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The Challenge of Linking Performance and Incentives

by Barry Bruce, Principal Consultant, SOAR Consulting and Training Inc.Tuesday, October 11, 2011

I recently contributed an article addressing the significant value, which can be generated from a well designed and manager-supported performance management system. I have seen the benefits and know they can be realized, but that does not happen without good planning, diligence and determination.

When I was writing the article, I was asked about the challenges of linking rewards and incentives to performance metrics, with concerns such as:

  • a workforce trying to skew numbers in their favour
  • a workforce setting low goals so they can more easily reach higher levels of achievement and associated reward, or
  • managers setting up the wrong measures to monitor/evaluate results.

Have I ever seen these types of outcomes? My experience leads me to these three short answers – no, no and yes. I will expand on each of these with some examples and explanation.

To suggest that an entire workforce would try to skew numbers or goals suggests a very high level of collusion. I have never seen this happen. That being said, it may occur in rare situations, and there may be readers out there who can provide examples (I would be very interested to hear about them). Let’s understand, though, that most people keep the results of their performance reviews and compensation outcomes private, between themselves and their managers or human resources. Any sharing of information that does occur tends to be between individuals, but rarely, if ever, is it acted upon in an aggregate, collaborative fashion by a group. To contemplate a situation where a number of employees have banded together to share their displeasure over the performance and incentive system, and then actually conspire to do something about it suggests a whole level of deeper dysfunction than the system itself. If it does happen, I would venture to say that the company most likely created the conditions, which earned the result. Let me give you an example.

A number of years ago I performed a human resources audit on a food services company where there were a number of lower paid employees preparing food for shipment to grocery stores and restaurants. This high volume, low margin business tightly controlled costs and since labour was a high percentage of the cost, these costs were tightly controlled. As a result, the company chose not to have a sick leave or short term disability plan (paid sick leave) and vacation entitlements were at the minimum required by law. We could debate for some time the obvious downside of motivating sick employees to attend work to prepare food for the public, but I will leave that for another time. What I did find in the audit, though, was that a few employees (6 or 7 out of a workforce of a couple hundred) had found a convenient loophole, which as it turned out was costing the company big time. These individuals, clearly lacking in the same moral compass as others or who were carrying their own grudge against the company, realized that by claiming to have slipped in the refrigeration or assembly area they could get a doctor’s note to say they needed time off (back injury) and then receive worker’s compensation payments for their time away from the job. These six or seven employees had multiple such incidents on record, while the remainder of the workforce had virtually none. In one instance an individual who had claimed a back injury was observed and reported shortly after his back injury helping a relative with his carpet installation business. Certainly you could say that this type of fraudulent activity was the result of poor employee choices and behaviour, but the company had to shoulder its share of blame for creating an environment where some employees felt their only choice was to “beat the system” to get paid time off. I know there are cost-benefit choices to be made, but I really had to question if the cost choices had been properly evaluated, because workers’ compensation costs were sky-high because of the company’s “accident experience”.

The second performance management question is about managers setting easily achievable goals. Frankly, if this is happening, it should be the managers who receive the poor performance reviews and negative rewards. Although I believe that a manager does NOT have to be the technical expert in a department, he or she must have enough technical knowledge of the work and goals of the department to be able to delegate, establish metrics, and measure the results of the work of the people in the department. If individual or team targets have to be measured, then the manager, if competent, should have a pretty good fix on what is reasonable. And if he or she agrees to lower-than-reasonable targets, there is probably a need for improvement of the manager’s negotiation skills or assertiveness. Goal setting is a mutual agreement based on discussion. You can also call this a negotiation. Any good negotiator never goes into a meeting without knowing what is being negotiated, what the parameters are, and what a reasonable outcome (at least from his/her point of view) will be. If you feel you get a poor outcome from a negotiation, look in the mirror. Either you didn’t do your homework, or you didn’t have the skill of your counter-part across the table, particularly in a target setting exercise with an employee, where there isn’t the likelihood of bigger picture surprises coming into play. Frankly, the bigger problem I have seen in this regard is when managers impose targets that are unreasonably high, quite often for their own gain or because of intense pressure from above to achieve the unachievable.

There is no doubt, though, that when you integrate an incentive pay system with the performance management system, the dynamics change significantly. I am a strong believer in behavioural assessments as part of a performance management system, and one such type of assessment is known as 360 degree feedback, where peers, manager, and sometimes customers or other work populations contribute to the evaluation of an individual’s work behaviour. There are companies which have done significant research in the development and use of their 360 degree evaluation instrument, and I recall one such company I contacted to inquire about using the results of their instrument for incentive pay decisions. Their short answer was no. Their explanation was that their research had indicated that on a five point rating scale, when compensation decisions were introduced into the mix, the average ratings went up by nearly a full point compared to when they were being used solely for development planning or team building purposes. Their explanation: raters get soft when they know that their opinion will affect someone else’s pay.

