Pay to Perform vs. Pay to Fail

Pay to Perform vs. Pay to Fail

by Maksim Ovsyannikov

 

Pay for performance has been seen by many as a magic formula that will virtually guarantee the implementation of a successful compensation strategy for any organization. It makes sense. When employees perform according to specific, well-defined measures, the business grows profitably and employees are appropriately compensated. If employees don't perform, the company doesn't pay. Unfortunately, it's not that easy.

 

The U.S. Office of Personnel Management certainly thought it was. After decades of building pay scales based primarily on federal workers' seniority, the government became a major proponent of pay for performance. Its example encouraged many large companies to take the plunge. Unfortunately, few government success stories have emerged. More often, pay-for-performance programs have foundered, including the U.S. Defense Department's National Security Personnel System (NSPS) a pay-for-performance plan designed for 700,000 federal employees. In 2009, Congress repealed the program and plans to transition all NSPS employees to existing civilian personnel systems no later than Jan. 1, 2012.

 

The reason the pay-for-performance concept has been so disappointing is because the human aspect of motivating desired behaviors is not as cut and dried as the pay-for-performance approach generally implies. Most organizations simply don't know how to successfully define the performance they want, so organizations end up paying for failure rather than for performance.

 

At the Root

 

Traditional compensation management is a flawed process often executed without adequate supporting data. Talent leaders give managers budget guidelines and expect them to allocate salaries and bonuses based almost entirely on scores from annual reviews, then record compensation information in a spreadsheet.

 

Organizations that believe people truly move the needle for their businesses need a more innovative rewards program that integrates multiple measures of success into a sophisticated management tool. The right compensation program must be:

 

a) Market competitive and capable of fairly rewarding all employees and providing strategically higher compensation to key performers.

 

b) Transparent and able to offer the entire workforce visibility into how compensation decisions are made and what people can expect to be paid if they do well.

 

c) Performance based and focused on real outcomes related to business performance, not simply a performance review score, and able to draw upon formal and informal measures that capture an employee's true contribution to organizational success.

 

It is critical that a pay-for-performance program incorporate these cornerstone elements, which work together to ensure success. For example, unless a company offers market-competitive salaries and bonuses, it can't afford to be transparent because the lack of competitiveness in the compensation structure likely would cause employees to leave over time. Further, transparency is required to communicate precisely what employees must accomplish to earn rewards.

 

Paying for Failure

 

Without the aforementioned three underpinnings in a properly structured pay-for-performance program, organizations could indeed pay for failure rather than for success, as the following examples illustrate.

 

1. Running off the road.

In the book Hard Facts, Dangerous Half-Truths and Total Nonsense: Profiting From Evidence-Based Management by Jeffrey Pfeffer and Robert I. Sutton, the authors describe a pay-for-performance plan implemented by the city of Albuquerque, N.M., for its garbage collectors. Apparently, it was taking too long to complete pickups each week, and as a result, the city was paying a significant amount of overtime.

 

The city staff devised a pay-for-performance plan that offered the garbage collectors bonuses if they could complete their routes during an eight-hour day. Unfortunately, this fostered two counterproductive behaviors:

 

a) The garbage collectors often exceeded the speed limits along their routes or on the way to the recycling yard or dump.

 

b) The trucks made fewer trips to dump their loads - leading to a high incidence of dangerous overloads.

 

The city of Albuquerque just wanted the garbage collected on time and on budget, but it ended up paying for heavily overloaded garbage trucks careening recklessly through city streets, endangering the lives of local residents.

 

2. Unseen crime.

New Orleans regularly found itself ranked as having the highest murder rate in the United States. Because New Orleans is dependent upon tourist revenue - and tourists tend to avoid vacationing where the risk of being murdered is so high it makes national headlines - the city instituted a pay-for-performance program for its police force.

 

Unfortunately, it turned out there are two ways to reduce the reported incidence of crime. One is to actually reduce crime. The other is to underreport it. Human nature chose the second path. So, while the city paid bonuses to the police, the criminals were still in town, and New Orleans' murder rate continued to rise - increasing 31 percent from 48 per thousand in 2006 to 63 per thousand in 2008.

