IT'S that time of the year again. Employees being appraised and managers making recommendations about bonuses and salary increases. Pay for performance, which is a much repeated slogan, is a staggeringly banal statement. To say one pays for performance is like stating that the rain is wet. Besides stating the obvious, there is the deeper problem of elevating compensation as the central motivator of performance. And, in practice, do people really get paid for performance?
The relationship between performance and pay is tenuous, except for a few roles such as salespeople and traders. What employers mean by pay-for-performance and what employees expect are often two different things. It's a beguiling simple promise but hard to deliver.
Fairly and accurately measuring individual performance is not that simple. Outcomes are a composite of individual contribution and external environmental factors. How do you separate the two? When results exceed goals, employees are quick to attribute it to themselves. When goals are not met, employees claim it has nothing to do with them but everything to do with externalities. In complex systems such as a business, cause and effect is neither linear nor certain. Financial results alone are a crude guide for measuring individual performance.
The reality is that performance management processes are unable to separate skill from luck. Good performance measurement must neither reward free riders nor penalise individuals unfairly for factors they don't control. Exactly the opposite happens in practice. Furthermore, how a business performs in a given year is often influenced by causes that are separated in time and space. Today's results may be due to actions that have nothing to do with the current performance cycle or the people being appraised. And the influence of market conditions cannot be overstated. Measuring goals that are not directly controlled by an individual's actions provide false precision.
How do you separate individual contribution from collective contribution? Except for a few jobs, most people's effectiveness is connected to and influenced by others in the organisation. On one hand, companies promote teamwork. On the other hand, they ignore the team and insist on measuring performance individually.
Taking the performance process to further unrealistic levels is the process of forced ranking. A tortured comparison is demanded between team members where one is forced to be ranked better than the other. The hypocrisy is not lost on employees. It's an own goal on the playing field of teamwork.
Is there a better way to measure individual performance? At the individual level, it might be far better to evaluate the means rather than the ends alone. You don't score goals by focusing on the scoreboard. You score goals by focusing on, evaluating and improving what is happening on the playing field. By all means give employees feedback on their competencies, attitude, behaviours and corporate values since these are important for achieving success. They are not distorted by external factors. Tell them what they need to do more of and less of and give them training and guidance to get there. Rate them if you must. Financial goals that are clear and quantified are fine but avoid disaggregating them unrealistically down to the individual. Establish financial goals at the right level of aggregation and correspondingly judge performance of individuals as a part of the group.
Since performance is hard to measure precisely and objectively, does it make sense to link pay to an amorphous concept? Pay for performance is a bit of a myth. Not only is performance subjective but the pay part of the equation is equally debatable. In practice, companies decide what they can afford or what they can get away with and then use the pay-for-performance mantra to merely spread it among employees. This is losing sight of the forest for the trees. What employees really care about is whether their compensation is competitive to the external market.
Linking compensation more directly to market value of the individual is a more sensible approach. Companies can decide based on their overall value proposition and strategic priorities, what percentile of market they wish to be at for different calibre of employees. Most companies don't determine bonus and total compensation by working backwards from market value, target positioning and where the individual currently sits. Instead they start with a budget for the year and use an unnecessarily elaborate and flawed process to spread the money.
Embedded in the pay for performance slogan is the untested notion that employees will be motivated to perform only if they see a direct link between pay and performance. Clearly money is an important hygiene factor. It needs to be fair and competitive. But other factors matter too, perhaps more. Companies risk shooting themselves in the foot by not focusing on other important factors such as benefits, status, security, opportunities and culture. Employees care about the total value proposition. Progressively cutting benefits, for example, and claiming pay for performance is playing with mirrors and rings hollow for employees.
Some progressive companies are beginning to recognise these problems and have started to make changes to the performance leg of the issue. Microsoft recently stated that they would abandon numerical ratings and forced rankings. There is too much invested in the currently flawed process. And herein lies the competitive opportunity. The source of any winning strategy is differentiation. There is a huge opportunity to be bold and to change how employees are not only measured but also rewarded. The question is whether chief executives and boards have the courage to be different.