This can also be the case with individual managers where they are the only raters. This is one of the factors that can lead to an erosion of confidence in even a well-designed performance management system. I have seen circumstances where, even when rating metrics are well defined, different managers rated employees performing at the same level of proficiency at different performance levels. This occurs, in my view, because some managers have a “softer spot” for certain (or all) employees and want to reduce the impact on them from the outcome of their ratings. Clearly, there is a need for a second level management review and approval of compensation recommendations, and the flexibility to be able to send some managers back to the drawing board where ratings outcomes across departments are irregular, or where individual ratings seem out of line relative to those of peers.

As for issue number three, I have seen some classic examples of managers setting up the wrong metrics. I don’t mean to pick on sales as a function, but a couple of my classic examples are sales-related, primarily because the metrics (sales targets) and results (commissions) are so closely linked and clearly measurable. But in all cases, I don’t hold employees responsible for the behaviour that resulted. When it comes to compensation (or payments, as with our tax system), I have seen a great many people go to significant lengths to clearly understand the rules and then figure out how best to benefit from them. And altruistic benefit to an employer doesn’t often factor into the plan of attack. Let me give a couple of examples.

In one case, a sales vice president established a set of measures for his sales managers based solely on top line (gross) sales. But those sales managers had significant discretion with respect to establishing volume discounts, sales incentives, and so forth which affected net sales results. They were not held to account for any gross margin targets. A couple of the sales managers flew straight, despite knowing where they could take advantage, but one really went to town on discounts and incentives. The result was predictable – great gross sales performance (and a really healthy commission), but at the cost of profitability. The V.P. was predictably upset and disappointed with that sales manager, but as I mentioned above, he really needed to be looking in the mirror. He had designed the system which had allowed someone to take advantage of it. That system got changed, quickly!

Another example, and the closest I have seen to true collusion (although it was more a group of individuals each taking what the system allowed rather than acting in a collaborative fashion), was a sales department that was having a banner year. They had all done well enough in ten months to provide for significant commission payments, and had the potential to do even better before year end, which would have been great for company sales and profits. However, this was a real feast or famine business, and with the prospect of an uncertain, upcoming fiscal year, and having already achieved their current annual sales targets, many of the sales representatives held back on closing sales before year end, choosing to defer sales orders to early in the new year. They saw this as significantly beneficial for themselves in terms of leveling their taxable income and being able to achieve their next year’s sales targets. But it certainly wasn’t in the company’s best interests, at least as far as the current year’s sales and profit performance was concerned. Again, I see this as a design and control issue, as opposed to an employee initiated attempt to take advantage. The consequence of “over-performance” and related behaviour should have been considered and integrated into the system.

Several of my examples relate to problems in design, and failure to really think through the potential consequences that can occur because of what an incentive system motivates. Any incentive system requires a great deal of conscious thought and “scenario testing” before it is put into place, and should be subject to close review during and at the closing of the measurement period (e.g. fiscal year end). Unintended outcomes must be quickly identified and management must be prepared to go back to the drawing board to correct design errors. My bottom line on this: management will get the results for which it plans and controls. Systems are inter-related, and unintended consequences can easily arise from narrowly viewed and constructed systems and goals. Here are a few learning points for managers from my experience:

  1. Be clear about the goals you want to achieve, but even more so, develop a very clear picture of the factors which will influence these goals, and how the goals may drive employee behaviours.

  2. Take the time to walk through some scenarios related to the achievement of those goals. For example, what would an employee working in good faith most likely do to achieve the goals, but also, what could an employee working out of pure self-interest do to achieve the same goals. The objective is to identify the weaknesses in the system, which would lead to unintended results.

  3. Sharpen your pencil to evaluate benefits and costs. Based on this wider perspective on how the system could be used and/or abused, what would the true cost be if the goals are achieved.

  4. Test and revise the system. This requires setting up metrics to evaluate the results, as well as the behaviours, which achieved (or failed to achieve) the goals. The way in which goals get achieved can be as important as the actual achievement, itself.

About the author

Barry Bruce is an independent human resources consultant whose company, SOAR Consulting and Training Inc. provides broadly based human resources management support for small and medium sized companies in a variety of industries. His company also provides project-based, human resources system design and human resources audit services. You can find out more about SOAR Consulting and Training Inc. by visiting its website at www.soarconsulting.ca

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