 

3. Failing grade.

In the Chicago public school system, students were underperforming. The system's board of directors decided to institute merit pay for teachers, based on bringing grade point averages up. Once again, human nature took over. Without needed transparency in the process, audits later discovered many teachers allowed students to cheat on tests to improve class GPAs. Grades and teacher compensation went up, but learning did not.

 

4. Taking stock.

In 2003, the New York Times suggested that to improve shareholder value, CEOs should have their compensation tied to the company's share prices. While that approach worked in some cases, many CEOs became adept at driving the stock price up to coincide with the dates on which their stock-option bonuses became available. The CEOs benefited, but the company and the shareholders ended up shortchanged.

 

All of these pay-for-performance programs were missing a key building block - either the appropriate transparency or real, employee-specific measures of success rather than standard performance review scores. As a result, instead of being paid to perform, people were actually paid to fail.

 

Performance for the 21st Century

 

There are some guidelines talent leaders can use to create a performance-driven rewards program that will foster a true culture of performance and organizational excellence.

 

1. Define a unique formula for success.

Do not try to base a pay-for-performance program solely on performance review scores or tie each employee's compensation to the company's overall financial performance. These measures may be part of it, but one must also define unique formulas for success based on competencies, proficiencies or performance tailored for each individual's role.

 

For salespeople, that can be relatively simple. A sales manager bases an employee's compensation on the sales quotas he meets or exceeds. But for a business consultant success criteria may be more challenging to identify. For example, a company might base compensation on community feedback or other measures of satisfaction regarding the programs or projects the consultant has overseen for clients.

 

Previously built compensation management solutions cannot help organizations define and measure the specific performance measures needed to work in today's business environment. Talent managers must employ tools that incorporate real measures of success from various talent processes - both formal and informal - to ensure reward dollars are spent where they provide the most value.

 

2. Reward potential as well as existing behavior.

Once a properly discriminating compensation program has been designed, is it better to reward employees currently exhibiting the desired behavior? Or should companies reward those with the potential to grow into the behavior - thus improving the business' performance over time?

 

The answer is to do both. Like maintaining a balanced investment portfolio, it's important to achieve a balance with pay-for-performance programs by both identifying current performers and motivating those who demonstrate they can reach proposed standards in order to nurture the performance required to succeed in the future.

 

3. Reward ability as well as hard work.

In many pay-for-performance programs, rewards have largely been tied to effort. A key goal in any organization is to motivate people to work harder, so using the rewards "carrot" based on effort makes sense.

 

But if talent managers do decide to reward effort, they must also build ability into the equation. Business success is s till based on results. And exceptionally talented people may be able to achieve superior results with less effort than others.

 

Traditional pay-for-performance programs have failed because companies have incorrectly assumed that by properly motivating everyone, effort would dramatically improve and goals would always be achieved. This assumes everyone has the same amount of ability, which is not the case. Talent managers need to enable performance excellence, not simply attempt to drive it by increasing the effort of the masses.

 

Monkey Business

 

In Competing for the Future, authors Gary Hamel and C. K. Prahalad describe an experiment involving four monkeys in a cage. Researchers dangled a bunch of bananas at the top of a pole in the center of the cage. But every time a monkey tried to climb the pole to get to the bananas, he or she was hit with a shower of extremely cold water.

 

One by one, the monkeys tried to reach the bananas but only received a blast of cold water. Eventually, they stopped trying, though the prize remained within reach.

 

After a time, a new monkey was added to the cage. When the new monkey started up the pole, the old monkeys yanked the surprised creature back down - sending the message, "Don't waste your time trying to achieve higher goals." Even once the entire population in the cage consisted of monkeys that had never received the cold shower, the culture of not trying for anything better remained.

 

And so it is if there's a negative culture within an organization, simply introducing positive influencers won't drive the intended change. A poorly designed compensation management program can actually reduce performance dramatically if it is not focused on the right attributes for success, and companies will end up paying for stunning failures instead of the inspiring performance they hope to achieve.

 

 

[About the Author: Maksim Ovsyannikov is senior director of product strategy for Saba.]