If you have been paying attention, you know that an increasing number of businesses worldwide are abandoning long-standing performance management systems and philosophies in an attempt to address the constantly shifting climate of talent acquisition, development and retention.  A recent Harvard Business Review article summarizes the reason for this trend:

 …the biggest limitation of annual reviews—and, we have observed, the main reason more and more companies are dropping them—is this: With their heavy emphasis on financial rewards and punishments and their end-of-year structure, they hold people accountable for past behavior at the expense of improving current performance and grooming talent for the future, both of which are critical for organizations’ long-term survival.  In contrast, regular conversations about performance and development change the focus to building the workforce your organization needs to be competitive both today and years from now.  Business researcher Josh Bersin estimates that about 70% of multinational companies are moving toward this model, even if they haven’t arrived quite yet.

The tension between the traditional and newer approaches stems from a long-running dispute about managing people: Do you “get what you get” when you hire your employees?  Should you focus mainly on motivating the strong ones with money and getting rid of the weak ones?  Or are employees malleable?  Can you change the way they perform through effective coaching and management and intrinsic rewards such as personal growth and a sense of progress on the job?

With traditional appraisals, the pendulum had swung too far toward the former, more transactional view of performance, which became hard to support in an era of low inflation and tiny merit-pay budgets.  Those who still hold that view are railing against the recent emphasis on improvement and growth over accountability.  But the new perspective is unlikely to be a flash in the pan because…it is being driven by business needs, not imposed by HR. (“The Performance Management Revolution,” HBR, October 2016, Peter Cappelli and Anna Tavis)

This trend is making the need for a strategic approach to compensation planning more urgent than ever. In VisionLink’s work with client companies throughout the United States and beyond, business leaders inevitably want to know how to marry their pay approach—especially incentives—to whatever performance management system they have adopted.  Over the years, many have even hoped we can actually help them engineer the right kind of performance appraisal system and then link it to the rewards strategy we design for them. 

We have resisted that role in part because we haven’t been fans of the philosophies and practices driving most employee evaluation systems.  As indicated by the HBR authors just quoted, the focus of most performance appraisal programs is to look backwards more than forward—while our philosophy is to use compensation as a means of linking the owner’s and employee’s vision of the future (hence, the name VisionLink).  If that can be achieved in a meaningful way, the organization ends up with a unified financial vision for growing the business.  Such organizations nurture a partnership environment wherein the wealth multiple of all stake holders is tied to the company’s success—not solely for the sake of wealth building as an end to itself but rather as a channel to fulfilling the contribution aspirations of both owners and employees, which rely on financial means for their realization.

So, what happens with a company’s pay philosophy and strategy in an environment where organizations are pulling back on formal appraisals and detailed metrics for evaluating employee performance?  To answer that, let’s return to the HBR article just quoted and focus on the three business reasons it gives for eliminating performance appraisals (as historically applied).  After each excerpt, we’ll explore the pay implications of the abandonment imperative the authors discuss. 

The Return of People Development

Companies are under competitive pressure to upgrade their talent management efforts. This is especially true at consulting and other professional services firms, where knowledge work is the offering— and where inexperienced college grads are turned into skilled advisers through structured training.  Such firms are doubling down on development, often by putting their employees (who are deeply motivated by the potential for learning and advancement) in charge of their own growth. This approach requires rich feedback from supervisors—a need that’s better met by frequent, informal check-ins than by annual reviews.

Pay Implications

This imperative reinforces the need for organizations to view and build compensation strategies in a Total Rewards framework and not as an isolated effort. A Total Rewards approach means an organization pays attention to four, interdependent employee engagement elements—and makes sure they remain in balance.  It ensures that an employee’s intrinsic drive is not stifled by factors that inhibit the autonomy, mastery and purpose elements authors like Daniel Pink point to as the primary forces motivating performance.  Intrinsic forces are critical in an environment where higher self-monitoring is being used to manage the performance of your workforce.  The four parts of a Total Rewards strategy include:

Compelling Future.  This means the company paints a clear and persuasive picture of where the organization is headed and why it’s meaningful.  More importantly, it communicates why a given employee (in the context of his or her role and unique abilities) is critical to the fulfillment of that vision.  And with the rise of millennials in the workforce, more and more employees want to know that the company’s success has meaning beyond driving profits.  This addresses the purpose element upon which intrinsic motivation relies.

