pay must decide what the basis of an award will be. If a practice's managers base the awards on the practice's level of success, they face the challenge of determining who is responsible, and to what degree, for that success. Since a practice's success depends primarily on teamwork, it's problematic to use individual performance as the basis for awarding merit pay. Certainly measuring performance based on individual criteria is at the heart of the pay-for-competency model as well. But rewards in that model are based on an individual's performance of a competency, not on business outcomes that may result from it.

• It can cause distrust among the staff. Because it's difficult to identify how individual performance contributes to overall success, those who rate performance tend not to use valid, objective measures but rely instead on subjective judgments. Staff members often view this as invalid and unfair, which undermines the practice's credibility in the staff's eyes.

• It decreases teamwork. Allocating a budget to a supervisor and asking him or her to divide it on the basis of merit creates a competitive, not collaborative, environment for staff.

• It masks the effect of management on performance. Because variation in staff performance is largely dependent on a practice's management systems, it's difficult to compare individual performance effectively.

Practice-effectiveness pay

One way to combine fixed and variable compensation is with the practice-effectiveness model. It involves setting base salaries plus establishing a formula that will provide bonus payments based on certain practice-performance criteria. (For suggestions about how to implement this model, see below.)

The practice-effectiveness model offers several advantages:

• It helps to control operating costs. A portion of each staff member's salary is tied to the practice's performance. In addition, the model itself has low overhead in that much of the administrative work related to it involves data collection that should already be taking place as a part of sound practice management. For example, all practices track their profitability, and an increasing number are monitoring their clinical outcomes, patient satisfaction and resource utilization.

• It rewards the right behaviors and builds unity. Staff members are reinforced only for actions that clearly benefit the practice's performance, which focuses everyone on the most important work and promotes a culture of “we're all in this together.” It builds an environment of change and adaptability and is compatible with TQM and CQI.

• It is readily adaptable to changing practice needs. As business conditions such as payer mix, reimbursement schedules and market competition change, a practice can focus on different indicators of effectiveness.

• It encourages self-management. Increased understanding of a practice's business interests improves staff members' motivation to perform. It also encourages employees to coordinate their work with others more effectively and to make decisions that reflect the best interests of the practice.

• It encourages innovation. Finding ways to lower overhead and improve operational efficiency produces tangible rewards for staff.

• It breaks down hierarchy. Since everyone is pursuing the same practice performance outcomes, pecking orders take a back seat to intragroup teamwork and intergroup collaboration.

There is at least one disadvantage of the practice-effectiveness model: Proponents of traditional merit pay argue that this model lacks a strong performance-pay connection in the eyes of staff. (This is a disadvantage of traditional merit pay, too.) In other words, it may be hard for staff to see the direct connection between their individual effort and their reward for it. This is less of an issue in a small to medium-sized practice than in a large one.

What's right for you?

Of course, there's more to implementing an effective compensation system than simply picking a model. Regardless of the model you select, the starting point is to develop job descriptions based on a thoughtful job analysis.

Here's the bottom line: The right model for your practice may not be the right model for the practice down the street. But each one requires that you identify what each staff position is designed to do, understand the model's advantages and disadvantages, affirm that it's compatible with the practice culture you want and ensure that it aligns with your business objectives.