The appeal of pay for performance
While pay for performance can be a solution for some organizations in search of new compensation concepts, it's not the answer for every company. Design is important, and the downside can be steep.
The rise of pay for performance
At a time of economic slowdowns and uncertainty, a compensation concept such as pay for performance is particularly tempting and increasingly popular. A recent survey by Hewitt Associates LLC found that nearly 8 in 10 companies have some kind of variable pay system, up from fewer than 5 in 10 in 1990. It's an understandable trend at a time when revenues slump, stock options shrivel, and across-the-board raises just aren't feasible for many organizations.
Does pay for performance really work?
The question for HR people who wonder if they should follow suit is this: does pay for performance really work? The answer is that while pay for performance can work, it's not the solution for every organization.
Diverse opinions on pay for performance
The range of opinion about pay for performance is broad and deep. Its proponents say that rigorous, long-term pay-for-performance systems offer effective methods of helping companies continually improve the workforce while getting and keeping the best people. Opponents argue that incentive pay plans tend to pit employees against one another, erode trust and teamwork, and create what critics call dressed-up sweatshops.
Sometimes, it's bad even while it's good. Lisa Weber, executive vice president of human resources for MetLife, calls the shift to a pay-for-performance model "absolutely gut-wrenching. Some people hate it."
MetLife's experience
But after MetLife placed all employees on a rating scale that is subject to change based on the performance of specific goals and core behaviors, the company's return on equity jumped from 7 percent in 1998 to 10.5 percent in 2000. "It's been tough, but it's been fabulous," she says.
Historical context
The concept of pay for performance isn't new. Ever since ancient Mesopotamians were paid by the basket for picking olives, there's been some form of performance-based pay. In the modern era, the term is used fairly loosely: commissions and bonuses are often thrown into the definition.
Defining pay for performance
For the purposes of this story, pay for performance means a variable pay approach that is anchored to a measurement of performance, whether that's how many hours an attorney bills every month or a more subjective standard—how well a manager fosters teamwork, for instance. Often, evaluations are based on best-to-worst forced ranking systems—known to many employees as rank and yank—which are thought to provide a way of identifying and rewarding strong performers and encouraging everyone to work harder and smarter. True pay for performance is more formalized than an occasional attaboy bonus. It is variable compensation that must be re-earned each year and doesn't permanently increase base salary.
What makes it work?
Measurable and objective criteria
Pay for performance is not limited to such environments as assembly lines or the piecework arena. It can translate to any business, including banks, accountants, and legal firms, says Niki Somerset, a management consultant in Virginia Beach, Virginia, who has helped many businesses move from a straight salary plan to a performance-based program. "Incentive pay has always been quietly done in boardrooms," she says. "If you've got 250 attorneys in 30 cities, you've got to set projections, people have to be productive. Billable hours are the ticket."
MetLife measures employees and managers by comparing each person to others who are on the same level. Employees are measured on a 1-to-5 scale. The company then calculates which employees are at the top, in the middle, and at the bottom. Employees who rate a 3 receive about 65 percent more in bonuses than those who earn a 2. A person rated 3 might receive a bonus of $6,900, whereas one who was rated 2 would get $4,200.
Focus on whole-company success
The company is concentrating a great deal of attention on the most senior 250 of the organization's 46,393 employees, says Weber. They are evaluated on their individual performance results and on questions such as: Do they show partnership? Do they demonstrate teamwork? Do they create heroes? How dedicated are they to learning and development?
Synygy, Inc., the largest provider of incentive management software and services, implemented its own plan a couple of years after the company was founded in 1991. Company spokesman Oliver Picher describes it as a bonus program that ranges in amount from 5 to 100 percent of an employee's base salary and is paid quarterly. Evaluation ratings are set by a "mentor" (supervisor), and also by coworkers who use an appraisal system called OPTIC: Ownership, Professionalism, Teamwork, (Continuous) Improvement, and Client Focus.
Employees are rated on a 1-to-5 scale. Objectives are set at the beginning of the quarter and at the end, and everyone in the company participates—whether clerical worker or top executive. As director of public relations, Picher says, he is evaluated on responsibilities that apply to his specific job, such as the number and quality of press releases and their impact, and the contacts he's made with specific people and organizations.
Challenges of pay for performance
When it pits employees against each other
This is the biggest problem with pay for performance, says Stanford University professor Jeffrey Pfeffer, who has researched the subject extensively and declares pay for performance "a myth."
"A company's success is not a consequence of what an individual does. It's a consequence of what the system does," says Pfeffer, the Thomas D. Dee professor of organizational behavior at the Stanford Business School.
"These programs do more damage than good," agrees Marc Holzer, a Rutgers University business professor and president of the American Society for Public Administration. He's watched agencies and schools trot out various compensation schemes, try them out, keep them, change them, and abandon them.