Positive Work Environment.  For intrinsic motivators to be unleashed, employees need to feel as though they are working within the realm of their unique abilities, that other team members have complimentary capacities, that they are sufficiently empowered to produce the outcomes for which they have responsibility and that they share the values of the organization.  They also want to know that their role has strategic purpose—and they are clear on what that is.  This produces the autonomy component essential to motivation.

Personal and Professional Development.  Self-management and motivation are fueled when employees feel as though they work in an environment that is accelerating their ability to improve.  This usually happens when the combination of resources to which an employee is exposed within the organization creates a unique learning experience—one that allows him or her to excel.  This enables the mastery factor to take hold that intrinsic motivation feeds upon.

Financial Rewards.  Organizations that understand the need to focus on people development see financial rewards through a different lens than those that don’t.  They do away with the concept of incentives and turn instead to a value creation and value sharing model.  They first decide how value creation will be defined in their organization and then articulate a philosophy about how and with whom it will be shared

Value-sharing gives shape and definition to the wealth multiplier opportunity that is the natural outgrowth of organizational success.  It fulfills a kind of continuity role in the Total Rewards make up by putting a financially codifying exclamation point on the relationship.  In essence, a value-sharing philosophy sends the following message to success-oriented employees: “We consider you to be an essential growth partner in this company and we have confidence in your ability to help us achieve the future business we’ve envisioned.  As a result, we want you to be clear about the financial nature of our partnership and what it will mean to you as we achieve sustained success.”  This speaks to all three motivational areas—purpose, autonomy and mastery—and allows employees to see how their role in the company will help them fulfill their contribution aspirations.

The Need for Agility

When rapid innovation is a source of competitive advantage, as it is now in many companies and industries, that means future needs are continually changing.  Because organizations won’t necessarily want employees to keep doing the same things, it doesn’t make sense to hang on to a system that’s built mainly to assess and hold people accountable for past or current practices. As Susan Peters, GE’s head of human resources, has pointed out, businesses no longer have clear annual cycles.  Projects are short-term and tend to change along the way, so employees’ goals and tasks can’t be plotted out a year in advance with much accuracy.

Pay Implications

An environment of constant change and innovation requires a pay strategy that is flexible and adaptable.  However, this doesn’t mean the core compensation plans that an organization puts in place have to be redesigned every few months.  What it means is that a company needs a comprehensive rewards approach that is effectively aligned with the organization’s business model and strategy and is managed in an operational construct that facilitates change and modification.  It also means business leaders look at compensation as they would an investment portfolio made up of various asset classes that have to be properly allocated and monitored.  When you set up an investment portfolio correctly, you don’t add and subtract asset groups or investments every time the economy shifts.  Instead, you rebalance and shift the “weight” given to certain classes of investments to reflect changing conditions.  Compensation is no different. 

In the realm of pay, this kind of approach requires an operational structure that allows the compensation “investment portfolio” to be monitored effectively.  That’s why we recommend companies build a Total Compensation Structure (TCS).  A TCS is a framework you create for managing and analyzing all of the components of pay and benefits you are offering.  Ideally, it includes an integrated “dashboard” that gives you an “all in one place” view of every employee tier, what plans they’re eligible for and at what level.  This allows you to evaluate the whole value proposition as opposed to each individual component in isolation.  Within this framework, it is easier to make decisions and adjustments in specific pay plans because you can measure each against its

 impact on the whole rewards picture—and in the context of change and innovation currently at play in your business.

The Centrality of Teamwork

Moving away from forced ranking and from appraisals’ focus on individual accountability makes it easier to foster teamwork.  This has become especially clear at retail companies like Sears and Gap—perhaps the most surprising early innovators in appraisals.  Sophisticated customer service now requires frontline and back-office employees to work together to keep shelves stocked and manage customer flow, and traditional systems don’t enhance performance at the team level or help track collaboration.

Gap supervisors still give workers end-of-year assessments, but only to summarize performance discussions that happen throughout the year and to set pay increases accordingly.  Employees still have goals, but as at other companies, the goals are short-term (in this case, quarterly).   

