In another month or so, HR will begin compensation planning season in most companies. That’s when they calculate annual pay increases, plan for bonus payouts, and determine the size of long-term awards. It takes thousands upon thousands of hours of work by HR, managers, and employees. And it’s often a wasted effort.

Pay-for-performance, in its pure form, is right. It makes sense. It works. But it can be a little more theoretical than practical when the system fails.

Here are five reasons that pay-for-performance fails in many companies:

1. Performance management is a joke. How many people do you know who get their annual goals in May or June, halfway through the year? Then they get a performance review at the end of the year with the “seven things you did right and three things you did wrong” approach? For pay-for-performance to work, performance management has to work, and work well.
2. Not enough performance differentiation. Not many companies are headquartered at Lake Wobegon, “where the women are strong, the women are handsome, and all the children are above average.” Not all of your employees are above average. Conversely. some are below average, and to make PFP work, they have to be told that they don’t measure up. If everyone’s performance is the same, then just pay them all the same and don’t waste your time with all that planning and agonizing.
3. Rewards aren’t differentiated. This is the corollary to “performance is punishing.” In many PFP systems, there’s just not enough pay difference between the really great ones and the mediocre ones. Not only are excellent employees asked to do more, they’re supposed to be gratified when their merit increase is 3.1% and a poor performer gets 2.9%. It’s even worse with annual incentives. You have to be willing to give no increase to bad performers and a lot more than average to the great ones.
4. Managers chicken out. Everyone talks tough about pay-for-performance, right up until they have to dole out performance ratings and money. Then managers chicken out and take the easy route. When they do that, when they let the slackers off the hook, the system rapidly falls apart. PFP requires commitment and consistency.
5. Employees are subject to the manager lottery. For PFP to work, the rules have to be applied consistently. But we all know managers who insistent that “no one is a 5″ and can’t get the highest rating, and we know managers who are softies and rate all their employees highly. In that case, employees are playing the managers lottery — who you get as a manager determines your pay. That’s just not fair, but it’s reality.

That’s a list of five major reasons pay-for-performance fails. It also works in some companies. I’ll get around to that soon. I’d be interested in other reasons you’ve seen PFP fall apart.