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: Workforce Transformation Through HR Technology, Outsourcing and Services Strategies
The Bottom Line: Performance-driven compensation is transforming the way organizations align
individual, group and company goals to determine business outcomes.
Key Concepts: HR, talent management, human capital management, performance management,
compensation management
Who Should Read: 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, Outline compensation

competencies and metrics plans and policies and
aligned with business alignment with budget
outcomes

Establish individual performance goals, ratings and objectives

Administer compensation plan and structure

Complete performance review and appraisal

Performance Compensation
Management Management
Align pay and performance

Access career development and adjust compensation plan

Plan succession and workforce based on business strategy

High-Performance Workforce

2 © Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved.

 October 2006

Table of Contents

I. Introduction .............................................................................................. 3
II. Effective Compensation Management....................................................... 4
Defining Performance-Based Compensation .............................................. 5
Why Performance-Driven Compensation Matters ...................................... 6
Adopting a Performance-Driven Compensation Solution............................ 7
III. Trends Shaping Compensation Management ............................................ 7
IV. Four Approaches to a Performance-Driven Compensation Strategy........... 9
Compensation-Focused Talent Management Vendors ............................... 9
Performance-Focused Talent Management Vendors .................................. 9
Suite-Focused Talent Management Vendors .............................................. 9
ERP-Focused Talent Management Vendors................................................ 9
V. 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.
© Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved. 3
 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 pay-
for-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.

4 © Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved.

 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 Performance Compensation Learning
Management Management Management 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.

© Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved. 5

 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 …to Performance-

Compensation… Driven Compensation

Variable,
Fixed, merit-based performance-based

Entitlement-centric Engagement-focused

Performance objectives
Objectives aligned with aligned with
individual performance business outcomes

Annual or Real-time,
biannual process continuous process

6 © Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved.

 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 For Managers For Employees

Increases ability to manage Provides a consistent, automated Maximizes input into

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
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
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.

© Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved. 7

 • 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, multi-
language 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

Performance-
Driven Inflection of Pay
Compensation and Performance

Employee
Turnover

Employee Engagement (in Time)

8 © Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved.

 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.

© Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved. 9

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, performance-
driven 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-of-
business 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 user-
friendly 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.

10 © Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved.

 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

© Copyright 1997-2006. Yankee Group Research, Inc. All rights reserved. 11