In the last few years, I have made it a practice to ask friends, college classmates and business contacts the question, "During your career, what changes in management have you observed, particularly in the last five years?"

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.

In an article published in the World of Work Journal, two compensation specialists with Sibson Consulting compared successful implementation of a broad-based compensation incentive system to building a bonfire on a beach for an all-night gathering.1 It takes a powerful spark to ignite the fire, a carefully constructed foundation and stamina to keep it burning throughout the evening. The article confirmed my belief that the foundation of an incentive system is critical. Three components of the foundation are relevant:

  • Seeking involvement from employees to select the KPIs, thus gaining their buy-in and commitment.
  • Setting objective, measurable and agreed-upon measures.
  • Recognizing employees with a carefully weighted bonus formula to differentiate over performers from underperformers.2

Of course, any performance review that affects an individual's compensation should contain elements of work behavior (e.g., their personal skill and behavior growth) as well as enterprise's financial results. The case I'm making here is that additional elements should be included to show how the individual is contributing to results that align with the executive team's strategic objectives.
The full vision of performance management is not only to integrate all methodologies and systems, but to position all of them on a common information platform where the data is cleansed, integrated and reliable. This eliminates the excuse that the administrative effort to operate a complex contingent pay-for-performance system exceeds the benefit.

A Way Forward

Can employees handle several weighted factors in their bonus equation to determine their compensation incentive? The compensation consultant I previously referenced said no. However, Bob Paladino, the balanced scorecard project leader for Crown Castle who received the top honor in 2005 from the Balanced Scorecard Collaborative, argues the opposite in his presentations at conferences about his company's scorecard implementation journey.3 Paladino describes the husband of an employee who approached a high-level executive in the aisle of a supermarket to ask, "How will the company end up at year-end with our safety index?" - a reference to a KPI affecting his wife's bonus. The startled executive initially asked the spouse, "Why would you want to know?" to which the spouse replied that his family was considering purchasing a new lawn mower and was wondering if his family would have the extra money to afford it.

The message here is that if a spouse can track KPIs and equate them in cash to an expected bonus, then maybe employees can handle multifactor weighted incentive formulas where some of the factors reflect the individual's performance regardless of how well or poorly the organization performed.

Organizations should not get it backward. Those that say, "The bonus plan doesn't work, and that is why we were unsuccessful," are confusing the role of a manager and an executive. It is more likely that the strategy was unsuccessful, and the employees were striving to meet poorly chosen objectives.

Ultimately, leaders must be able to communicate their vision - what success looks like if everything goes as planned. Leaders must inspire and empower others, combining their aspirations with delegated accountability. This is a cornerstone of performance management. Strategic vision must be cascaded through the organization so everyone aligns. In communicating the vision, the rewards system is important, but there are other factors. The executive team should also consider non-financial incentives and motivations for employees to perform. It is important to create and develop effective employee teams with favorable group dynamics and the right interpersonal behavior.

Performance management is a powerful way of linking employee behavior to the strategic intent of the executive team. And it provides business intelligence supported by predictive analytics, giving managers and employee teams the information they need to make better decisions and perform trade-off analysis. It's not just about monitoring the dials - it is about moving the dials.

References:

  1. Christian M. Ellis and Cynthia L. Paluse. "Blazing a Trail to Broad-Based Incentives," World of Work Journal. Fourth Quarter, 2000, pages 33-41.
  2. Kanter, Rosabeth Moss. "The Attack on Pay," Harvard Business Review. March-April, 1987. page 61.
  3. www.bscol.com.