Pay Implications

A teamwork environment requires organizations to execute what one HBR author called a “promise-based” operational and management style.  In such an environment, different departments or teams within a company take on either a customer or supplier role, depending on the needs of each during a given period.  For example, at times finance may be the supplier and sales the customer when the latter needs to formulate special pricing for a specific buyer or market.  At other times, the roles are reversed when finance needs certain performance projections or revenue data from the sales team.  Then finance becomes the customer and sales the supplier.

This kind of dynamic requires an organization to ensure that the payout potential of its value-sharing plans (such as annual bonuses and long-term incentive plans) is tied to a combination of  company, team or department, and individual performance.  Those factors have to be “weighted” in a way that is compatible with the employee’s ability to impact each area—but some percentage should be allocated to every category. This is how you align pay with an organizational performance model that is driven by the centrality of teamwork.  When some element of an employee’s pay is always dependent upon the performance of the “whole”—on either a company-wide or department basis—there is continuity between compensation and operations.  That kind of continuity breeds trust, which in turn accelerates execution and performance.

So what can we conclude from this analysis so far?  The demise of performance management—at least as it used to be applied—is simply a reaction to the pace at which the talent landscape is changing.  It’s an acknowledgment of an empowered workforce and the need for companies to adapt to a new way of managing their talent if they want to attract, develop and retain the best people.  All of this is requiring business leaders to think more strategically and creatively than ever before about the value proposition they construct for their workforce. 

It’s an exciting time but not one for the faint-hearted.  Those who choose to ignore these trends will likely find themselves first falling behind, then fading away.  For those who embrace “the new frontier,” the possibilities for accelerated growth are really limitless. However, this new direction is not nirvana.  It is fraught with pitfalls and hurdles.  So let’s talk about the challenges the demise of performance management has wrought and the role pay should have in addressing them.

Problems Still to Be Solved

The trend of ever increasing numbers of businesses adopting new ways of managing the performance of their people carries in its wake a bushel of difficulties and complications. So for this new direction to success, those potential obstacles have to be anticipated and effectively addressed—especially as it relates to pay for performance issues. The same Harvard Business Review article quoted earlier identifies what some of those challenges include:

Aligning Individual and Company Goals

…how do you coordinate individual priorities with the goals for the whole enterprise, especially when the business objectives are short-term and must rapidly adapt to market shifts?  It’s a new kind of problem to solve, and the jury is still out on how to respond.

Rewarding Performance

Appraisals gave managers a clear-cut way of tying rewards to individual contributions. Companies changing their systems are trying to figure out how their new practices will affect the pay-for-performance model, which none of them have explicitly abandoned.

…it will be interesting to see whether most supervisors end up reviewing the feedback they’ve given each employee over the year before determining merit increases…If so, might they produce something like an annual appraisal score—even though it’s more carefully considered?  And could that subtly undermine development by shifting managers’ focus back to accountability?

Identifying Poor Performers

…given how reluctant most managers are to single out failing employees, we can’t assume that getting rid of appraisals will make those tough calls any easier.  And all the companies we’ve observed still have “performance improvement plans” for employees identified as needing support.  Such plans remain universally problematic, too, partly because many issues that cause poor performance can’t be solved by management intervention.  (“The Performance Management Revolution,” HBR, October 2016, Peter Cappelli and Anna Tavis)

The article discusses other “hurdles”—such as avoiding legal troubles and managing the feedback “firehouse”—but you get the picture.  The byproduct of change is new challenges.  Change and challenge are progress companions; you can’t have one without the other.  But although they are inescapable, the issues created by the new performance management trends are forcing companies to figure out how they can still engender a performance culture that will attract, develop and retain the kind of talent they need to sustain success. 

A Performance Framework

The most effective way to address the fallout associated with the demise of performance management is to construct a performance framework.  An organization’s performance framework should address three related dimensions: The Business Framework, The Compensation Framework and the Talent Framework.  These parts are separate but interdependent.  They work together as a kind of performance “connective tissue” making sure that each area of focus is constructed to enhance and not diminish the others.  Any organization expecting to adopt a more fluid approach to performance management, while still sustaining or improving results, must ensure that each element of the overall framework is working properly and is effectively linked with its reliant partners.  So let’s examine what is required in each of these three areas.