"They set up competition between people. They emphasize the individual rather than the team. Virtually all innovations are group efforts. Yes, the exceptional person should be rewarded. But that exceptional person is dependent on others, on support services, which is often ignored."
"Incentive pay is toxic.... By the early nineties, I was spending 95 percent of my time on conflict resolution instead of on how to serve our customers," says Pat Lancaster, the chairman of Lantech, a manufacturer of packaging machinery with 325 employees, who is quoted by Pfeffer in his book The Human Equation: Building Profits by Putting People First (Harvard Business School Press, 1998). What the system bred wasn't profits, Lancaster told Pfeffer, but greedy rival gangs of workers.
Conclusion
Whatever HR professionals decide to do about pay for performance, Pfeffer urges them to keep this in mind: "Many studies strongly suggest that this form of reward (individual incentive pay) undermines teamwork, encourages a short-term focus, and leads people to believe that pay is not related to performance at all but to having the 'right' relationships and an ingratiating personality."
That suggests that the only way pay for performance can work is if it rewards teamwork and long-term focus, and is designed to be as objective and fair as possible. Some proponents obviously think that's possible. Critics like Pfeffer think the idea is inherently flawed, and that it ignores another reason people work: "for meaning in their lives."
"In fact," he adds, "people work to have fun." Companies that ignore this fact are "essentially bribing their employees and will pay the price in a lack of loyalty and commitment."
Jay Schuster, a partner in Schuster-Zingheim and Associates, Inc., in Los Angeles and co-author of Pay People Right! (Jossey-Bass, 2000), has argued with Pfeffer about pay for years. "Pfeffer is right. People do work for more than pay," he says. "But what they are concerned with is this: a compelling future, a positive workplace, individual growth, and total pay.
"The organizations that do indeed truly reward people consistently for performance outperform those that don't," Schuster adds. "My sense is, if you're not going to pay for performance, what are you going to pay for?"
It is a question that has no easy answer. But most of those close to the issue would agree with Pfeffer when he warns that the one thing above all others that can potentially inflict the most damage on an organization is to tamper with its pay system. When considering such a major decision, the first principle for the HR professional to address should be this: First, do no harm.
Workforce, August 2001, pp. 28-34 -- Subscribe Now!
Janet Wiscombe is Associate Editor for Workforce.
From India, Bangalore
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While pay for performance can be a solution for some organizations in search of new compensation concepts, it's not the answer for every company. Design is important, and the downside can be steep.
The rise of pay for performance
At a time of economic slowdowns and uncertainty, a compensation concept such as pay for performance is particularly tempting and increasingly popular. A recent survey by Hewitt Associates LLC found that nearly 8 in 10 companies have some kind of variable pay system, up from fewer than 5 in 10 in 1990. It's an understandable trend at a time when revenues slump, stock options shrivel, and across-the-board raises just aren't feasible for many organizations.
Does pay for performance really work?
The question for HR people who wonder if they should follow suit is this: does pay for performance really work? The answer is that while pay for performance can work, it's not the solution for every organization.
Diverse opinions on pay for performance
The range of opinion about pay for performance is broad and deep. Its proponents say that rigorous, long-term pay-for-performance systems offer effective methods of helping companies continually improve the workforce while getting and keeping the best people. Opponents argue that incentive pay plans tend to pit employees against one another, erode trust and teamwork, and create what critics call dressed-up sweatshops.
Sometimes, it's bad even while it's good. Lisa Weber, executive vice president of human resources for MetLife, calls the shift to a pay-for-performance model "absolutely gut-wrenching. Some people hate it."
MetLife's experience
But after MetLife placed all employees on a rating scale that is subject to change based on the performance of specific goals and core behaviors, the company's return on equity jumped from 7 percent in 1998 to 10.5 percent in 2000. "It's been tough, but it's been fabulous," she says.
Historical context
The concept of pay for performance isn't new. Ever since ancient Mesopotamians were paid by the basket for picking olives, there's been some form of performance-based pay. In the modern era, the term is used fairly loosely: commissions and bonuses are often thrown into the definition.
Defining pay for performance
For the purposes of this story, pay for performance means a variable pay approach that is anchored to a measurement of performance, whether that's how many hours an attorney bills every month or a more subjective standard—how well a manager fosters teamwork, for instance. Often, evaluations are based on best-to-worst forced ranking systems—known to many employees as rank and yank—which are thought to provide a way of identifying and rewarding strong performers and encouraging everyone to work harder and smarter. True pay for performance is more formalized than an occasional attaboy bonus. It is variable compensation that must be re-earned each year and doesn't permanently increase base salary.
What makes it work?
Measurable and objective criteria
Pay for performance is not limited to such environments as assembly lines or the piecework arena. It can translate to any business, including banks, accountants, and legal firms, says Niki Somerset, a management consultant in Virginia Beach, Virginia, who has helped many businesses move from a straight salary plan to a performance-based program. "Incentive pay has always been quietly done in boardrooms," she says. "If you've got 250 attorneys in 30 cities, you've got to set projections, people have to be productive. Billable hours are the ticket."
