Pay differentiation – the varying of pay rewards for staff – was found in 93 percent of firms responding to recent research.

According to the survey of 124 UK firms by professional services company Towers Watson, staff singled out for higher salary hikes and bigger bonuses were identified as ‘high-performing,’ receiving average base pay rises 67 percent larger than their peers.

Despite financial pressures, respondents reported a typical budget of three percent for base pay increases, equal to UK inflation. Over a quarter (28 percent) of firms has differentiated more than in previous years.

The overwhelming driver for pay differentiation was individual performance, followed by market alignment (72 percent), internal consistency (57 percent), key skills (44 percent) and potential (39 percent).

Organisations used traditional methods of differentiation to inform the differentiation process – the performance appraisal system (83 percent), a pay management matrix (62 percent) and a clear reward strategy (39 percent). Worryingly, just 18 percent felt supported by a clear talent management strategy and six percent by detailed workforce plans.

Just one-in-ten companies ring-fence a separate budget for differentiation, meaning above average pay increases for one group must be offset by below average pay increases elsewhere.

The survey also identified line managers as driving the pay review process, often with clear parameters set out by the HR department. However, half the companies surveyed said the poor line-management skills had been a barrier due to an unwillingness to differentiate – 23 percent cited a lack of tools to identify talent.

It’s not surprising that companies are trying to make the most of limited budgets by driving success through their top performers. Motivating staff through performance-related bonuses is an established way to drive productivity. The dangers, however, are clear – alienating other workers and reducing their motivation and loyalty, as well as potentially dividing up the workforce. And with only traditional methods of differentiation used in the process, businesses may be missing out on identifying hidden potential and talent.

“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.”