Business Framework

In this first category, enterprise leaders must envision the future company, define its revenue engine and standards and then identify the roles needed to execute its strategy and business model.  That analysis should include the following:

  1. Define the company’s growth expectations (vision). Here company leadership wants to clearly express key outcomes that need to be achieved in the future in quantifiable terms.  A financial model that looks at a three to ten-year horizon in terms of base, target (or budget) and superior levels of growth is recommended.  The model should also project what happens to shareholder value at each level of performance.
  1. Define the business model and strategy. This step involves a clear articulation of two separate but related issues.  The business model is how the company drives revenue and makes money.  Its strategy is how it competes in the marketplace with that model.  Business leaders need to identify where the leverage points are in each and how they can be maximized. This should help determine the growth opportunities that will lead to fulfillment of the financial vision modeled in step one.
  1. Identify roles and expectations. With the first two elements established, the company should next think about the specific skill sets that will be needed to drive the business model and strategy.  Those skill sets define the kinds of roles and expectations that are associated with the outcomes the company must achieve if the “future company” is to be realized.  Expectations should be articulated in the form “success” criteria that relate to the fulfillment of each role.

Compensation Framework

With the business framework in place, the compensation framework is more naturally constructed.  The pay structure should help align roles and expectations with the business vision, model and strategy by framing the financial partnership that will exist between ownership and the workforce.  It should include the following:

  1. Identify a Pay Philosophy. This is a written statement that acts as a kind of compensation “constitution”
    for the business.  It should define what the company is willing to “pay for”—and presupposes the organization has defined what value creation means in that business, so it can also articulate its belief about how and with whom it should be shared.  The pay philosophy is also where a company addresses whether it’s going to adopt an expansive or selective approach to structuring rewards for key producers.  Expansive essentially means everyone will be treated the same.  A selective approach recognizes there are key producers and contributors in the organization who should be treated different from others in terms of earnings potential and the level of participation in value sharing.
  1. Engineer Pay Strategies that Reflect the Philosophy.This means a company will pay attention to both its salary structure and value sharing—and strive to achieve an effective balance between the two.  Likewise, it will build both short and long-term incentive plans (value sharing arrangements) that reflect the kind of financial partnership it believes it should build with its people.  To do so, it must pay attention to both the structural and the mindset impact of their plans.  Structure addresses who should be in the plan, what kind of plan it should be, how much it should pay out and so forth.  Mindset has to do with whether or not a plan will build a greater sense of stewardship about ownership priorities and whether it will enable a higher level of commitment and engagement on the part of employees.
  1. Adopt a Total Rewards Approach. This simply means that an organization recognizes that there must be more to its value proposition than financial rewards.  The components of a Total Rewards approach were identified earlier.

Talent Framework

The final piece in our performance framework is talent.  This level of planning has to do with identifying existing key producers and then pinpointing potential talent gaps.  It also includes communicating expectations and rewards to both your current cadre of talent and those you are recruiting—then marketing a compelling future to those people. 

  1. Identify Key Producers. These are individuals who are most responsible for helping the company consistently achieve the “success” standards it has identified (see business framework).  A business needs to be able to recognize the difference between this kind of contributor and the rest of its workforce.  It should also be able to identify the skill sets of those in this category and how they compare with the expertise needed to achieve the growth goals the company spelled out in its business framework.
  1. Identify Talent “Gaps.” Step one should make it easier to identify where the company falls short in the skills needed to reach organizational performance standards and goals.  That gap should then drive the recruiting strategy the business adopts for seeking new talent.
  1. Communicate Expectations. Individuals that are capable of driving the performance of the company want there to be high expectations that are well-defined.  Expectations are—or at least should be—reinforced in the way people are paid.  When there is a clear link between company vision, business model and strategy, roles and expectations and rewards, “line of sight” exists.  This simply means those elements are mutually reinforcing and work together to create a unified vision of what the target is, who is responsible for its completion and how he or she will be rewarded when those expectations have been fulfilled.
  1. Communicate Rewards. In the context just described, pay strategies form the capstone that defines the financial partnership with the company’s key people.  As a result, compensation must be both effectively engineered and clearly communicated.  That communication should include a statement of the company’s pay philosophy, an articulation of the specific program(s) being introduced and a projection of the total rewards value a producer can receive from the business over an extended period of time.  This is not a matter, however, of simply walking employees through their compensation package.  It’s about marketing a future to each individual employee—especially key producers.  When all of this occurs, employees get a magnified view of the value proposition  they are being offered through their partnership with the organization.  A new employee, for example, is no longer being told they are being hired to fulfill a $175,000 salaried position.  Rather, she is there to fulfill an important role and as such will participate in a financial “partnership” that is worth $1.7 million (for example) over the next five years through the combination of rewards for which she is eligible (salary, annual and long-term value sharing plans, traditional and executive 401(k) plans, flexible benefits, etc.).