MetLife measures employees and managers by comparing each person to others who are on the same level. Employees are measured on a 1-to-5 scale. The company then calculates which employees are at the top, in the middle, and at the bottom. Employees who rate a 3 receive about 65 percent more in bonuses than those who earn a 2. A person rated 3 might receive a bonus of $6,900, whereas one who was rated 2 would get $4,200.
Focus on whole-company success
The company is concentrating a great deal of attention on the most senior 250 of the organization's 46,393 employees, says Weber. They are evaluated on their individual performance results and on questions such as: Do they show partnership? Do they demonstrate teamwork? Do they create heroes? How dedicated are they to learning and development?
Synygy, Inc., the largest provider of incentive management software and services, implemented its own plan a couple of years after the company was founded in 1991. Company spokesman Oliver Picher describes it as a bonus program that ranges in amount from 5 to 100 percent of an employee's base salary and is paid quarterly. Evaluation ratings are set by a "mentor" (supervisor), and also by coworkers who use an appraisal system called OPTIC: Ownership, Professionalism, Teamwork, (Continuous) Improvement, and Client Focus.
Employees are rated on a 1-to-5 scale. Objectives are set at the beginning of the quarter and at the end, and everyone in the company participates—whether clerical worker or top executive. As director of public relations, Picher says, he is evaluated on responsibilities that apply to his specific job, such as the number and quality of press releases and their impact, and the contacts he's made with specific people and organizations.
Challenges of pay for performance
When it pits employees against each other
This is the biggest problem with pay for performance, says Stanford University professor Jeffrey Pfeffer, who has researched the subject extensively and declares pay for performance "a myth."
"A company's success is not a consequence of what an individual does. It's a consequence of what the system does," says Pfeffer, the Thomas D. Dee professor of organizational behavior at the Stanford Business School.
"These programs do more damage than good," agrees Marc Holzer, a Rutgers University business professor and president of the American Society for Public Administration. He's watched agencies and schools trot out various compensation schemes, try them out, keep them, change them, and abandon them.
"They set up competition between people. They emphasize the individual rather than the team. Virtually all innovations are group efforts. Yes, the exceptional person should be rewarded. But that exceptional person is dependent on others, on support services, which is often ignored."
"Incentive pay is toxic.... By the early nineties, I was spending 95 percent of my time on conflict resolution instead of on how to serve our customers," says Pat Lancaster, the chairman of Lantech, a manufacturer of packaging machinery with 325 employees, who is quoted by Pfeffer in his book The Human Equation: Building Profits by Putting People First (Harvard Business School Press, 1998). What the system bred wasn't profits, Lancaster told Pfeffer, but greedy rival gangs of workers.
Conclusion
Whatever HR professionals decide to do about pay for performance, Pfeffer urges them to keep this in mind: "Many studies strongly suggest that this form of reward (individual incentive pay) undermines teamwork, encourages a short-term focus, and leads people to believe that pay is not related to performance at all but to having the 'right' relationships and an ingratiating personality."
That suggests that the only way pay for performance can work is if it rewards teamwork and long-term focus, and is designed to be as objective and fair as possible. Some proponents obviously think that's possible. Critics like Pfeffer think the idea is inherently flawed, and that it ignores another reason people work: "for meaning in their lives."
"In fact," he adds, "people work to have fun." Companies that ignore this fact are "essentially bribing their employees and will pay the price in a lack of loyalty and commitment."
Jay Schuster, a partner in Schuster-Zingheim and Associates, Inc., in Los Angeles and co-author of Pay People Right! (Jossey-Bass, 2000), has argued with Pfeffer about pay for years. "Pfeffer is right. People do work for more than pay," he says. "But what they are concerned with is this: a compelling future, a positive workplace, individual growth, and total pay.
"The organizations that do indeed truly reward people consistently for performance outperform those that don't," Schuster adds. "My sense is, if you're not going to pay for performance, what are you going to pay for?"
It is a question that has no easy answer. But most of those close to the issue would agree with Pfeffer when he warns that the one thing above all others that can potentially inflict the most damage on an organization is to tamper with its pay system. When considering such a major decision, the first principle for the HR professional to address should be this: First, do no harm.
Workforce, August 2001, pp. 28-34 -- Subscribe Now!
Janet Wiscombe is Associate Editor for Workforce.
From India, Bangalore
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Hi! I suggest you read (or attend a seminar) on W. Mercer's Three P's in Compensation Management. In this area, W. Mercer argues very well for their proposition that organizations must use the THREE Ps (person, position, and performance) as the basis for their compensation and rewards.
Best wishes,
Ed Llarena, Jr.
Managing Partner
Emilla Consulting
From Philippines, Parañaque
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95Best wishes,
Ed Llarena, Jr.
Managing Partner
Emilla Consulting
From Philippines, Parañaque
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