I expected to hear about trends such as the need to be more customer-centric or the move toward outsourcing. Instead, many people told me about seeing a sharp escalation in the tendency of businesses to hold managers and employees much more accountable for results. They said there is now no place to hide in an organization if you are not a value-adding producer. If you are not delivering expected outcomes, your job security or your job position is at risk.
It is a fact that competitive pressures in the commercial sector and increasing board-level governance have led to the demand for greater accountability. More and more, underperformers are increasingly detected and their career paths adversely affected. In higher education, the tradition of faculty tenure is gradually being abandoned. I am not trying to characterize organizations as cruel and insensitive entities that treat employees as disposable parts, but merely pointing out that economic forces are bringing pressure on organizations for higher yields with the same or fewer resources.
But how fair and equitable is the process of evaluating individuals? Do performance measures cause the desired behavior that management seeks? Can adopting the full vision of enterprise-wide performance management remedy these problems by deploying effective incentive, reward and recognition systems?
Reward Performance You Want to Encourage - Bucks for Behavior
Many organizations have implemented balanced scorecards and use the results to determine bonuses in pay. Regardless of how fancy and eye-appealing the visual meters and dashboards, at the core of a balanced scorecard is the selection of appropriate measures and the number of them. If the wrong key performance indicators (KPIs) are chosen, then the behavior, priorities and decisions of employees and their organization as a whole will not be well aligned with the direction of the executive team. If the KPIs are appropriate but too many KPIs are assigned to an individual, then the employee's ability to focus is diluted. I advocate no more than three KPIs per employee. With hierarchical cascading and linked KPIs, which are traits of a good balanced scorecard, that individual's supervisors will have higher-level KPIs that can be included in the weighted mix formula of the individual's cash bonus.
To complicate matters, if performance incentives are not strong enough or adequately linked to employees, there will not be sufficient traction. For example, receiving a tiny cash bonus or one that results mainly from high-level companywide measures (such as the company's year-end profit) may not motivate individuals. Additionally, if the KPIs are simply the traditional measures of the past, then do they measure what can be measured? What should they measure to realize the executive team's strategy?
For decades, compensation consultants have proposed elixirs such as profit-sharing pool bonuses or gain sharing, but are they enough? If working harder to earn a higher cash bonus motivates an employee, how focused will that person be if the contribution they make has minimal influence on the overall results of the enterprise? Will the distribution of cash bonuses be equitable? The term "pay for performance" (i.e., a contingent bonus depending on varying results) has been around for years, but the "performance" measured is typically not directly under the employee's control.
How Effective are Performance Measures without Consequences?
I asked a specialist in a leading compensation consulting firm how sophisticated the year-end cash bonus formula can be for individuals. He replied that it must be kept simple and should not link the incentive pay equation to KPIs, which this person believed to be too complicated. I was surprised. If the reward basis is too simple, how can you differentiate one individual's performance from that of another - particularly if the determination is based on high-level enterprise financial results such as year-end profits? A key factor in motivating someone, in my opinion, is his or her sense that over performers in the organization are differentiated from underperformers and that they are accordingly (and materially) recognized. Otherwise, "free riders" gain inequitably awarded rewards that can provoke resentment.
To clarify, the incentives I am referring to are merit-based annual bonuses - variable at risk payments - not salary increases. Linking salary increases to performance is ineffective, but many organizations continue to do it. The common wisdom by human resource experts is to link salary increases to market increases of a job skill, such as regional salary level for a financial controller, except perhaps for underperformers. Numerous salary surveys exist, but the key point here is to link performance to a variable annual bonus.
Incentive compensation is a sensitive topic with many thorny issues I can discuss in a future column. These include group-based versus individual-based incentives; short-term immediate bonuses versus longer-term deferred ones; payment frequency (e.g., annually, quarterly); and allowances for wide swings in the bonus pools affected by business cycles or poor decisions by senior management. Ultimately, we can talk about increasing accountability all we want, but performance measures without consequences simply have no teeth or traction.
How Does Performance Management Solve This?
As I described in a December 2005 column for DMReview.com, economists have wrestled historically with determining the appropriate organizational structure for implementing business strategy. In the 1970s, Professor Alfred D. Chandler of the Harvard Business School led the field with research and published articles that explored three S's of management: strategy, structure and systems. Businesses have constantly shifted organizational (i.e., human) structures to attempt to achieve better performance. But advocates of the balanced scorecard with KPIs that are determined by linked organizational objectives in strategy maps believe that there may never be a perfect organizational structure. The essence of the balanced scorecard is to focus less on the organizational structure and concentrate on designing a managerial system that aligns an individual's behavior directly with the executive team's strategic objectives through cascading and linked KPIs.