Any company that is serious about transitioning away from traditional performance management systems and practices will need a framework such as the one just described.  That way, the performance intent and focus of the business, its pay systems and its talent will be aligned.  The result is a more unified financial vision for growing the business in which employees are encouraged and trained to adopt a stewardship mindset.  They take ownership of their performance and progress because line of sight has been created—which carries with it an inherent accountability

In Conclusion

So where does this leave us?  Well...it leaves us with some decisions to make and some questions to answer, does it not?  Are we going to follow the current trend away from formal performance management systems and chart new territory or stick with our current system?  If we do adopt a new approach, are we prepared to address the difficulties and challenges that kind of change will bring?  Can our compensation strategy be adapted to a new performance management system or will it require significant remodeling?  Do we have a leadership team that can both embrace and drive a new system if we go down that road?  Can we (you fill in the blank for your company)? 

More questions certainly could be raised. Hopefully, you get the picture.  As with all things in enterprise, we are left with much to consider.

That said, if you lead a business, you recognize that there really isn’t a choice here.  Standing still is the same as retreating, and ignoring inevitable tides of change is tantamount to competitive surrender.  The only real alternative is to embrace and prepare for “new and improved” methodologies and philosophies—be they performance management related or otherwise.  

Therefore, as it relates to the employee appraisal and evaluation subject at hand, here are five steps I suggest you take as a result of the issues we’ve been considering.

  1. Define what your experience has been with performance management to date and determine what your philosophy will be going forward.
  2. Form a team that will work together to identify your company’s performance framework. This will be valuable whether or not you follow a new employee appraisal process. 
  3. Make a list of the pay for performance challenges you anticipate if you adopt a more flexible performance management system. Begin identifying strategies to deal with each one.
  4. Create a written compensation philosophy statement. This too will serve you well regardless of the performance management approach you take. Click here for guidance.
  5. Build a Total Compensation Structure that will allow you to evaluate your current pay strategy and manage it going forward. This too will inherent value whether or not your performance management approach changes.  Click here for guidance.

The future is an exciting place to those who prepare for it.  So, begin preparing.

Need Help with Your Pay Strategy?

If you lead a business and are struggling with developing an effective compensation approach, it might be the right time to have a conversation with a VisionLink consultant.  To speak with one of our experts about the rewards issues you are facing, call us at 1-888-703-0080. 

About the Author

Ken GibsonKen Gibson
Senior Vice President, The VisionLink Advisory Group


Ken has been consulting with middle-market private and public companies on executive compensation and benefits issues for over 30 years. In addition, he has authored numerous articles and white papers addressing compensation and rewards topics that modern businesses face. Ken also conducts a monthly webinar series on compensation best practices for business leaders throughout North America. His client work centers on the development of overall compensation strategies designed to enhance and improve shareholder value and workplace productivity. He is one of VisionLink’s six principals.

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The Reinvention of Performance ManagementStudies indicate that performance management is undergoing a revolution. Formal systems are on the decline and more fluid methods are on the rise.This new trend is likely leaving you with plenty of questions about compensation. VisionLink’s free report will help you navigate this new revolution. We have studied the research, tracked the trends and assessed the new role pay will have in this changing environment. Now we want to grant you access to what we’ve learned.

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